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Greece, Derivatives, and FX: What

Went Wrong?
David M. Shapiro

OVERVIEW swaps for legitimate

Circa 2001, Greece
and Goldman Sachs
(Goldman) entered into
cross-currency swaps
such that the parties
exchanged foreign
exchange (forex or FX)
obligations with matur-
ities extending over
several years. There
were at least two salient
economic issues: (1)
Whether Greece (facili-
tated by Goldman)
wrongfully concealed
the economic substance
of this class of interre-
lated transactions from
European Union regu-
lators and other exter-
nal parties; (2) whether
the underlying financial
instruments (i.e., deriv-
atives generally, and
over-the-counter [OTC] cross-
currency swaps specifically) were wrongfully concealed its debt
inherently excessively hazardous. through cross-currency swaps
As the proper resolution of the
first issue depends significantly
on records and testimonies
beyond the public domain, this
article focuses on the second
What caused the economic collapse of Greece? purposes. The coun-
One factor many people point to was an arrange- terparty credit risk
arising from unman-
ment between Goldman Sachs and the Greek gov-
ageable debt loads
ernment. Circa 2001, Greece and Goldman Sachs presented by entities
agreed to do cross-currency swaps in which the such as post-2001
parties exchanged foreign exchange (FX) obliga- Greece is a common
tions, which had maturities that stretched over hazard as entities
several years. Some say that Greecepossibly seek, among other
facilitated by Goldman Sachswrongfully con- objectives, unaf-
cealed these transactions from European Union fordable economic
regulators, and others. That will be determined by growth. Efforts to
the evidence. But the author believes that making make OTC swaps
OTC swaps or Goldman Sachs a scapegoat for bad generally (and Gold-
investment decisions is a wrongheaded diversion. man specifically) a
scapegoat for reck-
The more important question is: Were these cross-
less or unfortunate
currency swaps inherently too hazardous? The decision making by
author, who has practiced law, public account- counterparties repre-
ing, and investigations for more than 2 decades, sents a wrongheaded
unravels this complex story to get at the truth. diversion.
2013 Wiley Periodicals, Inc. Globally, the
International Swaps
and Derivatives
Association (ISDA
issue. Moreover, whether Greece at www.isda.org) may be the
most influential independent
sector organization, providing
to improve its debt-to-gross expert opinion, guidance, and
domestic product (GDP) ratio structure to the global OTC
to gain entry into the European derivatives markets. Market
Union (EU) is an issue indepen- participants (e.g., governments,
dent of the utility of these OTC banks, etc.) that demand the

2013 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.21886 15
16
risk management and trading
opportunities offered through
judicious use of OTC derivatives,
as well as exchanges, clearing-
houses, and repositories that
provide the infrastructure, back
office services, etc., in support
of these markets and financial
instruments are members of
the ISDA, which was formed in
1985; this self-regulatory asso-
ciation provides the essential
architecture (e.g., Master Service
Agreements) through which to
process and report OTC-deriva-
tives transactions.
FOREX REGULATION
In the United States, the
Commodity Exchange Act (see
7 U.S.C. 1, et seq.), which has
been amended many times,
including most recently by
the DoddFrank Act (Public
Law 111-203, approved in July
2010), provides a comprehensive
regulatory regime for swaps and
derivatives. The U.S. Commod-
ity Futures Trading Commission
(CFTC; see http://www.cftc.gov/
index.htm) creates supporting
regulations published in Title 17,
Chapter 1 of the U.S. Code of
Federal Regulations in support
of this regime.
Primarily, accounting and
financial reporting principles
have been developed and pub-
lished by the U.S.-based Finan-
cial Accounting Standards
Board (FASB; e.g., Accounting
Standards Codification Topic
815) and London-based Inter-
national Accounting Standards
Board (IASB; e.g., International
Accounting Standards 39); also,
public sector entities may seek
specific guidance from organi-
zations such as the U.S.-based
Governmental Accounting
Standards Board (GASB; e.g.,
Statement No. 53) and the Inter-
national Public Sector Account-
DOI 10.1002/jcaf
The Journal of Corporate Accounting & Finance / September/October 2013
ing Standards Board (IPSASB),
supported by the International
Federation of Accountants
(IFAC). Guidance from these
organizations regarding the
preparation of general purpose
financial reports, including the
reporting of OTC forex and
derivative transactions, is well
established. Specifically, the con-
ceptual foundation for Greeces
reporting of its forex deals with
Goldman circa 2001 was laid
by EAS95, published by Euro-
stat, the statistical office of the
European Union based in Lux-
embourg (see http://epp.eurostat.
ec.europa.eu/portal/page/portal/
eurostat/home).
The overarching purpose
of this infrastructure of public,
independent, and private sector
regulation and supervision is
to manage speculative risk, i.e.,
limit risk of loss from dealing
in forex. However, as the par-
ties and counterparties to forex
deals (e.g., Greece and Gold-
man) have different incentives
and take opposing positions
(e.g., long/short on a given cur-
rency), which may vary in time
(e.g., spot vs. forward rates of
exchange), external regulators
and internal supervision cannot
completely eliminate the risk of
loss for a given party. Moreover,
as these risks are complex and
interdependent (e.g., settlement
risk is affected by market risk),
rational economic analysis is
inherently contingent.
GREECE AND EUROPEAN UNION
Circa 2001, as Greece pre-
pared to enter the EU, it had to
meet certain obligations related
to its sovereign debt (e.g., debt-
to-GDP ratio). Goldman pro-
vided financial advisory services
and arranged certain derivatives
contracts involving the U.S.
dollar, Japanese Yen, and Euro,
whereby Greeces short-term
debt would not cause Greece to
fail to meet EU entry standards,
though the arrangements ulti-
mately required a balloon pay-
ment years later (Story, et. al.,
2010).
The arrangement was not
sustainable, resulting in the need
to restructure Greeces sovereign
debts; and the arrangement was
atypical in that the forex rates
used by Greece and Goldman
were off-market (i.e., the spot
rate at contract initiation was
not used, resulting in an upfront
payment by Goldman Sachs to
Greece, increased interest pay-
ments by Goldman to Greece
during the life of the agreement,
and Greeces obligation to make
the balloon payment at the
agreements unwinding). Appar-
ently, EAS95 did not require
recognition of an increase in net
liability of Greece resulting from
the cross-currency swap agree-
ment (Dunbar, 2003).
Typically, counterpar-
ties in derivatives transactions
must post collateralusually
in cashon the value of their
position, often on a daily basis
(i.e., margin rules). These margin
rules are effective both at the
initiation of the contract and
during the contract. Greece, as a
public sector entity, was in many
respects treated more favor-
ably than private sector entities
engaging in forex-derivatives
contracts by not having been
subject to the same rigor of all
of these rules (i.e., the collateral
requirements were looser and
set at a time favorable to the
economic outlook of Greece)
(Eavis, 2010).
Thus, the headline cause of
Greeces debt crisis became the
set of forex deals with banks
like Goldman, a set of deals
from which a balloon pay-
ment required an amount of
2013 Wiley Periodicals, Inc.
The Journal of Corporate Accounting & Finance / September/October 2013 17

currency not readily available
from Greeces reserve positions
or obtainable from Greeces
creditworthinessas determined
by experts such as credit rat-
ing agencies. This headline was
bolstered by imputations that
banks such as Goldman aided
and abetted the accounting
and financial reporting of the
Greeces forex transactions, a
potential scandal redolent of the
Enron collapse and its financial
institution creditors.
However, the cause(s) of
unsustainable debt in the public
sector and in Greece is no excep-
tion and is not generally found
in the accounting and financial
reporting of the entitys transac-
tions with its creditors. Conflat-
ing symptom with disease is too
common. Greeces unsustainable
debts arose over many years
through its practice of commit-
ting to expenditures that were
not offset by tax revenues and
user fees. Public sector finance
requires that expenditures,
whether for the social welfare,
weaponry, or general adminis-
tration, be fundedif not from
assessments like taxes and fees,
then from incurrence of debt.
CONCLUSION
Notwithstanding extensive
literature on the failures of risk
management techniques such as
cross-currency swaps and other
financial instruments, especially
derivatives, and numerous calls
to enhance regulatory power
so as to rein in the presumed
hazardous conditions result-
ing from use of these financial
instruments, precious little evi-
dence exists that regulators in
fact would have taken specific
steps to mitigate imbalances in
risk transfer: Regulators have
significant powers but cannot
seem to exercise them meaning-
fully in a preventive manner
(Petursson and Moriss, 2012).
After all, the GreeceGoldman
alleged scandal was driven more
by inadequacy in presentation
and disclosure, a domain long
subjected to the application of
independently researched and
agreed upon financial reporting
principles, than overreaching
by Goldman or other financial
institutions. As noted herein,
EAS95 was not established and
abused by the creditors.
Moreover, a distinction
should be made between com-
plex and opaque agreements:
That net positions are variable
over time does not imply opacity
but merely indicate market risk.
Regulators may be the least-
equipped set of individuals fit to
address risk shifting; they lack
the proverbial skin in the game.
Their models are at best hand-
me-downs as they more often
than not are preoccupied with
the last waran academically
intriguing area of study but one
woefully lacking in currency.
The approach for sovereigns
that cannot control conditions
of expenditures that continu-
ally exceeded revenues is not to
misrepresent or conceal material
events but to adopt policies that
are not so dependent on debt
as a financing source. Whereas
sovereigns such as Greece incur
significant debts in currencies
other than its own fiat money,
their economic outlook should
include considerations such as
reductions in deficit spending,
sales of sovereign assets, etc.
Neither conditions of austerity
nor conditions of deficit spend-
ing are sustainable. Other out-
comes are obtainable where sov-
ereign debt is in its own currency
(e.g., U.S. debt in U.S. dollars),
including the risk of conditions
of inflation.
REFERENCES
Dunbar, N. (2003). Revealed: Gold-
man Sachs mega-deal for Greece.
(cover story). Risk 16, no. 7: 20-21.
Retrieved from http://www.risk
.net/risk-magazine/feature/1498135
/revealed-goldman-sachs-mega-deal
-greece
Eavis, P. (2010, February 16). Greece
shows the need for an overhaul in
derivatives. Wall Street Journal.
Retrieved from http://online.wsj.com
/article/SB10001424052748704431404
575066982745810158.html
Petursson, B. T., & Moriss, A. P. (2012).
Global economies, regulatory fail-
ure, and loose money: Lessons for
regulating the finance sector from
Icelands financial crisis. 63 Alabama
Law Review. 691. Retrieved from
http://www.law.ua.edu/pubs/lrarticles
/Volume%2063/Issue%204/2%
20Morriss%20Petursson%20691%
20-%20800.pdf
Story, L., Thomas Jr., L., and Schwartz,
N. D. (2010). Wall Street helped to
mask debts shaking Europe. The
New York Times. February 14.

David M. Shapiro, JD, MBA, is a former adjunct lecturer in the Fiscal Policy Analysis and Oversight concen-
tration under the M.P.A.-Inspector General track at John Jay College of Criminal Justice, City University of
New York. He was also director of the program for the Advanced Certificate in Forensic Accounting at John
Jay, having worked in the practices of law, public accounting, and investigations for more than 20 years.
Presently, he is managing director at Aons Corporate Investigative Solutions practice in New York, NY.

2013 Wiley Periodicals, Inc. DOI 10.1002/jcaf

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