As readers of the financial press may recall, there was a kerfluffle over the fact that Greece had used a currency trades designed by Goldman in 2001 to mask the level of its indebtedness and secure Eurozone entry. Goldman continued to help Greece dress up its books and offered to intervene in 2009, although Greece turned them down then. The amount of debt raised, as in hidden, was €2.8 billion in 2001, and as a result of a restructuring in 2005, increased to €5.8 billion. Goldman earned large fees for these deals.
These transactions were of keen interest in the Eurozone, not merely because Goldman had helped Greece fudge its accounts and without this, erm, help, Greece would not have qualified for Eurozone entry (there have been efforts to downplay the accounting finesse, since Brussels was allegedly aware of the fact that Greece really was not qualified to enter). Mario Draghi, who was then the heir apparent to Jean-Claude Trichet as ECB chief, had joined Goldman in 2002 and was head of the group that handled the restructuring in 2005. The Bank of Italy issued a denial about Draghi’s involvement that Simon Johnson read as unpersuasive.
Roughly a year later, Trichet vetoed a request by Bloomberg to the ECB’s EU’s court to release more information. This was a month before the ECB nomination hearing for the new chairman. Pascal Canfin, Member of Parliament and former chairman of the ECON committee, grilled Draghi on how he could have known about these transactions and allowed them to go through. He was not satisfied with the answers. The New York Times reported after Draghi’s nomination was approved that Draghi had marketed similar transactions to European govenments
A new story by Financial Times shows that Draghi and the ECB had far more to hide than the Greece scandal. It appears Draghi was directly involved in arranging similar, much larger transactions for Italy while Draghi was the director general of the Bank of Italy, in 1999. Draghi then went to Goldman. The FT also reports that Draghi’s deputy on these deals, who left the Bank of Italy in 2000, returned as director general in 2012 with Draghi’s support. Sure looks like payback time.
The scandal is coming to a head now because the Italian government is set to lose billions of euros as a result of restructuring of derivatives, including the 1999 derivatives, at the worst of the crisis. The FT stresses that all the details are not known, but the losses look to be troubling:
The report does not specify the potential losses Italy faces on the restructured contracts. But three independent experts consulted by the FT calculated the losses based onmarket prices on June 20 and concluded the Treasury was facing a potential loss at that moment of about €8bn, a surprisingly high figure based on a notional value of €31.7bn.
The names of the banks involved in these transactions have not been disclosed, but previous reports show that Morgan Stanley and JP Morgan have been among the Italy’s counterparties.
There are two, possibly three, ugly implications.
First, the revelation that Italy is facing previously undisclosed derivative losses comes at a time when periphery Eurozone countries are again under stress, including Italy. From Ambrose Evans-Pritchard today at the Telegraph:
Mediobanca, Italy’s second biggest bank, said its “index of solvency risk” for Italy was already flashing warning signs as the worldwide bond rout continued into a second week, pushing up borrowing costs…
The report warned that Italy will “inevitably end up in an EU bail-out request” over the next six months, unless it can count on low borrowing costs and a broader recovery….
taly’s €2.1 trillion (£1.8 trillion) debt is the world’s third largest after the US and Japan….Italian 10-year yields spiked to 4.8pc, up 100 basis points since the Fed began to toughen its language in May. But Mediobanca is particularly concerned about the gap that has emerged between yields on short-term bills (BOTs) and longer-term bonds (BTPs) near maturity that expire at the same time. BOTs retiring on July 31 are trading at a yield of 0.48, while the equivalent BTP is trading at 0.74pc. The reason is that BOTs are protected from debt restructuring….
Mediobanca said the trigger for a blow-up in Italy could be a bail-out crisis for Slovenia or an ugly turn of events in Argentina, which has close links to Italian business. “Argentina in particular worries us, as a new default seems likely.”
Second is that given Draghi’s involvement in Italian books-cooking, it seems even more implausible than before that he did not know of the Greece deals with Goldman.
Third is that if Goldman was one of the counterparties to Italy when Draghi was at the helm of the Italian central bank, his subsequent employment looks an awful lot like a payoff.
The Bank of Italy and the ECB are certain to fight tooth and nail to defect questions about Draghi and might not be above using market stresses as part of their excuses for stonewalling. But the magnitude of these losses may galvanize the Italian public. The matter is now in the hands of the state auditors and the financial police, so how far this goes will also be a function of how they operate in the face of large public scandals. Stay tuned.
This piece is cross-posted from Naked Capitalism with permission.