When economic times turn bad, it's not hard to spot the investors with poor judgment or those who took excessive risks. As billionaire investor Warren Buffett colorfully puts it, “After all, you only find out who is swimming naked when the tide goes out.”
Buffett could have been describing the fallout from the current euro crisis. In one of his legendary annual letters to his investors, Buffett illustrates how unacceptable practices and nefarious deals in the eurozone came to light only after the crash — many involving Wall Street investment banks.
In 2000, for example, euro membership was seen as a symbol of success, modernity and pride, and the Greek government was desperate to join. But EU rules stipulated that government debt be no more than 60 percent of a country's economy, or gross domestic product (GDP), or at least “approaching” that figure. Greece's debt was 94 percent of GDP that year, and with state funds pouring into preparations for the 2004 Olympics in Athens the debt figure was going in the wrong direction.
But Goldman Sachs, the Wall Street investment bank, came to the rescue in 2001, lending Greece €2.80 billion ($3.64 billion) disguised in a complicated foreign-currency transaction. The secret loan made Greece's debt ratio appear to be improving enough to allow it to join the euro.
As Buffet essentially predicted, the full details of the transaction came to light in 2010, only after the euro debt crisis began. The already indebted Greek government had indeed agreed to pay Goldman €600 million ($540 million at the time) in fees and interest for the deal. But by 2005, the total cost had risen to €5.1 billion ($6.1 billion) — contributing towards Greece's downfall. Martin Wolf, the chief economics commentator at London's Financial Times, described the deal as “completely legal and completely scandalous.”
Greece was not alone in cooking its books to meet the euro entry criteria. Italy in 1996 engaged in a similar transaction with JP Morgan, another Wall Street bank. Similar deals have come to light across the continent, from Portugal to France. As recently as 2009 — as the euro crisis was unfolding — Goldman was back in Athens offering the troubled government a way to stretch its health-care costs over a longer period to make debt figures look better. This time Greece declined.
Banks also have manipulated the international interest rates on which much European debt is calculated. Again, the shenanigans only emerged this summer, “when the tide went out,” as Buffett would say. The issue concerns the London interbank offer rate, or “Libor,” which is used to set the interest rate on millions of international loans.
Libor is announced daily, by drawing together data from many banks on the interest rate they are charging and being paid in loans between themselves. Many consumer, auto and housing loans, for example, charge interest at the current “Libor rate” with the addition of a fixed percentage, such as “Libor + 4 percent.” So if Libor goes down, a consumer's repayments go down, and vice versa. But in July it emerged that this rate for years had been artificially fixed so that banks could profit from it, with the finger pointing at Bank of America, Citigroup, JPMorgan Chase, the Swiss bank UBS and Barclays in the U.K. Moreover, knowledge of the scandal went right to the top. It was revealed, for example, that Treasury Secretary Timothy Geithner knew about the scandal as far back as 2008, but did little.
Despite American bankers' claims that they are now “fully protected,” should the euro collapse, the Libor scandal highlights how little is known of their real exposure to European markets.
With fears growing that the euro crisis could get dramatically worse in coming months — possibly forcing one or more countries out of the single currency — it's likely that still other bankers were “swimming naked.”
— Christopher Hack