Smoking Swap Guns Are Beginning to Litter EuroLand, Sovereign Debt Buyer Beware!

Reggie Middleton's picture

There are broad indications hinting that Italy and Greece are not the only countries that have used SWAP agreements to manipulate its budget and deficit figures. France and Portugal may be two other European economies which have resorted to similar manipulations in the past in order to qualify as part of single currency member nations (Euro Zone). Below is a small subset of the research that I have been gathering as I construct a global sovereign default model. This model is very comprehensive and thus far has indicated that quite a few (as in more than two or three) nations of significance have an 90% probability of defaulting on their debt in the near to medium term. More on this later, now let's dig into what we have found that looks like gross manipulation of the numbers in order to hide debt in several European countries. Here's a quick quiz. What well known (in name only) Italian American has a significant chunk of the European Union Sovereign nations apparently modeled their financial engineering from?

Charles Ponzi (March 3, 1882 - January 18, 1949) was
an Italian swindler, who is
considered one of the greatest swindlers in American history. His
aliases include Charles PoneiCharles P.
Carl and Carlo.
The term "Ponzi
is a widely known description of any scam that pays early investors
returns from the investments of later investors. He promised clients a
50% profit within 45 days, or 100% profit within 90 days, by buying
discounted postal

reply coupons in other countries and redeeming them at face value
the United States as a form ofarbitrage.[1][2] Ponzi

was probably inspired by the scheme of William F. Miller, a Brooklyn
bookkeeper who in 1899 used the same scheme to take in $1

think I'll call it the Pan-European Ponzi. Conspiracy theorists are
going to love this post.

Like Italy (see below), Portugal has also been known for years
to take advantage of derivatives contracts to dress up its budget
numbers in the late 1990s.
In a recent press article (Debt Deals Haunt Europe) Deutsche Bank's spokesman
Roland Weichert commented that the bank has executed currency swaps on
behalf of Portugal between 1998 and 2003. He also said that Deutsche
Bank's business with Portugal included "completely normal currency
swaps" and other business activity, which he declined to discuss in
detail. He also added that the currency swaps on behalf of Portugal were
within the "framework of sovereign-debt management," and the trades
weren't intended to hide Portugal's national debt position (yeah okay!).

Though the Portuguese finance ministry declined to comment on whether
Portugal has used currency swaps such as those used by Greece, it said
Portugal only uses financial instruments that comply with European Union
rules. Thus, if the use of these instruments complied with European
Union rules, then there is nothing wrong with them, right??!! The word "if"
is probably one of the most abused words in the English language. As my
lawyer use to tell me as I once abused the word, "If
Grandma had balls, she'd be Grandpa, wouldn't she?"

The French 

In 1997, the French government received an upfront payment of
£4.7 billion ($7.1 billion) for assuming the pension liabilities for
France Telecom workers in return. This quick cash injection helped bring
down France's deficit, helping the country to meet the pre-condition to
join the Euro zone. You may reference the
pdf Laurent_Paul_and
Christophe_Schalck_study for a background on the deal. I don't
necessarily concur with their conclusions, but it does provide some info

  •  france_telecomm_transaction.png

For the record and according to the doc referenced above, according to
the State balance sheet for 2006, total pension liabilities of civil
servants have been estimated at 941 billion €, i.e. 53% of annual GDP in
France.  An attempt to reform all special schemes in 1995 collapsed
because of severe strikes on the railways. Sounds awfully Hellenic in
nature, doesn't it??? I, for one, believe that Greece is getting a bad
rap, and not becaue it is being falsely accused but because it is just a
lot sloppier at covering up its shenanigans than its European

Now, back to France. A transaction similar to the France Telecomm deal
took place in 2006 with La Poste which still employs 200,000 civil
servants, but is now facing the same evolution as France Telecom in
1997. But an important difference with France Telecom is the obvious
insufficiency of the lump sum paid by the postal company (2 billion €)
compared to the amount of pension liabilities transferred (70 billion €
at the end of 2006). This low amount is explained by the weak financial
position of the company. Thus, the balance of the transaction is
guaranteed by 1) additional contributions by the postal company which
will be paid until 2010, the scheduled year of the complete
liberalization of the
postal services; and 2) the annual contribution by the State Budget the
amount of which should progressively increase, from 0.5 billion € in
2006 to 2 billion € in 2020. 

Click to enlarge


As you can see, the French government has accepted 301 billion euros of
pension liabilities for 16.2 billion dollars of upfont payments. Who
want's to bet if these liabilities are drastically underfunded? Either
cut Greece some slack or jump into France's ass. We shouldn't have it
both ways!

As public entities replace the public company for the payment of
pensions and the collection of contributions, the tax burden can be
increased significantly: around 0.1% of GDP each for the EDF-GDF, France
Telecom and La Poste transactions. Overall, transfers of pension
implemented since 1997 have supposedly increased the French tax burden
by 0.3% of GDP.

Is France the only one doing this? You know the answer to that question.


The Greeks (again)...

According to people familiar with the matter interviewed by China Securities Journal, Goldman Sachs Group Inc.
did as many as 12 swaps for Greece from 1998 to 2001, while Credit
Suisse was also involved with Athens, crafting a currency swap for
Greece in the same time frame.

Under its "off-market" swap in 2001, Goldman agreed to convert yen and
dollars into euros at an artificially favorable rate in the future. This
helped Greece to use that "low favorable rate" when it recorded its
debt in the European accounts-pushing down the country's reported debt

Moreover, in exchange for the good deal on rates, Greece had
to pay Goldman
(the amount wasn't revealed). And
since the payment would count against Greece's deficit, Goldman and
Greece came up with another twist: Goldman effectively loaned Greece the
money for the payment, and Greece repaid that loan over time
And the two sides structured the loan as another kind of swap.
So, the deal didn't add to Greece's debt under EU rules
Consequently, Greece's total debt as a percentage of GDP fell
from 105.3% to 103.7%, and its 2001 deficit was reduced by a tenth of a
percentage point in GDP terms, according to people close to Goldman

Another action that smacks of Hellenic manipulation, at least to the
staff of BoomBustBlog:  for years it apparently and simply omitted large
portions of its military-equipment spending from its deficit
calculations. Though, European regulators eventually prevailed on Greece
to count everything and as a result, in 2004, there was a massive
revision of Greek deficit figures from 2000 (a budget deficit of 2.0% of
GDP in 2000 to beyond the 3% deficit limit in 2004), by then Greece had
already gained entrance to the euro. As in my trying to prepare for the
coming sovereign debt crisis, timing is everything, isn't it???

The Italians

As discussed in a recent ZeroHedge
, a 1996 Italian currency swap, arranged by J.P. Morgan,
allowed Italy to receive large payments upfront that helped keep its
deficit in line, with the downside of greater payments later.

In addition, to curbing their current deficits, countries are now using
these swap agreements to push off their loan liabilities (related to
swap agreements) to a later date through securitization, and Greece is
one such example. 

Under the 2001 deal brokered by Goldman, Greece swapped dollar- and
yen-denominated debt for Euros at below-market exchange rates. The
result was that the country got paid €1 billion ($1.35 billion) upfront
on the swap in exchange for an obligation to buy the swaps back later.
In 2005, this obligation was in turn securitized as part of a 20-year
debt issue, further pushing off the day of reckoning.

Moreover, one of the key reasons why such manipulations continued is the
apparent ignorance of the EU's Eurostat, which knew enough about these
deals to tighten the rules governing their accounting-albeit only after
they had served their purpose - the Ponzi! When Italy's then-Prime
Minister Romano Prodi miraculously achieved a four-percentage-point
improvement in Italy's budget deficit in time to usher the country into
the common currency, Italy's use of accounting gimmicks was widely
discussed, and then promptly ignored. As at that time, everyone was only
too eager to look the other way in the drive to get the single currency
up and running.

It wasn't until 2008-a decade after the deals became popular-that
Eurostat was able to revise its rules to push countries to include swaps
in their debt and deficit calculations. Still, till date too little is
known about countries' continued exposure to the deals that are already
out there.

Overall, though there is less evidence to support that there are more
such swap deals that happened during the late 90's till early part of
this decade, the data below showing a sharp decline in interest payments
as a percentage of GDP particularly for Belgium (apart from Greece and
Italy), hints that there are considerably more of these deals to be
discovred. The questions is, will they be discovered before or after the
respective sovereign issues record debt to the suckers
sovereign fxed income investors.


Notice the extremely supercalifragilisticexpealidocious reductions
Belgium, Greece and Italy have made in their interest payments from 1993
to 2000 in this graphic made pre-2000. If one didn't know better, one
would have thought theses countries actually used magic to make such
reductions. Hell, Italy practicaly cut their debt service (projected, of
course) in half. It really makes one wonder. I'm just saying...

by Gustavo Piga, "The political stakes of the
1997 budget package were enormous. Therefore, it was no surprise that
many countries were accused of ‘creative window-dressing' in their
budget through the use of accounting tricks to reach the desired goal.
One contentious item was interest expenditure, which is the interest
expense that governments sustain to finance their deficit and roll over
their debt. Interest expenditure represents a high percentage of public
spending and GDP in the European Union. It is highly variable over time,
especially when compared to other components of the budget. Because of
its relevance and because it is subject only to minimal scrutiny during
budget law discussions (and many times even after its realization during
the fiscal year), interest expenditure is an ideal target for reaching
fiscal stabilization goals without incurring excessive political protest
or opposition".

Oh, do you mean like this??? 


For those who have not been following me, I have published a signficant
amount of research on what I call the Pan-European Sovereign Debt
Crisis. I fully suspect quite a few countries to default on their debt,
and my next installment will include a full write-up, supporting data
and model for my subscribers, as well as an anecdotal list that I will
release publicly.  In the meantime, here is the crisis series to date:
  1. Can
    China Control the "Side-Effects" of its Stimulus-Led Growth? Let's Look
    at the Facts
     - Explains the potential fallout of the excessive
    fiscal stimulus in China. While not European, it is quite likely to kick
    off the daisy chain effect.
  2.  The
    Coming Pan-European Sovereign Debt Crisis
     - introduces the crisis
    and identified it as a pan-European problem, not a localized one.
  3. What
    Country is Next in the Coming Pan-European Sovereign Debt Crisis?
    illustrates the potential for the domino effect
  4. The
    Pan-European Sovereign Debt Crisis: If I Were to Short Any Country,
    What Country Would That Be..
     - attempts to illustrate the highly
    interdependent weaknesses in Europe's sovereign nations can effect even
    the perceived "stronger" nations.
  5. The
    Coming Pan-European Soverign Debt Crisis, Pt 4: The Spread to Western
    European Countries
  6. The
    Depression is Already Here for Some Members of Europe, and It Just
    Might Be Contagious!

  7. The
    Beginning of the Endgame is Coming???

  8. I
    Think It's Confirmed, Greece Will Be the First Domino to Fall

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ShankyS's picture

I have learned with Reggies posts to read the comments first after they have seasoned somewhat and then read the post. This helps. I'm not dissin his post. Just saying how I like to read them.

hbjork1's picture


IMO, the technical approach (renting) has great merit for survival at this particular time.  Ad nasium, I have posted about the Basilisk Lizard running on water. He puts his feet down correctly on the surface and very fast.  The PPS in some potentially profitable companies are continuing to rise but the game may change soon.   

My favorate real investment catagory is land (of which I don't have enough).  But land requires at least an intermediate size  commitment, long holding time and attention to its use. 

Thanks for the blog!


hedgeless_horseman's picture

If a soverign is the acting party it is not a crime.  Always has been that way, and it always will be that way, because the soverign defines crime.

It  explains why so many people migrate to government work, where they get to make the rules.  Better know by the brand name, power.


Anonymous's picture

mr prodi did it again in 2007 . he kept 6 billion funds from pension funds ( tfr ) stored in private company liabilities to finance the year deficit.that' s same scheme of france telecom but it implies all italians company's and all italian' s 296 of 2006

Anonymous's picture

... Moreover, one of the key reasons why such manipulations continued is the apparent ignorance of the EU's Eurostat, ...

It is widely known that Eurostat is absolutely the most corrupt branch of the EU. It is so corrupt that every time a whistle-blower emerges he/she is immediately sacked and given a gag-order and the findings of the EU's internal auditors are classified;

Members of the EU parliament can read a single, redacted, copy of the auditors reports, under observation of a guard, so they do not take copies!

Isn't Neo-Democracy great??

illyia's picture

Reggie. I wish you would do an expose' on Social Security - which I do believe is the most obvious Ponzi Scheme on earth - sitting right out there in every American's paycheck, like it is...

To me, SS is the very definition of a Ponzi!

Tic tock's picture

..Sure, it's a little worrying, all these extra billions that will have to be provisioned for. But in the scheme of things it's still a minor problem. French Public Funding may be a bit annoying, but it serves a purpose: eventually the Euro will switch to a cheese-based currency, something you can really smell. ..and who are these loans with anyway if not their own banks, who they just bailed out.. a non-event waiting to happen. 

jmc8888's picture

Looks like someone shined a fleshlight onto the twenty-seven pronged dildo. 


.......Good luck with the mess

Papasmurf's picture

And every prong occupied.

Gunther's picture

If my memory serves correctly, Belgium, Netherlands and Luxembourg had a hard peg or currency union before the euro. The interest rates there should have been similar. If the interest payment for the Netherlands goes down from 6% to 4% of GDP and in Belgium from 10.7% to 6.9% the Belgians have not been that savvy.
In Italy the interest rate 1993 was probably high due to memories of inflation and lack of trust. Coming into the more trusted Euro would reduce the risk premium and interest payment. Probably the hope was that the lower interest payment would lower the deficit to be ok.
A quick check would be debt/gdp levels and interest rates in the respective countries.
I have only Interest rates for Germany available right now; the 10-yer bond yielded
jan 93 7.13%, jan 97 6.24% and jan 2000 5.8%.  

There are several effects to consider; falling interest rate environment; falling inters rates due to economic convergence towards hard(er) money; real budget cuts and book cooking.

Anonymous's picture

Come on Ben, it's your move. Dead ol' Mr Rogers says , Can you say "Bailout"?

Anonymous's picture

What's new Reggie. They were too clever for their own good fibbing a bit to get into the euro, the regulators did not notice or were told not to notice, and governments spent and borrowed more than they should. Mind you this all happened long before the massive spending programs that were initiated he last years in response to the credit crisis.

And this is just Euroland. The UK looks even worse and let's not forget the US either. Surely this must lead to an onslaught on all currencies eventually.

So how on earth can ordinary citizens counter this? Their savings will be worthless? Interest rates on those worthless savings remain artificially low or too low to counter the devaluation of their currencies?

But riddle me this. For all the logical arguments that are presented here on Zerohedge for the doom and gloom that is around the corner I cannot understand how this could really turn out as badly as you guys are projecting. Surely if laymen like me can understand your arguments, then so can central bankers and finance ministers the world over. Even they would be affected. They cannot possibly be that short-sighted. A defunct economy has no value to them either.

Anonymous's picture

Gold is setting record highs in Sterling and Euro. Makes complete sense to me. Don't get caught with an IOU.

Anonymous's picture

So how on earth can ordinary citizens counter this? Their savings will be worthless? Interest rates on those worthless savings remain artificially low or too low to counter the devaluation of their currencies?

Having kids, bring them up well... and hoping the kids would reciprocate with care for their elderly parents. That is, if one can still afford to have kids. (Better sooner than latter.)

jimmyjames's picture

by Anonymous
on Wed, 03/03/2010 - 17:0

But riddle me this. For all the logical arguments that are presented here on Zerohedge for the doom and gloom that is around the corner I cannot understand how this could really turn out as badly as you guys are projecting. Surely if laymen like me can understand your arguments, then so can central bankers and finance ministers the world over. Even they would be affected. They cannot possibly be that short-sighted. A defunct economy has no value to them either.



That's the root of it all--we have nothing to drive us economically--

No more bubbles to blow--

Beer will cost a dime--that will be a good thing--

The rest--not so good--


Postal's picture

Surely the Emporer wouldn't parade about downtown naked, would he?

Crab Cake's picture

"If Grandma had balls, she'd be Grandpa, wouldn't she?"

I do believe someone from the SEC was asking himself that very question...

Gordon_Gekko's picture

It's like pot calling the kettle black - LOL! The biggest Ponzi scheme of ALL - the biggest Ponzi Scheme in human history - is being run by none other than the United States. Do you know what it's called Mr. Middleton? Didn't think so - it's the US dollar. What Europeans are doing is NOTHING compared to what the US is doing.

Reggie Middleton's picture

Hey, I never said the US wasn't in on it as well.

Anonymous's picture

No kidding. But what most people don't see is that when it comes to the U.S. it's different.

You'll have the Banksters, right up against the Politicians. And it was the Pols who not only allowed the Banksters to continue to exist, but also gave them their bonuses. Courtesy of the U.S. Taxpayer.

The Banksters are guaranteed to pull this.

It's going to be one ugly showdown.

Anonymous's picture

This is all of vast interest. But what I really want a handle on is WHEN will the US systemic collapse occur. Is there still time to make a killing buying metals, or should I invest primarily in "negotiable" bullets?

Anonymous's picture

we're fucked, let's all move to mars!

Anonymous's picture

Happy 128th birthday, Chuckie P!

The greatest "financial innovator" of his day.

37FullHedge's picture

These shenanigans just keep getting better, I was reading a blog titled the sultans of swap its a similar take to this one but the angle is using public private reverse type mortgages for off book governments spending, In my view this area will be hiding all sorts of governments liabilities, These type of acts may explain why no regulations of this area is fourthcoming.

It all must blow up one day you couldnt make this stuff up.


A Man without Qualities's picture

In defense of the French, these pension transfers were done when these companies were state owned.  Maybe they were smarter than the British as they recognized these pension obligations would in the long term ruin these companies once privatized?  As it is, the markets were more aware of the cost of these, so any proceeds to the state would be reduced accordingly.  Therefore, this may have been the smart thing to do and the accounting treatment of the payments were not the crucial driver.  

But I am sure there have been all sorts of other clever tricks going on with French economic data for years, given de Gaulle's obsession with getting French GDP above the UK.

bokapita's picture

Complete tosh. These companies would have been unsellable unless  the French Government took off the pension liabilty. Everyone knew it too.

Reggie Middleton's picture

You seem to have a benevolent bent to you. Don't you find the timing of the French Telecomm swap/transfer a bit suspicious in that it dropped France's debt ratio just in time to quality for Eurozone status?

I know its just dumb coincidence, after all...

A Man without Qualities's picture

It is hard for me to answer that.  One the one hand, it is a large transaction, that does not appear to have been done on an arms length basis - the deals were too generous for FT and La Poste.  I do not know enough about French budget statistics to see how this compares, and frankly, I never take official French economic data too seriously, as I see little evidence of the implied efficiencies.  I agree that every nation undertook certain slights of hand to reduce deficits.  

However, I do believe that the net consequence of this action was beneficial and this was therefore the right thing to do.  In the UK, privatizations were done with scant regards to the pension obligations of the firms and as a result, left the businesses with an enormous burden.  By the late 90s, the markets were more focused on these issues, so the proposed future privatizations (partially done by FT, not yet in the case of La Poste) would have reduced the value of the sale to the state if the pension problem were unresolved. 

So, in conclusion, the answer is that the French were going to do something to reduce the debt ratio, so this was a far more sensible option that a shady swap deal - this does make economic sense.

bokapita's picture

"In the UK, privatizations were done with scant regards to the pension obligations of the firms and as a result, left the businesses with an enormous burden.'


This too is not true. The pension funds of the privatised UK utilities etc. were very well funded at the time of their floatation. It was subsequent contribution holidays by the privatised companies, VERY foolishly allowed by UK GAAP, that stoked the current deficits as well as recent stock market drops, and chnages in rules on pension fund taxation.

MarketTruth's picture

Burning down the house...

It's the end of the Euro as we know it, and i feel fine...

...and the meek shall inherit the Earth.

Dirtt's picture

Let's continue with lyrics found so prevalent in Rush songs.

Bastille Day...."La Guillotine shall claim her bloody prize!"

Problem Is's picture


Is this what Leo and the Canadian bands do in their spare time?

Our first stop is in Bogota
To check Colombian fields
The natives smile and pass along
A sample of their yield

Wreathed in smoke in Lebanon
We burn the midnight oil
The fragrance of Afghanistan
Rewards a long day's toil

Almost sounds like the CIA's itinerary...

Then of course there is "Something For Nothing" off of the same album...

ShankyS's picture

Best comment thread yet on ZH +1000

It will all be settled eventually "by hatchet, axe and saw"



jeff montanye's picture

as we continue by force of arms to enforce the harrison narcotics act in afghanistan while importing alcohol (prohibited by their prophet) into same.  sheer genius.

Jim in MN's picture


OK, so who holds all of this sovereign debt?  What if it's just Western countries (through central banks and/or state pension and insurance funds) buying each others' debt?  "I'll keep putting the pap in your feeding tube if you keep putting pap in mine"...Or is it the world's creditor bloc, Japan/China/OPEC?

Let's play this out.  Who has to take the hit, either in artificially low rates for holding the risk or the default haircut?  Cut to the chase, the suspense is killing me!

Oh, uh-oh, you mean it's MY life insurance company?  You mean MY health insurance provider will start puking blood when the premium cash (the sweet, sweet premiums of the healthy) gets immolated in a sovereign default bonfire?