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