I wrote a few weeks ago about Goldman Sachs’ involvement in the problems that are plaguing Greece. This seems to be a confusing topic for everyone, both because it involves a lot of finance mumbo-jumbo and also because journalists have a vested interest in making their stories more interesting by taking somewhat of a “Goldman Sachs is evil, see?” editorial position.
Well, it just so happens that my friend Sean is in fact an editor, and he really wanted to understand this Greece thing. (He’s a really smart kid, so the fact that he is asking me questions highlights how confusing the issue is.) So obviously the best way to address his confusion is via Facebook chat. I think that there are several helpful analogies that came up in that conversation, so I figured I would reproduce it for you here.
(My favorite part is the time stamp.)
so explain this greece-goldman sachs deal to me
greece couldn’t join the EU unless it agreed to limit its debt
which apparently it couldn’t do
so it sort of cheated by entering into an agreement with goldman that would in effect allow it to temporarily hide its debt
now, and this is one of the more important parts…goldman sachs wants to make money by charging commissions on transactions, NOT by making bets on the market
so it went holy sh*t, we have this big uncovered position, and if greece defaults we’re screwed since we essentially lent money and won’t get paid back
so they took place in another agreement that paid off in exactly those situations where Greece screwed them so overall they weren’t subject to huge swings
in this way, goldman can’t really gain or lose very much in the market, but it already made its money from the commission that it charged to greece
apparently the market doesn’t entirely understand that goldman is not really trying to gamble, at least not in this case
explain that a little more
that last point you mean?
yeah. about the market not understanding
i’m not understanding
sorry, was talking to roommate
so the market took goldman buying the “insurance” against Greece as a sign that there was something wrong with Greece rather than just taking it as Goldman hedging its original position
which I sort of understand, since it wasn’t obvious to the outside world that goldman had a risky position that it was trying to hedge against
so it basically started a run on Greece
which made it really hard for Greece to keep borrowing, since would you lend money to a friend who seems desperate and where other people are taking bets on when that friend will get fired from his job or something?
did goldman do anything illegal?
what about hiding greece’s debt?
so that is obviously the closest to grey area
so here’s a completely unbiased article (snicker):
(Editor’s note: Even that article explicitly points out that the transactions were all legal.)
to a large degree, the transaction with greece was a common one
that a lot of countries partake in
i read that
some of these concepts are difficult for me to grasp
so the key piece there was that the original deal was a loan that was made to look like a currency trade
currency trades happen all the time and are harmless, since they’re basically a large-scale version of what you do when you go to the bank and buy euros in preparation for a trip to paris or something
so greece was all “oh, this old thing? It’s just a currency trade”
it would be cool if they said it just like that
I’ll make an analogy using the US and Canadian dollar, since I am not sure what the deal was with the euro back in 2001
the deal was the equivalent of goldman giving greece an “exchange rate” of 10 canadian dollars for each US dollar today and then in the future greece was to pay the money back at an exchange rate of 11 US dollars for each Canadian dollar
in other words, goldman gives greece 100 canadian dollars in exchange for 10 us dollars in 2001, and then greece is supposed to give goldman 110 us dollars in exchange for 10 canadian dollars at some point in the future
or something roughly similar to that
the point is that the exchange rate gives greece a profit in 2001 and gives goldman a profit later
(Editorial note: I think I am a little sloppy with this analogy going forward, but all the really matter is that part 1 of the trade gives Greece extra money and part 2 of the trade pays it back.)
see how that is akin to borrowing money?
but it wasn’t on Greece’s books as a loan
since, narrowly and technically speaking, it wasn’t
as far as I know, goldman is completely within its rights to make this deal
the aforementioned grey area is due to the fact that I don’t know how explicit the “hiding” was or what the implications of that would even be
so in 2001 goldman took in 100 US dollars and paid out 1000 canadian dollars or whatever
and then realized that it would get screwed if greece couldn’t close that open position
so it bought insurance
but rather that being called insurance explictly, it’s just a contract that gives goldman a profit if greece defaults on its debts
(and a loss if it doesn’t, since even goldman doesn’t get anything for free here)
and as a result the world decided there was something wrong with greece
and wouldn’t lend it money
are you saying there wasn’t something wrong with greece?
certainly not as much as there is now, but it did have a lot of debt
so what’s the trouble now?
so say hypothetically that your bills were more than your income and no one would give you a credit card…what do you do?
but you have bad credit, so no one will give you a loan
what do you do?
-or- they’ll only give you a predatory payday loan
ask my parents
ok, so Greece asked France and other EU countries for a bailout, so that isn’t a bad guess
they either told greece to sit and spin, or they pointed out that bailing out another country was against EU rules
so your parents told you to go f**k yourself…what do you do?
illegal stuff is out of the question?
let’s go with yes
find a different job?
ok, so, continuing the analogy, greece could raise taxes (i.e. get a better job) such that it wasn’t running a deficit and thus didn’t need to borrow…but this would have a negative impact on its output
it could also declare bankruptcy
technically, Goldman could get screwed even if Greece didn’t declare bankruptcy
since greece is killing (read, devaluing) the euro right now
which is why other EU countries kind of want to bail it out
so goldman faces the possibility of having given 1000 canadian dollars for 100 US dollars, and when it comes time to exchange 100 canadian dollars for 1100 US dollars, the US dollars aren’t worth the paper that they are printed on
see the problem?
so that is what is going on
and the reason that the EU had these debt rules in the first place was so that this couldn’t happen
I find it interesting that Greece is more pissed at Goldman than anyone else
since they are the ones that wanted the transaction
it’s not like it was predatory
“While Greece did not take advantage of Goldman’s proposal in November 2009, it had paid the bank about $300 million in fees for arranging the 2001 transaction, according to several bankers familiar with the deal.”
see? they make money from fees, and don’t really want gambles
And then I passed out from exhaustion.