The Eurozone’s Enron – Disclosure Threatens Economist’s Life

Piga Gustavo Piga, a professor of economics at The University of Rome Tor Vergata, in conjunction with the Council on Foreign Relations, wrote an article back in 2001 on a confidential banking report that exposed fraudulent accounting actions of the Italian government.  The Italians, in collusion with a “major market maker” *cough* Goldman Sachs *cough*, engaged in what amounts to Enron style accounting in order to keep debt off the government balance sheets during the period of time Italy was seeking admission to the Eurozone.

The following article is highly technical but it explains the specifics of the fraudulent transactions in great detail.  A Fascist Soup contributor was kind enough to do a write up and put the findings into English for the rest of us.

Zero Hedge writes:

It is not often that one finds smoking gun reports which refute all claims, such as those by EuroStat and Angela Merkel, in which the offended parties plead ignorance of the fiscal inferno raging around them, kindled by lies, deceit, and blatant mutually-endorsed fraud, and instead, now facing themselves in the spotlight of public fury, put the blame solely on related party participants, such as, in a recent case, Greece and Goldman Sachs. Yet a 2001 report prepared by Gustavo Piga, in collaboration with the Council on Foreign Relations and the International Securities Market Association, not only fits that particular smoking gun description, but the report itself was damning enough of another country [Italy],…

…but considering the critical similarities in the structuring of the swap contract to that used by Greece in 2001, and that ISMA cancelled Piga’s press conference discussing his findings out of fear for the academic’s life, we can easily venture some guesses as to which banks value their recurring counterparty arrangements more than human life…

…Disclosures made in this report forced the Council on Foreign Relations to make an explicit comparison between Italy and the greatest corporate fraud of the early 2000’s: Enron.

The parallel with the Enron transactions is uncanny. Like Enron, Italy took on debt but chose to represent it as a hedge for a yen bond it had issued in May 1995, which matured in September 1998. As with Enron, the hedge explanation was clearly misleading. If it had been a hedge, the exchange rate used would simply have been the market rate at the time the swap transaction was entered into. Off-market rate swaps were clearly selected for the purpose of producing interest revenue in 1997, with euro entry as the goal.

Contributor writes:

In 1995, the Italian government issued debt denominated in Japanese Yen to the tune of 200 billion Yen, with a maturity of three years and three months – that is, the principal would have to be repaid in late 1998. Why the decision was originally made to issue the debt in Yen not Lira is neither clear nor, for the purposes of this discussion, important.

Towards the end of 1996, the Yen had fallen against the Lira, meaning that the amount owed by the Italian government, in terms of their own currency, had been reduced. It would at this point have been by no means unusual or improper to enter into an orthodox “currency swap” deal, which would effectively have locked in the exchange rate, and hence the reduction in Lira debt, in return for a relatively small premium paid by the Italian government to the market-maker concerned.

Instead, the Italian government and an unspecified market maker, speculated by ZH to be Goldman Sachs and by others to be JP Morgan, struck a deal which had the surface appearance of a currency swap for hedging purposes as described above, but which was in fact an instrument by which the market maker paid the Italian government a regular revenue stream over the remaining time before the bonds matured (slightly less than two years) in return for a large lump sum payment at the end of that time. In this way, the Italian government was able to run a smaller budget deficit in 1997 and 1998 than would otherwise have been the case, enabling Italy to meet the deficit criteria for initial membership of the Eurozone in 1999. This deficit reduction was for all practical purposes artificial, since it came at the expense of a rise in net debt and hence interest payments from 1999 onwards, but an in any examination of the Italian treasury accounts at the time it would have seemed that the deficit reduction came simply from an organic decline in interest payments, since the instrument was on the books as a currency hedge (which it was structured like) rather than a loan (which for all practical purposes it was).

It is already known that a similar device was used more recently by Greece to mask the extent of its deficit. In that case, the market maker involved is known to have been Goldman Sachs, but it seems likely that most or all market makers have participated in or would be willing to participate in similar deals. Indeed, there is no reason why they should not: such instruments are legal in the relevant jurisdictions and no doubt highly profitable for the market maker concerned. What is troubling is that there is no real way of knowing which governments may have what amounts of similar de facto off balance sheet debt, or when it might mature. Indeed, it is likely even that the great majority of treasury employees in the countries concerned are unaware of the true nature of deals of this sort, since they are inadequately trained to properly understand them.

The specific case amounts to fraud on the part of the Italian government in order to gain early admission to the Eurozone. More generally, this is an illuminating example of the sort of accounting tricks of which governments avail themselves in order to keep the true scale of their debts and deficits out of the public domain.