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The Greek debt crisis has refocused attention on a controversial swap trade first reported by Risk in 2003. The deal, completed with Goldman Sachs in 2002, effectively allowed Greece to borrow roughly €1 billion without adding to its
public debt figures. At the time, the scale of its borrowing was
threatening to attract a fine from Brussels. The original Risk feature is available here.

There have been no new developments since then but, earlier this week, Germany's Der Spiegel revisited the issue, sparking widespread coverage by financial blogs – including those run by the New York Times, Reuters, the LA Times and the Financial Times. The story has provided commenters with fresh ammunition for their attacks on Goldman Sachs – even though the transaction was legal,
common at the time, and widely marketed by a number of banks.

The real scandal, according to Gustavo Piga, an economics professor at the University of Rome, is that European authorities such as the European Central Bank (ECB) and Eurostat – which sets the reporting
rules for European Union members – did nothing to shut down the
practice after it was brought to their attention in 2001. "It's not at
all clear to me why the European Commission, Eurostat and the ECB
didn't want to deal with this. The issue was real, so if they were
interested they would have done something about it," Piga says.

Piga drew attention to the subject with a 2001 paper describing how an anonymous country had used swaps provided by an unnamed bank to borrow money without disclosing it – the Financial Times
subsequently revealed that the trade involved Italy and JP Morgan. But
despite the heat generated by these revelations, little action was
taken – something Piga believes raises serious questions.

"What kind of relationships start to arise between these governments and these banks once they are in this mortal embrace of reciprocal blackmail potential? How does this change the dynamics on other issues
such as the regulation of banks? We have no idea – maybe nothing, but
certainly there is a conflict of interest here," he says.

According to Eurostat's 2002 accounting guide, sovereign issuers in the eurozone, such as Greece, could effectively – and legitimately – reduce the size of the debt on their balance sheet by issuing
euro-denominated debt and swapping it into a foreign currency such as
dollars, using an artificially weak or off-market euro exchange rate.
The debt would be recognised by Eurostat at the market rate. The issuer
would be paying higher coupons (because they would be exchanged at the
artificially weak rate) but would have a lower debt burden.

Eurostat explained this could mean, for example, that a country could issue €100 in debt; swap it into dollars at the artificially low rate of $1.05; and carry it on its books, for the purposes of reporting
government debt, at the market rate of $1.07, which would give it a
carrying value of only €98.13. Effectively, the swap counterparty had
lent the sovereign the other €1.87, and would be repaid either over the
course of the swap (in the form of the higher-than-usual coupons) or in
a balloon payment at maturity. In either case, the loan would not count
towards total government debt.

This was not changed until 2008, when, in response to requests from several member states, Eurostat issued new guidance. From March 2008 on, debt swapped into another currency using an off-market rate has
been regarded as two components – an at-the-market swap and a loan from
the swap counterparty – with the latter included in government debt.

It is still not clear how much of Greece's soaring government debt can be ascribed to the use of off-market swaps. Eurostat has repeatedly condemned the Greek central bank, statistics agency and finance
ministry for failing to provide accurate information on the country's
debt and deficit, both of which have been above eurozone limits for
several years. In a report issued in January this year, Eurostat
highlighted its own inability to deal with "deliberate misreporting and
fraud" on the part of governments, and said that, despite several years
of effort, resulting in repeated restatements of fiscal data, it was
still unable to validate the Greek government's deficit and debt
figures.