In Defense of Goldman. Really

This time, the vampire squid is innocent. The European Union is investigating Goldman Sachs Group's (GS) role in the financial maneuvering that helped Greece use swaps to postpone the day of economic reckoning past its ascension to euro zone membership. Goldman says, rightly, there was "nothing inappropriate" in the transactions it facilitated.

Most of the elements of a crime are present. There's a victim—trust in the common-currency project. There's a weapon, in the form of the derivatives that trimmed 2.37 billion euros ($3.2 billion) off the nation's debt burden. And there's a perpetrator, the Greek government, which knew its finances were too shaky to ditch its currency, the drachma.

There also seems to be an accomplice—Goldman Sachs, which had the financial engineering skills to crack open Greece's budget deficit and postpone enough of the country's obligations so it would qualify for entry into the euro zone. What's missing is any broken law. The architects of European integration knowingly and with malice aforethought added the words "additional measures" in a footnote to the blueprint. Those two little words were an acknowledgment that Italy would need to fudge its numbers to get into the club, giving the nation explicit permission to do whatever it took to massage the accounts into acceptable shape. They created a loophole that Greece was also able to exploit, in line with the rules, aided and abetted by Goldman Sachs.

So while German Chancellor Angela Merkel said last month "it's a scandal if it turned out that the same banks that brought us to the brink of the abyss helped fake the statistics," she's wagging her finger at the wrong party.

The DNA of investment bankers drives them to find and exploit malleable clauses, bend rules, take maximum advantage of the unintended consequences of legislation. Society doesn't want to outlaw investment banking (not yet, anyway). And creative accounting—which is just a polite way to talk about cooking the books—is nothing new for countries. Italy used a yen-denominated swap to give its finances a one-time puff and avoid the ignominy of failing to qualify for the euro. In the U.K., so-called public-private partnerships and private finance initiatives allow the government to shift the burden of costly infrastructure onto the balance sheets of companies that tender successfully to manage and build the projects. The companies get access to rampant profit potential in return for the government's suppressing its own debt burden.

As for Greece, recall that in September 2004 the nation had to revise upward its deficits for 2000, 2001, and 2002. It turned out that the country had missed the 3% deficit threshold for euro zone membership in every single year since it joined the common currency—transgressions that went unpunished. So no one should be surprised that Greek Finance Minister George Papaconstantinou confessed to "some sleight of hand" in Greece's 2009 deficit numbers.

The Greece debacle is likely to hasten increased oversight of the derivatives market. In particular, contracts where the buyer doesn't have any skin in the game are akin to writing auto insurance for people who don't own a car and don't even have a driver's license, but who nevertheless fancy a bet on the likelihood of a car crash.

Financial authorities will probably outlaw such behavior, ignoring the difficulties of differentiating between efficient risk management and risk creation.

Lightning Rod

Moreover, governments are clearly uncomfortable with the concept of investors being able to bet against a country's creditworthiness in the credit-default swaps market. This may spur an unwelcome round of regulation. The trick Goldman employed to help Greece massage its debt figures hinged on using historical, rather than prevailing, currency rates in a series of swap transactions.

While that undoubtedly comes under the heading of fast-and-loose, it's not illegal; swaps are over-the-counter contracts between consenting adults, so no matter how divorced the values are from reality, it really isn't anybody else's business.

Goldman has become the lightning rod for public anger about the bailout of the finance industry. The vexation is appropriate; the bankers fail to see that every financial firm would be dead without an ocean of taxpayers' money keeping the system afloat. In the case of Greece's swaps, though, Goldman Sachs has done nothing wrong. The EU's forensics squad should be looking closer to home for its culprit.

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