Balance Sheet Fraud Is Not Just For Enron (Or Banks)

Balance Sheet Fraud Is Not Just For Enron (Or Banks)

Posted by Karl Denninger

Oh, look at what the Zerohedge cat dragged in this time!

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, a country which used precisely the same off-market swap arrangement to end up with an interest expense of LIBOR minus 16.77% (in essence the counteparty was paying Italy 16.77% of notional each year as a function of the swap mechanics), in that long ago year of 1995. The country – Italy (for confidentiality reasons referred to in the report as Country M), was at the time panned as the Enron of the European Union due to precisely this kind of off-balance sheet arrangement by the Counsel of Foreign Relations. The counterparty bank: unknown (at least in theory, since the swap was highly confidential, and was referred to as Counterpart N), 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.

Uh, Libor minus 16.77%?

A hedge huh?

This was identical to you walking into your bank and taking a cash advance on your VISA card – at a rather high interest rate – and concealing it for the explicit purpose of being able to show a wad of cash at the end of the year on your books.

That is no hedge, it is a loan.  It was done to cook the book and, in my opinion, falsely present the “health” of the nation – in this case Italy – involved.  It was done over the counter with no paper trail or exchange trading for the explicit purpose of secrecy, so that nobody would discern that the government in question had borrowed the money.

The problem should be obvious here.  If I cannot trust the balance sheet of a sovereign government because I have discovered one “tricky deal” such as this, I have no means to know how many more “tricky deals” there are, what the liabilities might be, what the credit exposure is, and whether I will ever get paid back if I loan that government money.

The allegation is made that Goldman was on the other side of this deal.  That, if true, raises a further question: how many more of these hinky lending deals is Goldman involved in?  (Note that FT seems to think it was JP Morgan.  Not that the identity matters, by the way – the point is that the institution involved knowingly made a loan in a form that was intentionally designed to mislead those not involved in the transaction.)

The entire report by Zerohedge is well worth reading, although it’s fairly thick.  The essence of it, however, is that these deals were loans and were written “off balance sheet” using hinky derivative transactions for the explicit purpose of misleading investors about the strength of the nation involved – and that, unfortunately, directly implicates the Euro as a currency.

Buckle up folks.