In every European crisis, through war and peace, Americans typically start out thinking it’s “over there” until they get dragged in. It happened in the two world wars of the 20th century, and it’s happening now with the eurozone crisis as the bond markets shift their punishing ways from Greece to a bigger quarry, Italy, forcing the imminent resignation of Prime Minister Silvio Berlusconi.
But Americans are already a lot closer to the crisis than they might have realized. In the late 1990s and early 2000s, as Italy was seeking to reduce its debt to qualify as a member of the eurozone, it engaged in a number of derivatives deals with Wall Street to disguise the depth of its fiscal hole, according to “Derivatives and Public Debt Management,” a groundbreaking 2001 study by Italian economist Gustavo Piga published by the Council on Foreign Relations. Who was director general of the Italian Treasury at the time of these deals? Mario Draghi, who is now perhaps the most powerful man on the continent as the new head of the European Central Bank. Draghi, in the past, told a European parliamentary committee in June that he “had nothing to do” with such transactions, including with Greece. But after Draghi left the Italian Treasury, he immediately went to work for Goldman Sachs International (from 2002 to 2005) as vice chairman and managing director.
And now, it turns out that the man who is designated to replace Berlusconi in an emergency government created to guide Italy through the crisis has also been on the Goldman Sachs payroll: Mario Monti. A respected international economist who studied under Nobel laureate James Tobin at Yale, Monti is listed as “an international advisor to Goldman Sachs” in his official bio on the website of the European Commission. He is “part of what one can rightly refer to as a ‘financial mafia’ that wrecked the world economy since 2008,” says one critic, Marshall Auerback of Madison Street Partners, a Denver-based fund manager who closely follows Europe. “These hatchet men of this murky and opaque financial world are now being appointed to implement austerity on poor working households to save the financial sector from a debt deflation—an artificial crisis created because of the architecture of the euro system.”
A strategy of using arcane derivatives to disguise debt was designed by Goldman and other top Wall Street firms back in the 1990s, when countries such as Greece and Italy, with chronic fiscal deficits, were eager to join the European Monetary Union but couldn't match the standards of budget discipline imposed by the 1992 Maastricht Treaty. Wall Street helped them to do so, but at a high fee.
Arguably, the deals only made the crisis worse in the end. The countries were able to mask their true indebtedness by using swaps and other complex instruments that make government borrowing appear to be something else, like a currency trade or asset sale, and by committing to future payments that were not booked as liabilities. In some cases, such as a swap deal Italy did in the late '90s to defer interest payments on a bond issue, allowing it to squeak into the union, such instruments may have helped in the long run—assuming the eurozone and Italy's place in it remain intact. But many such transactions, by pulling the wool over the eyes of investors, also "led governments down the wrong policy path of avoiding to take strict measures to rein in their deficits and debt," says Gikas Hardouvelis, an Athens-based economist who has documented Greece's transactions with Wall Street. According to The New York Times, Greece paid Goldman about $300 million in fees for one 2001 transaction.
“It was a well-kept secret,” Piga, the Italian economist who exposed the derivatives deals at considerable risk to his career, said in an interview in 2010. He cautioned that many governments, such as Sweden’s and Denmark’s, have used derivatives “in a proper way in public debt management,” but that troubled economies such as Italy and Greece were sometimes operating according to different standards. “It was a mortal embrace that started between governments and banks. Both know they have entered into something that enters this gray area. Thus they both become blackmailable.”
And now some of the same bankers are in a position to be running the governments. Piga said no one paid attention to his warnings until the euro crisis began two years ago. “I got no phone calls for the past nine years. No regulator, no journalist ever called me. Then all of sudden the bomb explodes, and everybody’s on the case.”
The prevalence of Goldman Sachs in high U.S. government circles—the firm is sometimes called “Government Sachs”—has been much commented on in Washington since the financial crisis of 2007-09. In the 1990s and through the mid-2000s, major figures from Goldman Sachs such as Robert Rubin and Hank Paulson stood fast against derivatives regulation (Rubin) and lobbied successfully for higher leverage ratios so they could bet more on the market boom (Paulson). When those policies came to grief, Wall Street imploded, and the first $85 billion infusion of taxpayer money into AIG was announced in 2008, Goldman’s CEO, Lloyd Blankfein, was reportedly the only one invited to the meeting (by Paulson and Geithner, who convened it). Later on, Treasury Secretary Tim Geithner, himself a Rubin protégé, assigned two more ex-Goldman men to fix the vast mess their colleagues helped to create: Steve Shafran, a former favorite of Paulson’s, and Bill Dudley, Goldman’s former chief economist and Geithner’s successor as head of the New York Fed. Geithner also named as his chief of staff Mark Patterson, who is Goldman’s former lobbyist in Washington.
Both Draghi and Monti are considered able and honest by many financial market observers. But some critics have suggested that Draghi’s chairmanship of the Financial Stability Board, created by the G-20 in London in April 2009, was too cautious and deferential to the financial industry. “Draghi seemed to be muting financial reform,” says economist Robert Johnson, director of the Institute for New Economic Thinking in New York. Others on the board “were very frustrated at how much he seemed to be taking orders from Geithner.” In October, as Draghi was leaving, the European Parliament finally agreed on a permanent ban on so-called "naked" credit-default swaps on sovereign debt—a way of making bets without owning the underlying debt—but the U.S. has not done the same, under tremendous pressure from the Wall Street lobby. “All the hedge funds are panicked that the United States is going to follow suit,” says Michael Greenberger, a University of Maryland professor who is a former senior U.S. derivatives regulator.
All of these revolving-door connections—part of what economist Jagdish Bhagwati once famously called the “Wall Street-Treasury complex”—are one reason why the Wall Street lobby is believed to have had so much impact in moderating the Dodd-Frank reform bill last year, and success in continuing to water down its rules.