Wall Street's role in Greek crisis should be no surprise

By Allan Sloan
Wednesday, March 10, 2010

As I look at the uproar over Wall Street's role in the Greek crisis, one of the things I find most surprising is that anyone is surprised about Wall Street's conduct. You're upset that the Street helped Greece hide some of its debt and then began making bets that the debt wouldn't be paid? Welcome to the real world of finance in 2010.

Here's the deal. Wall Street makes most of its money these days by speculating. It doesn't care about the collateral damage that its activities can inflict on people, companies and entire countries -- unless the result is embarrassment, punishment, regulation or some combination of these.

Once upon a time, big investment houses' major profits came from underwriting deals for companies that wanted to raise capital and from helping customers buy and sell securities. But that's so '70s. Increasingly, the Street makes its real money by creating, peddling, trading and sometimes owning high-profit-margin instruments -- such as the Trojan-horse securities that helped Greece obscure its true financial situation for a while but now are costing the country dearly, on both the image and financial fronts.

The Street isn't trying to hurt Greece -- it just wants to make money. If there were more dollars or euros to be made creating securities that made Greece more prosperous and less indebted, the Street would happily create them. It doesn't care.

Goldman Sachs created the Trojan-horse issue -- a "special-purpose vehicle" called Titlos PLC -- because Greece was willing to pay to dress up its books and make European Union bean counters happy by understating its debt.

In an irony I'm sure was unintended, titlos, which means "title" in Greek, has a secondary meaning: a list of accusations, or rap sheet. Speaks for itself, doesn't it?

While helping Greece raise money (or obscure its debt, if that's the assignment), Goldman and other Street players happily went about creating credit default swaps would that pay off if Greece were to default. How much of this stuff do the Street people own? Where is it? What kind of securities has it been pushed into? No one knows. The one thing you can bet on, though, is that unraveling it all is going to be horribly complicated. Why? Because for Wall Street, complexity equals profitability.

Consider credit default swaps, which started as credit insurance. Let's say I wanted to buy $1 million of bonds from General Motors but was worried about their financial soundness. I could buy a swap from an investor willing to pay me $1 million if GM defaulted. That way I could sleep well at night. So could GM, because I'd settle for a lower interest rate than I would if I had to worry about the default risk.

Now, watch this good idea morph into something else. It turns out you don't have to own the underlying debt to buy a credit default swap. You can speculate with it, as opposed to hedging, and suddenly the default-swap tail wags the dog: the credit of the debt issuer.

In the case of Greece, a higher price on the country's default swaps raises price pressure on Greek bonds, which in turn makes it harder to raise new money -- increasing the likelihood that Greece will default. "When people pile on and take speculative positions [rather than just trying to hedge their exposures], you have the potential to destabilize a country or a company that's already in trouble," says Janet Tavakoli of Tavakoli Structured Finance. Indeed.

The transatlantic outrage over the Greek situation may bring enough heat on Wall Street to clean up its act, or at least seem to clean up its act, when it comes to sovereign countries. I don't know how that will play out. One thing I do know, though, is that unless someone smacks the Street -- hard -- Greece won't be the end of the story. And it won't be the last surprise.

Allan Sloan is Fortune magazine's senior editor at large.

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