The escalation of the conflict over Greece is more than a dispute between the

government of Prime Minister Alexis Tsipras and Greece's international

creditors. The conflict is a proxy for two wars—one intellectual and one
political—in which the Greek people, especially the poor, have been taken
hostage. The intellectual war is over the sustainability of the euro project and
the economic effects of austerity policies. The political war is over populist and
nationalistic policies aimed at addressing the economic cost of the long and
severe recession. As with all wars, propaganda has taken over, and facts are
being used selectively. For all the talk of Greece's failed policies, it is often
forgotten that the Greek economy last year was growing and Greek bonds had
recovered some market access. Last summer Greek GDP growth was
approaching 2 percent. The consensus forecast was for an acceleration toward
3 percent this year. Interest rates on 10-year government bonds had declined
to 5.5 percent. The debate last summer was whether Greece would be able to
achieve a "clean" (i.e. without financing) exit of the financial lifeline that had
been extended in return for tough budget, tax, and structural measures
imposed on it by the Troika (consisting of the European Commission, the
European Central Bank [ECB] and the International Monetary Fund) and
continue with just a precautionary credit line.

That positive growth trend was interrupted last winter. This interruption was
not a result of new austerity or of the policies adopted by the new government.
In fact, Tsipras' populist government has adopted no new policies. It was
caused by the tremendous increase in uncertainty generated by Tsipras'
confrontational strategy. Uncertainty kills growth. As a result, GDP in 2015 is
likely to contract again. Compared to the growth expectations prior to the
elections, every Greek could lose as much as €1,000 in income as a result, the
equivalent of almost two months of pension payments for the poorest Greeks.

The Greek government has taken the country to the brink by calling a
referendum on the program at a time when it knew such a step would lead to
capital controls and bank closures. Neither the form nor the content of
Tsipras' request was conducive to an extension of the program. The rules were
clear to everybody, including the Greek government. Capital controls and bank
closures hurt growth. When Cyprus implemented capital controls, GDP
growth declined more than 5 percent in that quarter. Something similar will
now happen to Greece. History shows that it is relatively easy to shut down
banks but always difficult to reopen them and normalize financial conditions.
The upshot is that the Greek economy will be much weaker on July 6, the day
after the referendum, than it was June 26, when the referendum was
announced. Tsipras says his tactics were an attempt to get a better deal. Was
the gamble really worth it?
Common sense would say no. But many pundits and economists on the left in
the United States and Europe are not only celebrating the referendum but also
advising the Greek people to vote "no." In their minds, Greece is the poster
child of the failure of the euro project and of the policies aimed at restoring
fiscal discipline, and thus opposition to austerity is a cause worth fighting. In
their view, the uncertain outlook and the suffering of the Greek people are less
important than their ideological agenda. Populist parties across the world are
supporting the referendum and a "no" vote, hoping that it will be seen as a
celebration of democracy and a restoration of national sovereignty. It doesn't
matter to these factions that the question of the referendum is too complex for
the layman to understand and lacks legal meaning. Nor does it matter that the
Council of Europe has said that the referendum will take place under
conditions far short of international standards. In a proxy war, the cause is all
that matters.

Let's discuss the economic issues in turn. First, advocates of a "no" vote argue
that the euro is a failure because it prevents Greece from devaluing its way out
of the crisis. An exit from the euro would allow it to devalue its currency,
solving all problems, this argument goes. In fact, a Greek exit and devaluation
would produce a near term depression, bankrupting the financial and
corporate sector. Given the track record in Athens, the new Greek currency
would have little credibility. Greece would likely become euroized. And no one
can be sure the government would adopt the right policies in an
unprecedented environment. In addition, having your own currency has not
been a panacea for countries in crisis. For example, the large depreciation in
the sterling has not boosted UK exports. All it did was to reduce real incomes
via higher inflation. Inside the euro, Spanish exports boomed and the current
account imbalance was reduced with no devaluation.

There have certainly been mistakes made in the operation of the euro
institutions. For example, the ECB should have implemented quantitative
easing (QE) when the Fed and Bank of England did in 2009, instead of
tolerating the drastic spike in interest rates that sank the euro area into a
serious recession. But mistakes have been corrected and the euro area is now
more robust. The European Stability Mechanism (ESM) and the banking
union are in place. The ECB is now doing QE and has explicitly said that
Greece would benefit from QE if it concluded the negotiations of its budget,
tax, and structural reforms. The monetary policy stance is now right.

Another argument for voting "no" holds that Greece's austerity policies have
failed and that an exit will enable Athens to adopt a more stimulative fiscal
policy and achieve better growth. This argument is equally misleading. A
country that defaults and loses market access always finds it must run a
primary surplus to pay the bills and to eventually be able to market its debt.
How big the surplus needs to be is unclear, but there are a few examples of
countries that have defaulted or had to regain credibility after a sharp crisis
that can serve as a guide. After its default, Argentina sustained a primary
surplus in the range of 4 to 5 percent of GDP. After hyperinflation, Brazil
sustained a persistent 3 percent primary surplus. Greece had been asked to
reach a 1 percent primary surplus this year, to gradually reach about 3.5
percent by 2018. That goal was very ambitious and possibly unrealistic, but
essentially similar to what Greece would have to run in the event of a default.
True, Greece has sharply reduced its fiscal deficit—in fact, probably too much.
But this has been partly the choice of Greek governments, who have preferred
fiscal adjustment over structural reforms to boost potential growth. Even
Tsipras' government, which campaigned on an anti-austerity platform, sent a
proposal that the IMF rejected for being too austere. Something in the Greek
polity seems to be getting in the way of reforming the economy.

This proxy war supporting Grexit is being fought to support the cause of
Keynesian fiscal policies in the United States and the United Kingdom, of
economists and others who want to say "I told you so" about the unfeasibility
of the euro, and of activists who want to promote populist policies elsewhere.
It is interesting that many Anglo-Saxon economists are supporting a "no" vote,
while Greek economists (and those in Latin American, who have experience
with these issues) are mostly supporting a "yes" vote. American pundits won't
have to live with the consequences of their advice. This proxy war must end.
What Greece needs is a government that can provide lasting and credible
political stability, liberalize the economy, break down oligopolies, reduce
clientelism, and unlock growth.

All parties involved have made mistakes, and Greece has suffered enormously.
Regardless of the referendum outcome, the Greek economy is going to need
massive external assistance. Europe, and especially Germany, cannot fight
against moral hazard and demand respect for the rules and then avoid dealing
with the consequences of fighting against moral hazard and demanding
respect for the rules. After the referendum, Europe must re-engage with
Greece, devote all the resources needed—including conditional debt relief—
and, paraphrasing Mario Draghi, do whatever it takes to help the Greek people
recover from this tragedy.
Introduction
In December 2009, what would become the Greek debt crisis began as investors and
governments voiced concern over Greek deficit levels. The new Socialist government
had increased its projected budget deficit to 12.7% from much lower estimates.[1] Over
the course of 2010 ratings agencies downgraded Greek debt, and spreads between
German bunds and Greek gilts grew ever wider. Aid packages by the IMF and the
European Union have thus far failed to stem concerns about Greek debt, which threaten
to spill over into a continent-wide crisis. The latest European plans for Greek debt put
the nation into selective default, in which private investors holding bonds accept a
partial reduction in the value of their holdings.

As the crisis unfolded, the Greek government faced scrutiny on the accrual of its debt,
and how they managed to hide fantastic budget deficits from European authorities.
The investment bank Goldman Sachs had entered into derivates contracts with the
Greek government, which allowed the government to securitize part of its debt in ways
that European rules did not require to be reported. Thus Greece could legally fudge its
reported debt and deficit figures. This case-study will examine Goldman Sachs’ role in
the accumulation of Greek debt, questioning whether the Greek government and the
bank acted ethically.

Background
On June 19, 2000, Greece joined the Euro-zone. This meant it adopted the Euro (€) as
its national currency, and agreed to abide by the Maastricht rules on debt and deficit
ratios. These stipulate that no Euro-zone member may have a debt greater than 60% of
its GDP or a budget deficit greater than 3% of it GDP.[2]

However, it is now generally acknowledged that the Greek debt and deficits far
exceeded these goals set by the Maastricht treaty. Greek debt was about $131 billion,
or 103.7% of GDP in 2001, far above the required 60%. However, the more important
deficit ratio was held under 3% through various accounting tricks throughout the early
2000s. Only in late 2009 and early 2010 did it become apparent that Greece’s true
budget deficit was about 12% of its GDP.[3] Among these “window dressings”
were cross-currency swaps with Goldman Sachs. Although European governments
commonly employ such derivates to hedge against changes in currency value, Goldman
Sachs and the Greek government negotiated unusual terms that allowed
the derivatives to function as a loan from Goldmans to the Greeks.

Nations often issue bonds denominated in other currencies to raise money in foreign
markets. In the Greek case, its government had issued debt in Dollars ($) and Yen (¥)
to tap markets outside of Europe. In similar cases, governments will enter into currency
swaps to hedge against exchange rate fluctuations; in most swaps the two
parties swap cash flows (the bond coupons) over the maturity of the swap, occasionally
exchanging the notional amounts at maturity.[4]
Greece, though, negotiated a non-typical swap with Goldman, which used an “historical
implied foreign exchange rate.”[5] In other words, the swap did not use the prevailing
rate, but rather one with a weaker Euro, thus allowing Greece to exchange its Yen and
Dollars for a greater number of Euros. This favorable exchange rate is estimated to
have netted Greece approximately $1 billion at inception.[6] But because Greece would
pay this amount back at the end of the swap, it resembled a loan on the part of
Goldman Sachs (See figure below). But European accounting rules did not oblige
Greece to report this credit as such, allowing its government to take $1 billion off of its
balance sheets.[7] Politicians have therefore asserted that Goldman colluded with
Greece to hide the true extent of its debt from European authorities and investors,
exacerbating Greek debt and helping to spawn the European sovereign debt crisis.
Possible structure of Greek swap

Ethics
The two ethical questions that present themselves in this scenario are whether the
Greek government acted ethically by entering into such currency swaps, and if Goldman
Sachs acted ethically.

1. The question of whether the Greek government acted ethically is somewhat difficult.
It seems reasonable to assert that it did so without great regard for the problems, which
large deficits can cause, or international reactions once the swaps with Goldman Sachs
became common knowledge. One can argue that by allowing such debt to accumulate,
and by adding greater debt through the swaps with Goldman Sachs, the Greek
government mortgaged the nation’s future, thus not acting for the greatest ‘good.’ From
a utilitarian standpoint, it would seem that the Greek government acted unethically.

However, there exist two problems with this reasoning. The argument sees the Greek
government harming primarily its own citizens; yet because of the government’s
legitimate, democratic nature it is false to distinguish between the Greek ‘people’ and
their government. For all intents and purposes the regime implemented the will of the
Greeks. By the same token, one can contend the government’s debt-fueled spending
expanded the Greek economy, improving the lives of most Greek citizens. Similarly,
there is no way to know how the debt crisis will play out. The crisis might convince
future Greek governments of the need for fiscal austerity, making them, in a century’s
time, one of the safest debtor nations on the planet. Any utilitarian argument in this case
fails to satisfy close inspection.

Regarding the question of hiding the debt from European authorities, it is difficult to
successfully argue that this was unethical. The means Greece used to do so were legal
(although this does not always imply moral), and, it could be argued, prevented Greece
from paying the enormous fines stipulated by the Maastricht treaty for those countries in
violation of debt and deficit limits.[8] From this perspective, the government was acting
in the best interests of its citizens. And despite the swaps’ role as ‘window dressings’ for
Greek book keeping, they primarily acted as a hedge against exchange rate instability.
Thus, while it seems as though the Greek regime proceeded recklessly with its debt,
one cannot argue that it did so unethically.

2. The question of the ethics of Goldman’s actions requires a bit more nuance. It is easy
to condemn Goldman’s actions, as German Chancellor Merkel did when she called its
role in Greece’s debt “scandalous.”[9] However, in such a case, where Goldman Sachs
functioned as a facilitator for its client – the Greek government – two pieces of
information play a key role in determining ethicality: the morality of the object of
facilitation; and, if that object were unethical, whether or not the facilitator knew or
suspected it to be unethical.

The object of the cross-currency swap was first to hedge against exchange rate

oscillations, and secondly to (allegedly) provide a covert loan of $1 billion to the Greek
government. Given the discussion in 1. it is clear that this object, which increased Greek
indebtedness and hid it from the European Union, was not unethical. Thus Goldman’s
actions withstand the higher level of scrutiny mentioned above. It has nowhere been
argued that Goldman Sachs acted illegally: “There is no doubt that Goldman Sachs’
deal with Greece was a completely legitimate transaction under Eurostat
rules.”[10] Furthermore, the practice of engaging in such swaps was, as mentioned,
quite common, and allowed those governments to guarantee their revenues from bond
issues in foreign denominations. Given that these swaps were legal and their object not
unethical, it need not have been a concern of Goldman Sachs that the swaps allowed
Greece to hide debt from the European Union.

Conclusion
We thus find that while the Greek government may have acted unethically in allowing a
great debt to amass, Goldman Sachs acted entirely ethically in designing cross-
currency swaps tailored to their client’s requirements. While it may be popular to
condemn the bank for allowing Greece to keep $1 billion of debt off their books, the
swaps were completely legal at the time, and followed European Union procedures. To
argue that Goldman acted unethically would be equivalent to arguing that a private tax
accountant acts unethically when he or she seeks legal means to decrease his or her
client’s tax burden. It may be contended that the Greek government acted recklessly or
without great foresight; but intelligence cannot be a stipulation of morality. As for
Goldman Sachs, it did not act recklessly, but as a private entity serving a client. Their
derivatives did not facilitate the funding of anything illegal or unethical. We thus
conclude that Goldman Sachs acted ethically in their sale of cross-currency swaps to
the Greek government.