COURTESY OF DING YIFAN

After an unprecedented rescue plan of 750 billion euros was agreed on by the EU finance ministers in early May, the sovereign debt crisis hovering over Greece seems to have been prevented from spreading in the euro zone. But the effectiveness of the bailout package is still questionable and the sovereign debt crisis still poses a threat to EU integration and stability.

Root of the crisis

The Greek sovereign debt crisis surfaced in late 2009 when credit rating companies downgraded Greek bonds. Then the country's financing costs began rising, pushing the interest rate of Greek bonds 3 percentage points higher than that of Germany, while their difference was less than 1 percentage point before the crisis. Worries about a Greek default increased, pushing up its financing costs and aggravating its burden of economic growth, which in turn damaged its ability to repay its debt. This all formed a kind of vicious circle. Greece's deteriorating debt crisis aroused people's doubts on other euro-zone countries' abilities of repaying their debts. Soon Portugal, Ireland, Greece and Spain became known as the PIGS countries.

SHOW OF DISAPPROVAL: Portuguese gather in Lisbon on May 29 to protest government austerity measures such as tax hikes, spending cuts and a freeze on civil servants' wages (XINHUA/AFP)

In fact, Greece wasn't totally qualified to join the euro zone. The euro zone requires its members to have a budget deficit-to-GDP ratio of no more than 3 percent and an inflation rate lower than 3 percent. Their public debt should not surpass 60 percent of their GDP. But when Greece applied to join the euro zone, its budget deficit and public debt ratios were both higher than the requirements. Greece then turned to Goldman Sachs, who designed the "currency swap" transactions and helped Greece mask a sum of public debt as high as 1 billion euros to meet the requirements and become a euro-zone member.

Goldman Sachs' "financial innovation" worked like this: Greece issued 10-15 year bonds worth $10 billion in tranches. Goldman Sachs exchanged the euros Greece raised into U.S. dollars. That is to say, Goldman Sachs lent 1 billion euros to Greece. But this loan didn't appear in Greece's public liabilities, as it was slated to be repaid in 10-15 years. After getting the money, Greece's budget deficit in book value was only 1.5 percent of its GDP. It was revealed recently that the ratio was 5.2 percent at that time, much higher than the required 3-percent ceiling.

Goldman Sachs also created several methods for Greece to increase its fiscal revenue. For example, lottery and civil aviation taxes were mortgaged to get cash. But the mortgage was not included in liabilities, but was sold as bank debt securities. Goldman Sachs grabbed a commission of 300 million euros through these services. To secure future gains on its investments, Goldman Sachs also bought a 20-year default insurance contract called credit default swap (CDS) from a German bank, so that the insurer could make up for the loss in case Greece defaulted.

Greece is not the only EU country that used this tactic. Several countries, including Italy, Spain and Germany, resorted to this means in order to keep their budget deficit-to-GDP ratio at no more than the 3 percent, as required by the Treaty of Maastricht.

But in late January and early February this year, Greek debts and the euro became targets of attacks in the market. When several Greek debts were about to mature, rumors about Greece's inability of repaying were afloat, causing market jitters. The direct result was a depreciation of the euro and rising borrowing rates for Greece (double the average level of emerging economies). As Greece's financial situations worsened, Greek CDS prices soared several times. The CDS is designed to cover the default risk of a country's sovereign debt, and should be closely related to a country's government bonds. But the CDS is often separated and allowed to become a financial product. Now, the total value of CDSs worldwide has amounted to astronomic figures, and 60 percent of their transactions are opaque, making it a speculators' favorite.

When Greece's ability to repay its debts came into doubt, prices of Greek CDSs went up. But who has held the Greek CDSs? They have primarily been Greek bond holders and issuers, including Goldman Sachs and two other U.S. hedge funds. Goldman Sachs bought the CDSs before the debt crisis when the CDS price was low, then attacked Greece's credit reputation to push up Greek CDS prices. Goldman Sachs finally sold them when the prices reached their peak.