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London firm was created to route cash

Section: Daily Dispatches

By Carrick Mollenkamp
The Wall Street Journal
Monday, February 22, 2010

Greece's fiscal woes, the exposure of the European financial system to them, and the role played by Wall Street in hiding the problems all converge in a fifth-floor office near London's Liverpool Street station where a company called Titlos PLC was created in early 2009.

Just 22 days after Titlos was born, the National Bank of Greece SA and Goldman Sachs Group Inc. arranged for the company to sell E5.1 billion, or about $6.96 billion, in notes, according to U.K. and U.S. documents.

But Titlos wasn't a real company and the notes weren't designed for ordinary investors. Titlos doesn't make anything and its only directors are two British executives who work for a firm that specializes in the formation of corporations and the sale of pooled assets.

Instead, Titlos, descendent of a 2001 deal to help Greece hide debt, was set up to take advantage of a European Central Bank effort to inject cash into a banking market hobbled by the financial crisis. Titlos' notes were designed to be pledged for that program, according to filings by Titlos and the National Bank of Greece, and the buyer was the bank itself.

The history of Titlos also illustrates how bank and government dealings, often deeply intertwined, can complicate efforts to unclog a global banking system.

Gustavo Piga, a professor at the University of Rome Tor Vergata, says the opaque derivative trades that Greece and other countries engaged in "tarnishes the reputation of government" as it tries to police financial markets.

"There is this huge mortal embrace between the government and the banks," Mr. Piga says. "It creates huge conflicts of interest in the actions of government."

Behind Titlos and the notes sale are Goldman and the National Bank of Greece, a 169-year-old institution whose operations span Eastern Europe into Turkey, Serbia, and Romania. The bank isn't the country's central bank, though the government owns a 12% stake through its pension system.

Goldman, the National Bank of Greece, and the Greek government have long had close ties. Last week Greece named Petros Christodoulou, who worked at both Goldman and the National Bank of Greece, as the government's new debt chief.

Titlos's origin dates to 2001 and a complex transaction that at its crux called for Goldman to loan Greece E2.4 billion. The structure permitted Greece to lower the debt it had.

Over the next decade, the structure would prove to be malleable -- and legal. In total, from 1998 to 2000, Goldman structured 12 currency-swap agreements with Greece, leading up to the 2001 transaction.

Greece's finance minister last week said the original transaction met with the legal standards of the European Union's statistics watchdog. Moody's Ratings Service rated the 2009 deal.

"This was a unique deal," says Christoforos Sardelis, the head of Greece's debt-management agency from 1999 to 2004. "It was made public, and there was no violation of any rules."

To hedge its credit risk, Goldman carried out a transaction with a small Dublin firm. The investment bank also agreed to a new deal with Greece that was structured as a way to hedge interest-rate risk. That deal compensated Goldman for losses it was experiencing from the currency swap, according to a person familiar with the transaction.

Goldman then exited from the interest-rate-swap deal in 2005 when the National Bank of Greece replaced Goldman as Greece's trading partner, according to people familiar with that transaction.

In late 2008, with the financial crisis peaking and banks struggling to borrow from one another or sell pooled assets, Goldman and the National Bank of Greece identified a way to turn that interest-rate transaction into an asset that could be pledged at the European Central Bank for money as part of a program the ECB had set up to exchange bank collateral for billions of euros in loans.

The program ended up offering a way for banks to easily make money because they could use the ECB's cheap money to obtain or hold higher-yielding assets in what is known as a carry trade. The moves then freed up liquidity for banks, including those in Greece that have been big users of the ECB program.

"There were a very large number of securitizations done during the financial crisis, of toxic waste, that were designed precisely for the purpose of creating collateral for ECB repo loans," said Darrell Duffie, a Stanford University finance professor and derivatives expert. "The ECB knew this was happening and decided that they wanted to play along in order to get liquidity out there."

An ECB spokeswoman declined to comment.

U.K. documents show that Titlos, which filed its incorporation records on Feb. 4, 2009, is housed in a London financial district office occupied by Wilmington Trust SP Services (London) Ltd., a firm that caters to corporation formations and securitizations. Both Titlos directors work for U.S. bank Wilmington Trust. One director, who describes his occupation as a "director of special purpose companies for financing transactions," also serves as a director of nearly 200 other enterprises, the U.K. documents show.

To finalize the deal, the National Bank of Greece transferred, or novated, its role as counterparty to Greece to Titlos, which now meant that cash flow from Greece would be running through Titlos and that Titlos would sell notes that then could be pledged to the ECB.

On Feb. 26, just 22 days after Titlos filed corporation records with the U.K., Titlos sold E5.1 billion in notes maturing in 2039. The notes, rated "A1" by Moody's Investors Service, then were repurchased by the National Bank of Greece through a private placement, according to a National Bank of Greece securities filing.

According to that report, "the notes will be used as security for obtaining liquidity from the ECB." It isn't known if the notes currently reside at the ECB. Those collateral pledges have been subject to a haircut, or charge, levied by the ECB.

One question today is whether a party to the transactions remains at risk of a large collateral payment following a ratings-agency downgrade. That concern stems from what happened in 2008 when U.S. insurance giant American International Group Inc. nearly failed because its own counterparties, including Goldman, demanded payments AIG couldn't cover.

A Titlos prospectus indicates that Greece isn't on the hook for a collateral payment to Titlos if Greece is downgraded. The National Bank of Greece, which remained in the transaction to provide hedges for Titlos, is responsible for collateral payments if the bank is downgraded to certain levels, according to Moody's.

The notes remain tightly intertwined, though, with Greece. In December, Moody's downgraded the notes to "A2," midway between the ratings agency's highest triple-A rating and its first junk-bond grade, from A1 after the ratings agency had downgraded Greece to A2 from A1.

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