AFTER FAILING TO abide by its own internal guidelines,
sidestepping industry best practice, and ignoring
internationally agreed standards, a one-time star borrower is
brought low. Underlying this is a combination of highly
structured financing often suggested and effected by
competing investment banks and inconsistent accounting.
This has disguised the true, excessive extent of the borrower's
debt. All of the deals involved might have been legal, but
their revelation has left investors shocked and out of
It sounds like the depressingly familiar tale of corporate
accounting in the Enron era: but the sort of borrower we are
talking about is a government not a corporate. And the
governments involved are the very ones that have explicitly set
themselves the task of borrowing responsibly western
Europe's EU members.
Governments have always been two-faced in these matters. They
like to borrow and spend money liberally while maintaining a
reputation for fiscal prudence. In Europe the combination of
the recently reformed Stability and Growth Pact and an
economic downturn that has made deficits worse has increased
the pressure that governments are under.
Now, it is the administrations of Berlusconi, Blair, Chirac
and Schröder, not corporates, that are stretching out
along the razor's edge of what is acceptable in financing and
accounting. It is finance ministers such as France's Breton,
the UK's Brown, Germany's Eichel and Italy's Siniscalco, not
CFOs, that are looking at ways to massage the books. And it is
government borrowing officials, and the agencies that borrow
for many governments, rather than corporate treasurers, that
are having to come up with the trade ideas to achieve it.
"There is a huge amount of creativity going on right now,"
says an analyst at a European bank.
That raises the question: is there enough transparency? And
is the entire European government bond market, totalling
2.94 trillion, trading on the basis of a
misrepresentation of the true extent of government
Back to basics
There is a whole range of things governments are doing that
investors and taxpayers should be paying more attention to.
"You go from the basic tricks through to genuinely creative
stuff like some of the pension transfers," says the
The basic tricks are truly basic. When the EU's statistical
agency, Eurostat, announced revised figures for Greece's
general government debt and deficit last year, one reason it
increased the debt to 110% of GDP at the end of 2003 up from
103% was that Greece had been under-reporting military
expenditure and over-estimating social security surpluses. It
confirmed long-held suspicions, after a time when Greek
government bond yields had all but converged with those of core
European governments. "We've always known Greece was
obligations as revenue. If a corporate tried using such
gimmicks it might send a sell signal to sceptical investors
who, post WorldCom and Parmalat, are increasingly vigilant.
Have governments been getting away with tricks corporates no
longer dare use?
"You have to think about government accounts as you think
about corporate accounts," says Gary Jenkins, European head of
credit research and fundamental strategy at Deutsche Bank. That
means looking not just at the headline numbers but in some
detail at the notes outlining what accounting techniques have
been used to allow those numbers.
Of course, this is not entirely new. "In the 1990s, it was
alleged that the French government took responsibility for
funding France Telecom's pensions and pocketed the assets,"
says Stephen Yeo, senior consultant at pensions consultancy
Watson Wyatt. "But by keeping them off balance sheet, France
got a windfall gain. In accounting terms, that is absurd."
In 2003, Belgium assumed Belgacom's pension liabilities.
Rather than transfer Belgacom's funded scheme, its assets were
liquidated and paid to the government in cash. Although the
government can use the cash to cut its debt, the unfunded
pension liabilities are not incorporated under the Maastricht
definition of general government debt. Hey presto! Without the
deal, Belgium would have had a budget deficit in 2003. With it,
it recorded a 0.2% surplus.
Belgacom's future pension liabilities are estimated at
5 billion, or 1.9% of GDP. That makes it the biggest
one-off measure by any EU country relative to GDP. It's not
just the Club Med countries (Greece, Italy, Spain and Portugal)
that are testing the limits. "Belgium has been transparent and
worked hard to bring its deficit down with surpluses," says
Price. "To suddenly find them relying on one-off measures was a
little bit sad." Investors should be on the look-out for more
Growing pressure on governments to address the problem of
unfunded pensions has resulted in similar deals elsewhere.
More systematically, many governments borrow large sums not
in their own name but through state-supported or implicitly
guaranteed vehicles. This is beyond accounting gimmickry, it's
a bold-as-brass casting off of government liabilities.
Germany's KfW is state-owned and state-guaranteed. "How that
isn't on the German government's balance sheet I don't know,"
says a debt syndicate banker.