Structured bonds are common, and quite useful, financial instruments
When ignorance meets alleged corruption, the cocktail is explosive. The affair of the overpriced bonds, straight and structured, issued by the Greek state and bought by some social security funds appears to be taking its toll on the government and has the potential to change the political landscape if left unchecked. However, it also reveals a frightening deficit of knowledge among politicians, commentators and others who have made it a habit to express opinions on this issue. There is no doubt that the purchase of overpriced government bonds by state pension funds speaks loudly about the incompetence of their board members. It is fair to say one has to be ignorant or corrupt to give the green light to these purchases at such elevated prices and it may well be the case that in some instances we may have both factors at work. People who are familiar with the way the boards decide are not surprised by what is coming to light and add that they expect to hear more stories about overpriced bond deals between pension funds and brokers or banks as the authorities dig deeper into the past. In shedding light on the whole process, they say the pivotal role belongs to the chairman of the board of the pension fund. According to them, the rest of the members of a typical board usually approve his recommendations because they think the chairman is in contact with a minister or other high-level government members and have the high connections. In other words, they assume the chairman expresses the will of the government who appointed them as well. The representatives of the trade unions sitting on the board usually go along with those decisions. So, if there is corruption, it is more likely to engulf the chairman of the board and much less the other members who simply follow his advice and approve his proposals. Of course, no one would expect the members of the board of a pension fund to know about structured bonds and other complicated financial products. One would expect, however, those who had no basic knowledge of finance prior to the appointment to undergo some kind of quick training program. Such programs exist in other countries, such as the UK, and aim to educate members of the board of pension funds who lack the knowledge to be trained within just a few months. Unfortunately, this is not happening yet in Greece. If it had happened, we would not have encountered the present case where pension funds bought overpriced bonds. But it is not just the boards of pension funds who lack basic knowledge about bonds and portfolio investments in general. The same is true of most politicians, journalists and others who inform the general public on this issue. It is no coincidence that a number of them have called on the boards to «return the money to the pension funds,» implying that they should sell the structured bonds at current market prices to get the money back since there is no other way. It should be noted that a structured bond, such as the 12-year CMS (constant maturity swap) issued by the Hellenic Republic in February and bought by the four pension funds at par, pays a fixed coupon in the first few years and then pays a variable coupon depending on a formula and certain conditions attached. Usually, it is a factor, such as 5, times the difference between the 10 and the two-year swap rates. We must point out that these structured bonds, which are presented in Greece as high-tech instruments, are very common abroad, and are regarded as plain vanilla instruments. In other words, they are like the typical fixed coupon bonds which pay interest every year for the life of the bond and its face value at maturity. So, is this the time to sell these structured bonds and return the money to the pension funds as some have called for? Whoever talks to bankers or dealers who are familiar with these structured bonds will get the same response and it would be a resounding «no.» Of course, this will not discourage the Greek «experts» from returning to their familiar topic. They may even see an international conspiracy behind arguments to the contrary. In this context, one is not surprised to see TV personalities express their dismay when they hear a reporter or one of their guests raise other issues, such as the fact that the manager of a structured bond issue, usually an international investment bank, has started working on the bond a month or more before it came out. It is normal to say so if you do not know that pre-marketing is part of the process but one would expect a greater degree of sophistication. Given the high degree of ignorance about these issues in Greece, one would also expect, at least the boards of the pension funds to employ advisers who have the knowledge and the integrity to help them with their investment decisions. Some have indeed advisers but these are usually low paid and have every incentive to make money on the side through other avenues. The most common of which is to suggest the purchase of bonds in which they play the role of the middleman and make a commission. In this regard, the more complicated the financial product recommended the better because the profit margin is higher for them as well. Of course, there is a conflict of interest here since the adviser also executes the transaction but no one seems to have been paying attention. This is another example of how bad things can go for pension funds when they choose to pay an adviser a low rate to look thrifty and lose millions in euros from the other side. Unfortunately, the saga with the overpriced government bonds purchased by pension funds has revealed something very disturbing for their boards and the country as a whole. The significant lack of knowledge which exists when it comes to financial products even among those who manage other people’s money, such as the boards of pension funds, the conflicts of interest in the fund management process, which have yet to be addressed, and the potential for corruption. It is sad for an EU country to find itself in such a mess in 2007 but it is the only one who can actually take care of the problem.
