The New Robber Barons Read online

  I called Warren Buffett about my concerns, but stuck to the public information already in the article. (Dear Mr. Buffett Pp. 164-165, 246).

  I stuck my neck out and met with Jamie Dimon, CEO of JPMorgan Chase, adding that the difference was material. JPMorgan Chase's credit derivatives positions exceeded those of all other U.S. banks combined at the time. JPMorgan was not a participant in the problematic deals, and it was not a recipient of AIG's subsequent settlement payments, but stability in the credit derivatives markets was an important issue. Jamie dismissed my explanation of the looming cliff risk and said he understood CDOs. (Dimon later said he wished he had listened to me back then.) In August of 2007, he did not want to contemplate a potential implosion of AIG.

  Goldman Knew (or Should Have Known) the Consequences

  Unbeknownst to me at the time, in July 2007, Goldman Sachs and AIG began a prolonged battle over prices and collateral payments. In February 2008--six months after Reilly's Wall Street Journal article--PricewaterhouseCoopers (PWC) said it found "material weakness" in AIG's accounting. PWC was also Goldman Sachs's auditor. Goldman hedged against the possibility that AIG could go bankrupt and also extracted billions more in collateral from AIG before the crisis. By September 2008 initial bailout, Goldman Sachs had extracted $7.5 billion in collateral from AIG against these trades.

  Goldman should have been well aware of the cliff risk posed by CDOs that it hedged with AIG. Moreover, Goldman created CDOs that other banks hedged with AIG, including some hedged by French banks Calyon and Societe Generale. In fact, Goldman Sachs was a key architect of AIG's crisis. (See details here).

  If any of the assets backing the CDOs were as bad as Goldman Sachs Alternative Mortgage Products' GSAMP Trust 2006-S3, the BBB-rated tranches (and most of the higher rated tranches) would be worth zero today. Goldman itself created some assets that amounted mostly to hot air, so it was in a good position to know that the CDOs AIG hedged were "backed" by too many value-destroying "assets."

  Details of AIG's Trades Were Kept Secret Even by the SEC

  The government's 100% payout to AIG's counterparties was extraordinary under these circumstances, and the negotiations were done in secret. In September of 2008, the Fed agreed to the first AIG bailout rather than let it sink into bankruptcy. It was very much to the benefit of Goldman Sachs and the other recipients of bailout funds that the details of the CDOs and the assets backing them were kept secret. Some CDOs held up moderately well, but others looked so bad, a public view of details would have prompted an immediate investigation. There appears to be a cover-up, and even the SIGTARP report did not reveal key details. So much for Washington's "investigations."

  Even the SEC allowed details to be suppressed until 2018. (Click here to see the redactions on the last four pages of the March 2009 SEC filing.)

  In September 2008, a good negotiator would have insisted that the collateral already extracted from AIG by Goldman Sachs, Societe Generale and others should be recharacterized as a loan and paid back after the crisis. As for subsequent payments including those made in November 2008--if they were made at all--they would only have been made as a loan.

  Goldman Sachs Worried About Billions in Crippling Losses

  Public funds bailed out AIG in September 2008, and the public did not get transparency. The secrecy benefited those involved in the initial negotiations, those involved in subsequent negotiations, and the banks that received the payments.

  Now that the crisis is over, this issue should be reopened, and billions in collateral should be clawed back to pay down public debt, before Goldman Sachs pays more than $16 billion in taxpayer subsidized bonuses to its employees.

  Goldman's CEO Lloyd Blankfein knew that if AIG failed, Goldman's counterparties would suffer collateral damage (Dear Mr. Buffett P. 167), and if AIG failed in September 2008, Blankfein worried about billions in crippling losses for Goldman Sachs. Yet, in an October 2009 Wall Street Journal interview, Blankfein said he didn't suspect AIG had problems producing collateral: "I never had reason to suspect....[I]t never occurred to me."

  * David Reilly is now with Bloomberg News.

  ** I gave Reilly an example of an aggregate position of AIG's credit default swaps (CDS) amounting to more than $19 billion. It was backed by BBB-rated tranches of residential mortgage backed securities (including some subprime loans) and other BBB-rated asset backed securities (auto loans, student loans, and more). Mark-to-market means one shows the market price, or if no market prices are available, one records a price based on a model that calculates a price at which one would expect to trade in the market. Given then market conditions, AIG's assertions were not plausible.

  AIG Paying Out Millions in Bonuses

  March 14, 2009

  The Wall Street Journal reported (“AIG to Pay $450 Million in Bonuses,” by Liam Plevin) that AIG CEO Edward Liddy said the company had entered into the bonus agreement in early 2008 before AIG got into dire financial straits and was forced to obtain a government bailout last fall. In the fourth quarter of 2008, AIG lost $61.7 billion, but it was in trouble long before that due to AIG Financial Products Group, even if AIG did not own up to it at the time.

  According to the article, "The large bulk of the [bonus] payments at issue cover the AIG Finance Products Group." Yet, this group had problems as far back as the second quarter of 2007, and AIG was in severe financial straits long before the first quarter of 2008. In my opinion the government interfered with the "sanctity" of AIG's credit derivatives contracts claiming it was in the public's interest, and as a matter of public policy, Treasury could have found a way to alter AIG's bonus agreements given the extraordinary circumstances.

  In August of 2007, I challenged AIG’s accounting saying they had large unreported losses. I was challenging AIG’s earnings for the second quarter of 2007, and contrary to Liddy’s representations in the above article, AIG had grave concerns by the first quarter of 2008.

  This is an excerpt from Chapter 10 of Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley, 2009).

  For example, AIG wrote credit default protection on a whopping $19.2 billion “safe” investment that had exposure to subprime loans (a super-senior tranche of a CDO backed by BBB rated tranches—the lowest rating that is still investment grade—of residential mortgage-backed securities, and these were backed by a significant amount of subprime loans. By August 2007, the prices of the collateral backing the super senior had tanked.) Anyone who buys insurance knows that even if you are “safe,” if you are in a high risk category, your cost of insurance goes up. If AIG were to pay someone to take over its insurance-like obligation, AIG would have to pay more than it had received, and AIG should have shown this as a loss. [See also the notes section of my book]

  AIG’s stance seemed bizarre given that five insurance executives from AIG and Berkshire Hathaway’s Gen Re Corp (even Warren Buffett cannot control every action of every employee) were under investigation (and eventually found guilty) of conspiracy to inflate AIG’s reserves and mislead investors about AIG’s earnings.

  I told Dave Reilly at the Wall Street Journal: “There’s no way these aren’t showing a loss.” That is simply a market reality. This is Wall Street speak for: In my humble opinion, you are a big fat liar. AIG responded: “We disagree.” That is Wall Street speak for: No, YOU are a big fat liar! [This was August 2007]

  Before Dave Reilly wrote his article, he talked to experts, including me, for background. Then he called AIG to ask them for their thinking. AIG stood firm. Then Reilly called me again. He didn't want the Wall Street Journal to look stupid, but told me “they pay me to go out on a limb.” He said he needed me to go on the record. It would make the article more forceful. I did not think that AIG would tell Reilly: You know, you have a point, maybe we should recheck our homework, but I did not anticipate arguing with AIG in the Wall Street Journal’s “Heard on the Street” column. I hesitated. AIG, a large global conglomerate, has the resources to crush me like a bug. On t
he other hand, I am not fat. I finally agreed to go on the record.

  By June 2008, AIG recorded two back-to-back quarters of its largest losses ever. AIG took more than $20 billion in write-downs on its derivative positions through the first quarter of 2008; net losses for the fourth quarter of 2007 were $5.3 billion, and in the first quarter of 2008, AIG reported losses of $7.8 billion. In February 2008, its auditor said it found “material weakness” in AIG’s accounting.

  Did AIG Insure Dodgy Mortgage Products for Goldman Sachs?

  March 25, 2009

  AIG had a lot of cliff risk (as in falling off of one) in some of their credit derivatives linked to mortgage backed products, and she questioned these trades in August of 2007. Goldman Sachs was a key trading partner. Some of the mortgage products coming out of Goldman Sachs Alternative Mortgage Products looked dodgy. AIG seems to have done most of its trades with Goldman during Hank Paulson's tenure as CEO at Goldman, and tough questions should be asked about the nature of the risk that AIG put on with Goldman Sachs

  According to the Wall Street Journal’s Serena Ng ("Goldman Confirms $6 Billion AIG Bets" March 21, 2009) prior to AIG’s September 2008 bailout, Goldman had insured $20 billion of chiefly mortgage backed products, and Goldman had already received $7.5 billion in collateral that contributed to AIG's cash problems. From the time of the bailout until the end of 2008, Goldman received another $8.1 billion in collateral from AIG for a total of $15.6 billion before the end of 2008 (the remaining exposure was said to be hedged with credit default swaps among other hedges).

  The key question is whether Goldman asked AIG to insure products that were as dodgy as the deal from Goldman Sachs Alternative Mortgage Products exposed by Fortune’s Allan Sloan in his October 16, 2007 Loeb Award winning article: “Junk Mortgages Under the Microscope.”

  Was the lack of disclosure at the time of the bailout to save Goldman from embarrassment or is there a perfectly innocent explanation?

  An explanation is due because one could argue that Hank Paulson as former Treasury Secretary (prior to that he was Goldman's CEO) was an interested man. Another interested man, Lloyd Blankfein,

  Goldman's current CEO, had discussions with Treasury Secretary Geithner, although it was denied the discussions were about AIG.

  Notice I said these were interested men, not persons of interest. Yet a detailed explanation of the underlying risk that AIG insured for Goldman Sachs--and others--is in order.

  VIDEO: Early Warning on AIG and Questions on Goldman's Role – Fox Business – March 18, 2009.

  AIG Bubble: Irrational Exuberance

  August 28, 2009

  American International Group Inc.’s equity is currently worth zero, whatever manic depressive Mr. Market may say today (today's open 52.98). It is likely to remain zero based on AIG’s own analysis of its future over the next few years. In fact, its obligations to the U.S. Treasury would trade at a discount today. The only reason AIG’s stock should trade above zero today is if you believe crony capitalism will fund the birth of an AIG clone—in other words if you believe AIG’s future will be a rigged game.

  Today’s Wall Street Journal reported that AIG has changed its timetable for selling assets. That was to be expected, because if it sold its assets quickly, shareholders would get nothing, and the government would not get paid in full. It is also AIG’s probable future scenario, albeit the losses may be mitigated.

  AIG’s new Chief Executive Robert Benmosche “is willing to wait as long as three years to spin off stakes in two multibillion-dollar foreign units.” He’s waiting for a “fair” price, and he admits that if he sells too soon (or doesn’t get a “fair” price), there will be losers all around.

  Benmosche’s own analysis shows AIG “wouldn’t be able to repay the government even if it sold everything.” His strategy is loss mitigation, not a return to AIG’s salad days.

  Even the U.S. Treasury, not known for its transparency or candor during this crisis, wrote that its AIG investment is highly speculative.

  AIG seems disappointed that its Asia focused life insurance unit, American International Assurance Co. (“AIA”), might only raise more than $5 billion as estimated last spring, especially since AIG valued it at $20-$40 billion in February 2009. AIG is also disappointed with valuations for American Life Insurance Co (“Alico”).

  As Mr. Benmosche pointed out: “If the U.S. government doesn’t continue to support AIG, we will fail. We have no right to use the government funding to make a profit; that is inappropriate.”

  If the government’s new policy is to be long-term distressed private equity investors in entities like AIG, then the U.S. Treasury should get a share of the profits. The same goes for some former investment banks—now banks—with which we are long-term business partners. We support them with cheap funding and low borrowing costs due to our guarantees and ongoing liquidity support. We should ask for a large share of the profits, if any.

  Goldman’s Lies of Omission

  October 28, 2009

  In my opinion, David Viniar’s (CFO of Goldman Sachs) comments in the fall of 2008 were a lie (see “I apologize to David Viniar and Goldman’s Lawyers and Call For More Regulation of Goldman Sachs” – November 5, 2009), and for that matter, Lloyd Blankfein’s (CEO of Goldman Sachs) later comments to the Wall Street Journal were disingenuous.

  In the context of what was happening near the time of AIG’s implosion, the key question was “What is going on between Goldman and AIG?” Their rhetoric surrounding this issue is a deft dodge. They may claim they didn’t “technically” lie, but Goldman’s business exposure to AIG posed both credit risk and reputation risk. They seem to overlook elements of the former and put insufficient value on the latter.

  [Afternote: Goldman’s exposure was not, as Viniar stated in September 2008, “immaterial “whatever the outcome at AIG.” Given Goldman’s key role in AIG’s distress, a reasonable liquidator of AIG may have clawed back most of the $7.5 billion in collateral Viniar claimed as a “hedge.” If AIG had gone bankrupt, the underlying CDOs would likely have plummeted further in value—as has happened in past similar market upsets—and his “hedges,” even if they remained whole would not have covered the loss. In fact, after the fall of 2008, the CDOs continued to rapidly lose USD billions in value. Secondary market values as of December 2009 for similar CDO product are bid at single digit pennies on the dollar in a supposedly more stable market.

  (See also: “Goldman Fueled AIG’s Gambles,” Wall Street Journal December 12, 2009)

  Now that the crisis is over, and given the special circumstances of the crisis, and Goldman’s contribution to value-destroying securitizations, it is in the public interest to claw back the money paid to Goldman Sachs. AIG did not need to settle for 100 cents on the dollar in November 2008, and in September 2008, a good negotiator would have refused to hand over more collateral, and should have clawed some back (or insisted it was a temporary loan).

  In late July 2008, SCA settled with Merrill for $500 million on $3.7 B of contracts, or around 13.5%. On August 1, 2008, Ambac settled $1.4 B with Citi for $850 million, or around 60% on the dollar, but unlike SCA and AIG, Ambac wasn’t on the brink of insolvency at the time. Calyon, a French bank also involved in AIG’s transactions, settled similar contracts with FGIC, another bond insurer, for only ten cents on the dollar in August 2008, yet $13.9 billion of Goldman’s contracts with AIG were settled for 100 cents on the dollar in November 2008 via purchases by Maiden Lane III. Ambac recently settled similar credit default swaps for ten cents on the dollar ($5 billion in contracts for around $500 million) as Ambac needed capital, and MBIA has made deeply discounted settlements.

  The November 17, 2009 SIGTARP report notes that Goldman refused to negotiate a settlement for AIG’s contract because it would have lost money. It is time to ask Goldman to buy back these CDOs from the Fed for 100 cents on the dollar, and there is another large position still held by AIG of Goldman’s Abacus CDOs that should also be considered for repurcha
se by Goldman Sachs, given the public’s large investment in AIG.]

  Goldman should have plainly stated that it was owed billions in additional collateral from AIG—after already having collected billions—due to credit default swap contracts and other trading positions. Whether or not Goldman thought its credit risk was totally hedged is a separate, albeit important issue, and I’ll get to that later.

  Among the proximate causes of AIG’s failure were previous calls for collateral made by its credit default swap trading counterparties, including Goldman Sachs. They were entitled to pressure AIG on its prices and demand more collateral; I had publicly challenged AIG’s prices myself more than a year earlier. These actions gave a major push to AIG’s subsequent credit downgrade, which tripped contract triggers that AIG had unwisely permitted its more clever counterparties to insert. (The credit default swap market is not standardized.) This meant AIG had to come up with collateral equal to the entire remaining amount of the credit default swap contract.