The New Robber Barons Page 6

  Goldman’s spokesman said that Goldman bought protection from AIG on underlying super senior CDO risk. I pointed out that if the underlying super senior CDO were backed by BBB-rated assets like those of GSAMP Trust 2006-S3, it would be worth zero. The underlying so-called super senior CDO appeared very risky instead of “super safe,” since Goldman extracted billions from AIG before and after the bailout.

  Trades like these contributed to systemic risk posed by AIG’s shaky situation. The spokesman initially claimed Goldman could not have been aware of AIG’s other positions, until I pointed out that my own early concerns about AIG were based on information available to Goldman.

  As for the separate issue of Goldman’s mortgage securitizations, when I expressed my view that securitization professionals knew or should have known that deals like GSAMP Trust 2006-S3 were overrated and overpriced, Goldman’s spokesman claimed it was a “minority” opinion, and that the “majority” had a different opinion of the risk at the time. But I maintain the risks were discoverable in the course of competent due diligence, and “disclosures” did not include the fact that ratings were misleading and did not reflect the risk.

  As for my opinion, it has been proven correct. It is in the public interest not to rely on Goldman’s opinion, if it counts itself with what it calls the “majority.”

  Goldman needs competent regulation and more of it. Among other things, Goldman’s credit derivatives should be cleared on the exchanges. Citadel’s CEO Kenneth Griffin commented recently in the Financial Times that Lehman’s collapse caused little disruption in the exchange traded markets. But unregulated credit default swaps and non-cleared interest rate swaps “triggered chaos in the market.” I join Mr. Griffin in saying “regulators must implement central clearing and put the integrity of the capital markets ahead of the profits of a self-interested few.”

  1 On September 16, 2008, Viniar did not mention the amount of Goldman’s gross exposure, or the amount of collateral it had already been paid by AIG, nor did he mention the dollar amount of collateral Goldman had received from hedge counterparties for credit default swaps on AIG. Goldman’s spokesman said the hedge was perhaps (Goldman’s spokesman was unable to confirm—the numbers weren’t to hand—if Goldman was covered for the full notional amount) fully cash collateralized by billions in payments from Goldman’s other hedge counterparties. In my Nov 2 commentary, I acknowledged that Goldman was apparently over hedged for an AIG collapse. Apparently David Viniar did not consider a scenario (or considered it very remote) where AIG and the Fed might settle with Goldman for a partial payment, and Goldman’s counterparties might wage a dispute for a return of their collateral. He also may not have imagined a scenario where U.S. taxpayers might be entitled to a claw back bailout payments made to Goldman.

  Goldman’s Undisclosed Role in AIG’s Distress

  November 10, 2009

  Goldman wasn’t the only contributor to the systemic risk that nearly toppled the global financial markets, but it was the key contributor to the systemic risk posed by AIG’s near bankruptcy. When it came to the credit derivatives American International Group, Inc. (AIG) was required to mark-to-market, Goldman was the 800-pound gorilla. Calls for billions of dollars in collateral pushed AIG to the edge of disaster. The entire financial system was imperiled, and Goldman Sachs would have been exposed to billions in devastating losses.1

  A Goldman spokesman told me its involvement in AIG’s trades was only as an “intermediary,” but that isn’t even close to the full story. Goldman underwrote some of the CDOs comprising the underlying risk of the protection Goldman bought from AIG. Goldman also underwrote many of the (tranches of) CDOs owned by some of AIG’s other trading counterparties.

  Even if all of Goldman’s CDOs had been pristine, it poisoned its own well by elsewhere issuing deals like GSAMP Trust 2006-S3 that—along with dodgy deals issued by other financial institutions—eroded market trust in this entire asset class and drove down prices.

  By September 2008, Goldman had approximately $20 billion in transactions with AIG. Goldman was AIG’s largest counterparty, and its trades made up one-third of AIG's approximately $62.1 billion [Note added Nov. 30, 2009: Goldman’s trades totaled $23 billion (as of November 2007). As of November 2008, the remaining amount was $22.1 billion of which $13.9 billion was resolved by Maiden Lane III’s purchase of $62.1 billion of CDOs. AIG retained another $8.2 billion of Goldman’s credit default swaps referencing multi-sector CDOs.] in transactions requiring market prices.2

  Societe Generale (SocGen) was AIG’s next largest counterparty with $18.7 billion (as of November 2007). SocGen, Calyon, Bank of Montreal, and Wachovia bought several (tranches) of Goldman’s CDOs and hedged them with AIG.3

  On November 27, 2007, Joe Cassano, the former head of AIG's Financial Products unit, wrote a memo about the collateral AIG owed to its counterparties. Goldman, Soc Gen, Calyon and others required more than $4 billion. Goldman asked AIG for $3 billion of the $4 billion required in collateral calls. (Click here to view the nine-page memo uncovered by CBS News in June 2009.) By September 2008, Goldman had called $7.5 billion in collateral from AIG.

  AIG lists its transactions as negative basis trades. This suggests Goldman earned a net profit by purchasing—or holding its own—CDO tranches and then hedging them with AIG.4 [Note added Nov 17, 2009 – The SIGTARP report shows that Goldman held this risk in the form of credit default swaps for which it was a protection seller and it hedged its risk with AIG. Whether the risk was held as cash or credit default swaps, the negative basis trades, profitability, and risk to Goldman Sachs still applies.] As AIG’s financial situation worsened, Goldman bought further protection in the event AIG collapsed.

  SocGen’s negative basis trades totaled $18.6 billion. For example, SocGen bought protection from AIG on two tranches of Davis Square VI, a deal Goldman underwrote. According to AIG’s documentation, SocGen got its prices for marking purposes for Goldman’s deals from Goldman. As of November 2007, Goldman marked down these originally “AAA-rated” tranches to 67.5%, down by almost one-third.5

  SocGen’s list includes other deals underwritten by Goldman: Altius I, Davis Square II, Davis Square IV, the previously mentioned Davis Square VI, Putnam 2002-1, Sierra Madre, and possibly more. SocGen hedged this risk by purchasing protection (in the form of credit default swaps) from AIG.

  Calyon had $4.5 billion of negative basis trades with AIG. Calyon and Goldman were co-lead on at least two deals: Davis Square II and Davis Square V. According to AIG’s memo, Calyon got its prices for these deals from Goldman.

  Goldman’s list of negative basis trades prominently featured many of Merrill’s CDOs (as underlying risk), and Merrill had its own list amounting to around $9.9 billion (as of November 2007). In Sept 2008, at the time of AIG’s near collapse, Bank of America had just agreed to merge with Merrill, which held $6 billion of super senior exposure to CDOs hedged with an insurer, now revealed to be AIG. Both Ken Lewis, then CEO of BofA, and Hank Paulson received tough questions about the merger, but not tough enough. Lewis later testified that Hank Paulson (then Treasury Secretary and formerly CEO of Goldman at the time of the AIG related trading activity) urged him to be silent about Merrill’s troubles. Merrill later received a $6.3 billion bailout payment from AIG.

  Bank of Montreal had $1.6 billion in negative basis trades with AIG, and at least two Goldman transactions (Davis Square I and Putman 2002-1) made up 6 of its 9 positions with AIG. Wachovia had 6 trades with AIG, all related to Davis Square II, a deal that Goldman underwrote.

  Goldman questioned PriceWaterhouse, Goldman’s and AIG’s common auditor, about prices. Goldman wanted lower prices, which meant that AIG would have to produce more collateral. When AIG was downgraded in September 2008, AIG was required to put up an aggregate amount of $14.5 billion in additional collateral to equal the full difference between original prices and market prices. But “market prices” in this illiquid market were influenced by Goldman Sachs.

  Goldman was
right to question the prices, make calls for collateral, and protect itself. Goldman’s activity was not the same as that of an arsonist buying fire insurance, but its trading activities with AIG and others were accelerants of AIG’s problems.

  During AIG’s bailout, Goldman had influence over the decision to use public funds to pay 100 cents on the dollar for these CDOs (the underlying risk of the credit derivatives), but none of the information about the volume of Goldman’s trades with AIG—or the Goldman CDOs hedged by AIG’s other counterparties—was made public.

  Goldman’s public disclosures in September 2008 obscured its contribution to AIG’s near bankruptcy and the need to bailout Goldman’s trading partners in AIG related transactions. Goldman’s trading activities played a starring role in the near collapse of the global markets.

  1 Goldman’s current and former officers were influential in varying degrees in AIG’s bailout. Hank Paulson was then Treasury Secretary and a former CEO at the time Goldman put on its trades with AIG and underwrote deals bought by some of AIG’s counterparties. Lloyd Blankfein was CEO of Goldman and was influential in the bailout discussions. Stephen Friedman, then Chairman of the NY Fed, also served on Goldman’s board.

  2 AIG’s Nov 2007 report showed Goldman’s positions at $23 billion, but something may have happened before Sept 2008 to reduce that amount. AIG was required to price these credit derivatives using market prices, and if applicable, AIG had to provide collateral if the prices moved against it. Terms varied, but after the downgrade, AIG owed collateral for the full mark-to-market value to several counterparties. This is the difference between the original value and the price that Goldman and others put on the credit default swaps.

  3 AIG’s other trading partners for the CDSs requiring mark-to-market prices included French banks Societe General (SocGen) and Calyon, Bank of Montreal, Wachovia, Merrill Lynch, UBS, Royal Bank of Scotland, and Deutsche Bank.

  4 AIG may have used the term “negative basis trade” loosely. Whether Goldman was an intermediary (stood between AIG and yet another counterparty), or whether it booked negative basis trades, Goldman had to manage its risk in the event AIG went under.

  5 SocGen’s total margin calls were not available in the November 2007 memo. It is possible that like Calyon—and like troubled Citigroup—SocGen provided a liquidity put on commercial paper (CP) distributed by Wall Street firms to a variety of investors. Calyon agreed to buy the CDO’s commercial paper (short term debt backed by the longer term tranches of the CDOs) if demand in the market dried up when it came time to roll the CP. Calyon hedged the risk of the liquidity puts by purchasing credit default protection from AIG.

  I Retract My Apology and Call for More Regulation of Goldman Sachs

  November 22, 2009

  According the November 17 report from Neil Barofsky, the special inspector for the Troubled Asset Relief program, both the Federal Reserve and Treasury agreed that an AIG failure posed unacceptable risk to the global financial system and the U.S. economy. On March 24, 2009, Fed Chairman Ben Bernanke testified before the House Financial Services Committee:

  Conceivably, its failure could have resulted in a 1930’s-style global financial and economic meltdown, with catastrophic implications.

  From July 2007, AIG’s financial situation deteriorated while so-called “AAA” collateralized debt obligations (CDOs) dropped in value. AIG sold credit default swaps (CDSs) on these CDOs and had to post more collateral, as the prices plummeted.

  Goldman Sachs was AIGFP’s (UK-based AIG Financial Products) largest CDS counterparty with around $22.1 billion, or about one-third of the problematic trades. Goldman underwrote some of the CDOs underlying its own CDSs, and also underwrote a large portion of the CDOs against which other counterparties had done trades with AIG. (“Goldman’s Undisclosed Role in AIG’s Distress”)

  In mid-September 2008, the global markets narrowly avoided Apocalypse AIG. It’s long-term credit rating was downgraded, its stock price plummeted, and AIG couldn’t meet its borrowing needs in the short-term credit markets. According to the report, “without outside intervention, the company faced bankruptcy, as it simply did not have the cash that was required to provide to AIGFP’s counterparties as collateral.”

  The Federal Reserve Board with Treasury’s encouragement authorized a bailout, and the Federal Reserve Bank of New York (FRBNY) extended an $85 billion revolving credit facility, a loan similar to a credit card—except that AIG will never pay interest rates of nearly 30%--so AIG could make its payments. (“AIG Discloses Counterparties to CDS, GIA, and Securities Lending Transactions”)

  On September 16, 2008, as the FRBNY arranged AIG’s $85 billion loan, Goldman CFO David Viniar said whatever the outcome, he would expect the direct impact of credit exposure to be “immaterial to [Goldman’s] results.” The CDOs’ ($22.1 billion) value was down around $10 billion, and AIG still owed Goldman $2.5 billion in collateral (hedged and partly collateralized by CDSs to protect against an AIG bankruptcy).

  The report shows the CDOs’ value fell another $2.5 billion in the next two months, and AIG’s new loan provided more collateral. The CDOs were losing market value. If AIG had collapsed, the value drop would have been swift and brutal with new protection either unavailable or too expensive, if past CDS market mayhem provided any information. As the Wall Street Journal put it, SIGTARP “throws cold water on [Goldman’s] claim.”

  Goldman didn’t seem as protected as it claimed. Barofsky’s report said Goldman might have had trouble collecting on its hedges on its hedges if AIG collapsed. When Viniar made his September 16, 2008, remarks, banks needed money. It was before TARP money was distributed.

  The report also showed that private investors walked away from a potential bailout on September 15, 2008, after their analysis showed AIG’s immediate cash needs were greater than the value of the company’s assets.

  Not addressed in the report is Goldman’s assumption that it would get to keep the billions in dollars it received from AIG, if AIG collapsed. That would normally be the case, but this was a global crisis with very special circumstances. AIG’s crisis was inflamed by value-destroying CDOs over which Goldman had pricing power, and Goldman had underwritten some of the CDOs.

  Authorities charged with resolving a collapse of AIG may have clawed back a substantial portion of those billions. Even if Goldman escaped that possibility, the report states the underlying CDOs posed substantial market value (price) risk. As for systemic risk, Goldman CEO Lloyd Blankfein worried about untold billions in losses. (Too Big to Fail, P. 382.)

  Before September 16, 2008, AIG tried to negotiate a settlement for forty cents on the dollar. Other insurers have negotiated even deeper discounts to settle their CDS contracts on CDOs. The SIGTARP report shows that the FRBNY’s decision to pay 100 cents on the dollar to resolve $13.9 billion (part of Goldman’s $22.1 billion) of credit default swaps by purchasing the underlying CDOs in Maiden Lane III was important to Goldman Sachs. “Goldman Sachs…did not agree to concessions, because it would have realized a loss if it had.”

  Was this a backdoor bailout? Pulitzer Prize winner Gretchen Morgenson put it this way in the New York Times’s expose on Sunday: On the question of whether this payout was what the report describes as a “backdoor bailout” of A.I.G.’s counterparties, Mr. Barofsky concluded: “The very design of the federal assistance to A.I.G. was that tens of billions of dollars of government money was funneled inexorably and directly to A.I.G.’s counterparties.” [T]his was money the banks might not otherwise have received had A.I.G. gone belly-up.

  Treasury Secretary Timothy Geithner, then President of FRBNY, appears in Ms. Morgenson’s article with apparent Stockholm syndrome rivaled only by Patty Hearst. He seems to echo Goldman’s talking points after discussions with Goldman’s CFO. In the fall of 2008, Henry (“Hank”) Paulson was Treasury Secretary. Paulson was formerly CEO of Goldman Sachs and held that role when Goldman executed its trades with AIG. Stephen Friedman, a former Goldman Sachs co-chairman, was C
hairman of FRBNY. Friedman owned shares of Goldman Sachs, and was a member of Goldman’s board, while he held his influential Fed position. He resigned the Fed position in May 2009, but not before purchasing 50,000 shares of Goldman Sachs, when the public was still in the dark about the terms of the bailout.

  Goldman’s Turn to Apologize

  In light of the SIGTARP report, I withdraw my earlier apology to Goldman. Public commitments to AIG are currently around $182 billion. If you wonder what Goldman CEO Lloyd Blankfein meant when he said: “[Goldman Sachs] participated in things that were clearly wrong and we have reason to regret and we apologize for them,” think of Goldman’s role in AIG’s crisis, Goldman’s bailout, and Goldman’s ongoing heavy taxpayer subsidies. That way, one of you will be genuinely sorry about it.

  Responding to Goldman Sachs

  December 25, 2009

  The New York Times published a Christmas Eve expose of Goldman Sachs's so-called "Abacus" synthetic collateralized debt obligations (CDOs). They were created with credit derivatives instead of cash securities. Goldman used credit derivatives to create short bets that gain in value when CDOs lose value. Goldman did this for both protection and profit and marketed the idea to hedge funds.