Must read piece from David Fiderer, first published on Huffington Post
How Paulson's People Colluded With Goldman To Destroy AIG And Get A Backdoor Bailout
Too Big To Fail
is revelatory, though not in the way Andrew Ross Sorkin intended. The
book offers startling evidence that Hank Paulson and his deputies
colluded with Goldman to create a liquidity crisis at AIG, and to
manipulate the government funding a backdoor bailout of AIG's CDO
counterparties, most notably Goldman. It's not that Sorkin's sources
recounted the truth. Quite the opposite. Rather, they told him stories
that were so transparently dishonest that the truth emerges by way of
To understand what happened, you need to remember that the top guys
at Goldman are really, really smart. They are like champion chess
players who anticipate the possible moves of their opponent. The guys
at Goldman can quickly grasp how pieces of a financial transaction work
together, like the pieces on a chessboard, to game out different
scenarios. This attribute is not unique to the guys at Goldman; it's an
essential quality of every good banker. But it does mean that the guys
at Goldman cannot credibly profess to being oblivious.
The other thing that you must remember is that the dagger hanging
over AIG and Goldman -- the eventual payout to the CDO counterparties
-- was a zero-sum game between the two financial giants. On June 30,
2008, AIG's net worth was $79 billion and its CDO obligations totaled
$62 billion. On August 27, 2008 Goldman's net worth was $42 billion and
its share of the infamous CDO portfolio was $22 billion. The stakes
Also, none of the critical elements that led to AIG's demise were
obscure. In retrospect they seem quite obvious. Unfortunately, few in
the financial media have attempted to understand those critical
Before we get to the liquidity crisis at AIG, we need to go back to that special relationship between Goldman and AIG...
Goldman bought credit protection exclusively from AIG because:
Like its peers, Goldman underwrote billions of dollars of toxic
securities known as subprime collateralized debt objections, or CDOs,
and simultaneously bought credit protection on those CDOs in the form
of credit default swaps. But Goldman was unique in that it only bought
protection from AIG Financial Products, or AIGFP, and no one else.
Under normal standards of risk management, this approach is imprudent;
a bank should diversify its risk exposures whenever it can. Given that
AIG was Goldman's biggest client, and that the CDO exposure at AIG was
a huge part of Goldman's equity base, it's inconceivable that Hank
Paulson, Goldman's CEO until June 2006, would not have been regularly
briefed on this matter. The same goes for Goldman's board of directors.
It's a very basic and essential part of any bank's risk management and
It's also a basic tenet of risk management to game out the different
scenarios under which Goldman might seek recovery under its credit
default swaps. Based on that analysis, the choice to deal exclusively
AIG, in retrospect, seems very obvious, for four reasons set forth
1) AIG Financial Products was not regulated, whereas the monolines were;
This is one of those really basic things that few in the media seems
to grasp. The other large companies offering credit protection on the
CDOs were the monoline insurance companies, names like MBIA or AMBAC.
AIGFP was not regulated, whereas the monolines were. A regulator can
order an insurer to withhold any payout that might impair that
company's ability to service its other policyholders. That's precisely
what the New York State Insurance Department
did last April, when it ordered Syncora, the monoline formerly known as
XL Capital Assurance, to suspend payments. This state's regulatory
authority to interfere with the terms of a contract proved to be a
powerful hammer. It incentivized the CDO banks to negotiate haircuts on
their claims throughout 2008.
A lot of people compare the settlements with the monolines with
those at AIGFP and wonder why the monolines negotiated better deals.
But in fact, they are comparing apples and oranges. The only government
entity legally authorized to interfere with AIGFP's contracts was a
bankruptcy court. But even that authority had been seriously curtailed.
2) AIGFP was willing to post cash collateral, which was outside the grasp of a bankruptcy judge;
Here's another very basic thing. The credit protection sold by the
monolines included financial guarantees as well as credit default
swaps, whereas AIGFP extended only credit default swaps. A credit
default swap is a financial derivative. One of the common, and
insidious, attributes of financial derivatives is that a counterparty
may need to post margin, or cash collateral, whenever the spot value of
its contractual claim turns negative. Here's an overly simple example:
Suppose AIG promised to sell Goldman one barrel of oil on January 25,
2011 for $80, and then on June 25, 2010 spot price is $100 (i.e. an
implicit $20 loss). AIG would post $20 in collateral with Goldman. If
the spot price falls to $65 on July 25, then AIG would get its $20
collateral returned, and also receive $15 in collateral deposited by
As a rule the monolines were unwilling to sign any contract that
required them to post collateral. They accrue insurance reserves and,
again, insurance regulation is predicated on the idea that one
policyholder 's recovery not should leapfrog ahead of all the others.
But that's precisely the idea behind posting collateral on a
derivative. If AIGFP filed for bankruptcy, Goldman would be entitled to
immediately liquidate the credit default swap and permanently keep its
cash collateral; a bankruptcy judge could not touch it. The recently
amended bankruptcy code clarified the special priority given to
derivative counterparties over other creditors.
So, as you would expect, It wasn't simply the support of the
regulators that gave the monolines the upper hand in negotiating with
the CDO counterparties; it was also the fact they they held the cash.
3) AIGFP would have been wiped out by a bankruptcy filing, because it was active in financial trading;
There's another reason why the monolines had the upper hand, whereas
AIGFP did not. Bankruptcy was always a viable option for the monolines,
whereas it was not for AIGFP. Aside from its book of business providing
credit support for CDOs, AIGFP was very active in all sorts of
financial trading of all sorts of derivatives. The monolines were not
really involved in that business.
The vast bulk of business done by financial traders is hedged,
meaning there are always two back-to-back contracts. Another overly
simple example: If AIG promised to sell Goldman one barrel of oil on
January 25, 2011 for $80, AIG would simultaneously contract with Morgan
Stanley to buy one barrel of oil on January 25, 2011 for $78, and lock
in the $2 profit. Throughout the next 12 months, any profit from one
contract would correspond to the loss on the other. But if AIG filed
for bankruptcy on June 25, 2010, Goldman could choose to liquidate its
contract and hold on to its collateral, whereas Morgan Stanley might
still insist of selling the oil on the later delivery date. The hedge
would then become unwound, and suddenly expose AIG to a huge trading
The preferential treatment given to derivatives subverts the entire
purpose of a bankruptcy filing, which is to buy time for an orderly
restructuring. For AIGFP, the downside risk of a bankruptcy filing was
vast and unknown, which was not the case for the monolines.
Because Goldman is very savvy about trading risk, it must have
mapped out an endgame enabling it to declare "checkmate" once AIG were
backed into a corner.
4) AIG did not understand what it was doing; it relied on the rating agencies.
But if Goldman was so smart, how could AIG be so dumb? There's a
short answer and a long answer. The short answer is three little
letters: AAA. The long answer gets to the same result; it just takes a
longer while to get there.
According to Michael Lewis's reporting in Vanity Fair, the guys at AIGFP were clueless:
Toward the end of 2005, Cassano [the head of AIGFP]
promoted Al Frost, then went looking for someone to replace him as the
ambassador to Wall Street's subprime-mortgage-bond desks. As a smart
quant who understood abstruse securities, Gene Park was a likely
candidate. That's when Park decided to examine more closely the loans
that A.I.G. F.P. had insured. He suspected Joe Cassano didn't
understand what he had done, but even so Park was shocked by the
magnitude of the misunderstanding: these piles of consumer loans were
now 95 percent U.S. subprime mortgages. Park then conducted a
little survey, asking the people around A.I.G. F.P. most directly
involved in insuring them how much subprime was in them. He asked Gary
Gorton, a Yale professor who had helped build the model Cassano used to
price the credit-default swaps. Gorton guessed that the piles were no
more than 10 percent subprime. He asked a risk analyst in London, who
guessed 20 percent. He asked Al Frost, who had no clue, but then, his
job was to sell, not to trade. "None of them knew," says one trader.
Which sounds, in retrospect, incredible. But an entire financial system
was premised on their not knowing--and paying them for their talent!
It seems less shocking if you understand how these CDOs were put
together and sold. Take a few minutes and glance over the prospectus
for Davis Square Funding VI,
one of the dozens of CDOs structured by Goldman before the risk was
laid off on AIG. You could spend all day studying the document, but you
will never be able to answer the question, "What am I buying?" The
document doesn't tell you. That's the point. It's evident in every
aspect of this document and the offering circulars for most of the
other CDOs. The business purpose, the essence of the deal, can be
summarized in one word: obfuscation.
Goldman argued that these CDOs were put together to meet market
demand, but demand for what? These subprime CDOs were not financing
anything (the underlying mortgages and mortgage securities had already
been financed), nor were they promoting liquidity in the marketplace
(they couldn't be traded because nobody knew what was in them).
If you wanted to invest in a diversified pool of subprime mortgages,
there was no reason to waste hours and hours studying the impenetrable
documentation of a CDO. Instead, you could look into any subprime
mortgage deal, like MASTR Asset Backed Securities Trust 2005-NC2. Skim
for five minutes, and you know that the deal is comprised of 3,380
subprime mortgages, all of which were originated by New Century
Financial, 55% of which were in California, 100% of which are interest
only, 60% of which closed with second liens, 58% of which relied on
"stated documentation," and 83% of which had prepayment penalties. If
you don't like MASTR 2005-NC2, you can easily compare it with hundreds
of other stellar transactions.
Remember, AIGFP only assumed risk exposure on the "super senior"
classes, or tranches, of these CDOs. They only assumed the risk on
paper that was rated AAA. Therein lies the faulty assumption that AIG
and almost everyone else made before they ever started slogging through
the impenetrable documentation. It's rated AAA so you don't need to
worry about the details. The offering circular for Davis Square Funding
VI is just like the offering circular for Davis Square Funding VII
and countless other CDOs. It tells you Moody's Expected Loss Rate on a
credit rated AAA. After 20 years, the cumulative loss is 0.02 percent.
It doesn't tell you that the deal was structured to make a sham of the
due diligence process.
People who bought these CDOs looked at the ratings and almost
nothing else. They relied on Goldman and the rating agencies to make
sure that everything was OK.
Which again brings us to the issue of posting collateral. As a
matter of policy, financial institutions rated AAA or AA almost never
agree to post collateral on their derivative trades. (That's one reason
why big banks find trading to be so profitable.) The only
reason why the guys at AIGFP would have ever agreed to post collateral
back in 2005 or 2006 is because they thought there was no way in hell
that these CDO tranches rated AAA would never be valued at anything
But Goldman's credit default swaps would not trigger a bankruptcy, because there was no way to figure out their market value.
Goldman started harassing AIGFP to start posting cash collateral as early as August 2007, when the matter went to the "highest levels" at Goldman Sachs.
But Goldman met with limited success, for obvious reasons. The idea
that these CDOs could be marked to market is a joke. There never was
any real market of buyers and sellers of these things. AIG's auditor, PricewaterhouseCoopers, and the Fed's auditor, Delloite & Touche,
determined under fair value accounting rules that there was no way that
the CDO obligations could be valued according to any market benchmark.
AIG and Goldman had spirited talks over the amount of posted
collateral for over a year, but those talks had remained at an impasse.
No one could agree on the CDOs' "market value." So long as AIG was
solvent, the inability to quickly ascertain the CDOs' value worked in
AIG's favor. Later, when AIG faced a liquidity crisis, the inability to
quickly ascertain the CDOs' value worked against AIG.
Various side deals mask the true magnitude of Goldman's participation in AIG's CDO portfolio.
According to the AIG memo on CDO exposures,
dated November 27, 2007, obtained by CBS News, Goldman's CDOs
represented about a third of the $67 billion total. But that may have
been understating Goldman's role in building up the portfolio. About 16
of Societe Generale's trading positions were for CDOs that were
arranged by Goldman. Apparently, one way that Goldman would offload
CDOs would be to sell them, along with credit protection from AIG, as a
package deal. In other words, some of the banks never seriously
intended to hold the CDOs in the first place. But Goldman used them as
a front for its own syndicating efforts.
Later, around the time Tim Geithner was brought in to settle the CDO
matter, Goldman pulled another stunt to make it appear as if its CDO
exposure to AIG was smaller than it actually was. The transaction is
alluded to in a couple of obfuscatory paragraphs (pages 16 and 17) in
Neil Barofsky's SIGTARP report
on the AIG bailouts. It appears as if Goldman suddenly sold $8 billion
in CDOs to Deutsche Bank, so that it would appear as if Goldman's share
of the total would look smaller. But the only way that Deutsche Bank
would have bought the stuff is if there were no risk involved.
On September 15, 2008, the rating agencies thought that AIG's CDO portfolio looked just fine.
The Washington Post printed
a 2,700-word article about AIG's internal e-mails during 2007, when the
guys at AIGFP kept insisting that the CDOs did not present any kind of
troublesome risk. But the Post left out a critical element in the narrative. At that time, virtually all of the 148 CDO trades, listed in a November 27, 2007 memo obtained by CBS, were still rated AAA.
In fact, most of these CDOs were first downgraded in May 2008, the
same month that AIG was downgraded from Aa2 to Aa3. At the time, the
CDO downgrades were fairly insignificant. Of course we don't know why
the CDO downgrades occurred when they did, because we don't really know
what's inside of them. But consider how bad the damage was by May 2008.
Among the subprime bonds that comprised the ABX 2006-1 index, the average foreclosure rate was already 25%.
Was AIG really too big to fail? Maybe if you worked for Goldman.
The party line, expressed in Too Big To Fail and elsewhere,
is that an AIG bankruptcy posed a greater systemic risk than a Lehman
bankruptcy, because AIG was so much bigger. But that analysis is highly
superficial and very misleading. AIG itself was a holding company,
which guaranteed the debt of its unregulated financial subsidiary,
AIGFP. The lion's share of AIG's revenues and profits, and about 80% of
its consolidated assets, were concentrated among its different
insurance company subsidiaries. Those insurance companies were solvent.
They did not pose any systemic risk. In fact, it's quite likely that
they would have continued to operate outside of bankruptcy.
The only subsidiary with major problems was AIGFP, whose financial
obligations were guaranteed by the parent. But AIGFP was only about
one-third the size of Lehman. It's almost impossible to see how AIGFP
ever posed a systemic risk, unless everyone's intention to provide a
backdoor bailout to the banks. Put another way, it seems that the only reason that the government needed to step in for AIG was to provide a backdoor bailout to its banks.
Goldman's scheme to create a liquidity crisis at AIG, in
order to manipulate the government into paying CDO counterparties 100
cents on the dollar
Because of laws that emasculated regulatory oversight, Goldman's
trading positions in credit derivatives with AIG had escaped the
scrutiny of the Fed until September 11 or 12, 2008, when AIG told the
New York Fed that it would soon run out of cash. The CDOs did not
trigger a liquidity crisis at AIG, at least, not directly. Rather, it
was the imminent cash drain from anticipated downgrades, from AA- to
A-, which would trigger $30 billion in new collateral postings on
AIGFP's trading positions. In addition, someone at the company had
screwed up. They had invested billions in cash collateral, intended for
someone else, in highly rated mortgage securities, for which there was
suddenly no liquid market. So AIG needed to come up with the cash right
Simultaneously, of course, Lehman Brothers was imploring the
government for support, and Paulson's position, at least on September
12, 2008, was that the Federal government would provide no support of
any kind to bail out a private company like Lehman or AIG. Private
bankers must come up with a private solution on their own.
On September 15, 2008, the same morning that Lehman's bankruptcy
sent shockwaves, Geithner had convened a meeting with JPMorgan Chase
and Goldman to work on an emergency bridge financing for AIG. Why
include Goldman? Traditionally, the bank with the largest credit
exposure to distressed borrower helps arrange the debt restructuring.
Geithner opened the meeting, and left soon thereafter, leaving
Paulson's deputy, Dan Jester, in charge. Jester was a former Goldman
banker whom Paulson had plucked in July 2008 to work on matters that
September 15, 2008: Paulson's deputy sabotages efforts to negotiate a private bank deal.
Sorkin describes the opening of the Monday morning meeting:
"Look, we'd like to see if it's possible to find a
private-sector solution," Geithner said addressing the group. "What do
we need to do to make this happen?"
For the next ten minutes the meeting turned into a cacophony of
competing voices as the banks tossed out their suggestions: Can we get
the rating agencies to hold off on the downgrade? Can we get other
state regulators of AIG's insurance subsidiaries to allow the firm to
use those assets as collateral?
Geithner soon got up to leave, saying, "I'll leave you with Dan,"
and pointed to Jester, who was Hank Paulson's eyes and ears on the
ground. "I want a status report as soon as you come up with a plan."
A critical point here is that Pauslon's deputy, not Geithner, sat at the table to lead government negotiations.
Job 1 was to persuade the rating agencies to forestall their
anticipated downgrades, which would have burned up billions because of
increased calls to post collateral. This task was assigned to the
government's representative, Dan Jester.
"He was as useless as tits on a bull." [AIG CEO] Bill
Willumstad, normally a calm man, was in an uncharacteristic rage as he
railed about Dan Jester of Treasury, while telling Jamie Gamble[a
lawyer at Simpson Thatcher] and Michael Wiseman [a lawyer at Sullivan
& Cromwell] about his and Jester's call to Moody's to try to
persuade them to hold off on downgrading AIG.
Willlumstad had hoped that Jester, using the authority of the
government and his powers of persuasion as a former banker, would have
been able to finesse the task easily.
Willumstad explained that the original plan "was that the Fed was
going to try to intimidate these guys to buy us some time." Instead,
when Jester finally got on the phone, "he didn't want to tell them."
Clearly uncomfortable with playing the heavy, Willumstad told them that
Jester could only bring himself to say, "We're all here, and, you know,
we got a big team of people working and we need an extra day or two."
If Jester spoke to Moody's the way Willumstad said he did, then
there is no doubt in my mind that Jester intended to sabotage the deal.
No other explanation is plausible. The importance of the phone call was
not unlike that of a death row lawyer seeking a last minute stay of
execution. Jester had been the Deputy CFO at Goldman. It would have
been his job to deal with the rating agencies regularly. There is no
way that he would not have known what to say. All he would need to say
is that since AIG's last meeting with Moody's, the situation is
evolving in a way so Treasury and the Federal Reserve are feeling
increasingly confident that the deal being hammered out will
significantly ameliorate the company's liquidity issues. Everyone knows
that the rating agencies do not like to abruptly pull the trigger when
a situation is still evolving. Everyone also knows that the rating
agencies are acutely aware of their chicken/egg role they play in
determining a firm's liquidity situation. (A company has access to the
capital markets because of its rating, but its rating reflects its
access to the capital markets.) Also, as Janet Tavakoli once mentioned,
investment banks train their analysts about how to place pressure on
the rating agencies. Finally, it would not have been indelicate to
allude to the agencies' no-so-clean hands in building up the AAA
pyramid scheme known as AIGP's CDO portfolio.
An in case there were any doubt that Jester's refusal to act as an
advocate for AIG made the critical the difference, here's how Jimmy
Lee, of JPMorgan Chase, tallied the numbers on the morning following
the downgrades. "They [AIG] have $50 billion in collateral and they
need $80 to $90 billion. I don't know how we can bridge the gap."
Because of the ratings downgrades, AIG posted an additional $32 billion
by quarter's end. In other words, they would have needed about $32
billion less if the downgrades had not taken place.
Minutes after Jimmy Lee briefed his boss, Jamie Dimon. Geithner,
Jester Lee and the people from Goldman sat down to figure out what to
September 16, 2008: Paulson installs a CEO at AIG who will favor Goldman.
And a few minutes after Goldman, JPMorgan Chase and the government
tried to figure out what was next, at 9:40 a.m., September 16, Goldman
CEO Lloyd Blankfein placed a call to Hank Paulson, which Paulson took,
even though such communication was illegal.
According to Sorkin's sources, they discussed Lehman and not AIG. Just
at the moment when the government was deciding whether to step in and
save AIG, Blankfein never mentioned that an AIG collapse could have
easily wiped out $15 billion in Goldman's equity and caused everyone to
scrutinize the dodgy CDOs underwritten during Paulson's tenure. Do you
think they just forgot?
As it happened, a few minutes after Paulson got done speaking with
Blankfein, Geithner briefed Paulson about a tentative proposal for the
government to extend AIG an $85 billion facility. The conversation with
Geithner ended at 10:30 a.m.
Sorkin's sources fabricated a tall tale about what took place afterward:
However resistant Hank Paulson had been to the idea of
a bailout, after getting off the phone with Geithner, who had walked
him through the latest plan, he could see where the markets were headed
and that it scared him. Foreign governments had already been calling
Treasury to express their anxiety about AIG's failing.
Jim Wilkinson [Paulson's deputy, formerly of the White House
Communications office] asked incredulously," are you really going to
rescue an insurance company?"
Paulson just stared at him as if to say only a madman would stand by and do nothing.
Ken Wilson, his special advisor, raised an issue they had yet to
consider. "Hank, how the hell can we put $85 billion into this entity
without new management?"-- a euphemism for how the government could
fund this amount of money without firing the current CEO and installing
its own. Without a new CEO, it would seem as if the government was
backing the same inept management that had created this mess.
"You're right. You've got to find me a CEO. Drop every other thing you are doing," Paulson told him. "Get me a CEO."
Their choice: Ed Liddy, the former CEO of Allstate and Goldman board member.
The "same inept management that had created this mess"? It's
impossible to overstate the mendacity embedded in that brief passage
from Sorkin's book. If Paulson actually spoke what was on his mind at
the time, the words would have been something like this:
"So if we don't bail out AIG, then Goldman takes a $15 billion
hit to its equity and faces shareholder lawsuits for actions taken
under my watch. And Willumstad, the new AIG CEO who joined management
after all these toxic CDOs were booked, will find it very convenient to
also point the finger of blame at Goldman. [Willumstad joined AIG's
board in April 2006, and became CEO in June 2008.] The AIG bankruptcy
trustee might even sue Goldman for making fraudulent claims about the
CDOs, the same way that HSH Nordbank sued UBS and M&T Bank sued
"But if we bail out the company, there's still no guarantee that
Goldman can recover on the CDOs. And Willumstad can still point the
finger at Goldman. So before we agree to anything we've got to get rid
of Willumstad ASAP and replace him with someone who will make sure that
Goldman's interests are being looked after. Let's use Ed Liddy. He's a
Goldman board member, so he will never disclose anything that makes
Goldman look bad. If he wants to preserve the value of his Goldman
stock, he'll discreetly pay off the CDOs before anyone figures out
what's happening. So I decided Willumstad's replacement will be Liddy,
beginning tomorrow, and I don't give a damn that my unilateral decision
to change CEOs overnight is a complete travesty of corporate governance
or government accountability. Our story will be that we are replacing
the management that created this mess."
How do I know that this was on Paulson's mind and that these were
his motivations? As noted at the beginning, the guys at Goldman are
very smart, and they knew that the CDO settlement was a zero-sum game.
Remember, AIG was Goldman's biggest client and the issue of collateral
postings had been in dispute for over a year. Up until June 2008, Ken
Wilson was CEO of Goldman's Financial Institutions Group. There is
absolutely no way that Wilson did not know what was going on with AIG's
management, and that Goldman, not Willumstad was primarily culpable for
building up the CDO portfolio.
Also, I've been a round the block a few times. Whenever faced with a
crisis, senior people immediately think about how the situation will
reflect on them. And they promptly think about damage control. And like
many people who rise to the top, Paulson knows how to avoid leaving
fingerprints. He probably learned his lesson decades earlier, working
as John Erlichman's assistant. Like those other famous CEOs, Bernie
Madoff and Donald Rumsfeld, Paulson never used e-mail at work. The day after he fired Willumstad, Paulson spoke on the phone with Blankfein five times.
Whoever bore the blame for creating the mess at AIG, it's
extraordinarily reckless, during the middle of a crisis, to immediately
install a CEO with no prior experience at the company, which is a huge
sprawling conglomerate. That's especially true when that new CEO has a
conflict of interest the size of the Grand Canyon.
Sorkin also makes clear that it was Jester, not Geithner, who took control in structuring AIG's bailout facility. Before Geithner gets on a conference call with Bernanke:
Jester and [Paulson's assistant Jeremiah] Norton were
poring over all the terms. They had just learned that Ed Liddy had
tentatively accepted the job of AIG's CEO and was planning to fly to
New York from Chicago that night. To draft a rescue deal on such short
notice, the government needed help, preferably from someone who already
understood AIG and its extraordinary circumstances. Jester knew just
the man: Marshall Huebner, the co-head of insolvency and restructuring
at David Polk & Wardell who was already working on AIG for JP
Morgan and who happened to be just downstairs.
Months later, Paulson's spokesman told The New York Times that, "Federal Reserve officials, not Mr. Paulson, played the lead role in shaping and financing the A.I.G. bailout."
October 7, 2008: Paulson's appointee unnecessarily pays out $18.7 billion to the CDO counterparties in exchange for nothing.
Actions speak louder than words, and AIG's new CEO acted in a way
that removed any doubt that he would make decisions in favor of
Goldman. Remember, there was no need to hand over anything to the CDO
counterparties, because there was no agreed-upon market value for the
CDOs, which were all still highly rated. On October 7, 2008, AIG paid out $18.7 in cash
in exchange for nothing. Before that October 7, only 26% of the CDOs'
face value had been paid out as cash collateral. Immediately afterward,
counterparties hold cash for 56% of the CDOs' face value of $62.1
billion. All of a sudden, the banks, not AIG, had the upper hand.
November 6, 2008: Only at the point when AIG is once again
running out of cash and running out of time, and the CDO banks now hold
the upper hand, Geithner is brought in to settle a matter when the
government is backed into a corner. (Checkmate anyone?)
On November 5, 2008 only $24 billion remained available under the
government's revolving credit facility, though that cash could have
been used up overnight if AIG were downgraded below A-. But, as S&P said, "if mortgage-related losses continue to worsen, then we could lower the ratings into the 'BBB' category."
The CDOs, (which would all be downgraded into the CCC category in a
few months), remained a dagger hanging over AIG's liquidity situation.
The only way to restore confidence in the company would be to remove
But the banks now had the upper hand, since they held most of the
cash. Time was not on Geithner's side, and protracted negotiations over
the CDOs' underlying value could have taken forever. Also, 29% of the
remaining CDO exposure belonged to two French banks, whose regulator
advised Geithner that it was illegal for them to settle at less than
par. Challenging another country's bank regulator would have opened up
a whole can of worms at a point when the risk of global financial panic
was very real.
Geithner's attempts to drive a harder bargain would have created a
crisis in confidence that could have likely triggered a further ratings
downgrade. The $27 billion to remove the CDO albatross off of AIG's
books was only 15% of the entire $180 billion bailout package.
November 12, 2008: Following public disclosure of the
backdoor bailout, Paulson announces his big bait-and-switch: his
refusal to use TARP funds to stabilize the mortgage markets.
The collective amnesia of mainstream media notwithstanding, there
was full contemporaneous public disclosure of the backdoor bailout of
the banks at the time the deal was cut. The bailout package had a lot
of moving parts, so it took The Wall Street Journal a day or so before it figured out precisely hat was going on. "New AIG Rescue Is Bank Blessing," printed
on page C1, explained that banks "will be compensated for the
securities' full, or par, value in exchange for allowing AIG to unwind
the credit-default swaps." And for anyone who was slow on the uptake,
the Journal printed a picture:
Once the public learned that the CDOs no longer posed a risk to AIG,
Paulson announced his his big bait-and-switch: his refusal to use TARP
funds to stabilize the mortgage markets. This about face causes the
value of all mortgage securities to plummet, imposing an additional
loss on Maiden Lane III (and triggering the insolvency of Merrill
But Paulson's coup de grace was to use one of his appointees to
fabricate a false history of the backdoor bailout. But that's for
Addendum: January 26, 2010 12:50 Bloomberg's New Puff Piece for Goldman
Once again, Bloomberg has come out with a story that has almost no real facts but plenty of misleading soundbites. From, "Goldman Sachs Drove Most Costly AIG Bargain, Document Shows":
A month before the September 2008 rescue, Goldman Sachs
approached AIG about tearing up contracts protecting the bank against
losses on collateralized debt obligations, or holdings backed by
mortgages, according to a BlackRock Inc. presentation dated Nov. 5,
2008. Goldman Sachs was the only counterparty willing to cancel the
credit-default swaps and bear the risk of further CDO losses, provided
that AIG make payments based on the bank's larger-than-average estimate
of market declines.
Tear up the contracts in exchange for what? Par? How much
less than par? If you don't the number, you don't have a story. Goldman
and AIG had been arguing over collateral postings for over a year. A
phrase like, "payments based on the bank's larger-than-average estimate
of market declines," is a meaningless term. Real journalists would put
up or shut up.
Instead, we story is padded with lots of empty filler, all of which are used to make Goldman look good. Stuff like:
"We had always made it clear that we were prepared to tear
up contracts, it just had to be at the right price," Lucas van Praag, a
spokesman for Goldman Sachs in New York, said in an interview...Goldman
Sachs, which created securities tied to home loans and serviced debt on
residential properties, "would have had a very decent view of what the
underlying mortgage bonds were and what they thought they were worth,"
said Thomas J. Adams, a partner at law firm at Paykin Krieg & Adams
LLP in New York...
<"Goldman was not Pollyanna on what the underlying mortgage bonds
were worth," said Adams, who was a senior managing director in charge
of the CDO business at FGIC Corp. from 2006 to 2008. "They were fairly
Let's hope that Bloomberg updates the story with something real.