David Fiderer's below piece, originally published on the Huffington Post, continues probing the topic of Goldman and AIG. For all intents and purposes the debate has been pretty much exhausted and if there was a functioning legal system, Goldman would have been forced long ago to pay back the cash it received from ML-3 (which in itself should have been long unwound now that plans to liquidate AIG have been scrapped) and to have the original arrangement reestablished (including the profitless unwind of AIG CDS the firm made improper billions on, by trading on non-public, pre-March 2009, information), and now that AIG is solvent courtesy of the government, so too its counterparties can continue experiencing some, albeit marginal, risk, instead of enjoying the possession of cold hard cash. Oh, and Tim Geithner would be facing civil and criminal charges.
Yet as we look forward, we ask, who now determines the variation margin on Greek CDS (and Portugal, and Dubai, and Spain, and, pretty soon, Japan and the US), the associated recovery rate, and how much collateral should be posted by sellers of Greek protection? If Greek banks, as the rumors goes, indeed sold Greek protection, and, as the rumor also goes, Goldman was the bulk buyer, either in prop or flow capacity, it is precisely Goldman, just like in the AIG case, that can now dictate what the collateral margin that Greek counterparties, and by extension the very nation of Greece, have to post on billions of dollars of Greek insurance. Let's say Goldman thinks Greece's debt recovery is 75 cents and the CDS should be trading at 700 bps, instead of the "prevailing" consensus of a 90 recovery and 450 spread, then it will very likely get its way when demanding extra capital to cover potential shortfalls, since Goldman itself has been instrumental in covering up Greece's catastrophic financial state and continues to be a critical factor in any future refinancing efforts on behalf of Greece. Obviously this incremental margin, which only Goldman will ever see, even if the CDS was purchased on a flow basis, will never be downstreamed on behalf of its clients, and instead will be used to [buy futures|buy steepeners|prepay 2011 bonuses|buy more treasuries for the BONY $60 billion Treasury rainy day fund].
In essence, through its conflict of interest, its unshakable negotiating position, and its facility to determine collateral requirements and variation margin, Goldman can expand its previous position of strength from dictating merely AIG and Federal Reserve decision making, to one which determines sovereign policy! This is unmitigated lunacy and a recipe for financial collapse at the global level.
This is yet another AIG in the making, with
Goldman this time likely threatening to accelerate the collapse not
merely of the US financial system, but of the global one, in order to
attain virtually infinite negotiating leverage. Of course, the world will not
allow a Greece-initiated domino, allowing Goldman to call everyone's bluff once again.
As the amount of gross and net sovereign CDS notional is constantly increasing, as more and more hedge funds join the shorting fray with Goldman as the intermediate (just like in AIG), it behooves any remaining regulators and any sensible Federal Reserve parties to supervise precisely what the terms of Goldman's collateral margins with various sovereign debt sellers are, especially when it pertains to increasingly distressed CDS, where a liquidity squeeze, again as in the AIG case, would have tremendous adverse downstream consequences. If indeed Goldman's counterparties are the banks of respective countries, then the parallels with AIG are nearly complete. And we all know what happened then.
Furthermore, we are now convinced that Goldman will join the government in facilitating the engineered market swoon with a bifurcated goal: while the Treasury will take advantage of a sell off to offload as many UST as it can in the rush for safety (which could backfire now that Gold is increasingly seen as a dollar alternative), Goldman (with or without Warren Buffett - it depends on what the actuarial tables say) will jettison its own stock price in order to go private in an increasingly hostile world.
We will discuss all these issue further in the near future, and in the meantime David Fiderer provides yet another nail in the AIG-Goldman coffin.
Placed in a broader context, the front page story The New York Times,
is even more damning of Goldman Sachs than readers might realize.
Goldman played an active role in the destruction of AIG. During Hank
Paulson's tenure as the firm's CEO, Goldman engaged in a series of sham
transactions designed to give the false impression that it was buying
credit default swaps as an instrument for risk management. In fact, it
acquired those swaps in order to double down on bets against
collateralized debt obligations, or CDOs, which it knew to be fatally
flawed. In the latter part of 2008, Paulson and his proxies maneuvered
AIG into a liquidity crisis in order to protect Goldman at the expense
of the U.S. taxpayer.
To appreciate how the Times piece fits into a larger picture, you need to understand why these CDOs were so obviously toxic.
The Fatal Flaw Of These CDOs
AIG went bust because it sold credit default swaps for CDOs stuffed
with slices of subprime mortgage bonds. Those subprime mortgage bonds
all had remarkably similar capitalization structures, divided among
different classes, or tranches, of seniority. The top 80% in seniority
had a credit rating of AAA. The bottom 10% was rated A and below.
The bottom 10% was especially vulnerable because of something that
was an open secret at the time. The subprime mortgage market was
riddled with fraud. So the data used by Goldman and others to structure
these bond deals was highly suspect.
Who bought the bottom 10% of these subprime bond deals? A lot of
those lower-rated tranches were not sold directly to investors. Rather
they were stuffed into CDOs. This point is critical. These CDOs were
not comprised of mortgage loans, or even slices of mortgage loans.
Rather, they held deeply subordinated claims on risky subprime
mortgages. Because these tranches were the last ones to get repaid, it
was easy to foresee, at the time these CDOs were put together, that
investors would lose significant amounts of principal.
People marketing these CDOs claimed that they were safe, because the
risks were diversified, and because of excess collateral cover. But
that line of reasoning never made any sense. The lower rated tranches
were like the passengers in steerage on the Titanic. Once the ship
starting sinking, those passengers were the last ones given access to
the lifeboats. As soon as the housing market started sinking, those
lower-rated tranches would be the last ones given access to any
AIG thought it was selling credit protection for AAA risk. And in
fact, these CDOs, like subprime mortgage bonds, were tranched in a way
that made them top heavy with AAA ratings. Consider, for example, for Adirondack 2005-2,
a CDO arranged by Goldman, which "sold" almost all of the AAA tranche
Societe Generale, which in turn bought credit protection from AIG. Of
Adirondack 2's $1.55 billion capitalization, $1.42 billion, or 91%, was
So how could anyone get comfortable with the notion that 90% of a
portfolio, heavily weighted with deeply subordinated claims on risky
mortgages that were likely to be infected with fraud, represented a
AAA-quality credit risk? It's a question for which there is no good
answer. If anyone looking at these deals had done proper due diligence
and done a common-sense analysis of the structural risks, he would have
realized three things:
1. The original credit ratings for lower-rated slices of these subprime bond deals were meaningless;
2. The original credit ratings on these CDOs were even more meaningless; and
3. The CDOs were destined in fail in a big and obvious way.
Goldman's Malign Intent
Obviously, the people at AIG never figured out what was going on
until it was too late. But there's a mountain of circumstantial
evidence that the people at Goldman had a keen grasp of the fatal flaws
of these CDOs, which they structured. The Times piece is a major addition to that mountain of evidence:
[Former AIG executive Alan] Frost cut many of his deals
with two Goldman traders, Jonathan Egol and Ram Sundaram, who had
negative views of the housing market. They had made A.I.G. a central
part of some of their trading strategies.
Mr. Egol structured a group of deals -- known as Abacus -- so
that Goldman could benefit from a housing collapse. Many of them were
actually packages of A.I.G. insurance written against mortgage bonds,
indicating that Mr. Egol and Goldman believed that A.I.G. would have to
make large payments if the housing market ran aground. About $5.5
billion of Mr. Egol's deals still sat on A.I.G.'s books when the
insurer was bailed out.
"Al probably did not know it, but he was working with the bears of
Goldman," a former Goldman salesman, who requested anonymity so he
would not jeopardize his business relationships, said of Mr. Frost. "He
was signing A.I.G. up to insure trades made by people with really very
negative views" of the housing market.
As further evidence that Goldman used AIG to profit by shorting CDOs, rather than to manage its preexisting risk exposure:
[N]egotiating with Goldman to void the A.I.G. insurance was
especially difficult, Federal Reserve Board documents show, because the
firm did not own the underlying bonds. As a result, Goldman had little
incentive to compromise.
Goldman's seven Abacus deals [Abacus 2004-1, Abacus 2004-2, Abacus
2005-2, Abacus 2005-3, Abacus 2005-CB1, Abacus 2006-NS1, Abacus
2007-18] were unique among all the CDOs in AIG's portfolio. For all the
other deals, the collateral manager, the entity that oversaw and
managed the CDO after closing, was entirely independent from the bank
that originally arranged and structured the transaction. For all the
Abacus deals, Goldman acted both as both the arranging bank and the
collateral manager. This is no small technicality. In other Abacus
deals, Abacus 2006-13 and Abacus 2006-17, Goldman used its "sole discretion"
to retire lower rated CDO tranches without regard to seniority. This
approach, under documentation drafted by Goldman, upends the entire
premise of structured finance.
Most importantly, the government never purchased the Abacus deals when
it bought $62.1 billion other CDOs at par, back in November 2008. Why
didn't the parties feel a need to take the Abacus deals off of AIG's
balance sheet? It's an extremely important question, for which we will
not have an adequate answer until we see the actual documentation,
specifically: the offering memoranda, the performance reports and swap
Hiding Behind Societe Generale
The Times story also suggests that Goldman used Societe
Generale as a front, to conceal from Frost and others the size of their
cumulative bet against these CDOs.
Mr. Sundaram's trades represented another large part of
Goldman's business with A.I.G. According to five former Goldman
employees, Mr. Sundaram used financing from other banks like Societe
Generale and Calyon to purchase less risky mortgage securities from
competitors like Merrill Lynch and then insure the assets with A.I.G.
-- helping fatten the mortgage pipeline that would prove so harmful to
Wall Street, investors and taxpayers. In October 2008, just after
A.I.G. collapsed, Goldman made Mr. Sundaram a partner.
Through Societe Generale, Goldman was also able to buy more
insurance on mortgage securities from A.I.G., according to a former
A.I.G. executive with direct knowledge of the deals. A spokesman for
Societe Generale declined to comment.
It is unclear how much Goldman bought through the French bank, but
A.I.G. documents show that Goldman was involved in pricing half of
Societe Generale's $18.6 billion in trades with A.I.G. and that the
insurer's executives believed that Goldman pressed Societe Generale to
also demand payments...On Nov. 1, 2007, for example, an e-mail message
from Mr. Cassano, the head of A.I.G. Financial Products, to Elias
Habayeb, an A.I.G. accounting executive, said that a payment demand
from Societe Generale had been "spurred by GS calling them."
As noted earlier in the story:
In addition, according to two people with knowledge of the
positions, a portion of the $11 billion in taxpayer money that went to
Societe Generale, a French bank that traded with A.I.G., was
subsequently transferred to Goldman under a deal the two banks had
See here for an analysis of the ten-figure purchases and sales between Goldman and SG.
The AAA Pyramid Scheme Embedded Inside AIG
The Times reports that Goldman tailored the terms of the swaps to exploit these defective credit ratings:
The terms, described by several A.I.G. trading partners,
stated that A.I.G. would post payments under two or three
circumstances: if mortgage bonds were downgraded, if they were deemed
to have lost value, or if A.I.G.'s own credit rating was downgraded. If
all of those things happened, A.I.G. would have to make even larger
Here's an example of how terminology for a general news readership can lead to confusion. In the context of the story, the Times
seems to be referencing the ratings of the CDOs, not the subprime bonds
held by the CDOs. The distinction is critical because almost all
subprime bonds were downgraded in 2007, whereas most of these CDOs were
not downgraded prior to May 2008, when they received minor downgrades.
Most importantly, almost all these CDO tranches were rated AAA during November 2007, when, as the Times
reports, Goldman was demanding billions in cash collateral. There is no
way to reconcile a 40% diminution of value, which Goldman repeatedly
asserted, with a AAA rating. It's like saying 2 + 2 = 11. In effect,
Goldman was admitting that the CDOs' ratings were a joke.
It was an especially cruel joke on AIG and on the American taxpayer.
If the ratings agencies had severely downgraded the CDOs in 2007 or
earlier in 2008, AIG's day of reckoning would have come sooner.
Instead, that day coincided with Lehman's bankruptcy. The ratings
agencies announced their major downgrades of AIG after the close of
business on September 15, 2008. Those downgrades triggered cash
collateral calls and on AIG on September 16, 2008, the same day that a
money market fund, which wrote down Lehman paper, broke the buck and
triggered widespread panic in the money markets.
As noted before, the timing of the CDO downgrades looks suspicious. Eric Kolchinsky, a former managing director at Moody's, has alleged
that the ratings agency deliberately and deceitfully delayed the
announcements of downgrades of various CDOs. The House Oversight
Committee is still investigating the matter.
Why Goldman Pressured AIG to Hand Over Cash
The thrust of the front-page Times article was that Goldman
aggressively pressured AIG to hand over cash collateral beginning in
2007, Goldman asserted, because, the CDOs "were deemed to have lost
value." But negotiations were always at an impasse, for an obvious
reason. There was no way to settle on agreed-upon "market value" for
the CDOs. These securities weren't bought or sold, like Treasuries or
shares of IBM. Nor was there any market benchmark upon which the CDOs
could be valued. The only way to set a price, according to auditors for
AIG and the Federal Reserve, was according to internal valuation models.
The Times reports:
[D]ocuments show there were unusual aspects to the deals
with Goldman. The bank resisted, for example, letting third parties
value the securities as its contracts with A.I.G. required. And Goldman
based some payment demands on lower-rated bonds that A.I.G.'s insurance
did not even cover. A November 2008 analysis by BlackRock, a leading
asset management firm, noted that Goldman's valuations of the
securities that A.I.G. insured were "consistently lower than
The Times reporting suggests that Goldman wanted to control
the dispute by using a nominally independent third party,
PricewaterhouseCoopers, which had shifted into Goldman's camp:
Adding to the pressure on A.I.G., [David] Viniar, Goldman's
chief financial officer, advised the insurer in the fall of 2007 that
because the two companies shared the same auditor,
PricewaterhouseCoopers, A.I.G. should accept Goldman's valuations,
according to a person with knowledge of the discussions. Goldman
declined to comment on this exchange.
Pricewaterhouse had supported A.I.G.'s approach to valuing the
securities throughout 2007, documents show. But at the end of 2007, the
auditor began demanding that A.I.G. provide greater disclosure on the
risks in the credit insurance it had written. Pricewaterhouse was
expressing concern about the dispute.
The insurer disclosed in year-end regulatory filings that its
auditor had found a "material weakness" in financial reporting related
to valuations of the insurance, a troubling sign for investors.
Of course, a highly plausible explanation is that Pricewaterhouse,
like AIG, had assumed that the CDOs' AAA ratings were credible, until
Goldman set them straight. But again, this gets back to the issue of
whether Goldman knew these deals were toxic from the start. Goldman
opposed proposals that would have enabled it to make its case to others:
When A.I.G. asked Goldman to submit the dispute to a panel
of independent firms, Goldman resisted, internal e-mail messages show.
In a March 7, 2008, phone call, Mr. Cassano discussed surveying other
dealers to gauge prices with Michael Sherwood, Goldman's vice chairman.
At that time, Goldman calculated that A.I.G. owed it $4.6 billion, on
top of the $2 billion already paid. A.I.G. contended it only owed an
additional $1.2 billion.
Mr. Sherwood said he did not want to ask other firms to value the
securities because "it would be 'embarrassing' if we brought the market
into our disagreement," according to an e-mail message from Mr. Cassano
that described the call.
The Goldman spokesman disputed this account, saying instead that
Goldman was willing to consult third parties but could not agree with
A.I.G. on the methodology.
The dispute would have been more than embarrassing for Goldman. It
would have shed light on the fatal flaws of these CDOs, which, at the
time, were not known to the broader financial community. These flaws
were not known because so few parties took a serious look at the credit
risk, which was largely assumed by a handful of companies: AIG
Financial Products (under a guarantee by its parent) and the monoline
insurance companies. In early 2008, the monolines started settling
their contingent CDO obligations for a fraction of par. As noted earlier,
they were able to do so because they had the backing of their
regulators. AIGFP, which was unregulated, was on its own. Ever
prescient, Goldman never bought credit protection from the monolines.
Goldman did not "own" the cash it held. Rather, the cash represented
margin that could, in theory, be returned to AIG if the CDOs' value
rose again. Of course, in reality, if you hold the cash you have the
upper hand in any negotiation. Also, the way structured finance deals
work, if early credit losses are worse than expected, the diminution of
value is permanent. The other borrowers in the pool, who never pay more
than 100% of their principal and interest, won't make up the
difference. Finally, as noted before,
the cash collateral for derivatives, like credit default swaps, is very
different than the cash collateral for a loan or other obligation.
Goldman's claims had preferred treatment, another reason why, once it got its hands on the cash, it held the upper hand in any negotiation.
How Hank Paulson Used Proxies to Rig the Eventual Outcome
One thing is as certain as death and taxes. During 2007 and 2008
Edward Liddy was repeatedly briefed, at length, by Pricewaterhouse and
by senior management at Goldman, about the firm's CDO exposure with AIG
and about the valuation dispute. If the matter was so important that
Goldman's CFO and vice chairman took an active role in negotiating the
circumstances for simply attempting to resolve the dispute, then Ed
Liddy thoroughly understood the matter and the stakes that were
involved. This will all come out when Liddy's briefing books, and other
related documentation and correspondence, are obtained by the House
Oversight Committee, which is investigating this matter.
Liddy was the Chairman of the Audit Committee
on Goldman's Board of Directors. Every audit committee of the board of
every publicly held financial institution is briefed in depth about
risk concentrations at the firm. There is no way that Pricewaterhouse
would leave itself exposed by not thoroughly briefing Liddy about these
matters. While it may be a part-time obligation, being Chair of the
Audit Committee at Goldman is a very important job. And during one
all-important week, Liddy did some moonlighting.
A few minutes after he spoke with Goldman's CEO, Lloyd Blankfein, on
September 16, 2008, and shortly after he first considered a government
bailout of AIG, Hank Paulson unilaterally decided that Liddy should
immediately become AIG's new CEO. Unlike Liddy, AIG's CEO at the time,
Bob Willumstad, had relatively clean hands in the CDO saga. Willumstad
had been part of AIG's management for about three months, and had
joined the AIG board in April 2006, when most of Goldman's toxic CDOs
had already been insured by AIG.
That same afternoon, Liddy was on a plane to New York, to start at AIG the next day. Liddy was officially made CEO and Chairman of AIG on September 18. And of course, he immediately immersed himself into negotiating the terms of the government bailout facility, which he signed on September 22. Only on the following day, on September 23, 2008, that Liddy chose to make his resignation from Goldman's board effective.
That was also the week when Paulson spoke to Blankfein 24 times by phone. For further clarification at to why it an innocent explanation of all this is beyond any realm of plausibility, see this earlier piece.
"Who the heck is Dan Jester?" asked Times Opinionator columnist William D. Cohen,
who answered his own question last week. Jester was the former Goldman
deputy CFO who was plucked by Treasury Secretary Paulson in the summer
of 2008 to act as his "contractor," i.e. someone for whom usual
formalities pertaining to government accountability would not apply.
But Tim Geithner made more calls to Jester, during the fall of 2008, than to any other bona fide Treasury employee, with the exception of Hank Paulson. Cohen writes:
One former A.I.G. executive told me that Jester was calling
many of the shots at the insurer between mid-September, when the New
York Fed decided to go ahead with the bailout, and the end of October
2008, when Jester was replaced at A.I.G. by another Treasury official
because, according to The New York Times, of Jester's
"stockholdings in Goldman Sachs." "He was Paulson's man," the former
A.I.G. executive told me. "He was the Treasury's representative, and he
was at every meeting" during that mid-September weekend.
One of the shots being called during that period was the decision for AIG to hand over $18.7 billion in scarce cash to the CDO counterparties in exchange for zero concessions.
At one point, on the following Monday, Sept. 15, as the
A.I.G. situation was spiraling out of control, Jester phoned the three
major credit-rating agencies and asked them to hold off from
downgrading A.I.G. any further, since that additional downgrade would
force the insurer to make even more collateral payments on the spot to
counterparties, further depleting its dwindling cash. Jester's efforts
weren't persuasive. "It was pathetic," the former A.I.G. executive told
There are many people who do not know how to speak forcefully and
effectively to the rating agencies, but that group would not include a
former deputy CFO from Goldman. It would be somewhat analogous to Katie
Couric getting flustered when asked to read a teleprompter. There is no
way that the agencies could have been aware of AIG's difficulties and
not have been equally aware of their own role in contributing to those
difficulties. Nor could they have been unaware that a downgrade would
trigger AIG's liquidity crisis. On the same day that the markets were
absorbing the shock from the Lehman bankruptcy, if the government asks
the agencies to wait just a bit longer to see how the evolving
situation plays out with regard to delicate negotiations for a private
bank deal to provide new liquidity for AIG, the agencies would
ordinarily be inclined to pause for a bit.
For those and other reasons,
I believe Jester's feeble performance was deliberate, that the endgame
was to trigger a liquidity crisis at AIG in order to force a government
bailout, which would be a backdoor bailout of Goldman. The House
Oversight Committee should review Jester's public and private emails
and phone records to get more clarity on this point.
As Paulson wrote in his new book,
"Much of my work was done on the phone, but there is no official record
of many of the calls. My phone log has many inaccuracies and
omissions." Why would the electronic records of his phone calls be
inaccurate, or have any omissions? It's the sort of disclaimer Dick
Cheney would give.