Guest Post: Goldman Sachs Responds To The New York Times

Submitted by Janet Tavakoli of Tavakoli Structured Finance

Pulitzer Prize winner Gretchen Morgenson of the New York Times wrote a must read article (“Revisiting a Fed Waltz with AIG,” November 21, 2009) on Sunday in which she recaps salient points from the November 17, 2009 report of the Office of the Special Inspector General (Neil Barofsky) for the Troubled Asset Relief Programs, “Factors Affecting Efforts to Limit Payments to AIG Counterparties,” and wrote: 

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.

Timothy Geithner’s interaction with the New York Times, first in his role as President of the FRBNY and later as Treasury Secretary, seems to be that of a bailout enabler and a PR spin doctor for Goldman Sachs.  Based on the Sunday article’s revelations, I would not characterize his behavior as that of “a good man in a storm;” he seems a mere water-boy:

According to an e-mail message that Goldman sent to the New York Fed at the time [September of ‘08], Mr. Geithner talked about the article with Mr. Viniar, Goldman’s chief financial officer, before calling me. When Mr. Geithner called, he said that Goldman had no exposure to an A.I.G. collapse and that the article had left an incorrect impression about that. When I asked Mr. Geithner if he, as head of the regulatory agency overseeing Goldman, had closely examined the firm’s hedges, he said he had not. Mr. Geithner told me on Friday that he spoke with Mr. Viniar that day to ensure that Goldman’s hedges were adequate. And, notwithstanding the inspector general’s findings, he said he still believes Goldman was hedged.”

Prior to the article’s publication, Goldman Sachs responded to Ms. Morgenson’s questions about the Barofsky report via an email from its spokesman Lucas van Praag.  The entire exchange can be found here “Goldman’s Response to Questions About A.I.G.,” November 22, 2009.
 
Did Goldman Sachs dissemble and equivocate in its responses to the New York Times? 
 
Based on these responses, the answer is yes.  Treasury Secretary Geithner may wish to keep that in mind the next time he looks to Goldman Sachs for his answers.
 
Mr. van Praag states “Starting in the mid-90s, we bought credit default swaps from AIG to protect our firm from the risk of a decline in the value of risk we had assumed on behalf some of our clients, (i.e. assets to which we had exposure).” Near the end of his email he again mentions “CDOs from our clients” (emphasis added).
 
His email never once mentions that the problematic CDOs requiring collateral calls from A.I.G. that precipitated its liquidity problems, the one’s referenced in the report, seem to be chiefly 2004/5/6 vintage CDOs.  Goldman underwrote the Abacus CDOs on its own list, and Goldman also underwrote CDOs that featured prominently and in large portion on the lists of French Banks SocGen and Calyon as well as Bank of Montreal and Wachovia that also hedged this risk using CDSs with AIG.
 
When responding about whether or not Goldman would have trouble collecting on its hedges in the event of an A.I.G. collapse as Barofsky’s report indicates, Mr. van Praag wrote that Barofsky’s report stated a collapse  “’might have made it difficult for Goldman Sachs to collect on the credit protection it had purchased’ (emphasis added by Mr. van Praag) – however, it might not, and it is our belief that it ultimately would not have done so.”
 
For a firm that trumpets its risk management, Goldman seemed to present only one scenario on September 16, 2008.  Lehman had just gone bankrupt, Bank of America had just agreed to takeover Merrill Lynch, and banks were starved for liquidity just like A.I.G.  The banks’ TARP bailout had not yet occurred.  I suggest that Goldman may be self-deluding with its claim to be stellar risk managers here: “I Retract My Apology and Call for More Regulation of Goldman Sachs.”
 
Mr. van Praag notes that Barofsky’s report said had AIG not been rescued, Goldman would have had to bear the risk of further declines in the CDOs that it transferred to Maiden Lane III.  He retorts “This is accurate in concept; however, Goldman Sachs has significant experience in adeptly managing this form of market risk.”
 
I previously noted how “adeptly” Goldman Sachs manages its risk: “Goldman’s Undisclosed Role in AIG’s Distress”.  How did that work out for the global markets?  Fed Chairman Ben Bernanke told Congress on March 24, 2009: “Conceivably, [AIG’s] failure could have resulted in a 1930’s-style global financial and economic meltdown, with catastrophic implications.
 
Mr. van Praag also wrote: “It is worth noting that we participated in the transfer of assets to the Maiden Lane III vehicle at the request of the New York Federal Reserve.”  I agree this is especially worth noting given that Stephen Friedman, a former Goldman Sachs co-chairman was Chairman of the New York Fed Board, and given the degree of capture Timothy Geithner, then President of the FRBNY demonstrated in his seeming lack of curiosity about Goldman’s hedges as mentioned above.
 
Ms. Morgenson also asked for some perspective about Goldman CEO Lloyd Blankfein’s apology for Goldman’s practices and its contribution to the credit crisis.  She asked why Blankfein said Goldman “participated in things that were clearly wrong and have reason to regret.”
 
Mr. van Praag responded:

Lloyd has expressed regret in various different forums, including a speech to the Council of Institutional Investors in April and one at the Handelsblatt Conference in September. He has stated that the financial services industry collectively neglected to raise enough questions about whether some of the trends and practices that became commonplace really served the public’s long-term interests. In particular, the industry let the growth and complexity in some new instruments outstrip their economic and social utility as well as the operational capacity to manage them.

Of special note is Goldman’s admission that these products have outstripped “their economic and social utility and operational capacity to manage them.” (emphasis added)  That statement is apt for many subsequent trading activities as well.  But as risk managers, Goldman is dodging its responsibility in its representation that these products merely outstripped management “operational capacity.” 
 
Goldman’a risk management ability was not up to the task, and its ability is not up to the task of managing the systemic risk of its now gigantic CDS operations in the wake of the demise and hobbling of many of its competitors.  Operational capacity is one part of the problem.  The other problem is that in Goldman’s responses to the New York Times, a bunch of operators tried to gaslight the press.

* * *

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors.  Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business.  Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008).  Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street  (Wiley, 2009).

Comments

[Anonymous]

Janet--

It seems to me that one key disclosure in the SIGTARP report is that unlike the other banks, Goldman did not hold the CDOs, but had entered into CDS transactions on them with its clients. Thus, its positions with AIG were offset by positions with its clients.

Presumably, Goldman was obligated to post collateral to these clients. Hence, without a collateral payment from AIG, Goldman would have been forced to come up with cash to meet its obligations to its clients--or default itself. This at a time when the market was, as you note, undergoing a profound liquidity crisis and banks were desperate for cash.

In its response to Morgenson, Goldman very obliquely acknowledges that getting the cash was "a benefit": "Did we benefit from Maiden Lane III then? In one sense, yes – there a was a timing benefit in terms of money received sooner than might otherwise have been the case."

"Timing benefit." I'll bet.

I discuss this on my SWP blog here http://streetwiseprofessor.com/?p=2899 and here http://streetwiseprofessor.com/?p=2931

[svendthrift]

JT.. Great work. I'm reading your latest book (Dear Mr. Buffett) now.

[svendthrift]

double.

[Anonymous]

Who could they possibly have hedged with that could have (or would have) honored billions in payoffs? That paper wasn't worth any more than the paper they had with AIG.

[Anonymous]

Dude, can't you read? Van Praag says Goldman is "adept" at that stuff. That's elitespeak for "It's all good, dawg."

[Anonymous]

I am reading JT's book as well. Between her comments on Goldman, AIG and the Fed, I am smitten. I am in deep smit.

[Anonymous]

Regarding Goldman's timing benefit: through what they call risk management (and what we call regulatory capture), Goldman was able to transmute "a bird in the hand is worth two in the bush" into "two birds in hand." Nice work, gentlemen.

[Anonymous]

Is it wrong that I find a women who speaks with such intelligence and passion against Goldman Sachs sexy?

[faustian bargain]

Seeing 'Goldman' and 'risk management' so close together in a sentence...lol

[deadhead]

Ms. Tavakoli:

Thank you for continuing to share your insights.

Your efforts are appreciated by many of us I am sure.

[Cognitive Dissonance]

I fully understand the absolute importance of documenting the Ponzi and all who are involved, even it it's only window dressing for now. Years or decades from today, this will all be research material for the prosecuting team in preparation for the criminal trials.

Unfortunately this will only happen when this country grows the pair it needs to actually do something about these high crimes and misdemeanors. For my part, I'm more interested in figuring out how to help my fellow citizens grow the pair needed to move forward.

Got milk.....er......testosterone?