Guest Post: Goldman's Abacus CDO (And Other CDOs), AIG, And Global Systemic Risk

Submitted by Janet Tavakoli of Tavakoli Structured Finance

Today’s FT Alphaville continues the saga of the Goldman Abacus deal that Bloomberg wrote about last week: http://ftalphaville.ft.com/blog/2009/11/16/83386/weird-waterfalls-and-the-synthetic-cdo-stumper-part-deux/. Yves Smith (mentioned in the post) is probably unaware that there were a lot of CDOs done with the spin that cash flow could be diverted from the senior tranches and payout priority could be changed (there has even been litigation around this issue).  I wrote about these “wrinkles” and more in the 2003 (and again in the 2008) editions of my book: Structured Finance & Collateralized Debt Obligations. Sophisticated investors are obliged to do their own due diligence.
 
Not mentioned in Jody Shenn’s Bloomberg article last week or in the FT Alphaville posts, is that the excess deal cash in the reserve account/GIC could be invested in ABS CDOs (as opposed to something liquid and high quality).  This feature applied to the Abacus deal (among other Abacus deals) Bloomberg wrote about last week, and I also wrote about this in the 2003 edition.
 
But when it comes to AIG and the U.S. taxpayer we are no longer talking only about a sophisticated investor.  AIG posed enormous global systemic risk, chiefly because it had to mark-to-market credit derivatives written on problematic CDOs.  A major slug of these deals came from Goldman or CDOs underwritten by Goldman, as I explain in my November 10, 2009 commentary (“Goldman’s Undisclosed Role in AIG’s Distress” http://www.tavakolistructuredfinance.com/GS3.pdf).
 
The U.S. taxpayer was not sophisticated and did not sign up for these risks.  Moreover, the global financial system did not sign up to be the victim of the systemic risk posed by these flawed securitizations.
 
I have been a big critic of the systemic risk posed by excessive leverage, problematic CDOs and the credit derivatives written against them.  But I did not specifically criticize Goldman’s deals until it became an issue of public interest when AIG blew up. 
 
Goldman may not have to answer to sophisticated investors, but it should answer for its role in the systemic risk posed by AIG’s near collapse, its role in the way in which AIG was bailed out, and the fact that the U.S. taxpayer had to bail out the global financial system along with a number of Goldman’s trading partners.