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Some Insights On David Viniar's Grilling By Brooksley Born On The Firm's Double Profit From AIG

Tyler Durden's picture




 

Goldman's David Viniar is currently being grilled in the second day of the FCIC's hearings by Brooksley Born, who is asking the smartest questions of the CFO we have ever heard on TV. The webcast can be seen here. The main question being hammered again and again is why and how did Goldman profit twice on AIG, first by being bailed out by taxpayers, when the firm received a par payout on its collateral exposure with the insurer, and secondly, and much more importantly, how and why the firm made a profit of $1.2 billion by buying and selling CDS on the insurer, which comports with Lloyd Blankfein's previous statement that the firm was fully insured against an AIG collapse. This is a topic Zero Hedge has covered since March of 2009. Much more important at this point is the tangent of the circumstances surrounding the AIG CDS sale: we harken back to our post from January 2010, titled "Did Goldman Sell Its $2.5 Billion AIG CDS While In Possession Of Material, Non-Public Information?" in which we speculated that not only did Goldman receive an unfair second profit via the CDS, but that in fact it sold this insurance while potentially in possession of material non-public information. Now that this topic has finally surfaced to the broader population, we would like to once again bring attention to it, and we hope Brooksley Born has a chance to follow up on it.

We recreate the January 13 post in its entirety below:

 


 

Did Goldman Sell Its $2.5 Billion AIG CDS While In Possession Of Material, Non-Public Information?

As frequent readers will recall, on March 20, 2009, David Viniar and
Lucas van Praag held a conference call in which, for the first time, the
firm discussed the impact of its hedging on AIG as well as its
collateral and otherwise exposure with the nationalized insurer. The
full transcript of the call can
be found here
, while our immediate comments on call, which
we posted after the call
, are replicated below in their entirety:

In
a nutshell - Goldman had bought billions in AIG CDS in the 2004 to
2006 timeframe. Whether this was predicated by their expectation that
subprime would blow up, or their very early understanding just how bad
things at AIG were, one will never know, especially not the SEC.
However, one look at the CDS chart below shows what prevailing levels
for AIG's CDS was in that time frame. As one can see, AIG 5 yr CDS
traded in a range of 4 bps to 52.50 bps between October 1, 2004 (only
goes back so far) and December 31, 2006. Indicatively 5 yr CDS closed
yesterday at a comparable running spread equivalent of 1,942 bps.

Purchasing
$10
billion in CDS (roughly in line with what Viniar claims happened)
at a hypothetical average price of 25 bps (and realistically much less
than that) and rolling that would imply that at today's AIG 5 yr CDS
price of 1,942 bps, the company made
roughly $4.7 billion in profit from shorting AIG alone!

This would more than make up for the $2.5 billion collateral shortfall
(out of $4.4 billion total) GS claims AIG had with Goldman Sachs... If
AIG had filed for bankruptcy, and assuming Lehman is any indication,
the P&L would have likely hit $6+ billion.

Implicitly,
one could say GS was incentivized to see AIG fail.
Does
that maybe answer some of the questions of why GS allegedly pulled
AIG's collateral and started the avalanche that lead to its bailout?
However, a fine point - if AIG had really tanked none of the CDS would
be collectible as the entire CDS market would have likely imploded...
Thus demonstrating the need for a zombie bank system: not totally dead
(systemic collapse) but barely alive to pocket a nice little CDS
annuity from daily cash collateral posts as it leaks wider (and
taxpayers foot the bill).

Now that the dust has
settled somewhat, we can refine this analysis: we now know that our
original read of Viniar's words was excessive, and in fact Goldman only
had $2.5 billion in long AIG CDS exposure. The linear relationship on
P&L, keeping in line with the above math, means the profit on the
CDS transaction was a quarter of the suggested $4.7 billion, or
roughly $1.2 billion: still a staggering number for a firm that
fundamentally did not experience any risk with regard to its CDO
exposure, which as everyone and the kitchen sink now know, was paid down
to goldman at par, thus assuring no P&L hit on the underlying
security.

So far so good.

Yet the reason we bring
up the topic of Goldman's AIG CDS transaction is due to a post James
Keller which points out some distubring observations
.

The
bigger story, still unexplored by regulators and Goldman's
critics, concerns that $2.5 billion in protection Goldman had acquired
before the crisis hit. What became of those hedges? What did Goldman
Sachs do with its AIG protection?

Goldman spokesman Lucas van Praag made a disingenuous case in
a letter to the Wall Street Journal
last April. He implied that nothing much became of the hedges: "In
order to collect under a credit default swap, there has to be an event
of default. No event of default means no payout." Goldman would have us
believe that since AIG did not default, the CDSs expired and vanished
forever.

The latter is of course not the case, and as
we demonstrated 9 months ago, the company very likely sold its
protection at a massive profit to cost. Keller continues:

This
is not quite right. A company can avoid default, but one can make
a lot of money selling protection on the company when everybody else
thinks they are going to default. That is especially true if one has
been involved in meetings with the Fed where the subject of the
meetings was how to avoid such a default. A good trader buys protection
when a company seems very safe, and sells it when the company seems
very risky. It is not appropriate for a trader to
sell protection when
he has non-public information that the risks have diminished, that the
government has unequivocally committed to saving this company.

The
last sentence is critical, as while debate may rage over the definition
of front running as it applies to Goldman, its clients, and its prop
desk, trading on material, non-public information is broadly frowned
upon by everyone in the marketplace.

When
did Goldman sell its $2.5 billion of AIG protection? Goldman
representatives have said that the protection was sold in the
six
months following the September 15, 2008 bailout loan
. This is
problematic. That is so because the details of the bailout were not
released until March 15 of last year, when the famous AIG counterparty
payments at last became public
.

This
suggests that Goldman sold its protection to counterparties
that knew materially less about the actual risk of AIG than Goldman
did.
Remember that this bailout was specifically designed to
avoid an
AIG default, the event that forces Credit Default Swaps to be
triggered. Goldman, in
frequent conversations with Paulson and
Geithner, knew that the government had just committed $85 billion to
avoid exactly this outcome.

And it keeps on getting worse for the vampire squid.

The
rest of the world, purposely kept in the dark, saw the risk of
an AIG failure as imminent. In fact, on September 21, 2008
then-Treasury Secretary Paulson went on Meet the Press and
explained that the $85 billion bailout loan would "allow the
government
to liquidate this company.
" Paulson may have been speaking
loosely, but
in the specific language of Credit Default Swaps a government
"liquidation" is a Credit Event akin to bankruptcy and would "trigger"
these swaps
. This is why, immediately after the bailout was
announced,
the cost of protecting AIG risk skyrocketed. It rose to more
than 40%
of the amount hedged; meaning that Goldman, which had $2.5 billion in
hedges, would have been sitting on over a $1 billion profit. [
This
number is in line with our estimates
]

Not
bad, even for Goldman. The government had just met their
collateral calls, their risk to AIG was gone, and their hedges were in
the money by $1 billion. What to do now? The right thing is to not sell
the protection until the full details of the bailout are in the public
domain. To wait
until you have no material, non-public information.

It
appears Goldman did not wait until after March to sell its
protection. Yet Goldman has denied making a windfall gain on AIG. AIG
CDS protection ended the second quarter of 2008 at about 200 basis
points. From September 15, 2008 to March 15, 2009 AIG CDS never closed
below 400 basis points. It is hard to see how Goldman could not have
had a windfall. Depending on when Goldman sold this protection, the
gain could have been as much as $1.5 billion. This would mean
that
while most of AIG's counterparties got 100 cents on the dollar, Goldman
actually got far more.

This was the point of our original post all along, yet at that point
we ignored the implications of the just released revelations of AIG's
counteparties "make whole" agreements, which were certainly not public
prior to March 15, except to Goldman and a select other few. The only
exculpation is if such material CDS trades occurred in the presence of
"big boy" letters, which as far as we know has never occurred.

In
conclusion we thoroughly agree with Keller, that while anger at Geithner
over the AIG fiasco is well warranted, the true culprit, with potential
alleged elements of actual criminality even according to our flawed,
corrupt and broken regulatory system, is and has always been Goldman
Sachs.

Criticism of Geithner seems
appropriate. Paying counterparties 100
cents on the dollar was unnecessary. Keeping the whole thing a secret
was indefensible. Allowing windfall profits was unconscionable. But the
Fed's behavior may not be the worst element of this episode.

Frankly,
it is hard to see how, in having sold its AIG protection
before March 2009, that Goldman Sachs can avoid the appearance that
these trades were improper. Over a year on, we still await a clear
explanation of how much the firm made from this protection and how its
subsequent sale can be justified when Goldman had information that the
federal government was deliberately keeping from the public.

Once again, we encourage Congress to invite not just Tim Geithner,
but Messers Van Praag and David Viniar to provide additional disclosure
on the exact timing of their AIG CDS sales, and specifically whether
these transactions occurred prior to March 15, while the firm was in
possession of material non-public information.

 

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Thu, 07/01/2010 - 12:33 | 446767 Jim in MN
Jim in MN's picture

Come now, friends, we need to move beyond trying to blame each other and simply get to the crisis we face: Plugging the hole that Goldman has blasted in our democracy.

 

Stop the damn corruption gusher already!

Thu, 07/01/2010 - 14:56 | 447129 nowhereman
nowhereman's picture

Just remember this...economics is hard and we non-economist bloggers don't know wht we are talking about, even if it's as plain as the noses on our faces.

Thu, 07/01/2010 - 12:36 | 446776 SayTabserb
SayTabserb's picture

Good forensic work, ZH. Fine-grained and increasingly inescapable. Nice that Government Sacks has so many friends in high places - almost as if their Angels in high government positions refuse to let them lose. Might this be a better explanation of their peerless record than financial genius?

Thu, 07/01/2010 - 12:51 | 446817 Mactheknife
Mactheknife's picture

Yes, it's good to be king. Right up to the part where we throw all their asses in prison.

Thu, 07/01/2010 - 13:32 | 446929 Walt Whitman
Walt Whitman's picture

Yes, but when both kings and minions are accessories to the crime(s), paid off by GS ill-gotten gains, who can stand for justice due? The porn-loving SEC? The "drop the voter intimidation case" DOJ?  Chicago Thugocracy currently in the WH?

 

Just who?

Thu, 07/01/2010 - 12:40 | 446789 sweet ebony diamond
sweet ebony diamond's picture

I think it is more of a cueball problem.

You can't have more than one cueball in the Fed meeting room.

Thu, 07/01/2010 - 13:27 | 446918 Duuude
Duuude's picture

 

The cueball in this game was Tha Hankster.

Thu, 07/01/2010 - 12:42 | 446794 williambanzai7
Thu, 07/01/2010 - 12:45 | 446804 Jim in MN
Jim in MN's picture

Close, almost on topic even: Goldman Sachs is the world's biggest skimming vessel. 

 

 

Thu, 07/01/2010 - 13:00 | 446840 williambanzai7
williambanzai7's picture

I am so sick and tired of these Squids. The release that AIG was forced to sign really is incredible. I can just hear them arguing that it is "market" in a bailout transaction.

Thu, 07/01/2010 - 13:45 | 446957 Kitler
Kitler's picture

+1,500,000,000

Thu, 07/01/2010 - 14:16 | 447038 moneymutt
moneymutt's picture

nice, funny...

Thu, 07/01/2010 - 12:56 | 446829 msgtb
msgtb's picture

The banksters need to go to jail.

 

Dave

Thu, 07/01/2010 - 14:30 | 447067 Cognitive Dissonance
Cognitive Dissonance's picture

msgtb

Today is your one year ZH birthday. Thank you for your contributions to the ZH community.

Thu, 07/01/2010 - 12:57 | 446831 Ted K
Ted K's picture

I applaud Tyler Durden for this post, one of the better posts at ZeroHedge.  And I hope that Tyler will latch on to this like a bulldog not letting go even after the matter has been dropped by the MSM (that should be roughly 12 hour time frame).  I hope they are as "sticktuitive", tenacious, dogged, unrelenting on this as Andrew Sullivan has been on Dick Cheney's torture crimes, long after the bastard has escaped the crime.

Thu, 07/01/2010 - 13:36 | 446939 traderjoe
traderjoe's picture

Unfortunately, but justified, one of the running threads of ZH (I'm new here) seems to be the 'pointlessness' of doggedly pursuing something that runs counter to the rosy view offered by the Military/WallStreet/KStreet complex (and the MSM that goes along). Any group of representatives that pass not one but two 2000+ page bills to 'save the economy' after pocketing massive campaign contributions aren't going to be interested in actual facts. I've read some divergent opinions on what to do to get the truth out, but the general consensus seems to be that the best approach might just be to prepare yourself for the massive shifts to come?

Thu, 07/01/2010 - 19:29 | 447878 lizzy36
lizzy36's picture

Ted, i recommend you go back in time and read Tylers posts from the inception of ZH (Jan 2009). If anyone has been a bulldog on this issue it it Tyler. 

Thu, 07/01/2010 - 12:57 | 446833 AccreditedEYE
AccreditedEYE's picture

Scum bags. Their end can't come soon enough...

Thu, 07/01/2010 - 13:11 | 446874 JuicyTheAnimal
JuicyTheAnimal's picture

Brooksley is one of the few honest people in government.  Lloyd is one of the biggest sociopath con artists on the planet.  You don't need to have any financial savy to know this, just a natural bullshit meter or a couple years experience playing poker. 

Thu, 07/01/2010 - 13:11 | 446876 Cistercian
Cistercian's picture

 I think they should be arrested right now.They nearly collapsed the banking system...so how much more of a threat to national security would you have to be to get busted?

  Someone needs to do their job and put these people in jail, pending a full and open inquiry.They are too dangerous to remain at large any longer.

Thu, 07/01/2010 - 13:22 | 446909 williambanzai7
williambanzai7's picture

They are a greater threat to the Republic than those Russian spies.

Thu, 07/01/2010 - 18:46 | 447806 sgt_doom
sgt_doom's picture

Seriously, williambanzai7, that was all about reducing everything to the nation-state or nationalist level (everyone realizes those were simply Russian illegals taking advantage of their state's monies to live in the US of A!).

It's all at the multinational level: for instance, those Chinese mining copper in Afghanistan, protected by American military, so their factories and production facilities can be replenished with copper -- those same facilities so many American (and Euro and Japanese) jobs have been offshored to.

And those pipelines slated to transport oil and gas across Afghanistan to India, to keep those production facilities and operations, which those American (and Euro) jobs have been offshored to by the multinationals.

And that China receives much, of not the vast majority, of oil from southern Iraq, to keep their factories and production facilities going, the ones to which those American (and Euro and Japanese) jobs have been offshored to.

Beginning to see the overall design, I hope?

If you happen to go to p. 39 of this report (Presentation to the Treasury Borrowing Committee) to the US Treasury's Office of Debt Management, a wholly-owned subsidiary of Goldman Sachs, staffed by former GS people, you will note how they recommend AGAINST banning naked shorts (naked swaps) --- yup, it's the multinationals, guys.....

Thu, 07/01/2010 - 13:16 | 446886 chet
chet's picture

The Frontline episode on Brooksley Born is a great one.  Pretty convincing that she was the one with integrity in a room full of dolts and power jockeys.

Naturally, she was rewarded by having the key responsibilities stripped from her agency altogether.

Thu, 07/01/2010 - 13:40 | 446948 Leo Kolivakis
Leo Kolivakis's picture

God bless Brooksley Born! She is the last true reformer left. Too bad she is fighting a lost cause.

Thu, 07/01/2010 - 18:48 | 447811 sgt_doom
sgt_doom's picture

And don't forget about Phil Angelides, he is the anchor of that bunch, several of whom have ties to either the American Enterprise Institute (hedge fund lobbyist group) and the Peterson Institute.

Angelides is a real stand-up guy, who really understands what's taking place.

Thu, 07/01/2010 - 20:36 | 447999 Leo Kolivakis
Leo Kolivakis's picture

Agreed.

Thu, 07/01/2010 - 13:52 | 446980 hbjork1
hbjork1's picture

Have to admit that I have a crush on Brooksley Born.

Thu, 07/01/2010 - 14:27 | 447062 Cognitive Dissonance
Cognitive Dissonance's picture

And woman who can rumble with the boys yet still retain her femininity has control of my heart. And she has class and style to boot. :>)

Thu, 07/01/2010 - 15:50 | 447325 anonnn
anonnn's picture

A dream come true...that Brooksley Born returns to get recognition for her integrity that cost her job under Clinton and Greenspan-Rubin-Summers et al gang...

Brilliant, forthright and effective in seeking justice.

Thu, 07/01/2010 - 16:02 | 447375 organicfarmer
organicfarmer's picture

Perhaps prosecution at the state level, (NY) since our Fed. Gov. is so corrupt!

Thu, 07/01/2010 - 18:17 | 447754 moneymutt
moneymutt's picture

agreed, don't care who they, what their qualifications are, just need someone we know is not corrupt...someone who is smart and tough too....goooo

Thu, 07/01/2010 - 18:54 | 447820 Rusty_Shackleford
Rusty_Shackleford's picture

Complete and utter lawlessness on all levels.

Thu, 07/01/2010 - 19:10 | 447845 DavidC
DavidC's picture

Agree with Leo about Brooksley.

She made a mistake about Nick Leeson (he was at Barings), I'm surprised she held her cool with the rubbish that was coming from Lehman and (mainly) Viniar - are we REALLY expected to believe that GS has NO idea about their derivatives positions?!

And the semantics! Viniar - we have no derivatives BUSINESS, but we DO have a derivatives 'business' - PLEASE!

DavidC

Fri, 07/02/2010 - 00:19 | 448434 Ned Zeppelin
Ned Zeppelin's picture

I do think it is interesting how GS is on some sort of rotating public stage of investigation , and hope only that by time the wheel turns and they appear again on stage, the crowd is well-armed, and angry.

Fri, 07/02/2010 - 01:04 | 448498 Johnny Dangereaux
Johnny Dangereaux's picture

Here is the ring leader. He needs to be in a chair....AN ELECTRIC ONE.  This piece of shit traitor is the worst of the worst. What do those swej's do with all the moiney anyway? 

http://www.marketwire.com/press-release/AIG-Names-Dr-Jacob-A-Frenkel-Vic...

A very sick and disturbed "person"

Sat, 08/21/2010 - 11:07 | 534693 herry
herry's picture

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