Tavakoli on AIG Swaps: "There’s No Way They Should Have Paid at Par. AIG Was Basically Bankrupt", and Goldman Sachs CFO Lied About AIG

George Washington's picture

Washington's Blog.

Derivatives expert Janet Tavakoli made the following comments by email about the Bloomberg article "New York Fed’s Secret Choice to Pay for Swaps Hits Taxpayers":

“There’s no way they should have paid at par,” she says. “AIG was basically bankrupt.”

I agree.

By way of contrast, Tavakoli points out that:

Inc. agreed last year to accept about 60 cents on the dollar from New
York-based bond insurer Ambac Financial Group Inc. to retire protection
on a $1.4 billion CDO.

Tavakoli also says that Goldman Sachs CFO David Viniar lied about AIG:

is a strong statement to say that a CFO lied to the public, and in my
opinion, David Viniar, Goldman Sach’s CFO lied about Goldman’s exposure
to AIG while the AIG bailout was in progress in September 2008. Viniar
spoke about risk management, but that is a separate issue from whether
or not Goldman Sachs would have money at risk due to its direct
business with AIG. Goldman Sachs would have been out billions of
dollars in collateral had a bankruptcy-like settlement been negotiated
with AIG, and that is material. 


This is what David Viniar said during his Sept 16, 2008 investor conference call:

David Viniar - The Goldman Sachs Group, Inc. - EVP, CFO Sure.
Without giving exact numbers, let me just tell you how we think about
this. AIG and Lehman, big important financial institution
counterparties to Goldman Sachs. We did and we do a lot of business
with both of them, as we do with all other major financial
institutions. The way we do business with financial institutions is by
having appropriate daily margin terms. That is how we are able to do
the volume of business with each other that we do. And that goes for
AIG, Lehman, and also Morgan Stanley, and JPMorgan, and Citi, and UBS,
and Credit Suisse. That is how we manage our risk. In addition to the
margin terms, we augment our risk management with appropriate hedging
strategies. You heard at the beginning of my remarks that we believe
one of the biggest challenges we have is to avoid large concentrated
exposures; and we took that very much into account in managing our
credit exposures to Lehman and to AIG, as well as we do with any other
financial institution. Given
that, what I would tell you is given the outcome at Lehman and whatever
the outcome at AIG, I would expect the direct impact of our credit
exposure to both of them to be immaterial to our results.


Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Cursive's picture


Dude, that was a bit long, but at least "panda6" doesn't have to look any further than this post to educate himself on the fraud that was CDS.

panda6, do you work at the SEC?

panda6's picture

No, I'm a cds trader, so I feel I have a better insight into how the market actually works than most other clowns on the internet.

Ducky's picture

Since CDS are basically bond puts they should be outlawed, right?

panda6's picture

True, betting against a company is UN-AMERICAN

calltoaccount's picture



AIG: Before CDS, There Was Reinsurance

http://www.ritholtz.com/blog/2009/04/aig-before-cds-the... /


"...the CDS contracts written by AIG with these various non-insurers around the world were shams - with no correlation between “fees” paid and the risk assumed. These were not valid contracts as Fed Chairman Ben Bernanke, Treasury Secretary Geithner and Economic policy guru Larry Summers claim, but rather acts of criminal fraud meant to manipulate the capital positions and earnings of financial companies around the world."

By Chris Whalen - April 2nd, 2009, 5:38AM


Below is the latest issue of The Institutional Risk Analyst. We did a lot of work on this one. Look forward to your comments.

Also, check out the earlier writings of Lucy Komisar on offshore shenanigans of AIG and the offshore transaction set:


– Chris

“What do many corporate buyers of insurance have in common with American International Group? Perhaps more than they would like to admit. Like AIG, many companies in the past few years have bought finite insurance, which transfers a prescribed amount of risk for a particular liability. What regulators now want to know is, how many companies, like AIG, have used finite insurance to artificially inflate their financial results?”
Infinite Risk?

CFO Magazine

June 1, 2005

“In the regulatory world, a ’side letter’ is perhaps the most insidious and destructive weapon in the white-collar criminal’s arsenal. With the flick of a pen, underhanded executives can cook the books in enormous amounts and render a regulator helpless.”
Fraud Magazine

July/August 2006

PRMIA Event: Market & Liquidity Risk Management for Financial Institutions
First, a housekeeping item. On Monday, May 4, 2009, in partnership with the Federal Deposit Insurance Corporation (FDIC) & the Office of Thrift Supervision (OTS), the Washington DC chapter of Professional Risk Managers’ International Association (PRMIA) is presenting an important day-long conference on managing liquidity and market risk for financial institutions. Speakers include some of the leading risk practitioners, investors, researchers, bank executives and regulators in the US financial community. PRMIA free and sustaining members may register on the PRMIA web site. Members of the regulatory community may register via the FDIC University. IRA co-founder Christopher Whalen will participate in the conference and serve as MC. See the PRMIA web site for more information on the program and speakers. And yes, our favorite bank regulator is making the opening remarks. 

For some time now, we have been trying to reconcile the apparent paradox of American International Group (NYSE:AIG) walking away from the highly profitable, double-digit RAROC business of underwriting property and casualty (P&C) risk and diving into the rancid cesspool of credit default swaps (”CDS”) contracts and other types of “high beta” risks, business lines that are highly correlated with the financial markets. In our interview with Robert Arvanitis last year, “‘Bailout: It’s About Capital, Not Liquidity; Seeking Beta: Interview with Robert Arvanitis’, September 29, 2008,” we discussed the difference between high and low beta. We also learned from Arvanitis, who worked for AIG during much of the relevant period, that the decision by Hank Greenberg and the AIG board to enter the CDS market was, at best, chasing revenue. No rational examination of the business opportunity, assuming that Greenberg and his directors were acting based on a reasoned analysis, could have resulted in a favorable decision to pursue CDS and other “high beta” risks, at least from our perspective. In an effort to resolve this conundrum, over the past several months The IRA has interviewed a number of forensic experts, insurance regulators and members of the law enforcement community focused on financial fraud. The picture we have assembled is frightening and suggests that, far from just AIG, much of the insurance industry has been drawn into the world of financial engineering and has thus become part of the problem. Below we present our preliminary findings and invite your comments. One of the first things we learned about the insurance world is that the concept of “shifting risk” for a variety of business and regulatory reasons has been ongoing in the insurance world for decades. Finite insurance and other scams have been at least visible to the investment community for years and have been documented in the media, but what is less understood is that firms like AIG took the risk shifting shell game to a whole new level long before the firm’s entry into the CDS market. In fact, our investigation suggests that by the time AIG had entered the CDS fray in a serious way more than five years ago, the firm was already doomed. No longer able to prop up its earnings using reinsurance because of growing scrutiny from state insurance regulators and federal law enforcement agencies, AIG’s foray into CDS was really the grand finale. AIG was a Ponzi scheme plain and simple, yet the Obama Administration still thinks of AIG as a real company that simply took excessive risks. No, to us what the fraud Bernard Madoff is to individual investors, AIG is to the global financial community. As with the phony reinsurance contracts that AIG and other insurers wrote for decades, when AIG wrote hundreds of billions of dollars in CDS contracts, neither AIG nor the counterparties believed that the CDS would ever be paid. Indeed, one source with personal knowledge of the matter suggests that there may be emails and actual side letters between AIG and its counterparties that could prove conclusively that AIG never intended to pay out on any of its CDS contracts. The significance of this for the US bailout of AIG is profound. If our surmise is correct, the position of Feb Chairman Ben Bernanke and Treasury Secretary Tim Geithner that the AIG credit default contracts are “valid legal contracts” is ridiculous and reveals a level of ignorance by the Fed and Treasury about the true goings on inside AIG and the reinsurance industry that is truly staggering.

Does Reinsurance + Side Letters = CDS?

One of the most widespread means of risk shifting is reinsurance, the act of paying an insurer to offset the risk on the books of a second insurer. This may sound pretty routine and plain vanilla, but what most people don’t know is that often times when insurers would write reinsurance contracts with one another, they would enter into “side letters” whereby the parties would agree that the reinsurance contract was essentially a canard, a form of window dressing to make a company, bank or another insurer look better on paper, but where the seller of protection had no intention of ever paying out on the contract.

Let’s say that an insurer needs to enhance its capital surplus by $100 million in order to meet regulatory capital requirements. They can enter into what appears to be a completely legitimate form of reinsurance contract, an agreement that appears to transfer the liability to the reinsurer. By doing so, the “ceding company” - an insurance company that transfers a risk to a reinsurance company - gets to drop that $100 million in liability and its regulatory surplus increases by $100 million.

The reinsurer assuming the risk does actually put up the $100 million in liability, but with the knowledge that they will never have to actually pay out on the contract. This is good for the reinsurer because they are paid a fee for this transaction, but it is bad for the ceding company, the insurer with the capital shortfall, because the transaction is actually a sham, a fraud meant to deceive regulators, counterparties and investors into thinking that the insurer has adequate capital. Typically the fee is 6% per year or what is called a “loan fee” in the insurance industry.

When it operates in this fashion, the whole reinsurance industry could be described as a “surplus rental” proposition, whereby an insurer literally loans another insurer capital in the form of risk cover, but with a secret understanding in the form of a side letter that the loan will be reversed without any recourse to the seller of protection. You give me $6 million in cash today, and I will give you a promise that we both know I will never honor.

Does this sound familiar? What our contacts in the insurance industry describe is almost a precise description of the CDS market, albeit one that evolved in the reinsurance industry literally decades ago and has been the cause of numerous insurance insolvencies and losses to insured parties. Or to put it another way, maybe the inspiration for the CDS market - at least within AIG and other insurers — evolved from the reinsurance market over the past two decades.

As best as we can tell, the questionable practice of using side letters to mask the economic and business reality of reinsurance transactions started in the mid-1980s and continued until the middle of the current decade. This timeline just happens to track the creation and evolution of the OTC derivatives markets. In particular, the move by AIG into the CDS market coincides with the increased awareness of and attention to the use of side letters by insurance regulators and members of the state and federal law enforcement community.

Keep in mind that what we are talking about here are not questionable risk management policies but acts of deliberate and criminal fraud, acts that often result in jail time for those involved. As one senior forensic accountant who has practiced in the insurance sector for three decades told The IRA:

“In every major criminal fraud case in which I have worked, at the center of the investigation were these side letters. It was always very strange to me that on-site investigators and law enforcement officials consistently found that these side letters were being used to mask the true financial condition of an insurer, and yet none of the state regulators, the National Association of Insurance Commissioners (NAIC), nor federal law enforcement authorities ever publicly mentioned the practice. They certainly did not act like the use of side letters was a commonplace thing, but it was widespread in the industry.”

It is important to understand that a side letter is a secret agreement, a document that is often hidden from internal and external auditors, regulators and even senior management of insurers and reinsurers. We doubt, for example, that Warren Buffet or Hank Greenberg knew the details of side letters, but they should have. Just as a rogue CDS trader at a large bank like Societe General (NYSE:SGE) might seek to hide losing trades, the underwriters of insurers would use sham transactions and side letters to enhance the revenue of the insurer, but without disclosing the true nature of the transaction.

There are two basic problems with side letters. First, they are a criminal act, a fraud that usually carries the full weight of an “A” felony in many jurisdictions. Second, once the side letter is discovered by a persistent auditor or regulator examining the buyer of protection, the transaction becomes worthless. You paid $6 million to AIG to shift risk via the reinsurance, but the side letter makes clear that the transaction is a fraud and you lose any benefit that the apparent risk shifting might have provided.

As the use of these secret side letters began to become more and more prevalent in the insurance industry, and these secret side deals were literally being stacked on top of one another at firms like AIG, the SEC began to investigate. And they began to find instances of fraud and to crack down on the practice. One of the first cases to come to the surface involved AIG helping Brightpoint (NASDAQ:CELL) commit accounting fraud, a case that eventually led the SEC to fine AIG $10 million in 2003.

Wayne M. Carlin, Regional Director of the SEC’s Northeast Regional Office, said of the settlements: “In this case, AIG worked hand in hand with CELL personnel to custom-design a purported insurance policy that allowed CELL to overstate its earnings by a staggering 61 percent. This transaction was simply a ’round-trip’ of cash from CELL to AIG and back to CELL. By disguising the money as ‘insurance,’ AIG enabled CELL to spread over several years a loss that should have been recognized immediately.”

Another case involved PNC Financial (NYSE:PNC), which used various contracts with AIG to hide certain assets from regulators, even though the transaction amounted to the “rental” of capital and not a true risk transfer.

As the SEC noted in a 2004 statement: “The Commission’s action arises out of the conduct of Defendant AIG, primarily through its wholly owned subsidiary AIG Financial Products Corp. (”AIG-FP”), (collectively referred to as “AIG”) in developing, marketing, and entering into transactions that purported to enable a public company to remove certain assets from its balance sheet.” Click here to see the SEC statement regarding the AIG transactions with PNC.

The SEC statement reads in part: “In its Complaint, filed in the United States District Court for the District of Columbia, the Commission alleged that from at least March 2001 through January 2002, Defendant AIG, primarily through AIG-FP, developed a product called a Contributed Guaranteed Alternative Investment Trust Security (”C-GAITS”), marketed that product to several public companies, and ultimately entered into three C-GAITS transactions with one such company, The PNC Financial Services Group, Inc. (”PNC”). For a fee, AIG offered to establish a special purpose entity (”SPE”) to which the counter-party would transfer troubled or other potentially volatile assets. AIG represented that, under generally accepted accounting principles (”GAAP”), the SPE would not be consolidated on the counter-party’s financial statements. The counter-party thus would be able to avoid charges to its income statement resulting from declines in the value of the assets transferred to the SPE. The transaction that AIG developed and marketed, however, did not satisfy the requirements of GAAP for nonconsolidation of SPEs.”

In both cases, AIG was engaged in transactions that were meant not to reduce risk, but to hide the true nature of the risk in these companies from investors, regulators and the consumers who rely on these institutions for services. Keep in mind that while the SEC did act to address these issues, the parties involved received light punishments when you consider that these are all felonies that arguably would call for criminal prosecution for fraud, securities fraud, conspiracy and racketeering, among other things. Indeed, this is one of those rare cases where we believe AIG itself, as a corporate person, should be subject to criminal prosecution and liquidation.

Birds of a Feather: AIG & GenRe

Click here to see a June 6, 2005 press release from the SEC detailing criminal charges against John Houldsworth, a former senior executive of General Re Corporation (”GenRe”), a subsidiary of Berkshire Hathaway (NYSE:BRKA), for his role in aiding and abetting American International Group, Inc. in committing securities fraud.

The SEC noted: “In its complaint filed today in federal court in Manhattan, the Commission alleged that Houldsworth and others helped AIG structure two sham reinsurance transactions that had as their only purpose to allow AIG to add a total of $500 million in phony loss reserves to its balance sheet in the fourth quarter of 2000 and the first quarter of 2001. The transactions were initiated by AIG to quell criticism by analysts concerning a reduction in the company’s loss reserves in the third quarter of 2000.”

But the involvement of the BRKA unit GenRe in the AIG mess was not the first time that GenRe had been involved in the questionable use of reinsurance contracts and side letters.

Click here to see an example of a side letter that was made public in a civil litigation in Australia a decade ago. The faxed letter, which bears the ID number from the Australian Court, is from an insurance broker in London to Mr. Ajit Jain, a businessman who currently heads several reinsurance businesses for BRKA, regarding a reinsurance contract for FAI Insurance, an affiliate of HIH Insurance.

Notice that the letter states plainly the intent of the transaction is to bolster the apparent capital of FAI. Notice too that several times in the letter, the statement is made that “no claim will be made before the commutation date,” which may be interpreted as being a warranty by the insured that no claims shall be made under the reinsurance policy. By no coincidence, HIH and FAI collapsed in a $5.3 billion dollar fiasco that ranks as Australia’s biggest ever corporate failure.

Click here to read a March 9, 2009 article from The Age, one of Australia’s leading business publications, regarding the collapse of HIH and FAI.

In 2003, an insurer named Reciprocal of America (”ROA”) was seized by regulators and law enforcement officials. An investigation ensued for 3 years. According to civil lawsuits filed in the matter, GenRe provided finite insurance to ROA in order to make the troubled insurer look more solvent than it was in reality. Several regulators and law enforcement officials involved in that case tell The IRA that the ROA failure forced insurers like AIG and Gen Re to start looking for new ways to “cook the books” because the long-time practice of side letters was starting to come under real scrutiny.

“These reinsurance deals made ROA look better than it really was,” one investigator with direct knowledge of the ROA matter tells The IRA. “They went into the ROA home office in VA with the state insurance regulators and law enforcement, and directed the employees away from the computers and records. During that three-year investigation, GenRe learned that local regulators and forensic examiners had put everything together and that we now understood the way the game was played. I believe the players in the industry realized that that they had to change the way in which they cooked the books. A sleight- of-hand trick that had worked for 25 years under the radar of regulators and investors was now revealed.”

Several senior officials of ROA eventually were prosecuted, convicted of criminal fraud and imprisoned, but DOJ officials under the Bush Administration reportedly blocked prosecution of the actual managers and underwriters of ROA who were involved in these sham transactions, this even though state officials and federal prosecutors in VA were anxious to proceed with additional prosecutions.

AIG: From Reinsurance to CDS

While some reinsurers are large, well-capitalized entities that generally avoid these pitfalls, AIG was already a troubled company when it began to write more and more of these risk-shifting transactions more than a decade ago. It is easy to promise the moon when people think that they can deliver, but because AIG and their clients saw how easy it was to fool regulators and investors, the practice grew and most regulators did absolutely nothing to curtail the practice.

It was easy for AIG to become addicted to the use of side letters. The firm, which had already encountered serious financial problems in 2000-2001, reportedly saw the side letters as a way to mint free money and thereby help the insurer to look stronger than it really was. AIG not only helped banks and other companies distort and obfuscate their financial condition, but AIG was supplementing its income by writing more and more of these reinsurance deals and mitigating their perceived exposure via side letters.

A key figure in AIG’s reinsurance schemes, according to several observers, was Joseph Cassano, head of AIG-FP. Whereas the traditional use of side letters was in reinsurance transactions between insurers, in the case of both CELL and PNC neither was an insurer! And in both cases, AIG used sham deals to make two non-insurers, including a regulated bank holding company, look better by manipulating their financial statements. Falsifying the financial statements of a bank or bank holding company is an felony.

AIG-FP was simply doing for non-insurers what was common practice inside the secretive precincts of the insurance world. The SEC did investigate and they did finally obtain a deferred prosecution agreement with AIG, which was buried in the settlement with then-New York AG Elliott Spitzer.

The key thing to understand is that if you look at many of these reinsurance contracts between ROA and Gen Re, they look perfect. They appear to transfer risk and seem to be completely in order. But, if you don’t get to see the secret agreement, the side letter that basically says that the reinsurance contract is a form of window dressing, then you cannot understand the full implications of the transaction, the reinsurance agreement. Not, several experts speculate, can you understand why AIG decided to migrate away from reinsurance and side letters and into CDS as a mechanism for falsifying the balance sheets and earnings of non-insurers.

Several observers believe that at some point in the 2002-2004 period, Cassano and his colleagues at AIG began to realize that state insurance regulators and the FBI where on to the reinsurance/side letter scam. A number of experts had been speaking and writing about the issue within the accounting and fraud communities, and this attention apparently made AIG move most of its shell game into the world of CDS. By no coincidence, at around this time side letters began to disappear in the insurance industry, suggesting to many observers that the industry finally realized that the jig was up.

It appears to us that, seeing the heightened attention from regulators and federal law enforcement agencies such as the FBI on side letters, AIG began to move its shell game to the CDS markets, where it could continue to falsify the balance sheets and income statements of non-insurers all over the world, including banks and other financial institutions.

AIG’s Cassano even managed to hide the activity in a bank subsidiary of AIG based in London and under the nominal supervision of the Office of Thrift Supervision in the US, this it is suggested to hide this ongoing activity from US insurance regulators. Even though AIG had been investigated and sanctioned by the SEC, Cassano and his colleagues at AIG apparently were recalcitrant and continued to build the CDS pyramid inside AIG, a financial pyramid that is now collapsing. The rest, as they say is history.

Now you know why the Fed and EU officials are so terrified about an AIG liquidation, because it will result in heavy losses to or even the insolvency of banks and other corporations around the globe. Notice that while German Chancellor Angela Merkel has been posturing and throwing barbs at President Obama, French President Nicolas Sarkozy has been conciliatory toward the US.

But for the bailout of AIG, you see, President Sarkozy would have been forced to bailout SGE for a second time in two years. So long as the Fed and Treasury can subsidize AIG’s mounting operating losses, the EU will be spared a financial bloodbath. But this situation is unlikely to remain stable for long with members of the Congress demanding an investigation of the past bailout, a process that can only result in bankruptcy for AIG.

Are the CDS Contracts of AIG Really Valid?

The key point is that neither the public, the Fed nor the Treasury seem to understand is that the CDS contracts written by AIG with these various non-insurers around the world were shams - with no correlation between “fees” paid and the risk assumed. These were not valid contracts as Fed Chairman Ben Bernanke, Treasury Secretary Geithner and Economic policy guru Larry Summers claim, but rather acts of criminal fraud meant to manipulate the capital positions and earnings of financial companies around the world.

Indeed, our sources as well as press reports suggest that the CDS contracts written by AIG may have included side letters, often in the form of emails rather than formal letters, that essentially violated the ISDA agreements and show that the true, economic reality of these contracts was fraud plain and simple. Unfortunately, by not moving to seize AIG immediately last year when the scandal broke, the Fed and Treasury may have given the AIG managers time to destroy much of the evidence of criminal wrongdoing.

Only when we understand how AIG came to be involved in CDS and the fact that this seemingly illegal activity was simply an extension of the reinsurance/side letter shell game scam that AIG, Gen Re and others conducted for many years before will we understand what needs to be done with AIG, namely liquidation. Seen in this context, the payments made to AIG by the Fed and Treasury, which were then passed-through to dealers such as Goldman Sachs (NYSE:GS), can only be viewed as an illegal taking that must be reversed once the US Trustee for the Federal Bankruptcy Court for the Southern District of New York is in control of AIG’s operations.

(Editor’s note: Officials of BRKA and GenRe did not respond to telephonic and email requests by The IRA seeking comment on this article. An official of AIG did respond but was not willing to comment on-the-record for this report. We shall be happy to publish any written comments that BRKA, AIG or GenRe have on this article.

Questions? Comments? info@institutionalriskanalytics.com


NEW YORK, March 17 (Reuters)

A day ahead of the hearing, Reuters posed 10 questions to Goldman about these issues. The following are the questions and the answers from Goldman spokesman Michael DuVally: 

(inter alia)

QUESTION: Did Goldman do any due diligence on AIG before buying credit default swaps (CDS) from it?

ANSWER: "We do extensive due diligence on all our counterparties."  



"What is the deeper relationship between Goldman and AIG? Didn't they almost merge a few years ago but did not because Goldman couldn't get its arms around the black box that is AIG? If that is true, why should Goldman get bailed out? After all, they should have known as well as anybody that a big part of AIG's business model was not to pay on insurance it had issued."
"The Real AIG ScandalIt's not the bonuses. It's that AIG's counterparties are getting paid back in full.
By Eliot Spitzer
Posted Tuesday, March 17, 2009, at 10:41 AM ET
American International Group Inc. Click image to expand.AIG's Manhattan, N.Y., office. Everybody is rushing to condemn AIG's bonuses, but this simple scandal is obscuring the real disgrace at the insurance giant: Why are AIG's counterparties getting paid back in full, to the tune of tens of billions of taxpayer dollars? For the answer to this question, we need to go back to the very first decision to bail out AIG, made, we are told, by then-Treasury Secretary Henry Paulson, then-New York Fed official Timothy Geithner, Goldman Sachs CEO Lloyd Blankfein, and Fed Chairman Ben Bernanke last fall. Post-Lehman's collapse, they feared a systemic failure could be triggered by AIG's inability to pay the counterparties to all the sophisticated instruments AIG had sold. And who were AIG's trading partners? No shock here: Goldman, Bank of America, Merrill Lynch, UBS, JPMorgan Chase, Morgan Stanley, Deutsche Bank, Barclays, and on it goes. So now we know for sure what we already surmised: The AIG bailout has been a way to hide an enormous second round of cash to the same group that had received TARP money already. It all appears, once again, to be the same insiders protecting themselves against sharing the pain and risk of their own bad adventure. The payments to AIG's counterparties are justified with an appeal to the sanctity of contract. If AIG's contracts turned out to be shaky, the theory goes, then the whole edifice of the financial system would collapse. But wait a moment, aren't we in the midst of reopening contracts all over the place to share the burden of this crisis? From raising taxes—income taxes to sales taxes—to properly reopening labor contracts, we are all being asked to pitch in and carry our share of the burden. Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won't be laid off. Why can't Wall Street royalty shoulder some of the burden? Why did Goldman have to get back 100 cents on the dollar? Didn't we already give Goldman a $25 billion capital infusion, and aren't they sitting on more than $100 billion in cash? Haven't we been told recently that they are beginning to come back to fiscal stability? If that is so, couldn't they have accepted a discount, and couldn't they have agreed to certain conditions before the AIG dollars—that is, our dollars—flowed? The appearance that this was all an inside job is overwhelming. AIG was nothing more than a conduit for huge capital flows to the same old suspects, with no reason or explanation. So here are several questions that should be answered, in public, under oath, to clear the air: What was the precise conversation among Bernanke, Geithner, Paulson, and Blankfein that preceded the initial $80 billion grant? Was it already known who the counterparties were and what the exposure was for each of the counterparties? What did Goldman, and all the other counterparties, know about AIG's financial condition at the time they executed the swaps or other contracts? Had they done adequate due diligence to see whether they were buying real protection? And why shouldn't they bear a percentage of the risk of failure of their own counterparty? What is the deeper relationship between Goldman and AIG? Didn't they almost merge a few years ago but did not because Goldman couldn't get its arms around the black box that is AIG? If that is true, why should Goldman get bailed out? After all, they should have known as well as anybody that a big part of AIG's business model was not to pay on insurance it had issued. Why weren't the counterparties immediately and fully disclosed? Failure to answer these questions will feed the populist rage that is metastasizing very quickly. And it will raise basic questions about the competence of those who are supposedly guiding this economic policy.


Monday, July 20. 2009 Posted by Karl Denninger in Banking System at 07:17  ...the real objection of Taibbi and others (myself included) is that Goldman managed to steal $13 billion dollars of American Taxpayer money, without which they would not exist today.  Having stolen that money through claims of imminent financial collapse made by their former head, Henry Paulson, at their urging, they now have speculated with that taxpayer money and kept the proceeds." "Obscene Profit" = You Stole It

Let's dispense with this sort of bilge from The Washington Post right here:

Money can't buy love? For proof, look no further than Goldman Sachs. Last week, the firm reported a spectacular quarterly profit -- close to $3.5 billion for the bank and about $385,000 in compensation for each employee for the first half of the year -- and right on cue, the braying began for the heads of the Goldmanites. Earlier this month, Rolling Stone's Matt Taibbi, in a comprehensive exercise in conspiracy mongering, primed the pump of outrage with his article "The Great American Bubble Machine." Now a chorus of supporters has chimed in, shocked that in a recession the evil Goldman could turn such profit.

I know nobody that objects to making a profit.

I know a lot of people who object to theft.

What began as an effort to keep the financial industry from repeating its mistakes has turned into, as at other points in history, an attack on the idea of trading profit. It is no longer enough that the banks should be reformed; the opportunity to make this kind of profit should be eliminated.

That's an outrageously false statement.

Many in the community, myself included, object strenuously to a poker player who has an extra set of aces up his or her sleeve.  We also object to a casino capitalist model where the winnings are kept but the losses are forced onto someone else.

And that, dear reader, is what Goldman and the rest of the big banks have been doing for the last two years.

Over the last several years Goldman Sachs entered into a metric ton worth of credit default swaps with AIG, even though AIG was incapable of paying off on those swaps.  They did so as the "brightest people in the room", that is, either knowing that AIG was incapable of covering the bet or simply not caring that AIG could not cover the bet.

These transactions allowed Goldman (and the other banks who engaged in them) to hold "assets" on their books at intentionally-inflated values - that is, at demonstrably more than those "assets" were actually worth in the market, under the rubric that should their value fall Goldman would be able to "recover" under their insurance policies (the CDS.)

But in point of fact these transactions were never any good, because AIG didn't have the money to pay.

When this became evident Goldman (and others) managed to connive the government into "saving" AIG by throwing more than $100 billion dollars of taxpayer money into the firm.  About $13 billion of that went directly to Goldman Sachs to "pay off" those contracts.  Billions more went to other institutions, including banks in Europe.

In doing this, Goldman and these other banks forced the taxpayer to eat their bad bet - that is, their loss.  That $13 billion was in fact unearned - they had no right to it, as AIG was in fact insolvent and they would have collected zero had the firm gone into bankruptcy.  Goldman and these other banks were either unable or unwilling to rescue the firm themselves, so through the use of political influence peddling they got the taxpayer to do it for them, thereby collecting on a transaction that they either knew or should have known had no chance of being paid off at the time they entered into it.

Having done this, they placed yet more bets.  This time they won those bets, and made a "profit."  But they would have never had the capital to place the bets but for the taxpayer bailing them out in the first place, as they would have likely gone under last fall.

The real objection of Taibbi and others is that Goldman, except for one bad quarter at the nadir of the financial crisis, has turned a profit. Big profit.

No, the real objection of Taibbi and others (myself included) is that Goldman managed to steal $13 billion dollars of American Taxpayer money, without which they would not exist today.  Having stolen that money through claims of imminent financial collapse made by their former head, Henry Paulson, at their urging, they now have speculated with that taxpayer money and kept the proceeds.

Nobody would object were Goldman to return not only their "TARP" money but also the entirety of the "passthrough" benefits they have received, specifically but not exclusively the $13 billion dollars that was funneled through AIG to them.

But if Goldman had done that, they would have posted a huge loss, and in addition would not have had the money to repay TARP.

Nobody I am aware of cares if a firm is able to turn a legitimate profit through their actions in the market.  We object not to profit, but to blatant chiseling of the taxpayer after a company or individual makes a bad bet due to their own incompetence or willful blindness, then demands that the taxpayer cover it, yet when their bets turn out well, they keep the money and hand it to their "associates."

That's robbery, and I and others will continue to point it out until the shills who advocate for same and try to excuse it, along with Goldman themselves, are held to account.


Miles Kendig's picture

My apologies.  I made my post above before I made my way here.

All The Best

sgt_doom's picture

Fantastic post, calltoaccount (Lucy Komisar does some great work!).

For those of us who enjoy some serious comprehension of structured finance and economics (especially forensic econ) the following phrase will make much sense: we no longer have an economy in the US of A, but are living through the Great Financialization (someone else coined this, I cannot improve upon it!).

Anal_yst's picture

I'm sorry if I'm missing this, only IFF Tavakoli has seen what Goldman's book looked like (including OTC trades, term sheets, and collateral) at or near the time of AIG, there is no way in hell she could make this claim.


Please, if I'm missing something, enlighten me.

panda6's picture

You are correct.


But unsurprisingly the daytrader fanboys on this website don't care, and just start drooling over any remotely anti-goldies headline....

Cursive's picture

Although you act as though you could teach a course on CDS's, I take it you couldn't answer any of my pointed questions above.

Anal_yst's picture

I'd like to think I am, also (not because I give a rats' ass about being right, but because I agree with your sentiments).

Also, from the BBG story linked-to above, "AIG paid Societe General $16.5 billion, Deutsche Bank $8.5 billion and Merrill Lynch $6.2 billion."

Goldman = $13BN.  Why all the hate for 85 Broad and no ire directed towards the frogs at SocGen, etc?

Ducky's picture

Yeah, John Hempton over at Bronte Capital blog said that the money paid to GS flowed through to their customers. Some say that the real reason everyone got paid in full was to prevent the foreign banks from collapse. They were the real worry.

Some of those banks are larger than the entire GDP of their respective countries. Talk about too big to fail.

Anonymous's picture

Probably because no one sees the fraternity at SocGen being a shadow gov't in the US as with the 85 Broad boys.

mannfm11's picture

Being as these guys are basically everyone elses counterparties, could the sudden crowding of the group into being counter party to AIG have upset the entire applecart?  It is clear they were all into creating synthetic CDO's and all were trying their best to hold more CDS risk instead of lay it off.  Could be AIG's guys were criminally negligent and could be they got one slipped to them by Goldman and others. 

Anonymous's picture

AIG comes to GS and asks for a loan.

GS agree and accepts an asset as collateral.

GS also takes out a derivative hedge in case of default.

When the asset held as collateral falls by 40%, almost overnight, there is no default, no payoff but the exposure and the reserves increase. These reserves are not readily available and thus require an expense to acquire and besides, reserves are "dead money" anyway.

You cannot make profit on "dead money".
You cannot make a profit when you have no collateral to lend and in fact are incurring an expense to acquire these reserves.

No profit = no bonus.
More importantly, even a reduced profit = less or no bonus.

The impetus then was not to shelter the organization from the possibility of a default protected by a hedge, but to ensure that profit levels did not fall to the point that the metrics for bonus determination were not breached.

Mission Accomplished!

Anonymous's picture

Let's take Mr. Blankfein at his word -- that Goldman Sachs was fully hedged against AIG's failure -- okay then, by whom? If not the U.S. taxpayer as most of us believe, then who underwrote Goldman's insurance policy against AIG's implosion? And more importantly, is this undisclosed counter-party that fully hedged Goldman with respect to AIG continuing to underwrite other reckless risks that have yet to blow up?

Anonymous's picture

Ok...So here is the real question.....

Just what can be done about the incestual Corp./US Govt. ?

Is it not clear that GS has employees where it matters most ?

Just what can be done about this ?

Or does the average US citizen just have to eat it
and shut the hell up ?

Really....what can be done about it ?

Is it not clear who the SEC and US Govt. really works for ?

So here it is ....

What's next ?

Is a black horse black ?

I guess not....

I guess the chair that I am sitting on is not real....

After all it can be argued the chair really is not there when it is....

So much for US legal largess....

And here's my "official 3 finger salute"....

For the US Govt. employees hiding behind future job desire
on "the other side"....

You are winning ? Winning what ?

Here is my most fitting term for YOU....


etrader's picture

Kashkari was saying the same thing

“Every single Wall Street firm, despite their protest today, every single one benefited from our actions,” he said. “And when they get up there and say, ‘Well, we didn’t need it,’ that’s bull. “They did need it. And they’re all happy with the actions that we took, and they need to show restraint today.”

Cursive's picture

Who doesn't think these guys aren't a bunch of gangsters?  That was Kashkari trying to intimidate any GS dissenters.  Yeah, you better show restraint or we'll take your ass down too, just like in the summer of 2008 when Paulie and the BOD of GS met up in Paulie's hotel room in Moscow (thanks again U.S. taxpayer) and plotted how we'd take down those little bitches at Lehman.  We owned them and we could own you too.

agrotera's picture

PS I guess that 13 billion 2 days later really didnt matter--GS could have easliy stayed solvent and waited for all that "protection" they had if the taxpayer money wasn't flowing through the backdoor of AIG and into GS.

And CLEARLY LB lied too--but since the House Committee serves martinis and offers spa treatments after these guys come to town, of course this was not under oath! GS WAS BANKRUPT ALONG WITH LEHMAN, but with the AIG free money train, and the win on Lehman CDS's and shorts, they managed to make it to the Saturday secret TARP feast held by papa paulson in October...it is obvious to the US citizens and the world what is going on.  If we don't kick most of these puppet legislators out and watchdog from now on, there is no hope of getting our country's integrity (also this is the basis of our country's currency value) back.

Cursive's picture

Blankfein loses his argument when he says "we assumed that they would pay."  In other words, GS was f***ed with the AIG bailout.  Lloyd may have down a bunch of tap dancing prior to that, but then he proceeded to fall flat on his little ass when he let that bit of truth out.

panda6's picture

No he doesn't lose his argument....don't you have a clue how cds's to hedge c/p risk work?

Cursive's picture


Riddle me this.  What happens when an "insurer" goes bankrupt and can't pay the insurance claim.  Well, CDS's aren't even insurance, they are swaps (check out ISDA).  Mainline insurers were subject to state regulation to check whether the insurer had adequate capital to pay claims.  CDS's were not and are still not subject to regulatory review.  CDS's are the root of the problem of this mess.  Very few of the CDS counterparties could actually pay any claims.  Maybe you should get a clue about side letters, CDS's and fraud.  Just because someone promises to do something or to pay something, doesn't mean they are going to do it.  Maybe you believe in the Easter Bunny and the Tooth Fairy, too?  GS was f***cked until Uncle Sugar made everything all right.

ghostfaceinvestah's picture

If a FG (like, say, ABK) went bust, under NY law, CDS contract are junior in precedent to real insurance contracts.

That's why Citi settled theirs - they knew if they pushed ABK to the wall, they would just screw themselves.

sgt_doom's picture

Good Citizen Cursive is completely correct, Panda6 has been smoking some loco weed!

Credit default swaps are specifically designed as the exact opposite of the insurance pool, for very sound and fraudulent reasons. (And side notes with regard to reinsurance, as well.)

Interesting point raised by Cursive, with possible billions to trillions of counterparty positions by Lehman's, what occurred after their bankruptcy?  Does risk disappear?  Does super-risk suddenly get factored in?  (While it was obvious that at least four specific funds suffered - Ajax, Carillon, etc., who knows the number of other extant counterparty CDSes positions?)

Methinks panda6 may be with Markit Group, DTCC, Climate Exchange PLC, IC US Trust, InterContinental Exchange, GS, Morgan Stanley or JPM?

agrotera's picture

Speaking of Lehman--it is my belief that there should be an investigation on who owned the Lehman shorts and CDS's and when the list is comprised, add up all the affiliates and subsidiaries of GS, and MS, C and JPM and take a look at how much these firms benefited from the Paulson/Bernake decision to deny Lehman of a 6 billion dollar loan 2 days prior to giving AIG their first 85 BILLION bit of money and their stonewalling Lehman's request for bankholding status when about a week later, MS and GS magically have bank holding status.....a big win on the shorting of LEH and owning heavily LEH CDS's would have been a positive bet for these criminals giving them just what they need until their brothers could spend THREE weeks getting money to pass out so they could all get together and decide that the market bottom was in and it was time to buy and buy big --and borrow all they want for free--HEARTBREAKING TO WATCH THE CRIMES GO UNPUNISHED, AND CONSISTENTLY PRAISED AND LEGALIZED BY THEIR SOLDIERS IN THE LEGISLATURE.

Paulson and Bernake orchestrated these crimes.

Miles Kendig's picture

So that is the guy the pregnant surrogate mother secretary calls to shit on other peoples porches.  Thanks

panda6's picture


CDS's are relatively liquid instruments and are subject to daily margin requirements between counterparties.  So even if a swap counterparty couldn't pay up fully in an event of default (and you have no evidence for this of course) you would still be able to collect your mtm gain all the way up to your counterparty's default.  At which point you could replace the cds at the current market value without taking too great a loss.

CDS's are NOT a root cause of the crisis imho...they remained the most liquid credit market throughout the period when other markets were frozen, and were a fantastic way for people to manage their counterparty and other credit risks.

Miles Kendig's picture

In the case of AIG CDS are a reincarnation of the side letter.  Know what you are talking about... Unless your commissions as a day trader in a cube are your all encompassing world view..  This came before the work sgt_doom discusses.


Cursive's picture


You present an argument for the way that things are suppossed to work.  Theory and practice are two separate worlds.  You know so much, please elaborate on the following:

1.) Can you state with certainty that all of the CDS's that GS held against AIG were registered as opposed to OTC?

2.) What agent was holding the AIG margin account?

3.) Was the AIG margin account in good standing?

4.) What were the margin requirments and how much margin had AIG posted?

5.) Are you familiar with side letters?

6.) How many of the GS contracts do you think were invalidated by side letters?

7.) How does one obtain a CDS of any value for Lehman AFTER it has been wiped out?

8.) How does one obtain a CDS at the current market value when the market disappears overnight?

9.) If all of what you say is correct and GS didn't need for AIG to receive a bail-out, then why did they lobby so hard?

panda6's picture

1.  No.  And I assume you can't state the opposite with certainty.

2.  I'm going to go out on a limb and suggest bony; or jp.

3.  I don't know.  Do you have evidence to the contrary other than hearsay on the internet?

4.  More to goldies than other counterparties if rumours are to be believed.

5.  Yes.

6.  If gs couldn't call for margin, their internal models would have pointed this out.  Pretty basic risk management.

7.  Quite easily.  Recovery markets continue to trade on defaulted names (thomson, icelandics etc)

8.  A good point.  Luckily the cds market proved it has a certain degree of resilience after the lehman fiasco.  And of course gs would have suffered from some jump-to-default risk and quite possibly lost out on some of their hedges; but this is totally different from the assumption many people make that they would have lost $13bn had the govt not stepped in.

9.  Because AIG was an important counterparty in the market, and it would have caused a great deal of disruption.


Of course, the ironic thing in all this is that if AIG hadn't unwound most of their contracts at the bottom of the market, gs and others would now have returned most of the collateral as the market rallied....

sgt_doom's picture

What's-his-face over at Investment Risk Analytics makes a very good case that the chief beneficiary of the bailouts, especially of AIG, was to keep the CDS exposure of JPMorgan from triggering and detailing the actual insolvency.

Reggie Middleton's picture

Why are you arguing with him? If he was correct about CDS, then monoline insurers and thier clients would have no issues and there would be no settlement at 60 cents on the dollar (quoted elsewhere on the thread).

CDS is the problem because they functioned as an insurance vehicle without reserve regulation and structured discipline of actual insurance. If these contracts would have been written as insurance or reinsurance governed by the NY state dept. of insurance, we would have had a totally different end to this story.

ghostfaceinvestah's picture

Exactly, Reggie.  Why would ABK or SCA be able to settle for pennies on the dollar?

Because, under NY ins law, CDS contracts are junior to insurance claims in cases of insurer solvency.  The wraps on second lien Countrywide paper would stand in front of any CDS on CDOs, and after all that craps got paid out, the CDS counterparty would be lucky to get anything.  So they settled for a sure thing up front vs a big question mark on the back end.

Cursive's picture

I guess it was his smug insouciance and EMH-type attitude.  Acting like the U.S. taxpayer didn't get raked over the coals so a bunch of greedy bastards could stuff their pockets.  And he was flagging Argotera and me as junk.  Alright, I'll cool off now that RM/boombustblog is on my side.

agrotera's picture

timing of cash payments is an issue when on the verge of bankruptcy

agrotera's picture

I wish i had the patience to pull out all of his testimony on 2/11/09, but i just grabbed one of the highlights.  I think someone else pressed him harder about the AIG and asked if GS was fine either way with AIG going down, and if you watch the webcast, LB looks like he is passing a watermellon...he squinched up his eyes and the he stumbled over the words that fell out of his mouth so much it was really astonishing to watch--and knowing what had happened, i just felt heartbroken that the IDIOT SHILLS that were asking the questions didn't bother putting these men under oath and that the record was being tarnished with such incredible deception.

Cursive's picture

There is so much lawlessness on Wall Street since 2007 that this is pretty low on the totem pole.  I believe he lied, but it wouldn't hold up in court without something else.  Besides, GS has the Bernanke/Paulson/Geithner put, so its not like a shareholder could bring suit for a falling stock price that is not correlated with a market meltdown.

Anonymous's picture

"The way we do business with financial institutions is by having appropriate daily margin terms." Oh yeah and I forgot, direct access to taxpayer wallets.

agrotera's picture

Turning then to some questioning. Mr. Blankfein, I would ask

with regard to your company and your information that you can

enlighten me on the situation with AIG. Some people say that

when the Federal Government stepped in and helped bail out AIG,

what they really were doing was saving the counterparties or saving

the banks in their relationship with AIG. I wonder if you could

just sort of enlighten us as to what your relationship is with or was

with AIG, and what your position with as far as counterparty obligations,

what the dollar amounts may have been at that point in


Mr. BLANKFEIN. Sure. AIG was a very large, obviously very large,

company. It also was a very large player in the credit markets insuring

credits. We and many people on Wall Street and many businesses

who would have had exposures would have dealt with AIG.

In our dealings with AIG, we were always subject to a collateral

arrangement, and so that with respect to our dealings with AIG,

we were always fully collateralized and had de minimis or no credit

risk at any given moment because we exchanged collateral. So we

had outstanding positions, as did most people, but we had no credit

exposure because we had collateral from them and in some cases

other kind of credit mitigants.

Mr. GARRETT. I have heard rumors or stories in the paper and

what have you as far as a position dollar amount. Can you give us

a ballpark figure?

Mr. BLANKFEIN. Our total outstanding, if you look at the nominal

amounts of positions, would have been $20 billion worth of nominal

positions. That wasn’t the exposure. The exposure was substantially

less. And we exchanged collateral.

I do know where the source of the rumors were. There was a

New York Times story that was partially retracted that made the

statement that AIG was being saved for the benefit of the

counterparty. Now, to some extent AIG had obligations to a lot of

people. Had they defaulted on their obligations, they would have

gone bankrupt, and that would have triggered. And in a particular

statement they said Goldman Sachs had a huge obligation, which

we immediately denied. Our CFO and our earnings call said to the

world that we had no significant credit exposure to AIG, and I repeat

that to you now.

Mr. GARRETT. So if they were fully collateralized, then what was

then, A, the point as far as the statements made by some that Federal

dollars that actually went through AIG to you would not be

a correct statement, because they were already fully collateralized?

Mr. BLANKFEIN. We were collateralized.

Mr. GARRETT. If you were collateralized, then what was the necessity

for the Fed to step in at that point to bail them out?

Mr. BLANKFEIN. AIG had exposures. It wasn’t being driven in

any way by its exposures to Goldman Sachs.

Mr. GARRETT. My time runs quick. Were you hedged on the way

down as well for that?

Mr. BLANKFEIN. We had a collateral—yes, the answer is yes, we

always had hedges. Sometimes the hedge—I am sorry. Sometimes

the collateral would lag, and we would also take out credit insurance

against their exposure. So it was always our intention. We

manage all our risks, including our credit risks.

Mr. GARRETT. Help me understand this in 15 seconds. Does that

mean that you can sort of win on the way up and on the way down,


Mr. BLANKFEIN. No, no, no, no. It just meant that we were insured

against losing money because of their default.

Mr. GARRETT. So you benefited on the fact that they were


Mr. BLANKFEIN. We had transactions with them, and if they had

gone the wrong way, they would have owed us money. We assume

they would pay it, but if they defaulted, they wouldn’t pay us. We

insured against that default. We didn’t win money from it. We

wouldn’t have made money, but we protected our downside.

Mr. GARRETT. I appreciate that. My time has run out. “





Reggie Middleton's picture

Pardon my lack of expertise in things legal, but would this be blatant perjury???!!!

Mr. BLANKFEIN. Our total outstanding, if you look at the nominal

amounts of positions, would have been $20 billion worth of nominal

positions. That wasn’t the exposure. The exposure was substantially

less. And we exchanged collateral.

I do know where the source of the rumors were. There was a

New York Times story that was partially retracted that made the

statement that AIG was being saved for the benefit of the

counterparty. Now, to some extent AIG had obligations to a lot of

people. Had they defaulted on their obligations, they would have

gone bankrupt, and that would have triggered. And in a particular

statement they said Goldman Sachs had a huge obligation, which

we immediately denied. Our CFO and our earnings call said to the

world that we had no significant credit exposure to AIG, and I repeat that to you now.

panda6's picture

Would you care to point out where the perjury is reggie ?

Cursive's picture

Five minutes.  Five freaking minutes.  Would it kill the Senate to take up hearings on this?  It would be nice to have a sustained, substantive Q & A.