Revisiting a Fed Waltz With A.I.G.
[See also: Goldman Sachs Responds to the New York Times - Huffington Post Nov. 24]
New York Times - November 22, 2009
by Gretchen Morgenson

“The [TARP] inspector noted in his report that Goldman made several arguments for why it is believed it was not materially at risk in an A.I.G. default, but he is skeptical of the firm’s reasoning.

So is Janet Tavakoli, an expert in derivatives at Tavakoli Structured Finance, a consulting firm. “On Sept. 16, 2008, David Viniar, Goldman’s chief financial officer, said that whatever the outcome at A.I.G., the direct impact of Goldman’s credit exposure would be immaterial,” she said. “That was false. The report states that if the New York Fed had negotiated concessions, Goldman would have suffered a loss.”

The report says that Goldman would have had difficulty collecting on the hedges it used to insulate itself from an A.I.G. default because everyone’s wallets would have been closing in a panic.

[JT Note: Banks were having severe liquidity problems, Lehman had just gone bankrupt and Merrill had just been sold to BofA. This pre-dated the TARP purchases of preferred stock that injected additional funds into banks.]

“The prices of the collateralized debt obligations against which Goldman bought protection from A.I.G. were in sickening free fall, and the cost of replacing A.I.G.’s protection would have been sky-high,” she said. “Goldman must have known this, because it underwrote some of those value-destroying C.D.O.’s.”

Ms. Tavakoli argues that Goldman should refund the money it received in the bailout and take back the toxic C.D.O.’s now residing on the Fed’s books—and to do so before it begins showering bonuses on its taxpayer-protected employees.

“A.I.G., a sophisticated investor, foolishly took this risk,” she said. “But the U.S. taxpayer never agreed to be a victim of investments that should undergo a rigorous audit.”

END OF EXCERPT - Click above link for full article at the New York Times


Goldman Sachs Responds to the New York Times (TSF November 24, 2009

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 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 role first 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. 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 Luca 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 my reading of the 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 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 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 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) – 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, it seemed to present only one scenario on September 16, 2008. Lehman had just gone bankrupt, Bank of America had just agreed to takeover Merrill, and banks were starved for liquidity just like A.I.G. The banks’ TARP bailout had not yet occurred. I suggest that Goldman may self-deluding with its claim to be the 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 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 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 its responses to the New York Times, a bunch of operators tried to gaslight the public.

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 professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008).

Janet Tavakoli's book on the global financial meltdown is Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley 2009)


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