Goldman Fueled AIG Gambles (Excerpt)
Wall Street Journal - December 12, 2009
by Serena Ng and Carrick Mollenkamp (contribution from Amir Efrat)

See also: "Treasury Cover-Up of Goldman's Role in AIG Crisis," Huffington Post - Dec 22, 2009
and "Response to Goldman Sachs" (re NYTimes expose) - Huffington Post - December 25, 2009

Goldman Sachs Group Inc. played a bigger role than has been publicly disclosed in fueling the mortgage bets that nearly felled American Insurance Group Inc.

Goldman originated or bought protection from AIG on about $33 billion of the $80 billion of U.S. mortgage assets that AIG insured during the housing boom. That is roughly twice as much as Société Générale and Merrill Lynch, the banks with the biggest exposure to AIG after Goldman,according an analysis of ratings-firm reports and an internal AIG document that details several financial firms roles in the transactions.

In Goldman's biggest deal, it acted as a middleman between AIG and banks, taking on the risk of as much as $14 billion of mortgage-related investments. Goldman's other big role in the CDO business that few of its competitors appreciated at the time was as an originator of CDOs that other banks invested in and that ended up being insured by AIG, a role recently highlighted by Chicago credit consultant Janet Tavakoli. Ms. Tavakoli reviewed an internal AIG document written in late 2007 listing the CDOs that AIG had insured, a document obtained earlier this year by CBS News.

END OF EXCERPT

JT Note: Goldman’s “middleman” trades were probably done from its proprietary trading desk, but had A.I.G. failed, Goldman would have had to make good on these trades. Whether it acted as a “middleman” on all of these trades or just some of them, Goldman had assumed the risk (and A.I.G. provided a hedge).

According to the WSJ article, Goldman spokesman said that “What is lost in the discussion is that AIG assumed billions of dollars in risk it was unable to manage.” Yes, and what Goldman’s spokesman lost in the spin was that Goldman Sachs also could not manage that risk. Instead, Goldman “hedged” with A.I.G., and Goldman overexposed itself to A.I.G. If A.I.G. had failed, a liquidator might have asked Goldman to return a large portion of the collateral it collected. When one examines the collateral of the deals underwritten by Goldman, it includes some collateral from Goldman Sachs Alternative Mortgage Products and other collateral that did not perform well. Goldman’s way to “manage” that risk was to stuff it into value destroying CDOs, portions of which were then sold to customers and/or hedged with A.I.G.

If A.I.G. had gone bankrupt, a sensible liquidator would have clawed back collateral that A.I.G. had already given to Goldman due to the extraordinary circumstances. After it saved the day by extending the credit line, the FRBNY should never have settled for 100 cents on the dollar. In late July 2008, SCA settled with Merrill for around 13 cents on the dollar ($500 million to settle $3.7 billion of CDOs), and on August 1, 2008, Ambac settled some contracts with Citigroup for around 60 cents on the dollar ($850 million to settle $1.4 billion in contracts). In August 2008, one month prior to the FRBNY providing A.I.G. with an $85 billion credit line to pay collateral to its counterparties, Calyon, a French bank that bought protection from A.I.G. (including on some Goldman originated CDOs) settled a similar $1.875 billion financial guarantee with FGIC UK for only ten cents on the dollar. Ambac settled $5 billion of similar (to AIGs) CDSs for ten cents on the dollar, and MBIA has also made deeply discounted settlements on similar CDSs.

A.I.G.’s near collapse created a potential global crisis brought on by extraordinary circumstances related to Goldman’s securitization and trading activity. The crisis is now over, and Goldman (and A.I.G.’s other counterparites) should buy back all of the CDOs (on which they bought protection) at full price.

This link provides two examples of the quality of the underlying collateral of the CDOs Goldman underwrote and were subsequently protected by AIG. (You will have to enlarge the image after clicking, and the document is a bit awkward.) The first section shows the collateral of Abacus 2005-2 (Goldman underwrote and bought protection) and Davis Square Funding IV (Goldman underwrote this CDO and Societe General bought protection from AIG against it).mong the many shards of glass masquerading as gems, you will find Tourmaline CDO 2005-1, which went into acceleration in April 2008. It was managed by Blackrock. Perhaps the Fed’s theory in handing out no bid contracts to Blackrock has something to do with the diligence displayed by a fox watching a hen house.

Parts of tranches of the CDOs that were protected by AIG ended up as collateral of CDOs against which MBIA and Ambac sold protection (to their regret). This serves to illustrate the interconnectedness of value destroying CDOs.

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), and
Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (John Wiley & Sons January 2009)

Clients of Tavakoli Structured Finance have the benefit of proprietary consultation, which is not available in any other paid or public forum. Clients also commission proprietary research and analysis.

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