Tavakoli Structured Finance LLC

The Financial Report

By Janet Tavakoli

Treasury Covered Up and Bailed Out Goldman Sachs in AIG Scandal

In November 2009, I wrote that Goldman Sachs Group nearly bankrupted AIG. In December, the Wall Street Journal explained to the general public that Goldman fueled AIG’s gambling and played a much bigger role in the mortgage bets that nearly felled American Insurance Group (AIG) than the Treasury, the Fed, or Goldman itself publicly disclosed.

The TARP Inspector General’s November 17 report missed the most damaging facts. Intentionally or otherwise, it was evasive action or just plain whitewash. The report failed to clarify Goldman’s role in AIG’s near collapse, and that of all the settlement deals, the U.S. taxpayers’ was by far the worst.

Goldman Created Securities that Helped Destroy AIG, Its Hedge

Goldman originated or bought protection from AIG on about $33 billion of the problematic $80 billion of U.S. mortgage assets that AIG “insured” with credit derivatives, about twice as much as the next two largest banks involved.

Goldman acted as middle-man on $14 billion of that amount, after it took the risk of mortgage assets originated by other banks and insured all of it with AIG. Goldman may wish to claim it “was only following orders,” but since Goldman also originated many of the mortgage assets ultimately protected by AIG, it should have been well aware of the risk posed to itself and to AIG. The risk was then Goldman’s. If AIG failed, Goldman Sachs would have had to make good on those trades. Goldman stuffed so much risk into A.I.G. that Goldman nearly killed its own “hedge.”

New York Fed Paid Goldman 100 Cents on the Dollar and Covered It Up

In November 2008, the New York Fed paid 100 cents on the dollar for the $14 billion of mortgage assets related to Goldman’s trades. Goldman estimated the assets had lost $9.6 billion, or around two-thirds of their market value. Overall, the government’s bailout out of AIG allowed Goldman to avoid losses on its trades covering $22 billion in assets.

The U.S. taxpayer deserved a much better deal. In late July 2008, SCA, another bond insurer, settled similar contracts for only around thirteen cents on the dollar. In August 2008, Calyon, a French bank also involved in AIG’s transactions, settled disputed financial guarantees with FGIC, a bond insurer facing bankruptcy, for only ten cents on the dollar. Ambac, another bond insurer in need of capital, recently canceled similar trades for ten cents on the dollar.

Defenders argue that circumstances surrounding AIG were different from the other bond insurers. They are correct; the circumstances were worse. The Fed should have made sure any payments that originated from AIG, before or after the bailout, were only temporary loans to be repaid as soon as possible.

This link provides a snapshot from January 2008 of two of Goldman’s value-destroying securitizations that were protected by AIG. (You will have to enlarge the image after clicking, and the document is a bit awkward.) The first is Abacus 2005-2; Goldman originated and bought protection on these mortgage assets. The second is Davis Square Funding IV; Goldman originated this deal, and French bank Societe General bought protection from AIG against it.

Inside Goldman’s mortgage assets were value-destroying assets created by other Wall Street firms. Everyone bought each others’ junk so prices stayed artificially high, and the risk could be dumped on someone else. Of course, this doomed strategy eventually fell apart. At the time of the AIG bailout, losses were quickly eating away at the insides of these products cooked up in Wall Street’s financial meth labs.

Among the many shards of glass masquerading as gems, you will find Tourmaline CDO 2005-1. It was managed by Blackrock, the manager of the AIG assets that the Fed purchased with public money. 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.

The Fed gave the U.S. taxpayer a raw deal. At the time Goldman got its give-away, Henry Paulson was treasury secretary — he was also Goldman’s CEO when it put on its trades with AIG — and former Goldman chairman Stephen Friedman was then chairman of the New York Federal Reserve Bank. Goldman CEO Lloyd Blankfein was the only Wall Street executive at one of Paulson’s bailout meetings. Goldman was inside the tent advising on the most self-serving way to save itself and gain unfettered access to public funds.

In the fall of 2008, Goldman Sachs became a bank holding company before switching to a less regulated financial holding company in August 2009*. This prevented a run on Goldman Sachs and gave it permanent access to Fed funds, taxpayer money. Goldman pays rates near zero for short-term borrowing while it earns profits on the higher rates paid on the capital it is required to deposit with the Fed. Goldman also issued nearly $21 billion in debt guaranteed by the FDIC. Most valuable of all, however, is the perception that Goldman is so well-connected, that the government will never let it fail.

Goldman paid mega bonuses in past years subsidized by selling hot air. Now it proposes to again pay billions in bonuses based on earnings made possible by taxpayer dollars.

Goldman Should Unwind Trades Giving Taxpayers Full Price

Now that the crisis is over, we should ask Goldman Sachs — and all of AIG’s other trading partners involved in these trades — to unwind credit default swap contracts and buy back mortgage assets at full price to bailed out entities like AIG. Alternatively, we can impose a special tax. Instead of calling it a windfall profits tax, we might label it a “hot air” profits tax.

A Goldman spokesman denies it could have known the underlying mortgage assets were a problem, but Goldman also acknowledged I had warned about them — and the grave risks they posed — at the time they were created. It said my opinion was in the “minority.” As it happens, Goldman’s opinion was proved tragically wrong, and mine was proved correct. It is not in the public interest to rely on Goldman’s opinion about the greater risk it now poses to the global markets, and the Treasury should exact a much greater financial cushion.

Treasury Rewarded Goldman Sach’s Value Destruction

The global financial crisis and the special circumstances surrounding AIG’s bailout were extraordinary. It is unconscionable to reward value destroying activity that damaged not only AIG, but enabled massive damage to the U.S. economy. It is in the public interest to claw back public money. Goldman should buy back these mortgage assets at full price, or we should impose a reparations tax. Furthermore, Goldman should pay off its FDIC guaranteed debt, and once again become an investment bank with no access to Fed borrowing, before it pays taxpayer-subsidized bonuses to its employees.

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