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Goldman’s Undisclosed Role in AIG’s Distress

November 10, 2009

by Janet Tavakoli

Goldman wasn’t the only contributor to the systemic risk that nearly toppled the global financial markets, but it was the key contributor to the systemic risk posed by AIG’s near bankruptcy. When it came to the credit derivatives American International Group, Inc. (AIG) was required to mark-to-market, Goldman was the 800-pound gorilla. It pushed AIG to the edge of disaster. [Hugh Son and Richard Teitelbaum, “AIG Trading Partners Squeeze Insurer Before Bailout (Update2),” Bloomberg, June 22, 2009.] The entire financial system was imperiled, and Goldman Sachs would have been exposed to billions in devastating losses.1

Goldman’s Spokesman Spreads Misinformation

A Goldman spokesman told me its involvement in AIG’s trades was only as an “intermediary,” but that isn’t even close to the full story. Goldman underwrote some of the CDOs comprising the underlying risk of the protection Goldman bought from AIG. Goldman also underwrote many of the (tranches of) CDOs owned by some of AIG’s other trading counterparties.

Even if all of Goldman’s CDOs had been pristine, it poisoned its own well by elsewhere issuing deals like GSAMP Trust 2006-S3 that—along with dodgy deals issued by other financial institutions—eroded market trust in this entire asset class and drove down prices.

By September 2008, Goldman had approximately $20 billion in transactions with AIG. Goldman was AIG’s largest counterparty, and its trades made up one-third of AIG’s approximately [Hugh Son and Richard Teitelbaum, “AIG Trading Partners Squeeze Insurer Before Bailout (Update2),” Bloomberg, June 22, 2009.][Note added Nov. 30, 2009: Goldman’s trades totaled $23 billion as of November 2007. As of November 2008, the remaining amount was $22.1 billion of which $13.9 billion was resolved by Maiden Lane III’s purchase of $62.1 billion of CDOs. AIG retained another $8.2 billion of Goldman’s credit default swaps referencing multi-sector CDOs.] in transactions requiring market prices.2 Societe Generale (SocGen) was AIG’s next largest counterparty with $18.7 billion (as of November 2007). SocGen, Calyon, Bank of Montreal, and Wachovia bought several (tranches) of Goldman’s CDOs and hedged them with AIG.3

Goldman Sachs Made $7.5 Billion in Collateral Calls to AIG by September 2008

On November 27, 2007, Joe Cassano, the former head of AIG’s Financial Products unit, wrote a memo about the collateral AIG owed to its counterparties. Goldman, Soc Gen, Calyon and others required more than $4 billion. Goldman asked AIG for $3 billion of the $4 billion required in collateral calls. (Click here to view the nine-page memo uncovered by CBS News in June 2009.) By September 2008, Goldman had called $7.5 billion in collateral from AIG.

Goldman Bought More Collapse Protection on AIG

AIG lists its transactions as negative basis trades. This suggests Goldman earned a net profit by purchasing—or holding its own—CDO tranches and then hedging them with AIG.4 [Note added Nov 17, 2009 – The SIGTARP report shows that Goldman held this risk in the form of credit default swaps for which it was a protection seller and it hedged its risk with AIG. Whether the risk was held as cash or credit default swaps, the negative basis trades, profitability, and risk to Goldman Sachs still applies.] As AIG’s financial situation worsened, Goldman bought further protection in the event AIG collapsed.

SocGen’s negative basis trades totaled $18.6 billion. For example, SocGen bought protection from AIG on two tranches of Davis Square VI, a deal Goldman underwrote. According to AIG’s documentation, SocGen got its prices for marking purposes for Goldman’s deals from Goldman. As of November 2007, Goldman marked down these originally “AAA-rated” tranches to 67.5%, down by almost one-third.5

SocGen’s list includes other deals underwritten by Goldman: Altius I, Davis Square II, Davis Square IV, the previously mentioned Davis Square VI, Putnam 2002-1, Sierra Madre, and possibly more. SocGen hedged this risk by purchasing protection (in the form of credit default swaps) from AIG.

Calyon had $4.5 billion of negative basis trades with AIG. Calyon and Goldman were co-lead on at least two deals: Davis Square II and Davis Square V. According to AIG’s memo, Calyon got its prices for these deals from Goldman.

Hank Paulson Urged Silence About Merrill, Recipient of $6.3 Billion AIG Payment

Goldman’s list of negative basis trades prominently featured many of Merrill’s CDOs (as underlying risk), and Merrill had its own list amounting to around $9.9 billion (as of November 2007). In Sept 2008, at the time of AIG’s near collapse, Bank of America had just agreed to merge with Merrill, which held $6 billion of super senior exposure to CDOs hedged with an insurer, now revealed to be AIG. Both Ken Lewis, then CEO of BofA, and Hank Paulson received tough questions about the merger, but not tough enough. Lewis later testified that Hank Paulson (then Treasury Secretary and formerly CEO of Goldman at the time of the AIG related trading activity) urged him to be silent about Merrill’s troubles. Merrill later received a $6.3 billion bailout payment from AIG.

Bank of Montreal had $1.6 billion in negative basis trades with AIG, and at least two Goldman transactions (Davis Square I and Putman 2002-1) made up 6 of its 9 positions with AIG. Wachovia had 6 trades with AIG, all related to Davis Square II, a deal that Goldman underwrote.

Goldman Sachs Influences Market Prices for AIG’s CDS Contracts

Goldman questioned PriceWaterhouse, Goldman’s and AIG’s common auditor, about prices. Goldman wanted lower prices, which meant that AIG would have to produce more collateral. When AIG was downgraded in September 2008, AIG was required to put up an aggregate amount of $14.5 billion in additional collateral to equal the full difference between original prices and market prices. But “market prices” in this illiquid market were influenced by Goldman Sachs.

Goldman was right to question the prices, make calls for collateral, and protect itself. Goldman’s activity was not the same as that of an arsonist buying fire insurance, but its trading activities with AIG and others were accelerants of AIG’s problems.

Goldman’s Influence in AIG Bailout without Consequences

During AIG’s bailout, Goldman had influence over the decision to use public funds to pay 100 cents on the dollar for these CDOs (the underlying risk of the credit derivatives), but none of the information about the volume of Goldman’s trades with AIG—or the Goldman CDOs hedged by AIG’s other counterparties—was made public.

Goldman’s public disclosures in September 2008 obscured its contribution to AIG’s near bankruptcy and the need to bailout Goldman’s trading partners in AIG related transactions. Goldman’s trading activities played a starring role in the near collapse of the global markets.


1 Goldman’s current and former officers were influential in varying degrees in AIG’s bailout. Hank Paulson was then Treasury Secretary and a former CEO at the time Goldman put on its trades with AIG and underwrote deals bought by some of AIG’s counterparties. Lloyd Blankfein was CEO of Goldman and was influential in the bailout discussions. Stephen Friedman, then Chairman of the NY Fed, also served on Goldman’s board.

2 AIG’s Nov 2007 report showed Goldman’s positions at $23 billion, but something may have happened before Sept 2008 to reduce that amount. AIG was required to price these credit derivatives using market prices, and if applicable, AIG had to provide collateral if the prices moved against it. Terms varied, but after the downgrade, AIG owed collateral for the full mark-to-market value to several counterparties. This is the difference between the original value and the price that Goldman and others put on the credit default swaps.

3 AIG’s other trading partners for the CDSs requiring mark-to-market prices included French banks Societe General (SocGen) and Calyon, Bank of Montreal, Wachovia, Merrill Lynch, UBS, Royal Bank of Scotland, and Deutsche Bank.

4 AIG may have used the term “negative basis trade” loosely. Whether Goldman was an intermediary (stood between AIG and yet another counterparty), or whether it booked negative basis trades, Goldman had to manage its risk in the event AIG went under.

5 SocGen’s total margin calls were not available in the November 2007 memo. It is possible that like Calyon—and like troubled Citigroup—SocGen provided a liquidity put on commercial paper (CP) distributed by Wall Street firms to a variety of investors. Calyon agreed to buy the CDO’s commercial paper (short term debt backed by the longer term tranches of the CDOs) if demand in the market dried up when it came time to roll the CP. Calyon hedged the risk of the liquidity puts by purchasing credit default protection from AIG.


Goldman Sachs either underwrote or bought protection via credit default swaps on the majority of the flawed collateralized debt obligations purchased from AIG for one hundred cents on the dollar by the Fed’s Maiden Lane II vehicle. This fact was obscured from reporters and the public during the government’s massive bailout of AIG that benefited Goldman Sachs and its business partners. I was the first to uncover this and put this information in the public domain, despite pressure from Goldman Sachs.

Details of the underlying collateralized debt obligations and beneficiaries of the Fed’s decision—without approval from Congress—to settle AIG’s swaps for 100 cents on the dollar using taxpayer’s funds were kept secret, and Bloomberg News quoted me: “There’s no way they should have paid at par.” Banks had already settled several credit default swaps on CDOs with other insurers at deep discounts.

In December 2009, the Wall Street Journal wrote “Goldman Fueled AIG’s Gambles,” and highlighted my analysis. In February 2010, Representative Darrell E. Issa, the ranking Republican on the House Committee on Oversight and Government Reform, released a previously secret five-page document showing the deals and listing of the bank beneficiaries of the Fed’s decision in light of allegations of conflicts of interest, cronyism, and a cover-up. The New York Fed successfully prevented publication of the document for more than a year.

In December 2009, the New York Times revealed that Goldman Sachs bundled bad debt and then bought credit default protection and made other bets against it as both hedges and gain making positions. A May 2010 Senate probe revealed that Goldman Sachs used credit derivatives to transfer the risk of the same losing CDO tranches into other CDOs over and over again, thus multiplying gains for Goldman and multiplying losses for investors.

See finance articles by Janet Tavakoli for more on Goldman Sachs and AIG