Tavakoli Structured Finance LLC

Goldman’s Lies of Omission

Prologue: In September 2008, Goldman Sachs claimed it had minimal exposure to AIG. It neglected to mention billions in margin calls it had made and would have to make on credit derivatives linked to flawed collateralized debt obligations that Goldman either underwrote or on which Goldman bought protection from AIG.

October 28, 2009

by Janet Tavakoli

In my opinion, David Viniar’s (CFO of Goldman Sachs) comments in the fall of 2008 were a lie, and for that matter, Lloyd Blankfein’s (CEO of Goldman Sachs) later comments to the Wall Street Journal were disingenuous. In the context of what was happening near the time of AIG’s implosion, the key question was “What is going on between Goldman and AIG?” Their rhetoric surrounding this issue is a deft dodge. They may claim they didn’t “technically” lie, but Goldman’s business exposure to AIG posed both credit risk and reputation risk. They seem to overlook elements of the former and put insufficient value on the latter.

Goldman should have plainly stated that it was owed billions in additional collateral from AIG—after already having collected billions—due to credit default swap contracts and other trading positions. Whether or not Goldman thought its credit risk was totally hedged is a separate, albeit important issue, and I’ll get to that later.

Among the proximate causes of AIG’s failure were previous calls for collateral made by its credit default swap trading counterparties, including Goldman Sachs. They were entitled to pressure AIG on its prices and demand more collateral; I had publicly challenged AIG’s prices myself more than a year earlier. These actions gave a major push to AIG’s subsequent credit downgrade, which tripped contract triggers that AIG had unwisely permitted its more clever counterparties to insert. (The credit default swap market is not standardized.) This meant AIG had to come up with collateral equal to the entire remaining amount of the credit default swap contract.

Unfortunately, AIG was essentially bankrupt at this point and it couldn’t meet its obligations. The government could have stepped in and renegotiated its contracts. [Goldman’s “hedges” might have disputed whether a reduced payment triggered a restructuring event, if applicable, in their contracts.] But that isn’t what happened.

Absent a bailout of AIG, Goldman was vulnerable to increasing systemic risk which would have likely affected its hedge counterparties and many of its other trading counterparties. Liquidity was very tight in the fall of 2008. [In March of 2008, Alan Schwartz, then CEO of Bear Stearns, saw tens of billions of dollars of seeming liquidity disappear in hours. Schwartz publicly stated he had ample liquidity, until suddenly he did not.] In September of 2008, Goldman negotiated for additional capital with Berkshire Hathaway and paid up for it. The outcomes for both AIG and Lehman were uncertain.

If AIG had gone under, the already illiquid market would have frozen. Collateral requirements for all trading would have increased (just as they did the week Bear imploded), and Goldman would have had problems collecting from many trading counterparties, if not the exact counterparties “hedging” its exposure to an AIG disaster.

It is never a given that hedges will pay off when the chips are down. A counterparty may dispute whether the contractual definition of a credit event is met, if only to buy time. Even when there is no default at issue, counterparties can try to change the rules when the market is in turmoil. In the fall of 2008, there were already anomalies in the derivatives market. For example, China refused calls for collateral on derivatives contracts in Asia, and its counterparties were forced to renegotiate. The entire market pretended this event didn’t cause a cross default.

Goldman was not a disinterested party in AIG’s bailout. AIG’s bailout—and the way the payouts were handled for its trading counterparties—hugely benefited Goldman Sachs. Goldman received a cash payment worth more than $10 billion from the U.S. Treasury—via AIG—during a system-wide liquidity crunch. Under the circumstances, I cannot think of any scenario that would have provided a more certain and stable outcome for Goldman Sachs.

See also the Bloomberg article and note below.

“New York Fed’s Secret Choice to Pay for Swaps Hits Taxpayers,” by Richard Teitelbaum and Hugh Son, Bloomberg News – October 27, 2009

Janet Tavakoli, founder of Chicago-based Tavakoli Structured Finance Inc., a financial consulting firm, says the government squandered billions in the AIG deal.

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

Citigroup 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 [Ambac said the underlying was worth about zero, and the protection payment would otherwise have been the full $1.4 billion].

JT Note: It is a strong statement to say that a CFO lied to the public, and in my opinion, David Viniar, Goldman’s CFO, lied about 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 (see also the commentary above).

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

David ViniarThe 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. [Emphasis added.]

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