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The NYT’s Latest Goldman/AIG Salvo: Missing the Real Targets?

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By Yves Smith and Tom Adams, an attorney and former monoline executive

Gretchen Morgenson has a lengthy article tonight at the New York Times, “Testy Conflict With Goldman Helped Push A.I.G. to Edge.” While it provides some useful new tidbits, it peculiarly focuses on an aspect of Goldman’s dealings with AIG that, particularly with the benefit of hindsight, the bank can defend, and gives short shrift to other issues that implicate not only Goldman, but much bigger fish, namely the Fed and the Treasury.

Let us stress that this post is NOT a defense of Goldman. We are no fans of Goldman; the firm does a masterful job of cutting the cake so it gets the biggest piece, and deserves to have its actions scrutinized. But as other commentator have mentioned, the fixation on Goldman often lets other culpable players get off easy (for instance, while roughing up Blankfein at the FCIC hearings was a welcome spectacle, no one laid a glove on Jamie Dimon). The story also at quite a few junctures gives an account that appears unduly in line with AIG’s point of view, which also serves to weaken the impact of some of the legitimate issues it raises.

Let us start with the central thesis which is:

1. Goldman was overly aggressive in marking down the CDOs it had insured with AIG. Remember, the bigger the losses reported on the CDOs, the more cash AIG would have to pony up to Goldman

2. Goldman’s actions contributed to AIG’s demise.

We’ll deal with each of these points, and then discuss the important issues (and we think bigger) issues we think this focus misses.

Shortcomings of the Morgenson Thesis

The story starts, dramatically, with a heated conference call in January 2008 in which Goldman and AIG staff are arguing over the “marks” or prices Goldman is assigning to its CDOs insured with AIG:

A.I.G. executives wanted some of its money back, insisting that Goldman — like a homeowner overestimating the damages in a storm to get a bigger insurance payment — had inflated the potential losses. Goldman countered that it was owed even more, while also resisting consulting with third parties to help estimate a value for the securities.

This remains the subtext of the article: Goldman was overly aggressive, other firms were marking the deals at higher prices.

There is a wee problem with this account. Goldman’s marks were proven correct. With the benefit of hindsight, most players, particularly AIG, were in denial. Moreover, AIG’s assertion that Goldman was not willing to get independent valuations is disputed later in the article. But if you didn’t get that far, or weren’t paying close attention, you would conclude Goldman was using “marks” that would not stand up to scrutiny.

In late 2007 and early 2008, the monolines were facing similar issues to AIG. Rather than getting cash calls, they were facing aggressive marks from their bank counterparties. The monolines argued vehemently with their accountants and their investors (and some of their employees) that the marks overstated the declines in their insured CDOs due to market illiquidity and that the bonds would recover in value. This is where Bill Ackman’s open source document, his detailed analysis of MBIA and Ambac came in – he put forth the analysis in January 2008 that showed that they mark to market write downs would translate into real losses. The rating agencies not long afterwards started downgrading AAA asset backed securities CDOs, verifying the “aggressive” position Ackman and Goldman were taking.

The story also repeats the AIG/Fed flattering claim that these CDOs have “rebounded.” We’ve discussed long form in other posts that given the continued, serious deterioration in the underlying mortgages, this notion is simply not credible. The decay in credit quality across the portfolio is severe, and there has been no “rebound” in prices of severely distressed CDOs.

One monoline insurer, faced with a material discrepancy between what the “market” was saying the CDO bonds were worth and what “management” was saying, had two outside firms to evaluate its portfolio. Both valuations differed in approach, but both confirmed material losses from the CDOs. This was in November 2007, before the AIG/Goldman dispute.

The jig was up for AIG by January of 2008 and the debate was only one of timing, not of what the actual outcome would be. Coincidentally, Ambac, FGIC and XLCA were downgraded in January 2008 directly as a result of high expected losses in their CDO portfolios. Any case against Goldman for aggessive marks against AIG by the SEC or other parties would have take the market environment into consideration. Across the board, CDOs were causing losses and downgrades for the people who insured them. It therefore makes plenty of sense that Goldman would be requesting more collateral for their exposure with AIG.

The more logical question then becomes: why weren’t AIG’s other counterparties, such as UBS and Merrill, requesting more in collateral when their CDOs were clearly losing value? Perhaps these other institutions had other reasons – and other exposures – which prevented them from marking down their CDO exposures and demanding more collateral. For instance, if they downgraded these CDOs to reflect downgrades and deteriorating market pricing, were there other CDOs, and perhaps even mortgage backed bonds they’d have a hard time NOT downgrading? Or was it that, unlike Goldman, they had hedges with monolines too. With the monlines being downgraded, they’d be having to mark down the value of the CDS with them. So even if the other banks were fully insured on their other CDOs, but they were insured with monlines, they probably would not be able to report hedge gains that corresponded to CDO losses due to the monoline downgrades (ie, the insurance was proving not to be as effective as it had been assumed to be at the time it was booked).

Many people, with vested interests, were arguing losses would not be that large. They couldn’t really imagine that the losses would be that large – it was beyond previous imagination, but they turned out to be wrong. Much of 2008 was a battle between these forces in the financial industry – bear, lehman, aig, the monolines and even, for a while, the rating agencies – arguing that the losses would not be as terrible as market pricing was suggesting.

Remember the dead body in the room: the portfolio of bonds that AIG insured went from AAA to CCC in less than a year. Goldman looks to have been the only AIG ounterparty on top of the crappy fundamentals.

In a very extreme interpretation of events, someone might be able to argue that the aggressive marks caused the value of the bonds to fall further and pushed the downward spiral. But that betrays a misunderstanding of the CDO deals.

The underlying MBS in the CDOs were already downgraded and declining rapidly in value by 4Q 2007. The credit market had already frozen. The die had already been cast. It was inevitable that this would lead to the CDOs collapse, regardless of their original ratings.

Now let’s get to point 2, that Goldman’s “overly aggressive” collateral calls helped push AIG over the edge. Narrowly of course, this is correct, all the collateral calls together (well, plus the $20 billion black hole of the securities lending portfolio, can’t sweep than under the rug, now can we?) pushed AIG over edge. Goldman was one of the counterparties, the biggest in aggregate, so this seems to stick, right?

Well, you need to dig deeper to prove this assertion, and the article fails to do that. First, per a November 2008 BlackRock memo, Goldman and AIG had reached a settlement of sorts re Goldman’s marks. AIG was applying a 12% haircut.

Now you would then have to look at:

The cash Goldman was getting AFTER the haircut, versus an average across the other banks (adjusted for credit quality, which BlackRock was capable of doing). In other words, you need to see the EXCESS of what Goldman was getting relative to what it would have gotten if it had marked its bonds like everyone else, and see if that differential was big enough to have made a difference in AIG’s demise. We don’t have that analysis, and ex that analysis, this may or may not be the case.

Possible Productive Lines of Inquiry That Get Short Shrift

The focus on Goldman’s marks with AIG largely bypasses what we think is a more serious issue: the role of all synthetic or heavily synthetic CDOs, which allowed Goldman to go net short. The usual vehicle for that was a “mezz” CDO, because the CDS would be on BBB subprime trances, the layer that would go “boom” first. The bulk of Goldman’s AIG-related CDOs were older vintage “high grade” CDOs, meaning the synthetic component was not large (on the deals we looked at, a maximum of 20%) and they would be on AA bonds, which were not the slice you’d be eager to use if your strategy was to go net short. So the fixation on the marks has the unfortunate effect of diverting attention away from what we think was the much more troubling activity: the use of heavily/all synthetic CDOs to establish a short position.

Even though the deal documents allowed for the possibility that Goldman would keep the short interest created by these deals, anyone who invested in them or acted as a guarantor would have thought very differently, and probably have asked for much higher returns if it had understood Goldman was acting as a principal rather than as a middleman (and how Goldman influenced the deal parameters to assure that its short position worked out). The story indicates that $5.5 billion of Abacus trades (a Goldman synthetic short program of 26 deals in total) were insured by AIG. Using the AIG Abacus trades as an entry point into the entire Abacus program would be a very useful exercise.

Then we have this bit:

Mr. [Ram] Sundaram [of Goldman] used financing from other banks like Société Générale and Calyon to purchase less risky mortgage securities from competitors like Merrill Lynch and then insure the assets with A.I.G. — helping fatten the mortgage pipeline that would prove so harmful to Wall Street, investors and taxpayers.

This may mean a lot, or it may mean very little. By our tally. $5.9 billion of Goldman’s CDOs that were insured with AIG had been structured by Merrill. Also note that it is pretty likely that this insurance was entered into at or within days of the closing on the CDOs.

AAA CDOs were eligible repo collateral. According to the IMF, the haircuts on AAA ABS CDOs (the type we are discussing here) were a mere 2-4% as late as April 2007. That means that when Goldman bought these CDOs, it could have financed as much as 98% of the purchase price in the repo market. If SocGen and Calyon were providing repo financing, this is not newsworthy. If there was a different, non-standard arrangement, that could be a very different story.

Also unexamined is the fact that most of the Goldman’s deals appear not to have been on the firm’s behalf. Goldman’s non Abacus trades would have been considered to be “cash” CDOs. Consider this section of the November BlackRock memo:

Goldman’s exposure to AIG is limited to the differential between collateral requested (what they are likely posting to swap counterparties) and collateral requested from AIG….Goldman’s swap counterparties are exposed to Goldman Sachs risk rather than AIG counterparty risk. and are therefore less likely to be receptive to deep concessions.

Goldman has said it does not hold the cash CDOs, but has back to back swaps on most of the positions.

Now why would Goldman not be holding the CDOs and have entered into back to back swaps? Goldman probably sold the CDOs to customers, and also provided CDS on them too. This was a pretty common arrangement. The banks preferred that the insurer did not “face” an end customer directly; the originating bank would take the CDS position with the monoline or AIG and then write swaps against it (this enabled the bank to earn more in fees).

This idea is also confirmed by Maiden Lane III disclosure:

AIGFP, the LLC and the New York Fed have entered into agreements with AIGFP’s credit derivative counterparties to terminate approximately $53.5 billion notional amount of credit derivatives and purchase the related multi-sector CDOs. Of these, CDOs with a principal amount of approximately $46.1 billion settled on November 25, 2008. Settlement on the remaining $7.4 billion is contingent upon the ability of the related counterparty to obtain the related multi-sector CDOs and thereby settle with the LLC and terminate the related credit derivative contracts with AIGFP.

Notice the mention of a single counterparty that had to settle later because it had not rounded up all its CDOs. That counterparty is believed to be Goldman. That does not preclude Goldman (and other banks that had sold CDOs and were acting as swap counterparties) from having better luck in getting their customers to do whatever they needed to do to settle with Maiden Lane III.

But that raises yet another issue that has yet to be examined: to the extent that the banks had sold CDOs to customers, and were merely acting as CDS middlemen, the purchase of the CDOs themselves by Maiden Lane III constituted a bailout of customers. And it is a near certainty that these were not, say, US pension funds, parties that the Fed might have a policy interest in assisting. Goldman’s CDO customer list is closely guarded, but it is believed to have a heavy representation of Middle Eastern investors. If true, why did the Fed extend a backdoor bailout to them?

Diverting Attention from the Fed, Treasury, and Paulson

Doubts about the monolines were becoming serious in the first acute phase of the credit crisis, September-October 2007. They were a daily focus in the business press in January-February 2008. Bear went under and was rescued because its failure would have rocked the CDS market.

There might have been a defensible case for denial of the seriousness of the problems afflicting the CDS market up through March of 2008. The Bear meltdown, the fact that the ratings agencies were starting systematic, aggressive downgrades of CDOs, and the belief that Lehman and Merrill were next to go meant understanding the risk of mortgage-related CDS exposures was imperative to understanding systemic risks. Even a cursory examination would have led straight to AIG. The “oh were weren’t their regulator” is an implausible excuse. The Fed and the SEC most assuredly WERE regulators of the parties exposed to AIG.

And this inattention raises further issues. Virtually all of the Goldman CDO exposures with AIG were entered into when Paulson was CEO of Goldman. Why has there been no inquiry into his role in overseeing, and ultimately profiting, from these deals?

AIG’s failure to understand the implications of the current market values and downgrades underlying its CDOs sheds light on its CDO underwriting process (or more accurately, lack thereof). How widespread was this problem at other companies? Did anyone that invested in (or insured) these deals really understand them? It suggests that only reason any of these parties were involved in these deals was because they were rated AAA. Yet to date, the SEC, Treasury and Fed have done nothing to address the essentially misleading nature of AAA ratings on such bonds.

Although details are emerging bit by bit on CDOs and credit default swaps, there is still a great deal that is not out in the open. The failure of regulators to push for much larger-scale inquiries suggests at best a troubling complacency, or at worst, the knowledge that a full bore investigation will reflect very poorly on the powers that be.

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45 comments

  1. Neil D

    Do I have this right?

    So GS was just being GS and should not be criticized for being smarter than AIG and everyone else. AIG was stupid to write all these insurance contracts and we blame the regulators for not stepping in.

    But the Bush administration was never going to provide regulatory oversight sufficient to prevent the crisis – it wasn’t in their nature to do so. Everyone knew that and took full advantage. What’s to investigate?

    Elections, as it turns out, matter.

    1. Yves Smith Post author

      Neil,

      This is a very serious distortion of the post.

      First, we said there WERE serious matters to investigate, in particular the Goldman Abacus trades. In general, synthetic and largely synthetic deals like the Goldman Abacus program were the really destructive product, and investigations have only scratched the surface. Even though ABS CDOs were a terrible product, the synthetic versions had far wider ramifications (they served to balloon subprime exposure well beyond the market of actual borrowers) and also involved more activity that was fraudulent in intent, even if the selling process technically stayed within the weak/non-existent rules that governed these trades.

      We are saying the issue of the AIG marks is a red herring. It actually feeds a story that is flattering to the Fed and Treasury, that there were no real problems with CDS on CDOs as of Jan 2008 (obviously not true if you look at headlines related to MBIA and Ambac around that time). Goldman can likely make a case for its conduct here (whether you like hearing that or not), and the focus on the marks diverts attention from other conduct (how it got net short subprime) that will be VERY difficult to explain or defend in the court of public opinion.

      The post ALSO says this narrative serves to divert attention from ANOTHER Goldman topic that deserves more scrutiny, Paulson’s role in the Goldman CDO strategy. Most of the AIG deals happened on his watch. Has his culpability led to less investigation/disclosure/action than there should have been?

      The post at the end clearly says we need much more, not less, investigation of the CDO and CDS market, and raises other issues for inquiry at various points earlier on.

      It is troubling that efforts to focus attention on real abuses are mischaracterized. Attacking Goldman on issues where it can mount a credible defense serves Goldman. There are a lot of areas where digging into Goldman’s conduct will not show it in a flattering light, and the Abacus trades are clearly a prime target.

      1. Neil D

        I have no particular problem with what GS did – they played the game within the rules and got their cash from AIG before anyone else. AIG got played and they deserved their fate. When drug dealers kill other drug dealers after a deal gone bad, I don’t particularly have a problem with that either. Unfortunately, sometimes innocent people get hurt too and I do have a problem with that.

        I’m struggling with what could have been done, given the disdain for regulation on the part of the Bush admin and the Fed. Unless I’m missing something, it seems to me any investigation will show there were many opportunities to step in, but that the regulators chose not to.

        I assume they did not step in for idealogical reasons and really couldn’t imagine (like Greespan) how bad it would get. That’s not criminal, it’s just who they are.

        The Times article might serve to demonize GS more than AIG. So what? Americans believe that government regulation is bad and we are paying for that ideology. Put the blame where it really belongs – with all of us.

        1. DownSouth

          Neil,

          You say: “I have no particular problem with what GS did – they played the game within the rules…”

          That is pure, unmitigated bullshit.

          That’s tantamount to the police deciding innocence before their investigation even begins, or a juror deciding innocence before the trial has even started.

          1. Neil D

            BS? – when the rules are “there are no rules” then you have no right to complain. We the people and our elected representatives said “there are no rules.”

            That’s the only reason I have no problem with it.

          2. DownSouth

            Neil,

            You claim “We the people…said ‘there are no rules.’ ”

            Again, pure, unmitigaed, unsubstantiated bullshit.

            In politics, abuse begets abuse.

            It’s like a candidate for a judicial bench in San Antonio once told me: “If the justice system doesn’t deliver justice, then what you get is street justice.”

            Guys like Blankfein, and the corrupt little marionettes he bought off, better hope like hell we don’t see another leg down on this GFC. If the pendulum happens to swing the other way, he and his little puppets will be lucky to get the type of investigation and measured justice that Yves is advocating.

      2. Fl Cracker

        Yves hit the nail on the head and I think everyone here is a little overreactive to Neil’s comments on GS. Certainly this article was barking up the wrong tree. According to the NYT it was all about GS arguing about the marks, and that hastened AIG’s demise? Goldman saw it all coming and you have to give that to them, but I kept reading this long article waiting for the Paulson shoe to drop and it never did. Very shoddy job at best for the NYT and outright MSM trash at worst. Maybe Ben and Co was the ghost writer here.

    2. DownSouth

      Neil,

      Presidents–Clinton, Bush, Obama–come and go. But the economic policy makers—Bernanke, Geithner, Summers–as well as the economic dogma they embrace, are all permanent fixtures. There also seems to exist a code of omerta that unites the current bunch with former policy makers like Rubin, Greenspan and Paulson.

      Think of it like this. You’re named president of a company and the company has an employee whose job it is to oversee the maintenance of company vehicles. The engine on your company limo freezes up, and this employee doesn’t want some independent, third-party mechanic snooping around under the hood because he might discover that the reason the engine froze up is because the oil wasn’t changed.

      You, as the new president, are willing to go along with this arrangement because:

      1) You are on the take
      2) The board of directors is on the take
      3) The employee is on the take
      4) The mechanics the employee is contracting are on the take

      Everybody wins, except of course the stockholders of the company.

      In this case, the stockholders are the American people.

      1. Neil D

        To take your analogy one step further, I would argue that the American people knew about, and benefitted from, the corruption for many years. We got our nice houses, expensive SUVs, and cool vacations all financed by debt for years on end. We went for the deregulation theology hook, line, and sinker. As ye sow… so shall ye reap.

        I understand the argument that some (many/all?) of the deals done in the heat of the crisis were shady. Perhaps the whole CDS/CDO/synthetic CDO enterprise was shady. I will stipulate that Yves is correct when she says there was “activity that was fraudulent in intent, even if the selling process technically stayed within the weak/non-existent rules that governed these trades.”

        But in a game with no rules what can you do about fraudulent intent? Perhaps it would have been better to let the house of cards collapse, but the collateral damage, we are told, would have been too great.

        There is a reason we keep calling this a house of cards.

        1. DownSouth

          I fully understand your rhetorical strategy here. After all, as Hannah Arendt has observed, “if everyone is guilty, then no one is guilty.”

          But let’s take a look at the figures. There are a total of about 115 million households in America. Of those, about 1/3 rent. Of the 2/3 that own, about 1/3 of those have no mortgage. So to summarize:

          Rent: 38 million households
          Own with no mortgage: 25 million households
          Own with mortgage: 52 million households

          The estimates I’ve seen, which assume real estate prices decline another 20% from their all-time highs in 2007, put the percentage of under-water mortgages in 2012 at 50%. So that means that 26 million households may be under water on their mortgage come 2012. Now, if we assume all of those default (which they won’t) then that represents only 26 million out of a total of 115 million, or 23%, of households.

          Now 23% of the American people (and again, this is assuming that 100% of under-water mortgage holders default) is a long ways from “the American people” whom you assert “knew about, and benefitted from, the corruption for many years.”

          1. Gary

            Down South – utter rubbish in, utter rubbish out. I live in Australia and have no mortgage yet I knew for years about the absolute dredge of sub prime – wake up mate. Almost everyone in America knew of the finance crap going on….yet almost no one did anything

  2. ozajh

    IMHO any ‘backdoor bailout’ to Goldman’s customers would have been purely incidental.

    If Goldman had indeed sold significant quantites of CDO’s to customers, and entered into back-to-back CDS arrangements with AIG against those CDO’s, then it seems to me that the collapse of AIG would leave them with a very substantial unhedged liability regardless of the collateral collected/disbursed.

    Goldman’s own balance sheet would have then taken the hit if the CDO’s failed, so they would have wound up wiped out completely before any losses were borne by the customers.

    Goldman was bailed out.

    1. Yves Smith Post author

      You are missing a point we have raised in other posts:

      The purchase of the CDOs cost nearly as much as the resolution of the CDS. It was also NOT necessary to buy the CDOs to deal with the CDS problem. The CDS could have been taken out at 100% (yes, we don’t like that either, but bear with me) WITHOUT taking out the CDOs. All of the Fed’s intense secrecy involving Maiden Lane III results from its decision to buy those CDOs. It had three other rescue options besides going this route, and its reasons for this choice are pretty dubious.

      Now this may have just been a stupid decision made in haste. But as bad as a backdoor bailout of banks is, there is at least a rationale for that, buying the CDOs as a reason to increase liquidity of banks that were under stress. But what is the rationale for buying CDOs held by customers? This says not only was any additional backdoor bailout (beyond the 100% payment on the CDS) via buying the CDOs was inefficient, since a lot of it “leaked” to counterparties who were not at all deserving of having the Fed make them liquid.

  3. Kid Dynamite

    “There is a wee problem with this account. Goldman’s marks were proven correct.” bingo. and this immediately brought to mind the fact that this same thing had happened a mere 6 to 9 months earlier, when GS was accused of unfairly marking down Bear Stearns’s CDO portfolio:

    quote from House of Cards:

    “He (Cohn) then shared an anecdote about a conversation he’d had with Nino Fanlo, one of the founding partners of KKR Financial Holdings, a specialty finance company started by KKR, the private equity shop. After Goldman sent out the marks in the 50¢ to 55¢ range, Fanlo called Cohn and told him, “You’re way off market. Everyone else is at 80, 85.” Cohn then offered to sell Fanlo $10 billion of the paper at his 55¢ price and encouraged him to sell that in the market to all the other broker-dealers at the higher prices they claimed to be marking the paper at. In other words, Cohn was offering Fanlo a windfall: buy at 55 and sell at 80. “You can sell them to every one of those dealers,” Cohn told Fanlo. “Sell 80, sell 77, sell 76, sell 75. Sell them all the way down to 60. And I’ll sell them to you at my mark, at 55, because I was trying to get out. So if you can do that, you can make yourself $5 billion right now.”

    Cohn had been trying to sell the securities at 55 for a period of time and people would just hang up on him. A few days later, Fanlo called Cohn back. “He came back and said, ‘I think your mark might be right,’” Cohn said. “And that mark went down to 30.”

  4. Warren Pease

    If I were smarter and could really follow all of this, I might be rich, too. My takeaway on this is that GS was acting as the house, but was also betting against the house, because it ultimately knew it wasn’t the house, even if the other parties thought is was.

    Seems like the challenge here is the role of market-making in a free market, when it may be more/most profitable for the market-maker to see said market fail. There are echoes here of a key element of so-called “predatory lending.” While that concept is notoriously hard to define, one notable aspect of it deals made that are “designed to fail,” where the best outcome for the lender is borrower destruction.

  5. Neil D

    My last point – made my Paul Krugman:

    “But Mr. Greenspan wasn’t the only top official who put ideology above public protection. Consider the press conference held on June 3, 2003 — just about the time subprime lending was starting to go wild — to announce a new initiative aimed at reducing the regulatory burden on banks. Representatives of four of the five government agencies responsible for financial supervision used tree shears to attack a stack of paper representing bank regulations. The fifth representative, James Gilleran of the Office of Thrift Supervision, wielded a chainsaw.”

    It’s worth reading again. We did this to ourselves. Elections, as it turns out, matter.

    http://www.nytimes.com/2007/12/21/opinion/21krugman.html

    1. DownSouth

      You and Krugman really do need to read Yves’ post yesterday about “simple stories.”

      Krugman asserts: “So where were the regulators as one of the greatest financial disasters since the Great Depression unfolded? They were blinded by ideology.”

      So what’s missing from this picture? Let me name a few things:

      • The revolving door between financial institutions and government.

      • The multi-million dollar pay packages financial institutions lavish on ex-regulators.

      • The hundreds of millions of dollars in campaign donations doled out by the finance industry.

      • The inordinate influence of lobbyists employed by the finance industry, the ranks of the lobbyists being predominately made up of ex-regulators and ex-elected officials as well as their friends, business associates and family members.

      • The perks lobbyists provide.

      • The capture of the finance industry of the academy through generous funding of research grants, tenured chairs, junkets, prestigious awards, etc.

      • The capture of the economics profession by the Fed through its employ of a majority of macro-economists.

      • The industry-Fed capture of leading economics journals.

      Ideology certainly plays an important role. But saying ideology is important is not the same as saying ideology is the only thing that is important.

      1. run75441

        DownSouth:

        Your explanation here and above reminds me of a discussion I would have with attorneys when I was shopping for one to sue another attorney for malpractice and malfeasant actions in representing us.

        “When one goes to a doctor, we depend upon them to properly prescribe a treatment because we lack the knowledge to understand what ails us and what actions or medicines be take to successfully cure ourselves. We place our trust in them. The same as a doctor, we depend upon attorneys to guide us through the legal morass that lies before us and we place our trust in them to lead us through it to successful conclusion. In either case, we do not plan on a doctor deliberating causing us greater illnesses or an attorney to deliberately take actions in the court to cause us greater harm.”

        I can not help but believe the actions taken by GS, as a whole, and those guiding such enties were not taken with the economy welfare in mind as a whole and were deliberately put into play for individuals alone and with willfull disregard for the outcome of such actions and impact upon society. If not illegal than certainly unethical behavior.

        Perhaps Federal Judge Ratkoff has the correct notion in looking for individuals rather than entities to pay the penalty for the Merril Lynch hidden bonuses given prior to BofA taking Merrill over. Too claim the guiding individuals of these entities die not know of the outcome is a bit of a stretch and disingenuous.

  6. Thingumbobesquire

    The contents of the NY Times article completely gives the lie to the oft repeated line by a supine media “that no one could have known that the markets would crash.” In actual fact, Goldman not only knew but did everything to make that happen, including inducing its partner in crime Paulson to grovel for more loot, on bended knee, crocodile tears and all, before a scarified congress. What a sordid, shameful con game these “honorable men” have foisted upon us rubes.

    1. Neil D

      Exactly. So why are we surprised and outraged that they gamed the system we created for them and stole us blind?

      1. craazyman

        There were only a few of us that created the system. The rest of you are sheep or ants who didn’t have a clue on the way up or the way down. Even the professors. It made me laugh. Now you’re being sheered and crunched. A few of you are confused. And that’s even funnier. What does a sheep look like when it’s confused? It looks like you, in a winter hat.

        Yours truly,
        Hunter Gunn
        Director of Proprietary Capital
        John Law and Company

      2. psychohistorian

        Neil D. said:
        “So why are we surprised and outraged that they gamed the system we created for them and stole us blind?”

        We didn’t create the system for them. They manipulated the system to their advantage. We used to have a semi-democratic Republic that was supposedly organized for the common good instead of for the rich of the world. Now we have our government and the financial sector that are protecting the investments of the rich from around the world on the backs of the American public.

        Nice job if you can get it. Immoral as hell but money buys happiness, doesn’t it?

        I think if the understanding that is presented here gets mass exposure to the American public there will be calls to put the heads of the rich predator class on some pikes and their minions in jail…..we can always hope, right Obama?

  7. mitchw

    If as you suggest Yves, the funds at the other end of these synthetics were Sovereign Wealth Funds in the middle east, then who wouldn’t have found the possibility of a breakdown emetic? If Paulson knew about who Goldman had stuffed, no one would have had to tell him what to do. I for one don’t want those sheikdoms to blow up,….just yet

  8. proton

    Real culprit and stupidity of all -that includes Goldman, AIG, Paulson, Rating Agencies and Fed – was to allow this market, bets on supersenior CDOs, to become so large without havings markets developed for them. THERE WERE NO DESCENT LIQUID MARKETS where bets on CDOs could be hedged or reliable price information could be extracted. In essence, the marks were not very meaningful, allowing disparate beliefs among market participants. Goldman took advantage of this to bet against them, to push the marks way down so that they can profit.

    AIG was doubly stupid because they actually enabled Goldman to do this. Even children know that you would be taken to cleaners if you agree beforehand that you would take any price the seller would set.

  9. Siggy

    I like this post very much. I suspect that it will prove to be very difficult to prove fraudulent intent, nonetheless, why the hell would GS want to create CDOs that are doomed to fail. Could it be that there was this firmly held and rationally supported belief that the securitized subprime mortgages would incur loss rates far higher than current market pricing indicated?

    Recognize that by its very nature, a CDO has an expected value of zero and its acquisition, as a part of a trading tactic requires the puchase of a offsetting CDS.

    The degree of abrogated regulatory responsibility is beyond my comprehension. In this case the line of inquiry should go thru the Abacus deal. Critical points of inquiry are: When was GS acting as agent and when was it acting as principal?

    While there is considerable focus on GS, the FED, the Treasury, the SEC and the CFTC, there has been limted focus on AIGFP to the point of executing contracts that AIGFP wittingly knew it could not honor. This is a very serious problem. It may well be that the contracts were out of the money when executed, nonetheless, the contingent liability was well defined, if not absolutely stipulated.

    Collateral to this point of interest there is the issue of why is the the AG of NY is bringing an action against Ken Lewis and B of A for fraud in the Merrill deal? Why not the Justice Department? The SEC settlement was a civil case, not criminal, why has there been no action by the Justice Department?

  10. Anonymous

    My problem with GS’s actions is that it was way over-exposed to a single counterparty, AIG, and it seems that the only beneficial outcome to the firm was to ensure that AIG would fail.

    OK, stupid for AIG to write so many contracts with Goldman, but Goldman received a portion of Soc Gen’s cash as well:

    “In addition, according to two people with knowledge of the positions, a portion of the $11 billion in taxpayer money that went to Société Générale, a French bank that traded with A.I.G., was subsequently transferred to Goldman under a deal the two banks had struck.”

    How could AIG prevent a build up of Goldman counterparty exposure when Goldman was masking its trades through other players?

    Everything subsequent to this situation just seems to be incredibly in favor of GS– CDS at par, Maiden Lane taking on a CDO portfolio before the US bailout. The real act of culpability stems from the appearance that GS built the cabal to bring the house down.

    http://www.commondreams.org/newswire/2010/01/27-10

    Kucinich Questioning Probes Goldman Sachs/AIG Myth:
    Congressional investigation finds Government gave Goldman a better deal than it was legally entitled to receive; Goldman was not protected from AIG losses in event of a government bailout

    1. observer

      “In addition, according to two people with knowledge of the positions, a portion of the $11 billion in taxpayer money that went to Société Générale, a French bank that traded with A.I.G., was subsequently transferred to Goldman under a deal the two banks had struck.”

      This is the part that I found most troubling. So the bailout of the French bank was also an indirect Goldman Sachs bailout, one that has been kept secret? So what was the true extent of Goldman Sachs’ take from the AIG bailout?

      Also, remember how Bernanke and Geithner keep pointing to Soc Gen as the reason why they could not impose haircuts on the CDS? Was it Goldman Sachs calling the shots behind the scenes on this one too?

      1. psychohistorian

        The bailout of rich foreigners had to go through a bank, right? Maybe this was the conduit.

        America, of the people, by the people, and for the rich wherever they may live.

        Tell me again Neil D. how the American people asked for this to be done to them.

    2. Yves Smith Post author

      Apologies for not discussing this point in a very long post, re “why AIG?”

      AIG very aggressively marketed its insurance as being “better” than that of the monolines……because it posted collateral, just like credit default swaps in the corporate bond market.

      Now even thought the monolines called their guaranteees “credit default swaps” too, they did NOT require collateral be posted. In fact, their contracts deferred payment not just till when when the amount owed had been finally adjudicated (I don’t have the exact language here, but it’s close to that) BUT the termination date of the underlying vehicle. And when was that? Oh, 40 or so years out.

      In other words, a VERY plausible argument could be made that the monoline CDS was a sham product, certainly the contracts that deferred payouts until the termination of the CDO.

      And that would be a particularly big issue if a bank then sold the CDO and entered into CDS on it. If it had written a typical CDS, it could/would be posting collateral to its counterparties and getting nothing back from the monoline. It would suffer a very big cash drain by virtue of having optimistically assumed it would never really need to post collateral, and not having understood how the monoline insurance worked.

      One can argue Goldman has a defense here…..but you’d also have to look at its behavior after AIG exited the subprime market (as in who guaranteed its AAA ABS CDOs then, and what were the payout terms on those deals). So there still may be something sus here, but the facts on the surface do allow for Goldman to make a plausible case.

  11. Hugh

    My understanding is that, whatever the ratings, Goldman sold CDOs that it knew to be crap to its customers. It then turned around and bought insurance (CDS) through AIG to cover expected losses on the crap. That money, the surrendered collateral from AIG, went to Goldman, not its customers. Goldman was aggressive both because it knew how bad the crap was and also because this was money that went to it, not the customers, so an added incentive to be tough.

    Goldman made money on selling the CDOs to its customers and on getting AIG to pay on its CDSs. The only exposures Goldman had in this involved any CDOs they had held on to. As for the CDSs, except for the premium payments to AIG, this all looks like profit for Goldman.

    So as Yves asks, why would the government buy the CDOs from the patsies Goldman sold them to? They had zilch to do with Goldman’s action with AIG. We all know that Goldman doesn’t act out of altruism so what was its incentive to push for the buy up of the CDOs it had sold to its customers? Did they get a kickback? Why would the government ever enter into such a buy back?

    I also wonder what Goldman’s other exposures were. Back on September 13-14, 2008 when the AIG bailout was being negotiated, and the day before Lehman blew up, it seems like Goldman really needed to recover the full value of its CDSs held with AIG to stay afloat. So the question is from where else was Goldman bleeding? Now when Lehman blew up, or was allowed to, this changed the calculus on everything. Goldman and Morgan Stanley became bankholding companies, a fiction if ever there was one, and got access to credit lines that stabilized them. So the AIG stuff while still representing real money for Goldman was no longer critical to its survival. Factor in too Buffett’s investment into Goldman and again you have to wonder where else Goldman was having problems it needed to cover with lots and lots of cash.

  12. MichaelC

    Your observation that the purchase of the underlying CDOs provided liquidity is significant and underreported. Good catch. I haven’t seen anyone else exploring that aspect of the MLIII transaction.

  13. Thomas Barton, JD

    Yves and Tom, I hope that you will submit a formal question to that DeLillo guy who is running for NY AG ( I think that’s right ) about his thoughts on Maiden Lane III. The primary purpose of thisNY Times piece was undoubtedly to protect the layered defenses around the Fed,AIG and NY Fed organism. I wonder if you think that this triumvirate is preparing to throw Monsieur Blankfein under the bus. I was astonished that his publicly stated compensation is 9 million in stock, no cash and this at a time when cash is king.

  14. Independent Accountant

    YS:
    You hit the nail on the head, i.e., neither the Fed, SEC nor Treasury was taken to task in this article. You write, “AIG’s failure to understand the implications of the current market values and downgrades underlying its CDOs sheds light on its CDO underwriting process (or more accurately, lack thereof). How widespread was this problem at other companies?” Absolutely! I’ve said this for about 18 months. PWC’s actions also bear scrutiny. Under the most generous of interpretations, PWC never understood the economics of AIG’s business or that AIG’s and Goldman’s accounting for these contracts should be identical. I won’t ask where the incompetent, craven SEC was. It was busy hiding from Harry Markopolos.

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