Spitzer, Partnoy, Black Call for AIG Open Source Investigation (and Goldman Implications)

An op-ed in the Sunday New York Times by former investigators and prosecutors Eliot Spitzer, Frank Parnoy, and William Black calls for AIG to put non-privileged e-mails, accounting documents, and financial models on line to allow for an “open source” investigation. The questions they want to examine include:

As fraud investigators, we would like to examine the trading patterns of A.I.G.’s financial products division, and its communications with Goldman Sachs and other bank counterparties who benefited from the bailout. We would like to understand whether the leaders of A.I.G. understood that they were approaching a financial Armageddon, and whether they alerted their counterparties, regulators and shareholders to the impending calamity.

We would like to see how A.I.G. was able to pay huge bonuses to its officers based on the short-term income they received from counterparties for selling guarantees that, lacking adequate loss reserves, the companies would never be able to honor. We would also like to know what regulators knew, and what they did with the information they had obtained.

This idea no doubt will strike most readers as quixotic. But the authors point out that three individuals have the power to force this to take place:

A.I.G.’s board of directors, a distinguished group of senior business executives, holds the power to decide whether to publish the e-mail messages and other documents. But those directors serve at the behest of A.I.G.’s shareholders. And while small shareholders of public corporations generally do not have the right to force publication of internal documents, in this case one shareholder — the taxpayer — holds an 80 percent stake. Anyone with such substantial ownership has effective control over corporate decisions, even if the corporation is a large public one.

Our stake is held by something called the A.I.G. Credit Facility Trust, whose three trustees are Jill M. Considine, a former chairman of the Depository Trust Company and a former director of the Federal Reserve Bank of New York; Chester B. Feldberg, a former New York Fed official who was chairman of Barclays Americas from 2000 to 2008; and Douglas L. Foshee, chief executive of the El Paso Corporation and chairman of the Houston branch of the Federal Reserve Bank of Dallas.

Ultimately, these three trustees wield all the power at A.I.G., and have the right to vote out the 11 directors if the directors are unwilling to publish the e-mail messages. In other words, if these three people ask A.I.G.’s board to post the messages and other documents, the board will have no choice but to comply. Ms. Considine, Mr. Feldberg and Mr. Foshee have the opportunity to be among the most effective and influential investor advocates in history. Before A.I.G. escapes, they should demand the evidence.

This is a good proposal, but I have a far more basic question: why was no forensic work done as a requirement of the bailouts? The Swiss Federal Banking Commission required UBS to perform an extensive investigation of exactly what it did so wrong that it needed a government handout, and it hired (presumably at the insistence of the regulators) third parties to conduct the investigation. It provided considerably more detail than any bank has provided so far of how a firm with a solid franchise drove itself into an abyss.

Why has there been NO serious investigation of ANY kind of the recipient of such extraordinary taxpayer largesse? Why has virtually NOTHING been demanded of them? Why the unseemly rush to let them off the hook and let them “pay back the TARP”? This is completely unwarranted in the case of AIG, which has had its deal with the government retraded in AIG’s favor a full four times. Why has AIG at every turn gotten a better and better deal, each time at the public’s expense, and is now allowed to lobby that it should be freed of its obligations? No private sector lender would allow a troubled borrower that could not meet its commitments to renegotiate and get IMPROVED terms. The inability to meet the terms of the original funding (one on terms private sector lenders were willing to consider, and that per Sorkin, AIG itself proposed) only strengthens the case to continue with the original plan, which is to break up AIG and sell the pieces for what they can fetch. This is the course that would yield the highest returns to the public, and that program will not produce a systemic event, which should be the ONLY offsetting consideration. There is no business rationale to have an agglomeration of diverse insurance businesses, particularly one that has been as badly managed as AIG (Sorkin’s account also reveals a shocking lack of financial and operational controls).

So why have there been no investigations? In AIG, the Goldman conspiracy theorists have a real case. Consider this commentary from a reader who was a senior executive at a monoline, on an article that looked like a PR effort to get ahead of a possible source of trouble for Goldman. The Wall Street Journal story noted that Goldman guaranteed $23 billion of CDOs with AIG and allegedly made a mere $50 million…. which is utter bullshit. Normal CDO originating spread are 1.25% to 1.5%. Its profits on these deals, separate on how it might have booked its trades with AIG, was at least $287.5 million. Even more important, a some of these trades were part of its Abacus program, which was a series of synthetic CDOs that it used to lay off its real estate risk (both RMBS and CMBS). In other words, the “short subprime” trade that everyone has lauded Goldman for was in part, if not in significant measure, borne by taxpayers.

The most curious part of this pattern is that Goldman used ONLY AIG for its CDO guarantees; all other banks also used the monolines to a significant degree. So Goldman would benefit far more than other firms from an AIG rescue; they would all still lose out on their monoline exposures.

The monolines started hitting the wall before Goldman did; in fact, their wobbly state played a direct role in the failure of the auction rate securities market (Feb 2008), when it became clear that Eric Dinallo’s efforts to create a bailout for Ambac and MBIA were likely to come to naught (the monolines were major guarantors of municipal paper, and municipalities were major issuers of ARS). Both retail investors and municipalities suffered as a result (retail investors who needed access to their funds but could not get liquidity; issuers who had to pay penalty rates because their maturing paper could not be rolled). The monolines, who Goldman had not used, were allowed to twist in the wind, but AIG was rescued. And Goldman hands are far from clean. From a reader who was a senior executive at a monoline on the WSJ story:

I find it amazing that after stuffing AIG with $23 billion of CDOs, which lead to AIG failing, Goldman’s spokesman has the audacity to blame the problem on AIG. meanwhile, Goldman researchers and CFO were criticizing Merrill and Citi for taking on so much exposure to the other bond insurers and insisting that these insurers not get bailed out. It also highlights again how outrageous it was that Goldman and the others gold paid off at par for taking a combination of CDO and AIG risk while the rest of the world (investors and insurers) got burned for taking CDO risk. The Goldman spokesperson acts indignant at the suggestion that somehow they shouldn’t have gotten this. This was the scam they played with the Fed.

While the subprime deals and CDOs were obviously going bad, an argument was made by many people at the time that the aggressive mark downs by AIG acelerated the death spiral for the market. It is pretty clear, here and elsewhere, that Goldman was the one that initiated the mark downs of collateral value. it would be interesting to explore this all the way through. Though not discussed in this article, Goldman shorted subprime through the Abacus deals, and perhaps elsewhere. this gave them an incentive to force mark downs. the intermediation deals described in the article, combined with AIG’s collateral posting, gave them another incentive to be agressive with mark downs. they were acting like they wanted to grab the money before anyone else could get their hands on it. this would have raised some issues in an AIGFP bankruptcy. (note – Hank Greenberg suggested that this was going on in his october 2008 testimony but there was a chorus of attacks on him for being a crook and unreliable, thanks to his problems with Spitzer.)

So here we have the pattern:

1. Goldman creates or sells $23 billion (or more) of CDOs and stuffs them into AIG.

2. Goldman proclaims to the world they have no exposure to CDOs and warns that banks and insurers with CDO exposure will get downgraded.

3. Goldman initiates the mark downs of CDOs with AIG and others, acelerating the market’s downward spiral.

4. Huge mark to market losses lead insurer and bank credit to freeze, short term markets to lock up, ABCP to collapse.

5. AIG posts as much collateral as it has to Goldman, who has more aggressively marked down the exposure.

6. Bond insurers are downgraded, banks begin commutations with them.

7. AIG fails, Fed steps in, Goldman gets bailed out at par.

Yves here. This looks like no accident. I suspect it was no accident. And no one in authority wants to find out where the truth lies.

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  1. Charles Frith

    I was hugely impressed with Eliot Spitzer’s interview on BBC Worldwide. He squirmed a bit on the personal stuff but with regard to his pursuit of truth and justice he came across as the real deal.

    1. David

      Which is why Spitzer was blown up politically, in my opinion.

      But for all the grief he takes, David Paterson is doing a solid and honest job in the Governor hotseat.

    2. Mike in Fairfax

      I have not seen the Spitzer BBC interview, but let me say this about him. Spitzer was a scum bag long before anything about his personal life hit the news stands. The way this guy abused his office’s power to beat company boards into jettisoning CEOs etc. was a sick travesty of justice.

      Whether or not you believe the CEOs were guilty of anything, the way the AG is supposed to handle things is gather evidence, make charges, go to trial, and abide by the ruling. Spitzer did everything possible to leverage bad press and anything else to drive a stock down and force corporations into near financial ruin in order to get his way without a trial. Imagine how shocked I was to see that he thought the law didn’t apply to him in his personal life as well. When someone’s methods are this sick and twisted, I can’t be bothered with caring about his motives. He should be doing time for abuse of power.

    1. Tom

      Goldman has publicly admitted that they bought CDS against AIG. They said they did this when AIG was facing a downgrade, to insure that they were hedged.
      i have questioned the timing of this version. first, who would be willing to go long AIG when they were about to get downgraded? certainly this insurance would have been very expensive and completely unnecessary after AIG got bailed out.
      also, Goldman would have access to information about AIG’s precarious risky state long before the downgrade because Goldman was responsible for stuffing AIG full of bad CDOs AND responsible for determining the collateral marks on these CDOs. It is likely that Goldman knew months before August 2008 that AIG was in trouble. the CDS on AIG would have been much cheaper back in 2007 and this would have coincided with when Goldman was selling all of the MBS and CDO bonds in their own inventory.

      once Goldman was “hedged” against an AIG downgrade, were they in a position to help make this bet pay off? did they give a helpful nudge? seems plausible…

  2. Itamar Turner-Trauring

    I started reading Richard Koo’s “Holy Grail of Macroeconomics” about Japan’s great recession; his description of how insolvent companies with positive cash flow proceed seems apropos. The management of the company will attempt to hide the insolvency from employees, creditors, suppliers, investors less they jump ship or cut off resources. Those creditors who do know about the problem try to keep quiet as well, so that the value of their investments doesn’t crash. So long as the company is cash flow positive and can pay for its debt this can continue. Koo writes that “… balance sheet recessions [are] invisible and inaudible.” Eventually Japanese corporations paid off their debt, and meanwhile government spending took the place of the reduced corporate spending caused by debt paydown.

    Keeping in mind that this is a book with an approving quote from Larry Summers on the cover, we can assume that the government has at least some knowledge of Koo’s model. So quite possibly in this case we have a third party that is knowing but silent: the government, trying to help the insolvent banks earn their way out of the hole every way it can … and trying very hard to make sure no one notices how insolvent they really are.

  3. attempter

    Why has there been NO serious investigation of ANY kind of the recipient of such extraordinary taxpayer largesse? Why has virtually NOTHING been demanded of them? Why the unseemly rush to let them off the hook and let them “pay back the TARP”?
    So why have there been no investigations? In AIG, the Goldman conspiracy theorists have a real case.

    I don’t see why anybody outside the establishent should call it a “conspiracy theory”.

    To argue that Goldman has captured the government through many years of high-level infiltration of personnel and campaign contributions, so that by 2008 the (any) administration literally believes “what’s good for Goldman is good for America” and enacts policy based on this principle, and that the proximate goal of the AIG bailout was to launder a bailout to GS, is the theory which best fits the evidence, while no other theory fits the evidence anywhere near as well.

    (Personnel placement far more systematic than the normal revolving door, campaign contributions, how Bear and Lehman were allowed to be destroyed, how GS itself may have helped engineer Bear’s immediate collapse through a dubious novation refusal, all the tricky moves with AIG detailed above, how Blankfein was the only CEO seemingly deputized as a de facto government official to attend the Fed’s consultations on AIG, yet how just days earlier Geithner had refused to discuss AIG at the Lehman conclave when JPM and Citi wanted to talk about it, and then of course the bailout and Goldman laundering itself, and all the subsequent AIG bailouts, and the psychotic secrecy about it all…)

    Occam’s Razor itself demands this way of looking at it.

    The same is true of the bailout as a whole. Detractors and the people at large instantly and correctly recognized it as nothing but a massive loot job. Here too every subsequent piece of evidence has proven us 100% correct.

  4. Independent Accountant

    Amen! I’ve followed the AIG-Goldman story for over a year. It is clear to me that no one in the US government wants to expose what really happened at AIG. Why not? All roads lead to the Vampire Squid and its “former” executives like Hank Paulson.

  5. Independent Accountant

    The trio writes, “So far, prosecutors have been unable to build such evidence into anything resembling a persuasive case against any financial institution”. This is an indictment of the SDNY US attorney’s office. Preet Bharara (PB), are you listening? I can write the indictments for you. I accuse PB of “wilful blindness” in not handing out indictments like haloween candy in the AIG-Goldman scam. Yes, you PB. If you can’t find the “ostrich instruction” West’s Key, here it is: criminal law 772(5). Now read it and pull half of Vampire Squid’s (VS) officers out of 85 Broad Street. In handcuffs. See how easy this is? I’ve even given you VS’s address! Show us peasants that VS doesn’t own the SDNY US attorney’s office. No more crap from you and Benton Campbell like the Bear Stearns Two case. PB, we’re watching you.

    1. Tom

      the US attorney is spending its time pursuing insider trading cases, instead. these make for a nice distraction from the bigger issues.
      despite Mr. Spitzer’s article today, he has historically missed the real issues at AIG – he thinks they were the criminals, rather than the dupes. maybe he is waking up, but i think he has a personal agenda with AIG on other issues that ultimately make him not the best candidate for solving the crimes in this case.

  6. Peter T

    Get over Eliot Spitzer’s past minor transgression already and make him chief investigator of Wall Street past major sins.

  7. Michel Delving

    Monolines did not just hit the wall. They were smashed into it. Proprietary traders rigged their bets using a steady stream of servicing data from subsidiary servicers engaged in fabricating bogus mortgage defaults. MBIA is fighting back, citing inappropriate mortgage servicing by Credit Suisse subsidiary Select Portfolio Servicing
    in this recent suit: http://www.mbia.com/investor/publications/603751-09-complaint.pdf
    And yet, mortgage servicing fraud continues to feed CDS casinos and no doubt servicers are already ramping up for Markit’s launch of ABX.PRIME which is certain to be another stacked deck. Just like ABX.HE, market makers will select reference entities, paint targets on them and servicers will go to work making those credit events happen.

  8. Doc Holiday

    Don’t forget the AIG/Buffett/Bershire-Hathaway connection and the use of derivatives, linked to offshore bullshit with crooks that are in bed with IRS, SEC, DOJ, FBI, FTC, CIA, Homeland Security. Buffy the derivative vampire should be investigated as well! But gads, he’s such a sweet old fucker and clean as a whistle….

  9. Doug Terpstra

    Ives’s questions render the whole premise of the NYT op-ed moot, mere cynical political pandering.

    Spitzer may not understand this kind of prostitution, but no autopsy a year later despite ample evidence of foul play makes it pretty obvious that these taxpayers’ mute “representatives” are in fact as captive as “our” regulators, congress and president. The fact that these three ‘fiduciaries’ have made no effort to raise manifest questions on their own without Spitzer’s helpful op-ed makes it patently clear that had they not already been confirmed members of the casino whore-house, they would never have been appointed for the cover-up in the first place.

    In the razor divide from greed to fear, the kleptocracy may now be paralyzed by the terror that the entire casino confidence game of Darwinian cannibalism is about to collapse and there is no longer anything anyone can to about it. It’s disappointing to think that “man-of-the-world” Spitzer could possibly be so naive.

  10. RebelEconomist

    What I do not understand is how AIG was able to take on such large exposure without being downgraded by the rating agencies. I can see why a triple A company can get away without posting collateral against modest unrealised losses, but not why it could remain triple A as its exposure built up. And if AIG’s exposure could not be determined, as opposed to being hidden, a lower rating ought to have been appropriate. What were the rating agencies doing?

    1. Tom

      The rating agencies are an important part of the puzzle. They not only permitted AIG and the bond insurers to take on so much exposure, they encouraged it. All of the toxic bonds were originally AAA (or super AAA) CDOs. under the rating agency models for AIG and the bond insurers, the capital charge for AAA bonds was only about 10bp. in addition, based on the rating agency (and insurer models), with only a 10bp capital charge, return on equity for these deals could be quite large, even with a small premium (around 10-12bp per annum). in contrast, the capital charge for muni deals was fairly high and the returns for these deals was quite low.

      so based on the rating agency models, AIG and the bond insurers were rewarded with better capital modeling and returns for doing more AAA CDOs and penalized for doing more low return muni deals.

      As we have since learned, the business of CDOs backed by mortgage bonds really depended on having an insurer write CDS on the senior class. the rating agencies were paid substantially more for rating CDOs than muni deals and they had become dependent on this source of income to help boost their own returns and stock performance (especially Moody’s). It would not be a stretch to say that the rating agencies were more than a little biased about this asset class and potentially quite tainted. how motivated would they be, if so much of their income depended on both CDO deals and insurer fees, to speak up and identify issues with the CDOs?

      in addition, we also know that investment banks had become very dependent on the fees from the CDO business, which also depended on the insurers being willing to insure the AAA bonds for a low fee. it was unlikely they would ever speak up to kill the golden goose. some banks and funds were not only making fees from the CDO deals, they were also make huge bets on the market, through the use of CDO deals. How much influence did Goldman and Deutsche Bank and other firms have in influencing the rating agencies to keep rating CDOs with high ratings? i suspect that they helpfully supplied dozens of research reports that argued why the models and analysis that the rating agencies used were adequately capturing the risk. in fact, they spent a lot of time arguing the rating agencies were being too conservative.

      the rating agency approach to CDOs was highly conflicted. it is too much of a stretch to believe that these conflicts were influenced by people, inside the agencies or outside, who had other, more questionable motives?

      fraud is a very difficult legal standard to prove in securities law. it’s a high burden to even getting into the courts to compel disclosure. perhaps there are other ways to address these wrong doings. until then, we have to keep pounding away at all of the problems, putting together the pieces, and shaming the responsible parties into revealing more.

      1. RebelEconomist

        Thanks for your reply Tom. I agree that the rating agencies had a conflict of interest, but I must say that I think there is far too much scapegoating of rating agencies and bankers going on, especially on this blog. Even if rating agencies and derivative structurers were devils, someone had to buy the product. I was an investment manager until shortly before the crisis, and there was in this community a collective failure of diligence (to insist on adequate information and understanding of investments before buying) and honesty (to explain to plan sponsors the unreality of their expectations in an era of low nominal returns). At the time such views were derided as “hair shirt”. Unless this buy side of the crisis is rigorously exposed (we hear a lot more about toxic waste losses at banks which mark to market than we do about losses at pension funds etc), I expect that the crisis will be repeated after a few years.

        By the way, one of the details that was overlooked was what a credit rating actually means. I believe it measures risk of default rather than volatility of value. I wonder how many formerly AAA CDOs have actually suffered default losses, as opposed to mark-downs. If not many, then maybe the original AAA ratings were not so far-fetched after all.

  11. psychohistorian

    All these questions. Yet these very questions are being characterized as puerile Orwellian claims instead of rational, rule-of-law based societal (at all levels) considerations.

    Call it propaganda, agnotology or whatever. The economic transgressions of the last 18 months represents a clear graphic representation of a breakdown in what we thought the US had in the way of civil society. How much this is perceived by the masses is another story. The media is still largely in control and given the oligarchy’s ability to create crisis at any level all over the world, there is never ending fear and doubt created about anything and everything.

    The cognitive dissonance is growing. How long will it take to set the stage for America’s Shock Doctrine event? I think it is coming soon.

  12. Blurtman

    @Tom re: “fraud is a very difficult legal standard to prove in securities law.”

    Misrepresenting the risk of securities that are sold is simple fraud. Not prosecuting this fraud only encourages it to continue. This “white collar” crime is anything but innocuous.

    What is the purpose of the law? Look at the destruction of lives and wealth that this fraud has caused. Compare it to the fraud that the NY street hustler, recently in the news, was perpetrating on passers-by. He was pursued for a $10 crime and shot to death. Yes, he appeared to be armed.

    viz: American Eagle’s complaint cites internal Citigroup e-mails and memos showing that as the market for auction-rate securities imploded in December 2007, Citigroup sought to “offload” them to its customers, including American Eagle. According to the suit, Citigroup allegedly made internal plans to stop supporting the auction-rate securities market at the same time it was promoting the securities to its customers.

  13. bob goodwin

    How about a freedom of information request against a company more than 50% owned by the goverment (might work against the fed as well). Activist courts might go for it.

  14. JCH

    The trustees are charged with acting in the best interest of the US Treasury.

    How on earth could they justify voluntarily doing something that might send the Trust asset, shares of AIG, into a deep downturn?

    Also, the trustees, acting in the place of the government, would have significant 4th amendment issues to resolve. Spitzer is looking for crimes. The government has to follow due process.

  15. Philico

    Can we add one more item to the pattern list?

    8. Goldman buys back the beaten down CDOs at 5-15 cents on a dollar and makes 40+ cents on the dollar profit for 2009 which accounts for over $500k per employee in bonuses.

    Also, in anticipation of what was about to happen, I am led to believe that Paulson’s nomination as Treasury Secretary was after all not a coincidence and it should be investigated.

  16. Wayne Jett

    Was it not Eliot Spitzer who took out Hank Greenberg as CEO of AIG, thereby clearing the way for Goldman Sachs to have its way with the AIG financial products division? Anyone selling CDS and hedging by selling short shares of the debt issuer without delivering them (as the “Madoff exemption” of Reg SHO permitted)ought to recognize that the practice would destroy the debt issuer and assure the CDS would pay off. AIG was the pigeon picked for sacrifice.

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