Goldman's 'Starring Role' in AIG's Bankruptcy Drama

Goldman Sachs was a chief potential counterparty beneficiary of AIG's federal bailout after its brush with bankruptcy in September 2008, according to structured finance analyst Janet Tavakoli. Goldman held credit default swaps with AIG against toxic derivatives it had underwritten and held. AIG was exposed to other Goldman-underwritten toxic derivatives held by other counterparties. All this was kept a secret as Goldman successfuly persuaded the Feds to pay 100 cents on the dollar for AIG's contracts, when they were worth far less in the market.

By Robert Stowe England
November 10, 2009

At the time AIG faced collapse in September 2008, the insurer's largest exposure was $20 billion in transaction contracts with Goldman Sachs on mortgage derivatives undewritten by Goldman. This represented one third of AIG's $62 billion in credit derivatives exposure to market pricing risk.

Indeed, AIG's exposure to Goldman Sachs was the key contributor to the systemic risk posed by AIG's near bankruptcy, according to Janet Tavakoli, President of Tavakoli Structured Finance, Inc., of Chicago.

Goldman's significant role in transactions that prompted the crisis at AIG contrasts with the claim by Goldman that its role at AIG was only that of an "intermediary," according to Tavakoli, who posted a commentary on the matter at her company's Web site at this link:

Goldman Sachs had bought protection from AIG through Credit Default Swaps (CDS)contracts that were tied to Collaterized Debt Obligations (CDOs) undewritten by Goldman Sachs. Apparently, Goldman Sachs had not only underwritten the deal but either purchased some of the CDOs it had underwritten or retained them.

Goldman Sachs was further implicated in the crisis at AIG by the fact that it had underwitten tranches of CDO's owned by some of AIG's other trading counterparties, where they later showed up as toxic assets.

As Tavakoli put it, Goldman Sachs had "poisoned its own well by elsewhere issuing deals [that] eroded market trust in this entire asset class and drove down prices."

Details of Goldman Sachs' exposure surfaced with a memo written November 27, 2007, by Joe Cassano, the former head of AIG's Financial Products unit; the memo was uncoverd by CBS News and made public in June 2009.

The Cassano memo can be found at this link:

In that document, Cassano details a number of transactions that were the basis of collateral calls from counterparties at the time the memo was written. Of the $4 billion in collateral calls, $3 billion came from Goldman Sachs, according to the memo.

AIG lists its transactions with Goldman as negative basis trades, which suggests that Goldman earned a net profit by purchasing -- or holding its own -- CDO tranches and then hedging them with AIG CDS, according to Tavakoli.

"As AIG's financial situation worsened, Goldman bought further protection in the event AIG collapsed," Tavakoli wrote.

France's Societe Generale, the third largest bank in the Eurozone, was AIG's next largest counterparty exposure with contracts $18.6 billion. Societe Generale bought CDS protection from AIG on two tranches of a deal (Davis Square VI) that Goldman had underwritten.

Societe Generale obtained its prices for determining its exposure from Goldman, according to the AIG memo. By the time of the memo, November 2007, Goldman had marked down the AAA-rated tranches of the Davis Square VI deal to 67.5 percent of their value.

There were at least six other deals on Societe General's list that were underwritten by Goldman Sachs.

Merrill Lynch was another significant counterparty to the transactions, representing $9.9 billion as of November 2007.

In September 2008, Bank of America had just agreed to merge with Merrill Lynch, at a time when Merrill held $6 billion of super senior exposure to CDOs hedged by contracts with AIG.

Merrill later received a $6.3 billion bailout payment from AIG. Further, Tavakoli notes, the Secretary of the Treasury Hank Paulson, a former Goldman Sachs ceo, urged Bank of America ceo Ken Lewis to be silent about Merrill's troubles.

Goldman Sachs ceo Lloyd Blankfein was influential in the bailout discussion, while Stephen Friedman, then Chairman of the New York Fed, also served on Goldman's board. And, of course, the talks were headed up by the former Goldman ceo Hank Pauls0on.

Thus, Goldman was in a powerful position to urge 100 percent payment for counterparties to AIG's collateral risk at a time when there was no information about the huge volume of Goldman trades with AIG or the CDOs underwritten by Goldman that were hedged by AIG's other counterparties.

Tavakoli concludes: "Goldman's public disclosures in September 2008 obscured its contribution to AIG's near bankruptcy and the need to bailiout Goldman's trading partners in AIG related transactions. Goldman's trading activities played a starring role in the near collapse of the global markets."

Yet, Goldman Sachs continues to minimize and downplay its role and has paid no price for its ability to manipulate bailouts to its advantage, due its political clout assured by the placement of its executives in key positions in the financial regulatory structure.

Copyright © 2009 by Robert Stowe England. All Rights Reserved.


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