Saturday, December 12, 2009

Tavakoli on the New Details About Goldman's Dealings with AIG

WSJ is reporting new details about the relationship between Goldman Sachs and AIG:
Goldman Sachs Group Inc. played a bigger role than has been publicly disclosed in fueling the mortgage bets that nearly felled American Insurance Group Inc.

Goldman originated or bought protection from AIG on about $33 billion of the $80 billion of U.S. mortgage assets that AIG insured during the housing boom. That is roughly twice as much as Société Générale and Merrill Lynch, the banks with the biggest exposure to AIG after Goldman,according an analysis of ratings-firm reports and an internal AIG document that details several financial firms roles in the transactions.

In Goldman's biggest deal, it acted as a middleman between AIG and banks, taking on the risk of as much as $14 billion of mortgage-related investments. Goldman's other big role in the CDO business that few of its competitors appreciated at the time was as an originator of CDOs that other banks invested in and that ended up being insured by AIG, a role recently highlighted by Chicago credit consultant Janet Tavakoli. Ms. Tavakoli reviewed an internal AIG document written in late 2007 listing the CDOs that AIG had insured, a document obtained earlier this year by CBS News.
Janet Tavakoli in an email to me writes on this latest development:
Goldman’s “middleman” trades were probably done from its proprietary trading desk, but had A.I.G. failed, Goldman would have had to make good on these trades. Whether it acted as a “middleman” on all of these trades or just some of them, Goldman had assumed the risk (and A.I.G. provided a hedge).

According to the WSJ article, Goldman spokesman said that “What is lost in the discussion is that AIG assumed billions of dollars in risk it was unable to manage.” Yes, and what Goldman’s spokesman lost in the spin was that Goldman Sachs also could not manage that risk. Instead, Goldman “hedged” with A.I.G., and Goldman overexposed itself to A.I.G. If A.I.G. had failed, a liquidator might have asked Goldman to return a large portion of the collateral it collected. When one examines the collateral of the deals underwritten by Goldman, it includes some collateral from Goldman Sachs Alternative Mortgage Products and other collateral that did not perform well. Goldman’s way to “manage” that risk was to stuff it into value destroying CDOs, portions of which were then sold to customers and/or hedged with A.I.G.

A.I.G.’s near collapse created a potential global crisis brought on by extraordinary circumstances related to Goldman’s securitization and trading activity. The crisis is now over, and Goldman (and A.I.G.’s other counterparites) should buy back all of the CDOs (on which it bought protection) at full price.

JT After Note: The last part of the WSJ article suggests that the SIGTARP report stated Goldman would have a difficult time “selling the collateral.” I am not sure what is meant here, but I believe it refers to the reports’ stating Goldman might have a difficult time collecting on the hedges Goldman bought to protect itself against an A.I.G. bankruptcy. I would also point out that if A.I.G. had gone bankrupt, a sensible liquidator would have clawed back collateral that A.I.G. had already given to Goldman due to the extraordinary circumstances. After it saved the day by extending the credit line, the FRBNY should never have settled for 100 cents on the dollar. In August 2008, one month prior to the FRBNY providing A.I.G. with an $85 billion credit line to pay collateral to its counterparties, Calyon, a French bank that bought protection from A.I.G. (including on some Goldman originated CDOs) settled a similar $1.875 billion financial guarantee with FGIC UK for only ten cents on the dollar.
Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).

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