How Safe Are Gold ETF's?

Janet Tavakoli has emailed a link to me of a long version of an article (Pdf)  she wrote for HuffPo outlining, "How to Corner the Gold Market."

What I found most interesting in her paper is her instructions to the would be gold corner operator on  how to deal with Exchange Traded Funds:

Get your buddies in the financial business to offer exchange traded gold funds (ETFs) that claim to buy physical gold. This will sound safe to retail suckers investors, but in fact, the ETFs are very risky. This will serve your purpose when you are ready to start a panic. These particular ETFs will allow the “gold” to be commingled with the custodian’s gold, and the custodian can lease out the gold. Moreover, the “gold” custodian can give it to a sub custodian that the manager doesn’t know. The sub custodian can give it to yet another sub custodian unknown to the original custodian. The manager will never audit the gold, and the gold is not “allocated” to a particular investor. Since this is an “exchange traded” gold fund, investors will probably assume the gold is regulated by the Commodities Futures Trading Commission (CFTC), but it isn’t. By the time investors wake up to the probability that there is very little actual gold backing their investment, your plan will be ready to execute.

There is a lot of odd stuff going on in the paper,electronic and depository gold business. Nathan Lewis writes (Thanks to Krassimir Petrov)

Four 400 oz. LBMA standard bars were discovered to be tungsten counterfeits in Hong Kong. This set off a wave of investigations, turning up more such phony bars worldwide.


These were very high quality counterfeits. According to some investigators, it appears that the original source and creator of these counterfeits was the U.S. government itself. Some people put the possible number of counterfeit bars out there in the hundreds of thousands!

Bottom line, to the degree possible. i.e. unless you are short-term tarding, take delivery of your gold and make sure it is gold! Here's Lewis again:

There is an easy way to sidestep all the scams, frauds, and phony nonsense. Take delivery on your bullion, whether a 1 oz. Kruggerand or a truckload of 400 oz. institutional bars. Put it in an independent, insured depository that is not affiliated with any bank. Assay all the holdings for tungsten counterfeits. Then audit it periodically, for exact serial numbers and specified weights.

Congress Exposes Potential Profiteering in AIG's Deals

Janet Tavakoli emails a link to her latest:

Yesterday the House released some missing details of the AIG bailout. (Click here to see the unredacted pages of the March 2008 SEC filing.) The public knew that the Fed paid 100 cents on the dollar to AIG's trading counterparties to resolve its credit default swaps, but the details of the assets behind the trades were kept secret.

Plenty of Time to Renegotiate AIG's ContractsThe first bailout of AIG occurred in September 2008 when the FRBNY extended an $85 billion credit line to AIG. By the September 2008 initial bailout, Goldman Sachs had extracted $7.5 billion in collateral from AIG, and other banks that bought Goldman's CDOs also extracted billions from AIG (click here for details).

Goldman CEO Lloyd Blankfein claims he had no idea AIG had trouble producing collateral. I knew AIG was headed for grave trouble more than a year before the September 2008 bailout and raised the issue with both Warren Buffett and JPMorgan Chase CEO Jamie Dimon. Goldman Sachs claims to be superior risk managers, yet asks the public to believe that it was clueless about AIG's distress, even though Goldman itself was a key contributor to it.

Then Treasury Secretary Henry Paulson was CEO of Goldman Sachs at the time it put on these trades with AIG. Lloyd Blankfein was (and remains) CEO of Goldman and was the only Wall Street CEO at one of Paulson's bailout discussions. Stephen Friedman, then Chairman of the NY Fed, also served on Goldman's board.

Details That Could Anger the PublicAn analysis of the previously secret details shows that at the time of the November 2008 buyout, some CDOs had implied prices of around 60 cents on the dollar. Others had implied prices of around 20 cents on the dollar.

Not revealed by the new report is that many of the assets backing some of the CDOs have a high risk of severe or total principal loss (many have actual losses). These CDOs have "cliff risk," as in falling off of one. (There is currently no reliable secondary market, and similar CDOs have traded as low as one penny.) One such CDO is Davis Square IV, a CDO on which French bank Societe Generale bought protection from AIG. The CDO is a poster child for Wall Street's key contribution to a financial crisis that devastated the U.S. economy.


Goldman Sachs created and closed Davis Square IV in April of 2005. The CDO was managed by Trust Company of the West (TCW). (Click here for a list of assets of Davis Square IV from the time period around January 2008). The original portfolio included mortgage-backed securities from Goldman Sachs Alternative Mortgage Products, Merrill, and problem mortgage lenders Countrywide, New Century, Novastar, First Franklin, and Fremont (among others). Assets include home equity loans, midprime loans, subprime loans, and adjustable rate mortgages. The CDO also includes other CDOs.

AIG's Joe Cassano said AIG was basically out of the business of guaranteeing mortgage product at the end of 2005, yet the report shows more than 10% of the CDOs on which AIG sold protection appear to be from 2006, 2007, or 2008. (Around 14% of the CDO tranches are 2006, 2007 or 2008 vintage, but they make up more than one-third or more than $21 billion of the $62.13 billion notional amount purchased by the Fed.) Furthermore, CDOs from 2006 and 2007 are buried within the portfolios backing the original CDOs. For example, TCW traded mortgages from 2006 and 2007 vintages into the portfolio backing Davis Square IV. These "assets" are among the worst of the lot.

CDO managers may disclose conflicts of interest, but a conflict of interest shouldn't mean that new assets "managed" into your portfolio are highly likely to do you harm. TCW and Goldman Sachs had a relationship that benefited TCW, which earned fees from deals like Davis Square IV. Davis Square IV included several tranches of Goldman's Abacus deals, including $53.5 million from 2006. By September 2008, Goldman's CDO, Abacus 2006-12, was already downgraded from AA2 to Ca, a junk rating--it means you are likely to lose your shirt. Another part of this CDO in Davis Square IV's portfolio was downgraded from A3 to Ca. Three of Goldman's slices of Abacus 2006-15 also made their way into Davis Square IV, and they were also all downgraded to Ca, a junk rating, by September 2008.


Among other eyebrow raising assets in Davis Square IV, one finds a CDO called Pinnacle Point Funding 2007-a. This CDO was managed by Blackrock. It closed June 7, 2007, and went into acceleration (not a good sign) on December 13, 2007. Davis Square IV's "investment" was originally rated triple-A. By the time of AIG's September 2008 bailout, it was already downgraded to C, a junk rating, by Moody's. Yet the Fed awarded no-bid contracts to Blackrock to manage the assets it bought from AIG.

Read the rest here.

Tavakoli and Keiser: It Doesn't Get Better Than This

Max Keiser interviewed Janet Tavakoli today on his television show.

It doesn't get better than this. Keiser knows enough about how Goldman Sachs ripped off America to ask Tavakoli the right questions, and then he is smart enough to just sit back and let her explain what went on. This isn't one of those interviews where the interviewer dominates. He lets Tavakoli display her knowledge.

If you are not an expert on financial derivatives, this is the best introduction to how the scam went down that you are ever going to see. (Even if you have to play it twice to get all the details) And don't miss her little show and tell with the former Zimbabwe dollar.

Tavakoli comes on the video at roughly the 12 minute mark. Before that it is Keiser pontificating on developments around the world. If you have the time, catch it all, but be sure to catch the Tavakoli segment.

Fraudulent Conveyance In an AIG-Soigné Transaction?

The New York Federal Reserve's attempt to cover-up details of the AIG trading partners that were paid 100 cents on the dollar continues to raise many questions.

Janet Tavakoli emails to point out that the curious transactions surrounding the details go beyond the payouts themselves:

Today’s WSJ reported that the French banks outmaneuvered the Fed to get 100 cents on the dollar in the AIG bailout.

The French banks should be grateful that the Fed didn’t claw back collateral that they had already extracted from AIG as of September 2008. For example, just prior to the September 2008 bailout, Soigné extracted $5.9 billion from AIG that in a “normal” bankruptcy may have been viewed as a fraudulent conveyance. Moreover, these circumstances were far from normal given that the CDS counterparties transactions and suspect underlying Cods precipitated AIG’s crisis. Public money was at stake on September 2008, when negotiations should have been pressed. It is likely that not only would the French not have gotten 100 cents on the dollar, they would have owed a return of billions in collateral. The banks obviously needed the bailout money, but it could have all been re-characterized as a loan that had to be paid back.

A month prior to the first September 2008 bailout, Canyon settled a dispute over a financial guarantee on a portfolio of similar collateral for only ten cents on the dollar with another bond insurer, FGIC UK. Canyon’s dispute was over a financial guarantee, not a credit derivative, but it was for similar underlying assets. If I were negotiating, I would have looked to this previous settlement to tell the French to take the discount or take nothing at all—and have a nice flight back to France.

Why the Federal Reserve and SEC Wanted to Keep Information Secret on the AIG Bailout Payments

Janet Tavakoli explains to Reuters the motive behind the regulators desire to keep secret the details of the AIG bailout:

Information about the American International Group bailout that regulators agreed to keep secret may reveal which banks held some of the worst performing mortgage-related securities at the time of the rescue.

Reuters reported Monday that the Securities and Exchange Commission approved a request last May by AIG to keep confidential some portions of a year-old regulatory filing that provided details about the funneling of tens of billions of federal bailout dollars to banks like Societe Generale, Goldman Sachs, Deutsche Bank and Merrill Lynch.

The SEC's order granting confidential treatment to the redacted portion of the filing, known as Schedule A - List of Derivative Transactions, lasts until November 25, 2018.

A close review of the non-redacted portions of the Schedule A exhibit, which the giant insurer filed with the SEC on March 16, reveals the regulatory agency permitted the giant insurer to keep secret any identifying information about the securities a group of 16 big US and European banks sold to Maiden Lane III, an entity set-up by the Federal Reserve of New York in November 2008 as part of the AIG bailout.

The NY Fed established Maiden Lane III to retire the credit default swaps-and insurance-like derivative product-AIG had sold to the banks to guard against a decline in value on those mortgage-related securities.

The redacted information includes things such as the CUSIP, or trading ID number, for each security; the name of each security and its face value. Also redacted was the distressed market price, or "negative mark to market" value, for each security sold to Maiden Lane III.

SOURED DEALS

Derivatives consultant Janet Tavakoli said the information kept secret made it difficult to determine which banks held the worst performing securities as well as the identity of the banks that arranged and marketed those securities.

"They didn't want you to know which deals had soured the fastest,'' said Tavakoli, president of Tavakoli Structured Finance and a vocal critic of the AIG bailout. "The reason they didn't want to release these details is because it would have shown that some securities suffered only moderate discounts while others were worth much, much less. And that could have prompted an investigation into the deals that performed the worst.''

Bottom line, the regulators were protecting the worst banks by lumping everything together. Only the details will show who the regulators were really bailing out. This, of course, brings immediately to mind the further question, "Why are regulators protecting certain banks, especially if they are the banks that created, sold and held the worst financial products?"

Bank of America's Shareholders (and All Wall Street Shareholders) Should Reject Bonus Plans

By Janet Tavakoli

In July 2009, New York Attorney General Andrew Cuomo's report found that, among other things, the compensation structures at most banks were "a major impetus for the subprime fiasco."¹

Shareholders fed up with the fact that key contributors to the global credit crisis plan to pay billions of dollars worth of cash and stock in bonuses to employees might consider following Goldman's suit. Goldman Sachs's shareholders brought separate actions against the Board of Directors for alleged breach of fiduciary duties in approving billions of dollars in bonuses.

Bank of America and its acquisitions, Countrywide and Merrill Lynch, were neck-deep in the subprime crisis. In July 2008, Bank of America acquired Countrywide, which made $97 billion in subprime or high interest loans during the peak years of 2005 through 2007.² On October 6, 2008 (three days after TARP was approved), Bank of America agreed to settle a multi-state predatory lending lawsuit against Countrywide for $8.7 billion. Bank of America received its first $25 billion TARP injection around three weeks later.

Bank of America proposes to pay billions of dollars worth of cash and stock bonuses to its Merrill Lynch employees. Merrill Lynch claims that the fact that it lost tens of billions of dollars on so-called super senior 'investments" during the crisis is proof it innocently sold risky investments to others. Don't believe it. Here's what happened. Merrill was involved with a lot of subprime lending and packaging and knew or should have known exactly what it was doing. What is more, Merrill had other pockets of risk unrelated to subprime.

For example, in December 2006, Ownit, a California-based mortgage lender partly owned by Merrill, declared bankruptcy. Its CEO, William Dallas, stated he was paid more to originate no-income-verification loans than for loans with full documentation. Michael Blum, Merrill Lynch's head of global asset-backed finance, sat on Ownit's board. When Ownit declared bankruptcy—instead of demanding a fraud audit—Blum faxed in his resignation.

After the bankruptcy, Merrill continued packaging Ownit's loans. Following a multi-year pattern, Merrill disguised the risk. Merrill packaged Ownit's risky loans in 2007, and failed to disclose that it was Ownit's largest creditor. Within a year, the so-called "AAA" rated tranche was downgraded to a junk rating of B, meaning you are likely to lose your shirt. (A mutual fund was stuck with it.) This meant that "investment grade" tranches below the "AAA" were worthless or nearly worthless, because those investors agreed to take losses before the "AAA" investors.

Losses were not simply due to fickle market prices. There was permanent value destruction.

Merrill Lynch further disguised risk by repackaging phony "investment grade" tranches into new investments called CDOs and CDO-squared. Credit derivatives amplified the problem, because one could sell value-destroying investments more than once. This was only obvious to professionals, because some mortgages took a couple of years for payments to reset. By 2007, things were so bad that many loans were total shams and began defaulting almost immediately. This is the classic end of a Ponzi scheme.

Read the rest here.

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based consulting firm to financial institutions and institutional investors. She is the author of a book on the cause global financial meltdown: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009), Structured Finance & Collateralized Debt Obligations (Wiley 2003, 2008), and Credit Derivatives & Synthetic Structures (Wiley 1999 and 2001).

The Bonus Question

Bonuses for bank employees will be announced in coming days. Simon Johnson is calling for a Supertax on them:

The administration should immediately propose and the Congress must at once take up legislation to tax the individuals who receive bonuses from banks that were in the Too Big To Fail category – using receipt of the first round of TARP funds would be one fair criterion, but we could widen this to participation in the stress tests of 2009.

The supertax structure being implemented in the UK is definitely not the right model – these “taxes on bonuses” are being paid by the banks (i.e., their shareholders – meaning you, again) and not by the people receiving the bonuses.

Essentially, we need a steeply progressive windfall income tax – tied to the receipt of a particular form of income. This is tricky to design right – but a lot of good lawyers can get cranking.

It's being leaked that President Obama plans to announce a new fee on banks, instead. Politico has those details:

Top administration officials tell Morning Money that President Obama’s budget, to be unveiled next month, is likely to include a fee on banks designed to recoup some of the cost taxpayers incurred in the bailout, which specified that the U.S. government should be made whole. This will stop short of a financial transactions tax, and the administration has decided that a tax on compensation packages would be too easily evaded. The officials said the final approach has not been locked down.

But the real problem is the bailout itself.

It's unclear if the big investment banks such as, Goldman Sachs, made any legitimate money in the private sector last year or whether it was a combination of bailouts and friendly bond trading with the Federal Reserve.

You can't reverse time and fix the mess completely. The best solution is the one proposed by Janet Tavakoli. That is for the investment banks to give back the money they received from the government and reverse the trades where the government bought who knows what kind of securities, then the firms should be left to sink or swim on their own without any new taxes or fees. Otherwise, we continue to march down the road to more and more control of the economy. New taxes are not the answer and, of course, new fees which end up choking off the competitors of Goldman and JPMorganChase are not the answer.

Timothy Geithner, I Call Your Bluff

By Janet Tavakoli

 

The Treasury responded to reports that the New York Fed asked AIG to suppress and delay facts about the bailout.  Meg Reilly, a Treasury spokesperson claimed: "In the transaction at the heart of this dispute…the FRBNY [Federal Reserve Bank of New York] made a loan of $25 billion which is on track to be paid back in full with interest."  She claims the loan is currently "above water."
 
In the first place, that loan is not the heart of the dispute.  Nonetheless, the FRBNY should immediately release the details of all of the Maiden Lane III assets backing that loan and show the current prices BlackRock has placed on them.  Based on the current market, it is extremely likely that the loan is underwater. 
 
The assets backing the loan are so-called super senior and AAA rated collateralized debt obligations (CDOs).  Similar CDOs trade for under ten cents on the dollar, not close to the average price of 35 cents for the loan's assets shown in a recent Fed report.  The Fed claims prices climbed 4.5%.  Yet in the secondary market, prices have dropped.
 
The Fed awarded no-bid contracts to Blackrock to manage and price these assets (among other things).  Given BlackRock's track record as a CDO manager*, I have no reason to believe its prices are reliable.  As I mention above, I have reason to question the prices.  

 

If the Treasury wants to publicly claim the loan is not underwater, now is the time to prove it, even though this particular loan is not the key issue.
 
As Representative Darrell Issa explained in his letter to the Fed, at the heart of this dispute is my assertion that Treasury Secretary Timothy Geithner, in his former role as President of the FRBNY, paid 100 cents on the dollar to settle AIG's credit default swap contracts, and he wildly overpaid.  Other bond insurers including Ambac, MBIA, and FGIC have settled similar contracts for as little as ten cents on the dollar. 
 
The general public was kept unaware of several politically explosive facts.  Risky subprime loans partly backed CDOs that AIG insured.  Goldman Sachs played a key role in AIG's distress with both credit default swap transactions and CDOs that Goldman underwrote.  The identities of the banks—including some foreign banks—that received payments were not revealed until five months after the bailout.  The November 2009 TARP Inspector General's report failed to mention that Goldman originated or bought protection from AIG on about $33 billion of the problematic $80 billion of U.S. mortgage assets that AIG "insured" with credit derivatives, about twice as much as the next two largest banks involved. 
 
The TARP report also failed to highlight the synthetic CDOs underwritten by Goldman Sachs that remain on AIG's books. There is nothing wrong with hedging or taking the opposite view to one's customers. There is nothing wrong with using credit derivatives to accomplish this goal. But there are serious questions about whether residential mortgage backed securities and downstream CDOs were value-destroying and misrated.
 
Wall Street was chiefly responsible for the "financial innovation" that did massive damage to the U.S. economy.  I assert there should be fraud audits of Wall Street's securitization activities. 
 
Given the extraordinary circumstances surrounding AIGs trades, the global financial crisis, and the AIG bailout, it is time to reopen this issue.  AIG's counterparties can repurchase the approximately $62 billion in CDOs from Maiden Lane III at full price**.  If the Fed really believes they are worth 35 cents on the dollar, then these counterparties will be getting a windfall versus ten cents on the dollar.  As for Goldman Sachs's approximately $8.2 billion in CDOs (including synthetic CDOs) that are still on AIG's books, they can be settled at ten cents on the dollar, and excess collateral currently held by Goldman can be returned. This is the value at which other bond insurers have settled similar deals. The return of payments to AIG can be used to pay down its public debt, before banks pay tax-payer subsidized bonuses to their employees.
 
* BlackRock managed Pacific Pinnacle CDO ($1 billion; closed 1/1/07; event of default 2/4/08); Pinnacle Point Funding ($2B closed 6/7/07; acceleration 12/13/07); Tenorite CDO I ($1 B closed 5/11/07; liquidation 2/7/08); and Tourmaline CDO III ($1.5 billion closed 4/5/07; event of default 3/31/08).  (Earlier I wrote a post that included a 2005 Tourmaline deal managed by BlackRock that ended up being part of a CDO bailed out by the Fed.)  I highlight BlackRock's 2007 CDOs similar to those in it now manages for the Fed, because in 2007 mainstream media was already reporting on the potential for these CDOs of this type to blow up.  I wrote an article for the precursor to Risk Professional in early 2007 warning about the type of value-destroying CDOs that AIG insured.  I had also issued earlier warnings on other types of value-destroying CDOs. 
 
**The price can be adjusted for interim principal and interest payments, as applicable.
 
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).

Janet Tavakoli Responds to FT's Perception of Widely Held Views Among the Financial Elite

FT writes:

What has been the most useful innovation from the financial world in recent decades? That is a question Paul Volcker, the former head of the US Federal Reserve, likes to pose to investors and bankers.

His slightly tongue-in-cheek answer might make some financiers seethe: instead of highlighting any derivative or complex financial product, Mr Volcker nominates the automatic teller machine (ATM)...His scepticism is echoed in the political and regulatory world. "Wall Street was chiefly responsible for the 'financial innovation' that did massive damage to the US economy," says Janet Tavakoli, a structured finance consultant, expressing a widely held view.

In an email Tavakoli comments:

Most of the attendees at the Wall Street Journal's Future of Finance Conference at which Paul Volker made his remarks were oblivious to this "widely held view," as I mentioned in my comments on the conference.

If this is now a widely held view, it is also news to many reporters at the Financial Times. Gillian Tett was one of the first journalists to follow the saga of questionable financial practices. We disagree on the need for widespread investigations and felony indictments. I am for them, she is against. The problem is much more profound than shattered faith in a flawed product; the manufacturers knew or should have known they poisoned the global financial food supply.

In late 2008, John Gapper told me he was the first and best stop to review an advance copy of Dear Mr. Buffett, my book on the financial crisis. He never wrote a word, and buried it. In late February 2009, Paul Davies, an FT reporter who was in the forefront of exposing dodgy financial products, wrote a good review shortly after I sent him the already published book. I clearly state that the relationship between imploded mortgage lenders and Wall Street's securitization and sales process was the largest Ponzi scheme in the history of the capital markets. Ponzi schemes are illegal in the United States. Problems were not limited to mortgage products and numerous players were involved: investment banks, certain banks and thrifts, credit rating agencies, hedge funds, CDO "managers,” monoline insurers, mortgage brokers, regulators, and Congress.

I do not know whether the book's content had anything to do with John Gapper's not writing a review. I am well aware that for the past several years, my views have not been widely held. Perhaps as Gapper claimed, he was busy with a new project. John Gapper recently authored a hagiography of Goldman CEO Lloyd Blankfein and dubbed him "Man of the Year" without mentioning what Tett labeled a "widely held view." Christopher Whalen cancelled his FT subscription after reading Gapper’s profile of Blankfein.

Response to Goldman Sachs

By Janet Tavakoli

The New York Times published a Christmas Eve expose of Goldman Sachs’s so-called “Abacus” synthetic collateralized debt obligations (CDOs). They were created with credit derivatives instead of cash securities. Goldman used credit derivatives to create short bets that gain in value when CDOs lose value. Goldman did this for both protection and profit and marketed the idea to hedge funds.

Goldman responded to the New York Times saying many of these deals were the result of demand from investing clients seeking long exposure. In an earlier Huffington Post article about Goldman’s key role in the AIG crisis; it traded or originated $33 billion of AIG’s $80 billion CDOs. AIG was long the majority of six of Goldman’s Abacus deals. These value-destroying CDOs were stuffed with BBB-rated (the lowest “investment grade” rating) portions of other deals. These BBB-rated portions were overrated from the start. Many of them eventually exploded like firecrackers.

Goldman said it suffered losses due to the deterioration of the housing market and disclosed $1.7 billion in residential mortgage exposure write-downs in 2008. These losses would have been substantially higher had it not hedged. Goldman describes its activities as prudent risk management. Many Wall Street firms wound up taking losses. The question is, however, how did they manage to get through a couple of bonus cycles without taking accounting losses while showing “profits?”

The answer is that they sold a lot of “hot air” disguised as valuable securities. Goldman claims this was prudent risk management. In reality, Goldman created products that it knew or should have known were overrated and overpriced.

If Wall Street had not manufactured value-destroying securities and related credit derivatives, the money supply for bad loans would have been chocked off years earlier. Instead, Wall Street was chiefly responsible for the “financial innovation” that did massive damage to the U.S. economy.

Earlier, Goldman denied it could have known this was a problem, yet acknowledged I had warned about the grave risks at the time. If Goldman wants to stick to its story that it didn’t know the gun was loaded, then it is not in the public interest to rely on Goldman’s opinion about the greater risk it now poses to the global markets.

Goldman excuses its participation by saying its counterparties were sophisticated and had the resources to do their own research. This is a fair point if Goldman were defending itself in a lawsuit with a sophisticated investor trying to recover damages. It is not a valid point when discussing public funds that were used to bail out AIG, Goldman, and Goldman’s “customers.”

Goldman claims the portfolios were fully disclosed to its customers. Yet at the time of the AIG bailout, Goldman did not disclose the nature of its trades with AIG, and Goldman did not disclose these portfolios to the U.S. public. If it had, the public might have balked at the bailout.

The public is an unwilling majority owner in AIG, and public money was funneled directly to Goldman Sachs as a result of suspect activity. The circumstances of AIG’s crisis were extraordinary and without precedent. I maintain that the public is owed reparations, and it would be fair to make all of AIG’s counterparties buy back the CDOs at full price, and they can keep the discounted value themselves.

Some similar CDOs currently trade for less than a dime on the dollar in the secondary market. Goldman’s trades amounted to more than $20 billion (albeit Goldman traded or originated $33 billion of AIG’s $80 billion of this ilk). If Goldman wants to claim it was “only following orders” for customers, that is between Goldman and the hedge funds or other “customers” involved. Goldman can fight it out with them if it wants its money back.

Goldman’s synthetic deals that are still on AIG’s books can be settled at ten cents on the dollar. This is the value at which other bond insurers have settled similar deals. The excess money already paid to Goldman can used to pay down AIG’s public debt.

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).

Goldman's Abacus Deals, the New York Times' Today, Hawala and More

Janet Tavakoli emails:

The New York Times wrote an interesting article today about Goldman’s Abacus synthetic CDOs and the counterparties who may have been on the other side of some of the credit derivatives used to create them. This month’s Risk Professional published an excerpt of Chapter 6 of my book, Dear Mr. Buffett, “Beware of Geeks Bearing Grifts,” in which I explain the strategy. Goldman wasn’t alone in employing this strategy. The strategy can be employed by the deal structurers, hedge funds, other types of clients or any combination of the former.

For example, hedge fund managers that are also CDO managers buy protection (in the form of a credit default swap) from the CDO it manages, and then sells protection to the hedge funds that it also manages. Among other deals, I recap a Merrill deal called “Norma.” The Wall Street Journal’s Carrick Mollenkamp and Serena Ng wrote about it two years ago, in December 2007 (I helped with background and was quoted), and they questioned Magnetar’s strategy. A hedge fund does not have to manage a CDO to participate, but it is all the more egregious when it does.

I also recap all of the ABS CDOs of this type that Merrill brought to market in 2007. How could it happen Merrill got “stuck” with losses? That isn’t the right question. The question is how did it manage to get through a couple of bonus cycles without taking accounting losses while showing “profits?” The answer is CDO hawala.

In a control fraud, the agents, highly paid “professionals” prosper, but often financial institutions and their shareholders and debt holders suffer (debt holders were bailed out in our recent crisis, and they shouldn’t have been).

CDO hawala is similar to the complex, but highly effective, money brokering system used in the Middle East. Hawala makes it virtually impossible to trace cross border money flows. Suspect collateral was traded among mortgage units and structuring firms. This makes it hard for anyone, except someone with the authority or subpoena power to examine your trade tickets, to figure out what you are doing. The hedge funds profit mightily, which is “lovely” for the hedge fund manager, since it earns much higher fees from the hedge funds than from the CDOs.

In the second edition of Structured Finance (Wiley 2008), I provide even more details and suspect strategies.

Several people asked about Goldman’s Abacus 2005-2 CDO mentioned in the article below. It is a synthetic CDO, the first one ever managed by C-Bass. Much reviled Litton is the servicer. Goldman purchased Litton from C-Bass in 2007. Servicers are part of the process, since servicers can influence the disposition of the collateral of any mortgage security backed by mortgage assets, whether it is cash, synthetic, or a hybrid of both.

There should be fraud audits of the securitization units of several firms. The audit should encompass the relationships with mortgage lenders, servicers, hedge funds, SIVs, and more. A fraud audit doesn’t mean you are accusing anyone of fraud, only that the audit will be thorough enough to uncover it, if it exists.

Janet Tavakoli Responds to Thomas Adams on Goldman and AIG

Earlier today, Naked Capitalism posted a guest column by Thomas Adams of Paykin Krieg & Adams LLP. In his column, Adams argued that Tavakoli should have made stronger accusations against Goldman, the Fed, the Treasury and AIG.  This is kind of  like arguing that Paul Revere should have gotten on his horse earlier to warn that the British were coming.

Tavakoli has been in front of the pack in many charges against Goldman et al. In the face of that Adams' comments about Tavakoli are, well, interesting. 

That said, Tavakoli is picking up a strong international following. Paul Jorion in France contacted her to get a response on the Adams post. Here is an English translation of what appears at Blog de Paul Jorion:

o Paul,

Apparently these people (I don’t know them) don’t like me, and so what? Regarding my position on AIG, the following information may make it clear that I have spoken up early, specifically, and in more than one venue.

I am sure I was the first to speak up in the mainstream media in August 2007 when no one else was even aware there was a problem with AIG. I also met with Jamie Dimon in August of 2007 for the purpose of discussing my concerns about AIG, and I spoke with Warren Buffett about it via telephone. I put my reputation on the line in a very big way.

This is not the first public article I have written about AIG, CDOs, or credit derivatives (my 1999 book covers information asymmetry in a lot of detail). I have an extensive body of work, and I have put many (but not all) public articles and videos on my web site going back to 2003 when I started my firm and began making information publicly available. http://www.tavakolistructuredfinance.com/press and http://www.tavakolistructuredfinance.com/videos I think readers can make their own decisions about the merits.

The facts may suggest a conclusion, but that doesn’t mean one should jump to one without having more to back it up. I am happy to make the case for reparations. Previously, I publicly stated there should be a fraud audit of the securitization activities of several Wall Street firms, including Goldman Sachs. This does not mean you are accusing someone of fraud, only that the audit will be extensive enough to uncover it, if it exists.

It is also likely that Goldman realized the game was up on everyone’s CDOs (not just their own). The circumstances surrounding the formation of the ABX index warrant more investigation as suggested investigative reporting by the late Mark Pittman of Bloomberg News. Regarding Goldman’s hedges, One would want to know details about Goldman’s hedges. I asked its spokesman for specific details about a variety of AIG hedges in various markets, and although he said he would respond to my questions, he did not.

Best,

Janet

Is the Treasury Covering Up Part of Goldman Sachs' Role in the AIG Crisis?

Find out what Janet Tavakoli of Tavakoli Structured Finance thinks in this FOX business clip.

In a private email Janet notes:

The coming weeks may bring more public questions about the AIG CDS settlements.

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. This wasn’t exactly comparable, because of the March 2008 lawsuit, but it was on a subprime related ABS portfolio. It does highlight that French banks will settle, however, when the motivation is right.

These are much more comparable: Ambac settled $5 billion of similar (to AIGs) CDSs for ten cents on the dollar, and MBIA has also made deeply discounted settlements on similar CDSs.

Gossip from the Wall Street Journal’s Future of Finance Initiative

By Janet Tavakoli

Last week I was a participant in the Wall Street Journal's Future of Finance Initiative in England. WSJ has written a summary of the conference highlights, and missed some key points. Allow me to fill in the blanks.

Paul Volcker, former Fed Chairman and current Chair of the President's Economic Advisory Board, made the most worthwhile comments. Moral hazard was not discussed in the open forums, so Volcker reminded the assembly. Yet even Volcker did not broach the topic of fraud.
Alistair Darling, Chancellor of the Exchequer, spoke on the opening evening. I asked him why massive financial fraud remained unaddressed. Darling appeared momentarily confused and seemed to suggest this was exclusively a U.S. problem to be handled by the courts. I pushed back on this notion. By the time one needs a lawyer, it is too late. I noted that we, the middle aged financiers in the room, are responsible for taking action. If we don't face this issue head on, we will never restore trust in the financial system.

Ana Botin, Banesto's Executive Chairman, suggested that the risk manager should report to the board. Then she blew it with the assertion--made several times--that the CEO can also be Chairman. (Ken Lewis defended his dual role as CEO and Chairman of Bank of America at a Fed conference in 2003. How did that work out?)

I didn't challenge Botin's assertion, because I used my two minutes (literally) during the "Too Big to Fail" breakout session to (unsuccessfully) try to carry the point that when banks fail, we should allow shareholders to be wiped out, and debt holders should take losses. (Under that scenario, most of the current managers would be booted out.) Instead, the group posted the need for a "living will" to be designed by the managers that made life support during our recent crisis a debatable necessity.

Elizabeth Corley, CEO of Allianz Global Investors in Europe, presented conclusions from her panel's discussion of the "Regulatory Frontier." The panel's idea of upgrading regulatory resources was to deploy senior financial institution officers to regulators for two or three years and vice versa. Meanwhile, the financial institutions should chip in to maintain the regulators' former high pay. Howard Davies of the London School of Economics saved me from having to explain the concept of regulatory capture. After he spoke, I was the only one to clap. Apparently everyone else thought the panel was titled the "Predatory Frontier."

Read the rest at HuPo.

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).

Guns, Goldman Sachs, and Bloomberg’s B.S.

By Janet Tavakoli

Bloomberg News has done a lot of good research during this financial crisis, so I was surprised yesterday when it released Alice Schroeder’s article claiming Goldman Sachs Group Inc.’s employees are buying guns to protect themselves against an uprising against the bank.

Twenty years ago I worked for Joe Argilagos on Merrill Lynch’s interest rate swap desk in New York. His father was Jose Argilagos, one of the brokers in a Merrill Lynch Florida office shot dead, after an investor lost money in crash of 1987. Our current crisis has provoked public outrage, and Bloomberg has the ability to uncover facts that may help us get monetary justice not of the violent variety.

Instead, Bloomberg gave us a badly executed theme born of gassy gossip. Schroeder’s source was “a friend” repeating hearsay from yet another friend. Beyond that, it seems she just made things up without doing a lick of financial research about what really has Goldman Sachs spooked, or as it turns out, without much research at all.

Goldman’s spokesman did not return Schroeder’s call. The New York Police Department told her it believed some of the bankers she asked about have gun permits, but didn’t name names. In other words, there is no verification. She claimed it is “almost impossible” to for ordinary citizens to obtain a concealed gun permit in New York and nearby states. ZeroHedge debunked Schroeder’s article. Connecticut is nearby to the New York City and metro area, and its requirements are among the more reasonable of the “may issue” states on the East Coast.

Schroeder wrote that Goldman Sachs’s CEO Lloyd Blankfein installed a security gate for his home two months before Bear Stearns collapsed. She offers this mundane act as evidence of “foresight” and that “Blankfein somehow anticipated the persecution complex his fellow bankers would soon suffer.” Schroeder made this up and wrote it down. She added: “Imagine what emotions must have been billowing through the halls of Goldman Sachs to provoke the firm into an apology.”

Meanwhile, Vanity Fair published, “The Bank Job,” by Bethany McLean, the investigative reporter who first questioned Enron’s accounting. McLean offered a more plausible explanation. Goldman Sachs played games with the facts to avoid responsibility for its key role in the huge systemic risk posed by A.I.G.’s crisis. (McLean cited my research and gave me credit for it.) Blankfein apologized after the truth saw daylight: “We participated in things that were clearly wrong and have reason to regret.”

Goldman insured securities with A.I.G. that were created by Goldman itself, and Goldman’s deals made up a large portion of the deals for which other firms bought protection in the form of credit default swaps. These trades were the key reason that billions of dollars of public money was funneled to Goldman Sachs and other trading partners. The Vanity Fair article did not include verification revealed in a report by TARP's Special Inspector General that Goldman refused to negotiate concessions during the A.I.G. bailout, because it would have lost money.

Goldman continues to spin the facts. It recently claimed that it would make money if it bought back $13.9 billion of assets purchased from it by the Federal Reserve during one phase of the A.I.G. bailout. That is nonsense. The market value of those assets has declined dramatically and similar assets now trade for a few pennies on the dollar. Congress should call Goldman’s bluff and insist it buy back these wasting assets at full price.

Schroeder’s article is an injustice to Bloomberg’s true reporters. It’s a shame when sensationalism drowns out good journalism. There are a lot more facts yet to be uncovered, and investigative financial journalists are the kind of people that really give Goldman Sachs reason to worry.

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).

Goldman Sachs: A Bunch of Operators Trying to Gaslight the Press

By Janet Tavakoli

Pulitzer Prize winner, Gretchen Morgenson of the New York Times wrote a must read article (“Revisiting a Fed Waltz with AIG,” November 21, 2009) on Sunday in which she recaps salient points from the November 17, 2009 report of the Office of the Special Inspector General (Neil Barofsky) for the Troubled Asset Relief Programs, “Factors Affecting Efforts to Limit Payments to AIG Counterparties,” and wrote:

On the question of whether this payout was what the report describes as a “backdoor bailout” of A.I.G.’s counterparties, Mr. Barofsky concluded: “The very design of the federal assistance to A.I.G. was that tens of billions of dollars of government money was funneled inexorably and directly to A.I.G.’s counterparties.” [T]his was money the banks might not otherwise have received had A.I.G. gone belly-up.

Timothy Geithner’s interaction with the New York Times, first in his role as President of the FRBNY and later as Treasury Secretary, seems to be that of a bailout enabler and a PR spin doctor for Goldman Sachs. Based on the Sunday article’s revelations, I would not characterize his behavior as that of “a good man in a storm;” he seems a mere water-boy:

According to an e-mail message that Goldman sent to the New York Fed at the time [September of ‘08], Mr. Geithner talked about the article with Mr. Viniar, Goldman’s chief financial officer, before calling me. When Mr. Geithner called, he said that Goldman had no exposure to an A.I.G. collapse and that the article had left an incorrect impression about that. When I asked Mr. Geithner if he, as head of the regulatory agency overseeing Goldman, had closely examined the firm’s hedges, he said he had not. Mr. Geithner told me on Friday that he spoke with Mr. Viniar that day to ensure that Goldman’s hedges were adequate. And, notwithstanding the inspector general’s findings, he said he still believes Goldman was hedged.”

Prior to the article’s publication, Goldman Sachs responded to Ms. Morgenson’s questions about the Barofsky report via an email from its spokesman Luca van Praag. The entire exchange can be found here “Goldman’s Response to Questions About A.I.G.,” November 22, 2009.

Did Goldman Sachs dissemble and equivocate in its responses to the New York Times?

Based on these responses, the answer is yes. Treasury Secretary Geithner may wish to keep that in mind the next time he looks to Goldman Sachs for his answers.

Read the full article here.

Harvard Business on AIG: The Secret Bailout

By Bob Pozen

When an insolvent AIG paid out $165 million in executive bonuses, the public was outraged. But that is peanuts compared to the $62 billion AIG has quietly paid out to settle its obligations with some of the world's largest banks. Last week, the details of this settlement were finally disclosed.
The financial products subsidiary of AIG had sold these banks a huge volume of credit default swaps (CDS) — obligations of AIG to pay the full face value of designated bonds if the issuers were to default. Many of these bonds were backed by mortgages, whose values deteriorated sharply during the summer of 2008. In response, AIG executives tried to persuade these banks to settle its CDS obligations at a 40 percent discount to the face value of the relevant bonds.
Then, on September 16, 2008, the federal government took over almost 80 percent of AIG's stock in return for an $85 billion line of credit, which was later increased to over $180 billion in other loans and investments.

During the first week of November, 2008, the Federal Reserve Bank of New York — with the current Treasury Secretary Timothy Geithner as its then president — took over the negotiations with the large banks owning CDS contracts with AIG. After a week of negotiations, the New York Fed instructed AIG to settle these CDS contracts by paying the full face value of all the relevant bonds — $62 billion, as compared to their then market value of less than $30 billion.
In my view, these $62 billion in AIG payments were unjustified gifts to sophisticated investors, who had made an error of investment judgment in choosing a weak counterparty for their CDS contracts. The choice of appropriate counterparties is a critical component of risk management at all financial institutions. Even the vice-chair of the New York Fed admitted that the payments "will reduce their incentive to be careful in the future."

Moreover, no one disclosed the existence of these huge payments by AIG until March of 2009, when the US Senate Banking Committee pressed for some details about the AIG settlement. More information emerged last week in a report by a federal auditor, who wrote that the New York Fed "refused to use its considerable leverage" to negotiate discounts with AIG's counterparties. According to Janet Tavakoli, an expert on structured finance, "There is no way they should have paid at par (face value). AIG was basically bankrupt."

If the New York Fed had threatened to put the financial products subsidiary of AIG into bankruptcy, the counterparties would probably have agreed to settle their CDS contracts with AIG at 70 or 80 cents on a dollar. After filing for bankruptcy, the AIG subsidiary would have been allowed to repudiate all its CDS contracts subject to a court-approved reorganization plan. Most investors would accept discounts to settle CDS contracts now, rather than roll the dice in a lengthy legal proceeding.

Since federal officials have not explained why they chose to pay in full instead of negotiating discounts, we can only speculate. One theory is that the US Treasury wanted to provide financial assistance to foreign banks suffering the fallout of the American credit crisis. These foreign banks received roughly $40 billion of the $62 billion in payouts from AIG. Perhaps this was an indirect way to achieve the US Treasury's objective since Congress would not authorize a direct bailout of foreign banks.

There are conspiracy theories as well. Some observers point out that Stephen Friedman, the chairman of the New York Fed, is a director of Goldman Sachs. Goldman received almost $13 billion in settlement from AIG and Friedman bought 50,000 shares of Goldman shortly after the federal takeover of AIG. Goldman claims that it was fully hedged against any losses if AIG had failed, but the reliability of these hedges has been questioned by the federal auditor.
Why do you think the New York Fed acted the way it did in dealing with the large exposure of AIG to CDS contracts on mortgage-backed bonds? What do you think the Fed could or should have done instead?

Bob Pozen is a senior lecturer at Harvard Business School and the author of Too Big to Save? How to Fix the US Financial System


The above originally appeared at HarvardBusiness.org

Warren Buffett, Stop Using My Credit Card!

By Janet Tavakoli

I like Warren Buffett. I even wrote a book about the financial crisis contrasting his principles of prudent finance with recent excessive leverage, bad lending, and malfeasance (Dear Mr. Buffett). Buffett is not a regulator, an altruist, a consumer advocate, or an elected official. As CEO and largest shareholder of Berkshire Hathaway, his goal is to maximize shareholder value.

U.S. capitalism has morphed into a financial oligarchy. If Buffett’s choice is between getting along in the financial community or the public interest, public interest loses. But he didn’t cause our financial crisis, and he spoke out in advance about excessive leverage and bad lending. The financial markets are now wildly distorted. Others have funding advantages Buffett can only dream about, so he exploits an advantage when it becomes available.

I have been a trenchant critic of rampant financial malfeasance, and Buffett has only wished me well and told me to “keep writing.” For my part, I try to keep in mind that we view the world through different lenses.

On October 25, 2009, when BBC’s Evan Davis interviewed him, Buffett surprised me : Click here to view the eight minute video. It started out so well, but after six minutes the interview went sideways. [Not shown in this clip Buffett said his $5 billion investment in Goldman Sachs’ preferred stock (plus free warrants) last year was, in part, a bet on a US government bailout.1 He thought the U.S. taxpayer got a good deal, but we got a worse deal than Buffett negotiated, and as I explain here, I feel taxpayers got chump change.]

@ 3:14 min: Buffett explains that if there were only 50 people on a fertile island, we wouldn’t take the five smartest people out of the 50 and give them the most money and tax breaks for trading rice futures and speculating: “Hell no! We’d get everybody producing rice. The idea that people that move money around are some favored class—and they are in this country, even in terms of taxes—strikes me as getting pretty far away from where we should be.”

@ 6:00 minutes: Buffett claims shareholder losses obviated moral hazard. Not true. In control frauds (first identified by William K. Black), financial institutions are destroyed, and shareholders lose. Only the agents: CEOs, CFOs, and highly paid employees are enriched. Unlike Buffett, these agents are “stewards,” not major owners. Moral hazard remains an intractable problem.
@ 6:25 minutes: Buffett claims taxpayers have not bailed out anybody, because tax rates have not gone up (yet), and “tax receipts are way down this year.” Chinese and Japanese buying U.S. government bonds have bailed out financial institutions. Not true unless we default or destructively print inflationary dollars. Tax receipts are down because of unemployment. U.S. taxpayer credit bailed out financial institutions, and we will have to pay back our debts.

Imagine this scenario: Warren grabs my credit card and charges twelve suits. When I object that I don’t want to bail out his wardrobe, he chuckles and says, don’t worry, you haven’t paid anything yet. The bank that issued the credit card bailed out my wardrobe, and it hasn’t even had time to charge you interest on my purchase.

When I protest that I’ll have to eventually pay off both the balance and accrued interest, he tries flattery. You are so productive that by the time you have to pay this off, you’ll have so much more wealth that you won’t even notice these charges. You’ve always been good for it before, and you’ll figure out how to pay!

Don’t fall for it.

Read the rest here.(PdF)

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based consulting firm to financial institutions and institutional investors. She is the author of a book on the cause global financial meltdown: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009), Structured Finance & Collateralized Debt Obligations (Wiley 2003, 2008), and Credit Derivatives & Synthetic Structures (Wiley 1999 and 2001).

Tavakoli: Undo the Goldman "Bailout" Before Bonuses Are Paid

Bombshells are falling in light of the new report from Neil M. Barofsky, special inspector general for the Troubled Asset Relief Program. Derivatives specialist Janet Tavakoli of Tavakoli Structured Finance is calling for the undoing of what she views as essentially a Goldman bailout.

Here's NYT's Gretchen Morgenstern with the backstory:

The Fed, under Mr. Geithner’s direction, caved in to A.I.G.’s counterparties, giving them 100 cents on the dollar for positions that would have been worth far less if A.I.G. had defaulted. Goldman Sachs, Merrill Lynch, Société Générale and other banks were in the group that got full value for their contracts when many others were accepting fire-sale prices.

On the question of whether this payout was what the report describes as a “backdoor bailout” of A.I.G.’s counterparties, Mr. Barofsky concluded: “The very design of the federal assistance to A.I.G. was that tens of billions of dollars of government money was funneled inexorably and directly to A.I.G.’s counterparties.” The report noted that this was money the banks might not otherwise have received had A.I.G. gone belly-up...

Mr. Barofsky says the Fed failed to strong-arm the banks when it was negotiating payouts on the A.I.G. contracts. Rather than forcing the banks to accept a steep discount, or “haircut,” the Fed gave the banks $27 billion in taxpayer cash and allowed them to keep an additional $35 billion in collateral already posted by A.I.G. That amounted to about $62 billion for the contracts, which the report describes as “far above their market value at the time.”

Here's what Tavakoli told Morgenstern:

The inspector noted in his report that Goldman made several arguments for why it believed it was not materially at risk in an A.I.G. default, but he is skeptical of the firm’s reasoning.

So is Janet Tavakoli, an expert in derivatives at Tavakoli Structured Finance, a consulting firm. “On Sept. 16, 2008, David Viniar, Goldman’s chief financial officer, said that whatever the outcome at A.I.G., the direct impact of Goldman’s credit exposure would be immaterial,” she said. “That was false. The report states that if the New York Fed had negotiated concessions, Goldman would have suffered a loss.”

The report says that Goldman would have had difficulty collecting on the hedges it used to insulate itself from an A.I.G. default because everyone’s wallets would have been closing in a panic.

“The prices of the collateralized debt obligations against which Goldman bought protection from A.I.G. were in sickening free fall, and the cost of replacing A.I.G.’s protection would have been sky-high,” she said. “Goldman must have known this, because it underwrote some of those value-destroying C.D.O.’s.”

Ms. Tavakoli argues that Goldman should refund the money it received in the bailout and take back the toxic C.D.O.’s now residing on the Fed’s books — and to do so before it begins showering bonuses on its taxpayer-protected employees.

“A.I.G., a sophisticated investor, foolishly took this risk,” she said. “But the U.S. taxpayer never agreed to be a victim of investments that should undergo a rigorous audit."