More on Goldman and AIG

Thomas Adams, a lawyer and former bond insurer executive, wrote a guest post for naked capitalism on the question of why AIG was bailed out and the monoline bond insurers were not (wow, is it really almost two years since the monoline insurer crisis?). He estimates that the monolines together had roughly the same amount of exposure to CDOs that AIG did; in addition, since the monolines also insured trillions of dollars of municipal debt, there were potential spillover effects. (AIG, by contrast, insured tens of trillions of non-financial stuff — people’s lives, houses, cars, commercial liability, etc. — but that was in separately capitalized subsidiaries.)

The difference between the monolines and AIG, Adams posits, was Goldman Sachs.

Apparently while all the other banks were paying monoline insurers to insure their CDOs, Goldman wasn’t, because the monolines refused to agree to collateral posting requirements (clauses saying that if the risk increased and the insurer was downgraded, it would have to give collateral to the party buying the insurance). Instead, Goldman bought its insurance in the form of credit default swaps from AIG, which was willing to agree to collateral posting requirements, as we all now know. This is one way in which Goldman was smarter than its competitors. Another way, which we also all know, is that at some point in 2007 Goldman began shorting the market for mortgage-backed securities — which would given extra incentive to make sure that they were fully insured.

Until, suddenly in September 2008, it turned out that maybe Goldman wasn’t that much smarter than everyone else, when it seemed like AIG might not be able to post the collateral it owed. And so:

“I hate to get sucked into the vampire squid line of thinking about Goldman, but the only explanation i can think of for why AIG got rescued and the monolines did not is because Goldman had significant exposure to AIG and did not have exposure to the monolines.”

There’s more.

Yves Smith points out (in an update) another possible difference between AIG and the monolines — AIG’s business in swaps allowing European banks to reduce their capital requirements, which meant that big European banks had a lot of exposure to AIG.

Another difference might be timing — AIG hit the fan at the same time as Lehman and a week after Fannie and Freddie were taken over. Another difference might be raw size: even if the monolines together were as big as AIG, that’s precisely the point — their problems could be spaced out over time, allowing the markets more time to adjust, while AIG would go bankrupt in one big lump.

By James Kwak

13 responses to “More on Goldman and AIG

  1. I hate to get sucked into the vampire squid line of thinking about Goldman

    In Soviet Amerika, SquidCo. suck YOU!


  2. What you say is true, but do you think Goldman had anything to do with spreading the fear? Maybe bailing out AIG was the better idea but even so did the government do it because of Goldman?

  3. Many human activities of the 20th century were more novel, less recognisable and on a massively bigger scale than almost ever before.

    Including, apparently, elite capture of our government institutions.

  4. The question, I’d like someone to address is a situation where instead of pouring billions into AIG, could the USG have explicitly nationalized AIG, then split off the AIGFP as a separate entity and allowed FP to undergo bankruptcy, while supporting the remaining AIG activities?

    What would have likely resulted had AIGFP defaulted, while the non-CDS activities remained capitlaized?

    I fear the long term consequence of these prior actions has only served to increase future moral hazard by outlining exactly how to go about making yourself a systemic risk and therefore TBTF.

  5. I don’t have a problem with saving AIG when we did. I think it was probably necessary whether they were connected to Goldman Sachs or not. My problem is the week negotiating done by Treasury. They should have gotten a much bigger “haircut” from AIG’s partners for ripping up their contracts with AIG. Treasury paid 100cents on the dollar. That’s where Geithner comes across as a coward. I would say dimwit, but I’ll give Geithner credit for being intelligent even if he is lily-livered.

    That’s one of the killers for me with Geithner, and why I have little patience for the man. The rumor was Geithner dared to say Sheila Blair was not a team player. Excuse me?? “Team player”??? You have AIG’s partners demanding from Uncle Sam 100cents on the dollar, money that they were NEVER going to see from AIG when your country is going down the toilet right before your eyes. And according to rumors Geithner said Blair is not a “team player”. Maybe not on YOUR team Geithner. But I’ll take Blair in a street fight over Geithner any day of the week.

  6. I should have typed “weak negotiating” above, NOT week negotiating.

  7. Bair, not Blair. Oh, a little embarrassing. I think I need a proofreader.

  8. Just one more benefit of belonging to the “Back Room Boys” where Henry Paulson and Larry Summers (such incredible continuity you must agree) will see that your backside is covered, even if you rigged the whole catastrophe in order to consolidate market dominence (no doubt they have, especially since Bernanke is now guaranteeing all of their trades). Talk about gaming the system, talk about OWNING THE SYSTEM, well that’s what they did and do.

  9. this sort of crap talk is utterly worthless, and harmful to thinking, without an analysis of the timeline, legal status, and amounts of collateral postings.

    the only purpose this talk has is to spread fear and anger.

    if you want to get serious, you have to follow the money, not repeat hearsay.

    info that i’ve read says that GS was on the hook for about $2.2B in losses if AIG went bankrupt. ($8B in exposure, 5.5B in collateral already posted by AIG to GS before default.) is this untrue?

  10. markets.aurelius


  11. markets.aurelius

    The coup de grace was delivered by stoking the panic over AIG’s failure. If AIG failed, then all of the chains involving AIG paying out on CDS would collapse. All of the banks with which GS would have hedged also would be imperiled, so they would have had to either file or find ways to delay payment (e.g., disputing marks from a cp demanding more collateral). But with GS on the hook to pay out too, they likely would have had to decide whether they too would file or delay as best they could. In such a world no one wants to put collateral up with a cp they believe is the next to file — it’s like pouring money into a black hole.

    To StatsGuy’s point, it is likely Timmy G! only realized this when Hank conveyed the hang-wringing despair he just heard from Lloyd. All of the talking points would have been scripted between them — just like back in the day at GS — in a manner that both their stories would be consistent when pressed by the Fed, Summers and the media, most of which are not equipped to challenge any assertions from a guy like Hank or Lloyd. Treasury would do what it was told to do, after all these guys lined up. (Tim really wasn’t and isn’t equipped to parse the economic or financial arguments — he’s a government studies undergrad + government studies grad) — so he’d be relying on the folks he’d always relied on at 85 Broad, many of whom were either at the NY Fed, ensconced in Treasury, or a phone call away at home base. The internal deliberation at Treasury and the Fed would be informed by this script, and, after enough iterations, everyone had their story straight.

    The panic was absolutely required to make the seizure of AIG seem necessary. And it made it possible to ignore the obvious — AIGFP could be allowed to fail, because the actual insurance side of the business was separately collateralized and regulated at the state level. So there was never any risk of the insurance side going belly up. The real risk was all the banks and former investment banks were so exposed and so highly levered that AIGFP’s collapse meant they would all be caught up in the dance of long knives all of FP’s creditors would be forced into. The massive leverage they all had meant they could not survive the bankruptcy cycle initiated by AIGFP — their thin slivers of equity already had evaporated and no one in their right mind would lend them any money for exactly the same reason they would not post collateral with each other. There was no there there. So, it wasn’t that they’d be fighting over 40 or 50 cents on the dollar in bankruptcy … the real issue was if there was no money coming in immediately they’d all collapse. There was nothing to fall back on. AIG had to be seized.

    What’s really amazing is all this risk piled up on Timmy G!’s watch while he presided over the NY Fed. It was set up in 2000 when Hank lobbied for and received complete relief from all oversight and regulation, and the necessity for holding any equity at all at the five investment banks granted the dispensation ( ). The guys that created the conditions for this train wreck were now charged with maintaining and rescuing the system, including Larry. This is tragic in the sense only the ancient Greek playwrights would appreciate! ( ).

    By now this is old news, but for some reason it’s being buried and ignored even now. SIGTARP was a big splash that completely dissipated. What’s up with that? Are the media, Congress and the White House incapable of pursuing the obvious and connecting the dots?

    As that brilliant post from whetstone below says, it’s All In the Game (AIG) … hi-ho the dario …