The Next Subpoena For Goldman Sachs

Yesterday’s release of detailed information regarding with whom AIG settled in full on credit default swaps (CDS) at the end of 2008 was helpful.  We learned a great deal about the precise nature of transactions and the exact composition of counterparties involved.

We already knew, of course, that this “close out” at full price was partly about Goldman Sachs – and that SocGen was involved.  There was also, it turns out, some Merrill Lynch exposure (affecting Bank of America, which was in the process of buying Merrill).  Still, it’s striking that no other major banks had apparently much of this kind of insurance from AIG against their losses – Citi, Morgan Stanley, and JPMorgan, for example, are not on the list.

This information is useful because it will help the House Oversight and Government Reform Committee structure a follow up subpeona to be served on Goldman Sachs with the following purpose:

  1. Did Goldman actually deliver the security that was insured?  Ordinarily when you close out a contract of this nature – particularly at par – you turn over the insured security in return for the payment.  The insurer pays in full but is left holding a security; if this recovers in price, the insurer recoups some of the loss.  But if Goldman was using AIG as reinsurance, which is what some news reports suggst, it did not have any security to turn over.  (Remember that with CDS – unlike cars – you can insure something that you don’t own).
  2. If Goldman did not turn over a security, then how was it determined that the security had esssentially zero value – which was the rationale for the payment really being made at par?  Was this assessment provided by Goldman or by some independent third party?  These were highly illiquid markets, so there was generally no widely quoted price that could be used.
  3. How did this valuation process differ from standard practice among market participants – when close out under such conditions is typically not at par?  If the Fed effectively allowed Goldman unilaterally to declare a security worthless and to demand payment in full, we have a major problem.
  4. Secretary Geithner claimed yesterday that, if payment had not been made in full, the economic consequences would have been dramatic.  To assess this claim, we need to see the value of these claims on Goldman’s books prior to this bailout transaction.  Best practice would suggest that Goldman was not carrying this asset at face value – as it is an articulate proponent of mark-to-market and there must have been a reasonable expectation that AIG would not pay off in full.  Therefore the transaction represented a windfall gain for Goldman shareholders and insiders – rather than something that in any sense “saved the day” for the financial system.
  5. As the evidence stands currently, the entire AIG transaction therefore appears to have been structured in such a way as to benefit primarily Goldman – although, for fair comparisons, we should obtain parallel details from other counterparties.  What was the entire timing and content of interactions between Goldman and the Fed on this matter?  Who exactly designed the deal and with which advisers?

The House Oversight and Government Reform Committee has done an extraordinary job peeling back several layers of a potentially rotten onion.  They need to follow the lead provided by this evidence and ask the next hard round of questions.

Some of these issues are rather technical but evidence either way will speak directly to accusations of favoritism and unreasonable government behavior.  It is time to get fully to the bottom of this matter.

By Simon Johnson

62 responses to “The Next Subpoena For Goldman Sachs

  1. Goldman have already reduced average compensation from $660,000, $500,000.

    I think we can all agree that, in banking terms at least, this qualifies as an all-encompassing grovelling apology of the biggest proportions, and absolves them of all blame for all known and as-yet-undiscovered misbehaviour?

  2. Simon,

    don’t worry about all us little guys understanding whats going on. this is exactly how the White House and bankers think which is why we’re all so pissed off. keep up the great inquiries and explanations.

  3. Just stop already, Simon, you’re making yourself look like an idiot. Paying counterparties at par does NOT mean that anyone was claiming the securities had no value. That’s just basic arithmetic. If Goldman had been marking these contracts at zero on their balance sheet, then AIG would have had to post the entire face value of the contracts in collateral. That’s how CSAs work, buddy.

    You’ve clearly never been involved in a close-out of any kind. Under CDS contracts, the protection buyer is entitled to 100 cents on the dollar. If the market value of the underlying has dropped 30 cents, then the protection seller (in this case AIG) will have posted 30 cents in collateral. If you want to close out the contract at that point, then the protection seller will have to pay the protection buyer 70 cents for the underlying security, and let the protection buyer keep the posted collateral. After all, the protection buyer is entitled to 100 cents on the dollar, so absent a credible threat of bankruptcy (which AIG didn’t have, since it had already been bailed out), the protection buyer has no incentive to accept less than 70 cents + 30 cents in posted collateral.

    That’s exactly what happened here! Notice how nowhere in this story does anyone mark the underlying security to zero, or ever even imply that the underlying security has no value. Seriously, how are you an MIT professor if you can’t get your mind around something this basic? I pity MIT students if this is the kind of instruction they’re getting.

  4. maynardGkeynes

    What exactly happened here is that VS should never have been allowed to be in better position than it would have been had there been an AIG bankruptcy. Any payment above that was a pure gift to VS and the other banks, thanks to their inept cronies, Geithner, Bernanke , and Paulsen. Of course there was no longer a credible threat of bankruptcy due to the taxpayer bailout, which is precisely why Treasury and the Fed had a moral and legal obligation to use their power and authority to protect the public, instead of spewing a lot of bogus nonsense about the sanctity of contracts in order to protect their buddies at VS. And I’ll add for the record, that the students at MIT are blessed to have someone like SJ teaching them. There just may be hope for the future.

  5. “How did this valuation process differ from standard practice among market participants – when close out under such conditions is typically not at par? If the Fed effectively allowed Goldman unilaterally to declare a security worthless and to demand payment in full, we have a major problem.”

    Ahhh, Houston?

  6. “as it is an articulate proponent of mark-to-market and there must have been a reasonable expectation that AIG would not pay off in full”

    Marking to market and writing down for impairment are different things.

  7. Whatever, Mr jhedges. Jargon do not a reality make. The fact is, the People was left holding the bag. Thus the practice was neither safe nor effective, and thus should not have been allowed anymore than Thalidomide (or then, as Thalidomide, under very serious restrictions).

    Goldman Sachs should have disappeared, or become property of the People. Using jargon cannot possibly hide the simple truth: there was a massive failure, the practice ought to be discontinued, the parties one paid for (Goldman) ought to be owned.

  8. Excellent reporting

  9. I guess the alternative to closing out the contracts would have been to keep them open until their predefined expiration. As the underlying securities continued to drop in value, more and more collateral (taken from the US Treasury) would have to be posted. Additional downgrades to AIG’s credit rating would trigger more collateral calls. (It is possible that with Public ownership Moody’s/S&P would raise AIG’s credit rating — did that happen?) At some point, Goldman might have considered it within their rights to just seize the collateral, and the end result would have been about the same as what we got.
    But the interest of Treasury/Fed was to wind down the operation of AIG FP as quickly as possible. Holding the CDS contracts open until expiration would have kept the Public involved in those products another 5 years or more.

    For examination of claims of financial Armageddon if AIG failed to cover its obligations, one would have to look beyond Goldman and the other direct recipients of the close-out proceeds. A common tactic among financial service providers was to sell CDS contracts and then buy offsetting contracts at a slightly lower price (often from AIG). There were very long such chains of contracts running through banks, hedge funds, institutional investment funds, etc. Failure to pay at one end of the chain would have cascaded all the way down, and the imputed “losses” at the end of the chain, where the markup was greatest, would have been significantly higher than at the front of the chain. That was why settlement at 100% was deemed important — even a few percentage points would have wiped out the sellers at the end of the chain. (Such will be the story told by the bankers involved, at any rate.)

  10. First, I’ll second what jhedges said regarding how these contracts work.

    The whole issue of whether Goldman and others should have been paid at par strikes me as simply raving mad. The upside of paying less than par is that one immediately saves the taxpayers a few billions of dollar–maybe more than ten billion if the haircuts are aggressive enough. The immediate downside is that the taxpayers’ entire investment in AIG is at risk. The company is next to worthless if downgraded by the rating agencies, and involuntary haircuts (selective default) make a downgrade automatic. The much larger downside is twofold. First, the unraveling of AIG would create a clear risk, even a probability, of sending the financial system right back into heart-attack mode. Second, recall the small detail that the U.S. government is now the main owner of AIG. A legitimate, if narrow, question, is whether failure to pay at par qualifies as a sovereign default. (My reading of the usual rating agency rules: Yes. But it’s a close case.) Less narrowly, failure to pay would raise immediate question about the U.S. government’s willingness to stand behind its other obligations under current or potential future populist pressure. We assure the Chinese that their investments in Agency bonds are good as gold. Why should they believe us? They’re not, strictly spreaking, obligations of the U.S. government, and any legal distinction offered between standing behind AIG and standing behind the agencies is likely to strike them as dissembling bullshit. (You’re recall that U.S. officials were getting nervous calls back then from Chinese counterparts asking for reassurance about their safety of their investments.) And so, too, with other foreign and domestic investors. A run out of U.S. assets would be a clear possibility. (An unlikely one? Maybe–but then you’d better hope you’re right.) The notion that one should play with fire in a tenderbox to save the taxpayer maybe ten billion bucks is just barking mad. People who argue this line just haven’t thought very hard about it.

  11. @jehedges. You may well be right on the narrow letter of the contract. Surely the bigger point is intention and whether this was CDS as reinsurance not insurance. I personally find the notion of CDS as not requiring insurable interest a pretty unlovely one, since it absolutely encourages purely speculative and highly destabilising market practice. This has generated a Sorcereres Apprentice world of bets on bets on bets, increasingly and wildly out of control. This is a long way from normal hedging activities. It places GS and many others in the role of bookmakers not bankers.

  12. Here’s what I don’t quite get..

    Assume that I did not loan AIGFP the original $.

    I, thinking the AIGFP is a turkey, buy a CDS against AIGFP for, let’s say 10M at .20. I have an investment of 2 Million (Throwing away commissions)

    I hold that for a year, and AIGFP starts sinking, fast. Then, I come to the stark realization that since the Insurance companies are ring-fenced, I only can look at AIGFP, and it IS defunct. No funds to get at all, so I won’t get 100%, I’d get 1% if I’m lucky if it goes south.

    Then Mr. Federal Reserve Employee calls me up. He says “I see you own 10M of CDS on AIGFP. You do know if the FP goes bankrupt there’s no funds in there? How about this, it’s about 1 week from death’s door. I can on behalf of the Federal Reserve of NY (Or the FED national, whichever) buy those obligations from you at .40.”

    I have just made double my investment in one year, and assume the FRBNY would eat the commissions to transfer the obligation over, and wire the funds to my account free, they have an in with my bank)

    And the Fed just saved 6M of funds, as it owns the CDO and AIG after the takeover. It’s the only party on both sides of the transaction, so it can cancel it out..

    Lather, rinse, repeat to cover all outstanding CDOs, and then take over AIG (Or AIGFP), the debt owed is to the Fed, The Fed has all the collateral. If the Collateral ends up being worth anything, the Fed gets it.

    I know there is something wrong with this, what is it?

  13. I read over a number of months ago that the insureds simply retained the posted collateral and received net settlement funds. That would be the easiest methodology. On the other hand,returning the collateral for gross proceeds to settle the transactions would be better for the insured’s. Let AIG sell their own collateral . A gross settlement is far cleaner for the insured’s. I could give illustrative journal entries for the total transactions but they are quite elementary.

    There is another much more important question here. Who did the insured’s in turn pay out their proceeds to for insurance they wrote and reinsured with AIG? If you look at Comptroller of the Currency schedules over the last few years the banks were net hedged in their favor.

    According to Gregory Zuckerman’s book, The Greatest Trade Ever, the banks and brokerages sold coverages to John Paulson and others. Even more interesting is the time overlay here if AIG stopped selling coverage on the worst mortgage products by late 2005. This was before John Paulson and other speculators that smartened up were able to buy coverages. These are cash flow items and you must look at everything as a flowing river not a spring fed pond. Financial statements are merely a very fast still photo of a flowing river.

    What was the net on these transactions to the insured party receiving the AIG payout? We also know now that the big players like GS also insured their contracts with AIG had they been blown or settled for less. The shortage of coverage payoff by AIG would have been paid off by others. Given how cheap coverages were quoted that would probably be multiple of the shortage from settling AIG at a lower value. In short, settling AIG at 100 % caused less losses that the Feds and Treasury had to cover to avoid a total collapse of the system.

    Any decently experienced accountant involved in cash flow work would see that the real danger was a chain reaction.

  14. My, some of the commenters here sure are wordy.

    The question is very simple. Prof. Johnson asserts:

    Ordinarily when you close out a contract of this nature – particularly at par – you turn over the insured security in return for the payment.

    Is that true? Anybody care to provide a reference supporting or refuting it?

  15. And you’ve just defined PONZI – the whole thing fails if the value falls.

  16. It was widely reported that one of the counter parties did not hold the security, and that they eventually, in a few days, delivered it to the NY Fed. In other words, they themselves were insuring the CDO they had sold to a 3rd party, and they had hedged this liability by purchasing protection from AIG. They obviously purchased the CDO back from their client and sold it to the NY Fed – probably for 5.6 billion.

    There, can I teach at MIT? Jhedges nails it, and can probably eviscerate my hunch here, but he should be writing articles, not Simon Johnson.

  17. I agree with Nemo. Rather than the long winded answer, pl point out the issues in Simon’s post.

    For non finance folks can someone answer Nemo’s simple question.

    In addition,

    If AIG paid 100 cents to GS, because the underlying security was zeroed on value.. and did not get anything in return, does that asset still have value, appreciating and GS is making money off that?

  18. Nemo, the NY Fed negotiated a total liquidation of the position. AIG owed GS 14 billion on the contract, and not a dime less. My hunch is GS owed somebody else 14 billion. How much collateral they had posted to that somebody, I do not know, but when the transaction was done it was widely reported one of the counter parties had to go out and get the CDO, so they had to close it out with that party. My hunch – they(GS) paid them 14 billion and they got the security. AIG then paid them (GS) the remainder of the 14 billion they were owed and they sent the security to ML III – the Fed.

    The GS haters have turned off at least 80% of their brains. In their hatred, they make brutal mistakes.

    I ain’t no securities person, so I could be wrong.

  19. No, it’s not true. You can close out the CDS at its fair value (tear up), without turning over the underlying security, or you can tear up both the CDS and buy the securities (sum of CDS + SECURITY = PAR) which is what was done with AIG for cash CDOs (and was not done for synthetic CDOs).

  20. Basically, AIG forecast that the housing market will not fall. Other firms were betting that the market would fail, and entered into contracts with AIG that would pay in that event.

    The housing market fell, and AIG couldn’t make good on its commitments, which were above $100bn.

    This was unexpected, since the parties that entered into contracts with AIG assumed that it was prudent enough to manage its risk exposure conservatively. In other words, these parties made the winning bets, but the bookie went bankrupt.

    The government then entered the scene, and the Fed guaranteed that the housing market would not fall – or actually, that whatever happened to the masses of mortgage payers, the large financail firms would be protected from any losses from mortgage-related losses.

    This left both AIG and its counterparties at a neither win, nor loss state of “business as usual”, because if the market didn’t collapse (or at least the financial players were insulated from any housing-related losses), then all the CDS contracts were still in effect and neither AIG, nor its counterparties had to post any profit or loss from them. Nor would have AIG suffered any credit downgrading from its AAA level, since it enjoyed a government backing.

    However, some of the countreparties ate their cake and got to keep it, too: instead of having to wait until the housing market rebounded (and who has the patience for that?), they were reimbursed for the losses they were supposed to have suffered, but – simultaneously – shielded by the Fed from actually absorbing these same losses.

    In short, the Fed prevented losses from the real estate market from spilling over into the financial sector, but also paid the financial gamblers who placed bets on the fall of the real-estate market. The government shielding worked like a unidirectional membrane: cash flowed into the financial sector, but never out of it, even though the problem was in the housing market and not in the financial sector to begin with.

  21. Also, in a cash settlement, the security stays with the owner. It’s still essentially at par. The security is priced at its cash value, and the deficit from par is paid in cash. Cash value plus green cash equals par. If the CDS buyer does not hold the security, then he can either go buy it at cash value (green cash out of his piggy bank), or settle for par minus the cash value of the security. He is still essentially being taken out at par either way.

    In other words, all this hysteria about par, 100 cents, etc., is misplaced as long as the mark – marked to market – is approximately correct.

  22. Goldman Sachs has intimated they think their portion of ML III (whatever it was that they sent them for 5.6 billion) has appreciated in value. It has been widely reported in the news that income from the ML III “assets” has paid off 25% of the 20-plus billion loaned to purchase those “assets”.

  23. ze, I have a problem with characterizations that imply business people were betting there would be no decline in housing. A CDO, as I understand it, are engineered to absorb a fairly significant amount of losses. So, what AIG was betting is the housing decline would be contained, and short lived, and that there would not be large collateral demands, and that the collateral would quickly come back to them. And all that while they would be collecting fat premiums from the morans who bet they were wrong.

    What business people were betting is that a deep, system-wide decline in housing was not in the cards. In modern times, it has never happened. Nobody would ever fund a 30-year mortgage with just 20% down if they thought that was in the cards. It would be 50% down.

  24. You did not necessarily need an insured interest to buy CDS coverage. You just paid the up front fee and annual fee and were covered. The contract could just as easily be a cash only settlement. If the contract required settlement, surrender of the insured subject, the speculator could buy the security to cover at the near worthless price. Paulson and others deliberately bought coverage for the most recent worst tranches of products. It would be in your interest to not buy the insured security until the last moment. Having to surrender an insured interest is not the same as owning an insured interest at the time of buying coverage.

    The sellers of coverage wanted the cash proceeds. The premiums to report as income without a corresponding reserved cost entry. The key here was always that these transactions not be construed as insurance for accounting or regulatory reasons on the part of the protection writer. If the insured party has no ownership interest at the time the contract is entered into there can not even be an insurance argument. Insurance theory only covers an insured ownership interest. In theory and you make money by busting theories.

    As far as can figure out there was no standard CDS contract until people like Paulson wanted tradable contracts. That was mainly after AIG stopped covering sub prime tranches. So, as a guess, the AIG coverages must have been largely ad hoc. GS has written down in exchange for cash and posted securities like Treasuries. At that point any reserve on the books set up to cover value loss of the covered security on the the books of GS could be reversed to income. ( A negative cost netted against other costs.)

    The CDS might be called ” pasta”. How many kinds of pasta are there? The simpleton would say that pastas are ” effectively” the same. The grifter knows that “effectively” is like ” spirit of the law”.

    Thus, if a tranched product is worth 5 % of par and you get par in settlement. The net cost of the deal is 5 % cost if bought at the tail end plus insurance costs and carrying interest if you are leveraged. These are waiting for a tail event to mature transactions. The same as any bet at a bookie. The proceeds of receiving par would be retention of posted collateral plus the cash settlement.

    There are many permutations here.

  25. For info on this issue see here:

    http://online.wsj.com/article/SB123756518992096521.html

    Only the CDS on which Goldman could turn over the insured security were put into Maiden Lane III. The $6 billion in CDS on which Goldman was unable to turn over the security just remained outstanding with AIG (which did not default on the terms of the contract).

  26. jhedges, the protection buyer (GS) had no incentive to accept less than 70 cents + 30 cents precisely because the taxpayer bailed out AIG. Absent that bailout, there would have been a credible threat of bankrpuptcy, and GS would have had to mark down the CDS. Therefore, GS was bailed out by the taxpayer, but the taxpayer received nothing from GS in return.

    I am surprised that jhedges didn’t see this simple point. Does he work for a bank, perchance?

    For the record, I was lucky enough to be a student at Sloan from 1998 – 2000 and to have the privilege to be taught by Simon. So, take your mudslinging elsewhere. You can start with all the banksters and their revolving-door cronies who got the world into this mess.

  27. Excellent work everyone. From which I conclude:
    Economists don’t know much about finance.
    Finance people don’t much about economics.
    Neither manage risk very well.
    The taxpayer cleans up after the games have ended.
    What did I miss?

  28. maynardGkeynes

    Does anybody really know what time it si?

  29. maynardGkeynes

    Does anybody really know what time it is?

  30. There’s that $14B again.

    Did we ever find out what the $14B in AIG’s “unofficial vaults” was all about?

    http://www.nakedcapitalism.com/2010/01/the-most-stunning-and-uncommented-on-revelation-in-too-big-too-fail.html

  31. One must consider then, how very very convenient that tinderbox fire was.

  32. The less the transparency coming from the Treasury and the Fed, the more the rumor of a cover-up grows and the more viral the conspiracy theories become.

  33. All I know is this kind of rotten system gave plenty of people enough rope to hang themselves but instead the public got dropped through the trapdoor.

  34. IMHO the nature of the bet is perhaps not the only issue.

    Imagine the following: Mr. Gambler goes to the racetracks and bets on a horse. It wins. Mr. Gambler then learns that the bookmaking agency didn’t balance its positions properly because it was sure that specific horse would never win. Actually, the agency was so badly hit it cannot pay gamblers the amount it promised.

    Now, the gambler is faced with two choices: give up the “invested” money and forget the whole affair, or take over the agency (together with the other gamblers who were hit) and salvage whatever money is still left in the cash register.

    Instead of this, Mr. Gambler urgently calls the deep-pocketed Mr. Taxpayer, who also happened to place bets with that bookie – though not on the winning horse, and asks him to become the bookie’s partner and pay the wins. Mr. Taxpayer agrees. Mr. Gambler, on the other hand, loses nothing from the bookie’s bankruptcy. He actually wins handsomely, at the expense of Mr. Taxpayer.

    In short, the bookie’s business decisions are already water under the bridge. Now let’s talk about Mr. Gambler.

  35. One again, one wonders if Mark Pittman really handed a bombshell to ZeroHedge before he passed, as ZeroHedge has told us he had.

  36. In real life a crony is often the chump. In fact , to get the mark to submit requires he be a crony. Are Geithner and Bernanke typical academics that would be lost doing “bad” things? People who pride themselves on their innate goodness? Here is where the services of first rate shill’s are required.

    Blankfein is a real life guy, one that could be said to ” know life”. As for the Fed academics, they seem to be types that once did not know the seamier side of life. The CYA by the Fed is a result of learning the seamier side of life in the last year. Thus, made chumps but chumps no more.
    Are they amateurs at doing a CYA?

    You must look at sequences as events change and people smarten up . Some are more adaptable than others and are unable to chuck aside goodness fast enough to survive.

    So we must be observing a moving tableau of CYA. In such cases , amateurs need not apply.

  37. Who cares about the arithmetic mean compensation? That number is entirely irrelevant and completely fails to capture anything besides its simple definition, total comp divided by total headcount. The reality is that compensation at Investment banks is heavily skewed, with a few making millions (or tens thereof) and hundreds, if not thousands making about the same about of $ as similarly-experienced employees in other industries.

  38. I loved the image of the secretary walking across Park Avenue carrying a briefcase stuffed with millions of dollars worth of bonds. Like a bad TV procedural drama.

  39. Anyone need more proof that jhedges is a sophist?

    http://www.newdeal20.org/?p=7904

  40. You missed “They got rich. We got screwed.”

  41. And the wheel of fortune spins ever faster…

  42. What can we glean from available documents available to us? The audited financial statements of Maiden Lane II LLC indicate that MLII purchased investments of $19,838,294. Maiden Lane II owns them and the assets were audited . These assets were purchased and presumably owners like GS sold them to Maiden Lane under agreement. They may also have been sold to MLII by AIG receiving $19, 898,294and in turn paying the insured owners. Either way, the result is the same. We know from other released documents who were paid net proceeds on insurance contracts to payoff and cancel AIG insurance contracts. This was a separate payment settled by the owners of the insured contracts receiving settlement by retention of posted collateral and a need settlement check to close everything out.

    Based on the list in the Huffington Post the settlement reconciliation would be as follows. Payments by MLII were $19,898,294. The sellers retained posted collateral of $35,005,450,192. The settlement checks from AIG were in the aggregate of $7,285,975. In actuality some of these assets must have been retained by AIG. I am deliberately conforming this to the list on the Huffington Post.

    These big finance types at the Fed cannot settle something done by a first year senior accountant?

    The FRBNY gets the senior loan cash flow after costs until it is redeemed out.

    Huffington and members of Congress talk about tax payer money. That is untrue because the FRBNY is not owned by the United States. No US money was invested in these transactions. Mo noney was appropriated by Congress to settle out the AIG contracts settled by FRBNY. The only money that the Treasury would lose is any loss offsetting profits of FRBNY that would not escheat to the treasury in lieu of interest on the Federal Reserve Note liability. In the meantime , the Treasury would be getting profits arising from the cash flow of these assets. No taxpayer dollars at all.
    Political theatre only.

    These Fed types seem to be pansies that are out of their league dealing with political trash and banking grifters.

    The upshot of it all is that big banks collected insurance for their junk. That is what they paid premiums to AIG for. What they paid consideration for.

    I have been watching the cash flow on these MLII transactions and they are generating debt reduction by MLII owed to the FRBNY. Right now these assets look to be able to payoff FRBNY by 2014. After that FRBNY and AIG share in the cash flow 55- 45 as I remember the deal.

    Of greater interest to me is that AIG should have been given a capital contribution in MLII of the amount of their posted collateral. Certainly , that must have been the case for tax purposes. In lieu of a capital position for GAAP purposes, AIG shares once FRBNY is paid off.

    If it is taxpayer money as the Congress people are screaming they ignore the future cash flow. They also insult every citizen whose loan is now held by MLII that pays according to contract. They insult the good citizen’s of the United States. But, what do you expect from Congressional types?

    Political theatre.

  43. Even more barking mad is this crazy system where the firm’s own customers (taxpayers), however indirectly, are called upon to reimburse a company who lost the customer’s money through risky investments at full value. That is not capitalism, its lunacy. There’s got to be a better system than this.

  44. Here are some close approximations of cash flow coming in on the securities bought by Maiden Lane II for calendar 2009 based on the sixty one day period ended December 31, 2008. The most recent FRBNY balance sheet shows the Maiden Lane II receivable to be $15.493 bn, a reduction of $4 bn during 2009. Based on daily interest income for 2008, the total interest income and security liquidation proceeds from the Maiden Lane Securities would be around $18 bn. These two factors indicate a gross cash flow from the securities of $22 bn more or less. This would be enough to pay interest at Libor one month plus 3 %.
    The par value of assets purchased by Maiden Lane II were $39 bn purchased for nearly $20 bn. Obviously the remaining assets in the schedule were retained. That is , there is aagical difference from the $62 bnthat seemingly disappeared. $62 bn less $39 bn or $23 bn.

    Here it get’s cute and I suppose only a grifter would ask the question. Was the difference of $23bn simply double insurance coverages on the same assets? Look at the titles ” Notional coverage”. Very correct if it included CDS’s of more than 100 % of the assets. Is this possibly what all the sweating is about? After all, the banks and such were perfectly free to buy more than one set of coverages and are home free with total worthlessness. Generally, they can elect at their pleasure to get a het settlement and not surrender the insured securities. Perfectly legal. All that is needed is one sided election to take a net settlement of the loss.

    I watched Mr Baxter the General Counsel of the Fed all red pated, flustered and fearful and wondered why he did not repeatedly correct the Congress persons every time they did a grandstand. If I were Mr Baxter’s boss I would have instructed him to attack every time he started to get browbeaten.

    It would be a cold day in hell I would submit to such trash without being a gangster in return. All within the bounds of a contempt citation, of course. That, or I was being paid $25,000 an hour for the humilation. Then , they get the harried pansy act.

    At least blurt out. “You may have your pandering theatre but not at my expense. I will correct you to the facts every chance I get”.

  45. It’s kind of like a Daumer mass-murderer burying corpses in their basement. Nice that this committee has located the apparent cause of the caustic odor. Can they follow the stench to the corpse and find out the cause of death. Forensic accounting can track this, but it will take lots of subpoenas and lots of smart accountants to analyse discovered bodies and determine whether the deaths were due to natural causes and whether the insured was complicit in their deaths. It seems to me that since Goldman (and others) participated in gaming the demise, or even covering the fact that the patient was on life support when they pulled the plug that that fact alone should (under normal legal conditions) cause a loss limitation provision to kick in and either dilute or eliminate the value of any claim. But then this is the real world theory, not applicable in the Alice in Wonderland version of our universe playing out in the land of the TBTF monsters.

  46. Oops. A correction. I was interrupted. The pro forma Maiden Lane II 2009 interest income should be on the order of $1.8 bn. Thus total incoming 2009 cash flow should be about $5.8 bn adding in $4.0 principal reduction of the Maiden Lane Senior Note due FRBNY.

    So, did the recipients of the AIG settlements of some $62 bn multiple insure their raunchy tranches? If the total actual holdings of these holders were the $39 bn at par holdings sold to Maiden Lane II, the doubled up CDS protection totaled $23 bn. So, that would mean that , more or less, the holders got their money back around 100 % plus a profit of $23 bn less the insurance and incidental costs.

    One would think that Congress would have constant wet drawers over such a gleeful result for the holders. On the other hand maybe they have not wised up. If they were wised up they could have asked Geithner directly in a yes or no way.

    If you integrate the published Maiden Lane II 2008 Report with the schedule leaked to Huffington Post the question becomes obvious.

  47. JerryJ,

    Just a question, but isn’t ML II the resting place for the securities lending position? The multi-sector CDOs ended up in ML III. Maybe this is a coincidence, but the CDS collateral posted by AIG to the counter parties was 35 billion. The purchase price of the CDOs was 27 billion. Liquidating the CDO/CDS position took 62 billion. Some of that was done by AIG prior to the Fed loan of 85 billion, and some after that. The taxpayer will get the 27 billion back from ML III, and their portion of the 35 billion either through loan payments from AIG or the sale of taxpayer-owned equity.

  48. Both Maiden Lane II and III are two separate stages of taking out directly or indirectly highly degraded assets that otherwise would have wound up on AIG’s books or in part were already on AIG’s books . Maiden Lane II was the first step in paying off the CDS’s owed to the counterparties that AIG sold protection to. The Huffington Post leak gives us the total problem as far as money owed by AIG to settle up with the counterparties. Remember, the special trading session to figure out who was owed what by AIG? That must have been the total of $62 bn owed ( Notional value) that leaked. That $62 bn was settled out first. But how? I read that the settlement was made where the counterparties kept the deposited collateral in any settlement. On the basis of the Huffington Post schedule offsetting posted collateral that net was $29,585,936. Obviously, the FRBNY had to get settlement money over to AIG and they did not have much. One way out would be to take out the positions of the insured counterparties. That take out was by using Maiden Lane II on October 31, 2008. The value purchased on October 31, 2008 was $19, 494,286 based on the MLII Cash Flow statement. Thus , the remaining settlement to clear out the entire settlement was $7,285,975. That could easily have come from the direct loan to AIG of $85 bn. I remember reading that the net settlement around $8 bn. All this seems to fall in place from the AIG events covered in Andrew Ross Sorkin’s book. Willumstad, the AIG CEO was terrified that he had no way to cover. This was in late September and October of 2008.

    So, based on the sequence of transactions in MLII , the critical timing of settling up by AIG with it’s counter parties I suspect MLII covered the transactions in the Huffington Report leaked schedule.

    Again, going back to Sorkin’s book, Willumstad visited Geithner in the critical period of mid September and told Geithner that AIG had $1.7 trillion of CDS coverage exposure. The MLII assets I suspect were the assets at market by the time the covered transactions settled in point of fact.

    The Maiden Lane III assets closed a few weeks later when things had settled down a bit and the CDS’s had already been settled out . I suspect they were other similar assets on the books of AIG itself and later CDS failures subsequent to the big list of transactions leaked in the Huffington Post. Besides, AIG had became a cash drain sewer by the time of MLIII and this was another way to provide funds.

    Might there be overlap ? Sure. But it must be limited. First, if you were a counter party would you give the collateral back to AIG and ask for a check to cover instead? No one would do that when they can liquidate the collateral in their possession themselves. That limits the overlap to around the amount of the required settlement of $7,285,975.

    MLIII came after the crisis high point. Might it be only a clean up?

    My little exercise in forensics here from highly limited but cogent data was to see if the FED’s disclosure fears really revolve around the fact that counter parties bought more insurance than their asset cost? I suspect many did just that and that AIG either just took the money or was not aware that they were doubling up coverage. In short, some counterparties were doing via AIG exactly what John Paulson was doing.

    I have heard hedgies comment that it was better for GS to get 100 % of notional value on these transactions because GS was also insuring the insurance bought from AIG. In short, if GS and others did not get 100 % here they would get the difference and more from other contracts they would simply not renew.

    Why would this not be viable considering all we now know about how the lousiest subprime tranches could be shorted using open ended purchases of protection for assets they do not own? We know how much Paulson and others made doing just that.

    I could do a study consolidating MLII and MLIII but the timing simply suggests that MLII was just a clean up and a way to get more needed money to AIG.

    If John Paulson could do it why not GS and others? Deutsche Bank had a guy doing it while his colleages were buying subprimes. They thought he was nuts. This is heavily covered in Gregory Zuckerman’s book.

    I am trying to bring disparate sources together here. MLII fits right into what was going on.

    MLII and MLIII taken by themselves directly or indirectly relieve AIG of liabilities by a take out or simply a financing source , in part.

    Conclusion. Some counterparties paid 100 % via the ” bail out” recovered their cost in full plus a gain in excess of recovered cost. How much of a gain over cost recovery seems to be in the range of $15 bn to $23 bn. This must be why the FRBNY people are sweating. It is obviously political dynamite given the screams about a 100 % recovery. Am I absolutely certain? No. But a lot of facts meld together to make the suggestion. People have made huge trades on less certainty. Zuckerman’s book is key here.
    What do you think?

    This can be summarized. the counterparties wanted $62bn. Before AIG collapsed mostly AIG deposited $35 bn later taken as payment. MLII bought the positions at issue from the counterparties for $20 bn . The Fed or AIG source cash itself closed out the remaining amount due of $7 bn. The counterparties are paid off having received their $62 bn. All within MLII framework.

  49. JerryJ

    The RMBS that ended up in ML II had a par value of 39.3 billion.

    I do not think any of that stuff is in the recently “disclosed” AIG confidential schedule A at the HuffPo. That document covers the details of the CDO that went into ML III. I guess I could be wrong here, but I think ML II is strictly RMBS, and had to do with AIG’s insurance subsidiaries.

    The assets that ended up in ML III had a par value of 62.1 billion, and they were covered by AIGFP CDS.

    If have this wrong, I apologize.

  50. JCH, you are correct. Perhaps, I should have consolidated both Maiden Lanes to make my point. Both entities paid $49,385,726 for $101.4 bn of face value securities. They did so in two closings the first being late November and December 2008.

    The crisis was in September. AIG’s crisis was over the inability to post sufficient collateral to cover value losses on Notional Values of CDS’ protection of $62,129,719,487. This was
    brewing
    when the NY Insurance regulators allowed AIG to swap assets for deposit against AIGFP deposit requirements. The Fed stepped in to prevent an AIG bankruptcy over the post deposit net values of $29,585,936 not being covered right now as far as the insured counterparties were concerned. Willumstad was upping the cash needs daily to over $100 bn and climbing. Yet the principle heat was the $30 bn at issue. AIG received it’s credit line of $85 bn and went through that. Ok, why would these people wait for their $30 bn when AIG had the Fed loans? What I am suggesting is the possibility that the counterparties were nearly settled out weeks before the purchases by either Maiden Lanes. Just guessing , but how about another $25 bn in an escrow. Another cash deposit. In other words , were the Maiden Lanes crafted after the fact to fill in an inside straight story wise. That took time. Too much time in terms of what was going on unless cash advances were made to keep claimants happy. Time for the claimants to cover because the FRBNY insisted on taking the property .

    What were the expectations of the insureds here. Certainly they did not expect the involvement of the Fed as a participant and certainly not as a purchaser of their position. Most probably expected to elect to just take cash for the loss and keep the assets which some may not have even purchased. Along comes the Fed bureaucracy who says we want property for every coverage. Everyone covers. What i am suggesting is that the Fed had no idea that a lot of naked shorting was going on . Thus, the Fed set’s up Maiden Lanes to cover but finds they have to take out $101 bn of toxics that would otherwise wind up on AIG’s books.

    I have followed all three Maiden Lanes out of curiosity. I tried to use the Financial statements as a tool to illustrate but it does not work very well.

    Ok, what does Congress smell about these transactions and what is the Fed fearful about?
    the Congressional staff if nought else have read books like Zuckerman’s. Any CFO owed money on these CDS contracts from AIG would be bears about being protected immediately. They would desire to collect now and close the contract given their own needs to book profits.( Which would include reversing booked loss reserves once settled out, if any.) To that end might they have used the Fed to get just that end?

    The Feds are very scared of something damaging. That says dig deeper.

  51. Robby Dougherty

    I agree but, the problem that is overlooked, or completely avoided, by plausible deniability by Geithner and Paulsen,(by using AIG as a delivery device) is they were either protecting their previous employers and friends (GS) or they were protecting their invested assets with the company that benifited the most. A true independent investigation of their portfolios and ties to GS, including any family should be launched imediately. We dont want to believe this to be the case, coruption could not be that high up in our government, it would bring the markets to their knees if it were true.

  52. What was the possibility that at that point in the crisis, the USG would not support AIG for the purpose of preventing its bankruptcy? Or, in other words, was there a credible threat of bankruptcy?

    The government bailed out, directly or indirectly, overtly or covertly, AIG, GS, Citi, BofA, other major lenders, and a variety of foreign banks, which in the government’s mind was necessary to prevent a cataclysmic disaster (which in their mind was a good ROI for taxpayers). One can argue about the government’s premise but its actions were consistent with that premise, even if clumsily performed.

  53. jerryj – the collateral crisis resulted in both facilities being created. If you look at the 12.9 billion paid to GS after the bailout, 4.8 billion was a loan repayment. AIG had used to proceeds of that loan to purchase RMBS that had suffered devaluation. They did not have the cash to pay GS back. GS was holding very high quality agency securities as collateral. They were worth approximately the loan balance – 4.8 billion. GS was paid 4.8 billion in cash and they returned the agency securities to AIG. This was a wash transaction for GS. AIG sold the RMBS at their depressed market value to ML II. GS was never in jeopardy of losing this 4.8 billion because they had very high quality collateral.

    2.5 billion of the 12.9 was collateral posted on the 62 billion notional CDS protection on the CDOs, 20 of which was GS. Failing to post this would have been a default, which, as I understand it, would have risked placing AIG’s entire CDS portfolio, 100s of billions notional, into default – an economic earthquake of immense strength.

    5.6 billion was for the CDO GS was able to buy back from clients. This 5.6 billion in GS CDO went into ML III. There were 27 billion in total (27 plus 35 equals 62.) Note carefully, GS had to pay somebody around 5.6 billion to get those back. The 20 billion minus 14 billion leaves 6 billion, and as somebody above mentioned, those CDS are still in the AIG portfolio. GS has indicated collateral on that 6 billion has been flowing back to AIG.

    These transactions are basic. There is nothing to them. There is no missing money. Nobody got more than they deserved. It’s just. The AIG bailout was structured to save the American people from an economic catastrophe – the suffering of severe and widespread loss of income and wealth. An economist would have to be brain dead to review these transactions and conclude that Goldman Sachs was the primary beneficiary. I am an American. I live in Houston. I have never worked in the financial sector at any level. I’m in the oil business. I have a retirement account and a house and an income. In September of 2008 I was in jeopardy of losing it all. So was Goldman Sachs. We were the lucky. The bailout saved us: me and Goldman. I thank the Federal Reserve for saving my family. This congressional nitpicking will amount to nothing. The Federal Reserve did nothing wrong in the AIG bailout. They saved the country.

    Good luck. Keep me posted. For some strange reason I also enjoy reviewing the ML financial statements. There we agree.

  54. Assumming you are correct for the moment, AIG did not pay Goldman, the US Taxpayer did that.

  55. And, Matt, the US Government had an obligation to stand behind AIG?? So not paying at par would be the equivalent of defaulting on US debt?

  56. JerryJ

    I think you have missed an important point in your analysis. You seem to assume the Fed received something in the nature of assets when it paid off on behalf of AIG. I see nothing in the reports on ML to indicate that the CDOs were not all or mostly synthetics, which means there are no underlying mortgages generating principal and interest payments, nothing upon which the Fed ultimately can recover its ‘investment’. A synthetic CDO is just insurance on a bet. The protection buyer pays a constant premium and the seller is required to make payments determined by any loss in ‘value’ of the bundled securities from which the CDO is derived. Note that the same bundles are used and reused over and over again to create a mountain of CDOs from a small hill of mortgages. As Gertrude Stein said of Oakland, there is no there there. When AIG paid off on its insurance obligation, the insurance contract ended. In the case of synthetic CDOs, there is now no premium stream, no underlying mortgage payment stream, no anything. Just what exactly is the Fed carrying as an asset on its ML account? I have never read an answer to this question anywhere, and I doubt 95% of all the critics understand synthetic CDOs well enough even to ask it.

  57. What you’ve got wrong is that if there is no money in FP the recovery is zero so your CDS pays out 100 from the 3rd party that sold the CDS. You just made 400% on your trade, congratulations.

    This situation is totally different.

  58. I find it a real stretch that Goldman Sachs did not know that AIGFP could not pay off on a default. Did Goldman Sachs not know that AIGFP was an essentially unregulated entity with virtually no reserves? Why didn’t Morgan Stanley and JP Morgan do the same thing as Goldman Sachs? Is it possible Morgan Stanley and JP Morgan knew that a bet with AIGFP would not payoff and Goldman Sachs didn’t know? Maybe the only reason Goldman Sachs bought the swaps was to protect its reserve balance.

  59. Goldman, irrespective of the reason for the CDSs they bot from AIG, had legitimate and enforceable claims against AIG for payment. AIG, and maybe the gov’t, tried to negotiate haircuts with their CDS creditors, but the creditors stonewalled and may have threatened to force AIG into bankruptcy. Bankruptcy would tie up for months all the money AIG owed, which was too scary to let happen. Goldman and the others played chicken with Chmn. Bernanke, Treas Secty Paulson and NY Fed President Geitner, and the gov’t blinked first since they didn’t know what would happen to the economy and did not want to take any chances.
    So GS was paid fully by the taxpayers for all the CDSs they held with AIG. I assume that some(most?) of the CDSs were bot by GS as part of legitimate hedges, but others were pure unhedged gambles. If these latter CDSs were not paid, the non-payment would have had no impact on the economy or GS’s ability to pay off anyone they needed to. The effect would be to reverse the unrealized profits booked by GS, and their contribution to the provision for bonus distribution. Did the taxpayers really directly fund GS’s bonus pool? Say it ain’t so, Lloyd, say it ain’t so.