Goldman Fueled AIG Gambles

Wall Street Titan’s Role Shown in Journal Analysis; Firm Says Problems Hidden

Published on The Wall Street Journal, by SERENA NG and CARRICK MOLLENKAMP (Amir Efrati contributed to this article), DECEMBER 12, 2009.

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 was one of 16 banks paid off when the U.S. government last year spent billions closing out soured trades that AIG made with the financial firms.  

A Wall Street Journal analysis of AIG’s trades, which were on pools of mortgage debt, shows that Goldman was a key player in many of them, even the ones involving other banks … //

… A Goldman spokesman said that between mid-2007 and early 2008, Goldman showed AIG “market price levels” at which trades could be undone, allowing AIG to decrease its risk, but “AIG refused to accept that the market was deteriorating.”

When Goldman didn’t get as much collateral as it wanted from AIG, in 2007 and 2008 it bought protection against a default of AIG itself from other banks.

AIG officials were skeptical of the prices Goldman presented, according to the minutes of a February 2008 AIG audit committee meeting, which noted that Goldman was “unwilling or unable to provide any sources for their determination of market prices.”

Additional calls for collateral from Goldman and other banks eventually led to AIG’s September 2008 bailout and led the New York Federal Reserve two months later to fully cover $62 billion of insurance contracts Goldman and 15 other banks had with the financial products unit of AIG.

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.

The Journal analysis of that document in conjunction with ratings-firm reports shows that Goldman underwrote roughly $23 billion of the $80 billion in mortgage-linked CDOs that AIG agreed to insure.

One such deal was called Davis Square Funding VI. That CDO, assembled by Goldman in March 2006, contained mortgage securities underpinned by subprime home loans originated by firms such as Countrywide and New Century Mortgage Corp., one of the first subprime lenders to fail in 2007.

A big investor in Davis Square’s top layer was Société Générale, which bought protection on it from AIG, according to the internal memo. The French bank was the largest beneficiary of the New York Fed’s Nov. 2008 move to pay off banks in full on their AIG insurance contracts.

A company financed largely by the New York Fed ended up owning both the Davis Square and South Coast CDOs. Société Générale received payments from AIG and the New York Fed totaling $16.5 billion.

Goldman received $14 billion for its trades that were torn up, including $8.4 billion in collateral from AIG.

A representative of Société Générale declined to comment.

The special inspector general for the Troubled Asset Relief Program, which recently reviewed the New York Fed’s effort to stanch collateral calls last year, said Goldman officials said the company believed it would have been fully protected had AIG been allowed to fail because of collateral it had amassed and the additional insurance it had bought against an AIG default.

The auditor, however, questioned that conclusion. The report said Goldman would have had a difficult time selling the collateral and that the firm might have been unable to actually collect on the additional insurance. (full text).

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