How Goldman Bet Against Mortgages and Got Government to Foot the Bill

Monday, February 08, 2010 at 3:36 pm

Gretchen Morgenson and Louise Story’s New York Times piece yesterday was a thorough explanation of Goldman Sachs’ machinations that contributed to the collapse of AIG and the government’s perceived need to jump in and pay for everything without negotiating prices.

But unless you’re well-versed in the modern minutiae of the financial market, it probably didn’t help explain anything about why Treasury Secretary Tim Geithner is facing an investigation into his role in the affair.To recap Morgenson and Story:

  • The people at Goldman Sachs invested in mortgage-backed securities they expected to decline in value in order to make money off the insurance claims.
  • Due to a long-standing relationship, they went to AIG for a kind of insurance — credit default swaps — which were not regulated.
  • They then used other companies, including Société Générale, to purchase more of the unregulated insurance that AIG might not have otherwise underwritten in order to manage its own risk.
  • When Goldman’s investments declined, they submitted insurance claims for the losses, but insisted on determining the amount of their damages on their own, without any input from AIG, any auditor or the market.
  • After Goldman got as much money out of AIG as they thought they could, their stock analysts issued a report about how AIG was bleeding cash and their creditors wouldn’t negotiate, without mentioning that AIG was bleeding cash because of them and that Goldman was the creditor that wouldn’t negotiate. AIG’s stock tanked.
  • The government stepped in, took an 80 percent share in AIG and then paid Goldman and the other creditors all the money they’d asked AIG for at the start of the negotiations in 2007, without using their power to force AIG’s creditors to negotiate.

When the federal government, including then-Treasury Secretary Hank Paulson (who once served as chairman and CEO of Goldman Sachs), directed AIG to pay Goldman exactly what it wanted, it overrode significant and long-standing misgivings by AIG’s lawyers and accountants that Goldman’s estimates of its losses were correct. Morgenson and Story note that the prices on the very securities for which Goldman demanded insurance payments have since rebounded — but under the terms of the deal struck by the federal government, Goldman doesn’t have to pay a cent of its insurance settlement back to either AIG or the taxpayers. That’s quite the sweetheart deal for Goldman Sachs, if not taxpayers.

Now-Treasury Secretary Tim Geithner’s role in the November payouts is under investigation; his spokesperson said last month that then-New York Fed Chair Geithner officially recused himself from participating in the AIG bailout after Nov. 24, 2008 — the date of his nomination to Treasury — and had begun to insulate himself from such decisions “weeks earlier in anticipation of his nomination.” The Presidential election was held Nov. 4, 2008, and the plan to give Goldman everything it wanted was made official 6 days later, on Nov. 10. Either Geithner was insulating himself from his own job weeks before the election, or he was as involved in the negotiations as his detractors have charged.

Documents have recently emerged showing that the N.Y. Fed, starting as early as Geithner’s Treasury nomination announcement, worked with AIG to prevent full disclosure of how the bailout money it received in November went straight to companies like Goldman Sachs, Société Générale and Deutsche Bank, among others. The order to AIG from the government not to negotiate with its creditors may have cost U.S. taxpayers $13 billion; it was only under pressure from the SEC that AIG made public in March 2009 (after Geithner’s confirmation) the banks to which it had transferred its bailout funds.

As the N.Y. Fed staffers — who, despite his recusal, still worked for Geithner — were pressuring AIG to refrain from disclosing the government’s demands on behalf of Goldman and the secondhand amount Goldman received from the bailout, Geithner was amending his tax returns and paying back taxes in order to survive his confirmation process. Revelations that he’d also used his position at the N.Y. Fed to preserve the financial interests of Goldman Sachs over taxpayers or the company in which the government had taken a majority stake might have scuttled his nomination entirely. These days, many Democrats seemingly think that perhaps it should have.

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Comment posted February 8, 2010 @ 8:57 pm

Thanks for this article. I read the NYT article a few times and still couldn't fully grasp what happened. A few questions though. Regarding bullet three, shouldn't AIG have had been keeping track of the credit default insurance it was issuing regardless of the party (GS, SG, etc.). For example, Allstate insures homeowners in a flood prone region, but after it reaches a certain threshold it begins to cut back to mitigate its risk. It shouldn't matter if the insurance is going to homeowner A or B at that point (unless for some reason the risk between A and B is different).
Second, why did AIG pay out and refuse to negotiate from the very beginning? Based on questionable valuation of the losses at issue, it seems like they had the grounds to dispute these claims.
Third, the NYT article left me confused about when/how the losses were triggered. Can you elaborate on this? Was GS valuing its holdings and seeking payouts based on these devaluations while at the same time keeping the holdings in case their positions improved? There wouldn't seem to be an actual loss under an insurance policy until the holdings are sold.

Comment posted February 8, 2010 @ 10:17 pm

See this is all part of Saul Alinsky's plan.

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Comment posted February 9, 2010 @ 5:21 am

So the looters are now running the government ensuring that noone will be able to investigate and prosecute the looters. Geithner the grifter.

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Comment posted February 9, 2010 @ 7:44 pm

The answers to all the world's problems can be found in silly things Glenn Beck says…

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Comment posted April 16, 2010 @ 7:27 pm

I only know AIG did balk at paying out the claims. Goldman spread the rumour that AIG wasn't able to pay out claims (without mentioing that Goldman's claims were the ones not being paid) as Goldman made another ton of money shorting AIG!

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