Self-fulfilling prophecy? Panel pushes Goldman on AIG collapse

McClatchy NewspapersJuly 1, 2010 

WASHINGTON — Goldman Sachs executives first threatened to stop making exotic trades with the American International Group in July 2007 unless the insurance giant posted $1.8 billion in cash collateral to compensate for a slide in the mortgage securities market, internal AIG e-mails show.

When AIG refused to meet its demands, Goldman began betting hundreds of millions of dollars on the insurer's collapse, ramping up those wagers to $3.2 billion over the next 10 months in a strategy that put AIG under huge financial pressure, a congressional commission found.

While Goldman executives defended those tactics in testimony to the Financial Crisis Inquiry Commission Thursday, panel members took turns publicly pushing the embattled investment bank to fully disclose dealings that brought it hefty profits and might have helped force a $162 billion taxpayer bailout of AIG.

A central issue surrounding Goldman, panel Chairman Phil Angelides said, was whether the Wall Street titan turned the screws so tightly on AIG that it created a "self-fulfilling prophecy," forcing the insurer into a massive cash squeeze.

The commission, appointed by Congress to ferret out the root causes of the worst financial crisis since the Great Depression, was mostly docile in January in taking sworn testimony from Goldman chief executive Lloyd Blankfein.

However, with four Goldman executives and six present and former AIG officials under oath over two days this week, several panel members turned skeptical and confrontational in asking about AIG's management failures and Goldman's wagers against the housing market that drained the world's largest insurer of more than $15 billion.

The panel also heard from present and former state and federal officials also described gaping regulatory holes that allowed a London-based unit of AIG to build a $2.7 trillion book of exotic trades with little reserve capital, all but forcing the taxpayer bailout of the insurer to avoid systemic chaos.

David Viniar, Goldman's chief financial officer, told the panel that Goldman behaved toward AIG as it always does with insurance-like contracts known as credit-default swaps. When the housing market began to sour in the summer of 2007, he said, Goldman "tightly managed" contract provisions requiring AIG to post collateral to compensate for drops in the securities' value.

"We're pretty passionate about fair value accounting," Viniar said. " . . . We have 1,000 people in our controller's department. Probably half of them spend their time trying to verify marks," or securities' valuations.

In a lesson in how steel-knuckled Wall Street executives duke it out in high-stakes deals, commission investigators pieced together a chronology of Goldman's negotiations with AIG. Even in July 2007, the market for mortgage securities had begun to freeze, leaving few trades on which to gauge the market value of securities in the AIG deals.

Nonetheless, on July 27, Goldman jolted AIG with a demand for $1.8 billion in collateral, simultaneously making its first purchase of swaps that would pay $100 million if AIG went bankrupt.

The moves led to a series of tense exchanges over the ensuing days. After a conference call on Aug. 1, Tom Athan of AIG's Financial Products unit e-mailed Andrew Forster, a former AIG senior vice president for financial services, that Goldman had warned that AIG must honor the contract or it wouldn't do similar deals in the future.

Goldman executives promised to set a mid-market valuation of the securities to determine collateral requirements, AIG executives wrote, but that Goldman posed "a very credible threat" because it could influence market valuations.

For example, Athan wrote on Aug. 8, 2007, if Goldman asked rival Merrill Lynch to submit bids on 100 mortgage-backed bonds similar to those that AIG was insuring and prices them at 80 cents of face value, dealers could use the bid to set market prices.

By Aug. 10, investigators wrote, Goldman had bought $575 million in swaps that would pay off if AIG defaulted. AIG ultimately posted $450 million in response to Goldman's demands, but that was just round one.

On Aug. 16, Forster wrote that he'd heard rumors that Goldman was "marking down asset types that they don't own so as to cause maximum pain to their competitors."

The two companies haggled over the next year, as Goldman's collateral demands mounted and its swap "protection" reached $3.2 billion.

Viniar told the commission that Goldman was primarily an "intermediary" buying swaps with AIG after selling similar credit insurance to investors. When AIG posted collateral, he said, Goldman posted the same amounts in cash with investors.

However, Commissioner Byron Georgiou pressed Goldman executives about a McClatchy story published Tuesday describing Goldman making proprietary trades — wagers with its own money — on so-called bets with AIG in which neither party actually bought any mortgage securities.

When Viniar said he knew nothing about it, Angelides and Vice Chairman Bill Thomas told Viniar that the commission wants records of all such trades.

The commission, which recently subpoenaed documents from Goldman, wasn't through with its demands for information.

Georgiou asked Viniar to identify the companies that sold Goldman coverage on an AIG collapse, saying he was "incredulous" that other financial institutions could cover such huge bets if AIG couldn't during the meltdown of 2008.

"I do not know the specific names of the parties," Viniar said, but added that the bets "were predominantly with other major financial institutions."

In addition, Georgiou noted that Goldman likely sold swaps for higher fees than the typically modest amounts it paid to AIG, saying that Goldman's $2.1 million in fees for $1.76 billion in coverage in a 2004 deal amounted to 0.12 percent. He asked Goldman to provide details of all fees it charged clients for whom it was an intermediary with AIG.

Commissioner Brooksley Born, a former chairwoman of the Commodities Futures Trading Commission, said she found it odd that Goldman couldn't say how much profit it made on swaps and other exotic bets known as derivatives.

"Your risk officer said the other day you can't manage something that you can't measure," she said. "I am very skeptical that you can't measure these profits."

Born also demanded to know how Goldman and other swap partners of AIG wound up with releases of legal liability, meaning taxpayers would have a difficult time suing them for fraud, as part of settlements awarding them the full $62 billion face value of those contracts in late 2008.

Viniar said that Goldman would cooperate with the panel's requests.

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