Was the AIG bailout a Goldman bailout by proxy?

By Felix Salmon
July 27, 2009
Joe Hagan has a big story on Goldman Sachs in this week's New York, and Moe Tkacik and Matt Taibbi both pick up on the way that Hagan deals with Goldman's share of the AIG bailout funds. It's worth quoting at some length:

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Joe Hagan has a big story on Goldman Sachs in this week’s New York, and Moe Tkacik and Matt Taibbi both pick up on the way that Hagan deals with Goldman’s share of the AIG bailout funds. It’s worth quoting at some length:

Goldman Sachs was AIG’s biggest banking client, having bought $20 billion in credit-default swaps from the insurer back in 2005…

By that weekend in September, Goldman Sachs had collected $7.5 billion from its AIG credit-default swaps but had an additional $13 billion at risk—money AIG could no longer pay. In an age in which we’ve become numb to such astronomical figures, it’s easy to forget that $13 billion was a loss that could have destroyed Goldman at that moment.

Hank Paulson and then–New York Fed chief Tim Geithner called an emergency meeting for the following Monday morning…

At the meeting, it was hard to discern where concerns over AIG’s collapse ended and concern for Goldman Sachs began: Among the 40 or so people in attendance, Goldman Sachs was on every side of the large conference table, with “triple” the number of representatives as other banks, says another person who was there. The entourage was led by the bank’s top brass: CEO Blankfein, co-chief operating officer Jon Winkelried, investment-banking head David Solomon, and its top merchant-banking executive Richard Friedman—all of whom had worked closely with Hank Paulson two years prior…

On the government side, Goldman was also well represented: Geithner himself had never worked for Goldman, but he was an acolyte of former Goldman co-chairman and Clinton Treasury secretary Robert Rubin. Former Goldman vice-president Dan Jester served as Paulson’s representative from the Treasury. And though Paulson himself wasn’t present, he didn’t need to be: He was intimately aware of Goldman’s historical relationship with AIG, since the original AIG swaps were acquired on his watch at Goldman.

The Goldman domination of the meetings might not have raised eyebrows if a private solution had been forthcoming. But on Tuesday, Paulson reversed course and announced that the government would step in and save AIG, spending $85 billion in government money to buy a majority stake…

Of the $52 billion paid to AIG’s counterparties, Goldman Sachs was the biggest recipient: $13 billion, the entire balance of its claim. The amount was surprising: Banks like Merrill Lynch that had bought credit-default swaps from failed insurers other than AIG were paid 13 cents on the dollar in deals moderated by New York’s insurance regulator. Eric Dinallo, the former New York State insurance commissioner, who was at the AIG meetings, characterizes the decision this way: AIG’s counterparties, Goldman being the most prominent, “got to collect on an insurance policy without having the loss.”

Over time, it would appear to many that Goldman Sachs had received a backdoor bailout from a Treasury Department run by the firm’s former CEO. Why did Paulson bail out the banks that did business with AIG, critics have demanded ever since, and not Lehman Brothers? Certainly executives at Lehman want to know. (As one former Lehman managing director there puts it, “The consensus is that we were deliberately fucked.”)

The first thing worth noting here, beyond Hagan’s clearly prosecutorial stance, is that he’s got Eric Dinallo on the record criticizing the AIG bailout on the grounds that it was a backdoor Goldman Sachs bailout. That’s an important development, I think. Dinallo knows what he’s talking about, and he’s clearly not scared of annoying Goldman.

As Hagan notes, Dinallo was the person who orchestrated the unwind of smaller monolines’ positions; I believe that the 13-cents-on-the-dollar deal with Merrill Lynch was over CDS sold by ACA. I believe that ACA was rare in that it never had a triple-A rating to start with; Merrill was buying insurance from a single-A-rated insurer, which means that it had every reason to assiduously hedge its counterparty risk there.

I don’t think, in all fairness, that ACA ever provided all that much of a precedent for AIG. ACA was small enough that it could fail without much in the way of systemic consequences; it also had no consumer-facing obligations which it might default on. Even Taibbi seems to concede that if AIG had been allowed to fail, the entire financial system would have come down with it:

I was on a radio show a few weeks back with a hedge-fund manager, a Goldman apologist, who insisted on the air that Goldman would actually have made more money if AIG hadn’t been rescued, because the bank was properly hedged against AIG’s collapse… it wasn’t until the show was over that I realized the proper response to that argument was just, “Bullshit!” Goldman has been making that argument ever since the AIG bailout, but it has never come out and identified that magical counterparty or counterparties who’d have been able to come up with $20 billion after a system-wide financial collapse.

I think this is true. Yes, Goldman had as much counterparty hedging as it could, with respect to AIG, but counterparty hedging, like all hedging, is imperfect. For a detailed explanation of how Goldman hedged its counterparty risk, go here. But here’s the conclusion:

Ultimately, you try to hedge what you can hedge; what you can’t hedge, you try to quantify; what you can’t quantify, you try to understand; and what you can’t understand, you keep small enough not to sink the firm.

According to Hagan, Goldman failed on the last front: a loss of $13 billion on its AIG exposures would, he says, have sunk the firm. But then again, a loss of $13 billion on its AIG exposures would only have happened in the context of what Hagan calls “an overall collapse of the financial system” — and no investment bank is set up to survive that.

So yes, the AIG bailout was, to some degree, a Goldman bailout. But really the AIG bailout was a bailout of the entire financial system. Goldman was a beneficiary of that, to be sure, but so was every other financial company in existence.


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Considering that the sources of Goldman’s hedges against the default of AIG were other investment banks, I think it is clear that a systemic breakdown would have rendered most of them practically useless. From Hagan’s article:

“Similarly, they say, when it came to AIG, the firm was “prudent” in hedging its bets, buying credit-default swaps from Bank of America, JPMorgan, Société Générale and other banks in case AIG failed to pay the money it owed Goldman—in effect, hedging its hedge against the mortgage market.”

I think it’s important to be blunt here:

What Goldman’s “hedging” means is that Goldman was sure there would be a government bailout, they just weren’t sure whether it would be at the level of AIG or whether AIG would be allowed to fail and the taxpayers’ money would flow to them at the next level. This can only be considered moral hazard on an outrageous scale and the system needs to be changed so that it cannot happen again.

If some Goldmanites were at the forefront of cracking down on the financial industry — because you need a thief to catch a thief — I would have a little respect for them (while keeping my hand on my wallet). As it is, vampire squid seems like a far more polite phrase than the one the average taxpayer should be using.

Posted by Anon | Report as abusive

I think the former Lehman person says it best…deliberate or not, LEH was never going to get the kind of assist that was necessitated in March 2008 for JPM to acquire Bear Stearns. Which still begs the question…what the hell happened during the 6 months in between (March – September 2008) ?

Lost in much of this discussion is how ridiculous the investment rating firms performed: at the instance of failure, whether arranged or legitimate, both LEH and AIG were investment grade institutions. Goldman was a solid high AA, and Morgan Stanley middle AA. Bailout or not, the ratings firms enabled a lot of this ongoing BS to occur

Posted by Griff | Report as abusive

Really good post. It’s refreshing to see someone look past the “get Goldman” slant and put the entire episode in context.

I believe it was XL Capital Assurance — now Syncora — which settled with Merrill for 13 cents on the dollar. Like most of the other monolines it had a triple-A rating to start with.

http://online.wsj.com/article/SB12397597 6173619467.html

E=MC2 agreeg?

Goldman=Evil but if Goldman recommends a stock, buy it!

Posted by Carl In San Francisco | Report as abusive

any bank or financial institution that took tarp money was in trouble last year. the system protected large fiancial companies but permitted banks and other companies to fail. wall street will always prevail over main street. as an aside, two of my sons are attorneys in nj. they represent debtors, not creditors in this whole bankruptcy mess. you cannot imagine the number of chapter 7 cases they file. hang on to your hats, ladies and gentlemen– you have not seen the worst yet..bless all of our leaders. i cannot figure out if they are dumb or dishonest.

Posted by kenray | Report as abusive

See website link below.

Major trading exchanges, SEC and other regulators long ago gave a favoured few like GS a license to steal. Closest and fastest computers to the exchanges are the winners in the manipulative game played by high frequency traders. A blind eye continues to be turned by politicians & regulators to these well-known unfair trading practices because the favoured few who are stealing billions of dollars are experts at maintaining their clout “on the hill” by greasing the “right” political allies in ways that will never see the light of day.

http://www.philstockworld.com/2009/07/22  /the-latest-wall-street-trading-scam-th at-costs-you-billions/

Posted by Jude Judlaw | Report as abusive

FElix had written, “But really the AIG bailout was a bailout of the entire financial system.”

Apparently he doesn’t fully understand the fact that AIG’s bailout wasn’t systemically threatening. AIG’s bankruptcy would result in a divestiture of its wholly-owned subsidiaries and not a run on deposits…

Someone help this guy out.

Posted by Shaw | Report as abusive

“Dinallo knows what he’s talking about”

Say what? Dinallo is a total clown, and always has been. He’s not even remotely serious.

Why do people keep assuming that Dinallo is some sort of authority on CDS? It was the NY Insurance Dept that ruled that CDS are NOT insurance contracts. So why on earth would an insurance regulator be an authority on a non-insurance financial product?

This whole post is horribly misinformed.

While I find it interesting to analyze what happened, I find it discouraging to realize that nothing is going to change.

Posted by Rockfish | Report as abusive

an aig bailout a goldman bailout by proxy ?

is that like goldman sachs having munschhausens syndrome — beating your child and then taking them to the doctor –in this case the FED ??

Posted by j knott | Report as abusive

This is not the first time. As a matter of policy since 1987, when it front ran a $4b Venny bond issue, Goldman S has tried to infiltrate and control the global financial system. Rubin was ejected by the Young Turks at the time (Corzine et al) because he failed to alert GS traders that Greenspan was about to raise rates. Then again in August 1998, soon after GS front ran the Russian bond issues, LTCM collapsed and Corzine (the avid Merriwether clone) was front and center “behind” Kaminsky (Merrill, the peoples brokerage house) clamoring for an LTCM bailout. Fisher orchestrated that with Greenspan safely esconced far away in Washington, out of sight. Corzine was then ejected for putting at risk partners money. Now its Blankfein at bat with Paulsen at Treasury and GS wannabe Geithner at the NY Fed whose Chairman at the time was yet another GS alumnus..
This country will never recover until, and unless, the GS is shut down…or, at the very least, divorced from Government.

Everybody needs to stop calling the AIG takeover the “AIG bailout”. AIG didn’t get bailed out, they got taken out and shot. Not saying they didn’t deserve it, but they would have been better off if the govt didn’t insist on making their counterparties like GS whole, they should have forced them to file for bankruptcy and negotiate. their CDS customers probably wouldn’t have gotten 100 cents on the dollar, but they wouldn’t have lost everything, either.

And Goldman didn’t just get bailed out, they got a huge gift. If they got bailed out, they would have been stuck with at least some of the losses from the risk they took on when they bought swaps from the under-collateralized AIG. Why did they have to be made whole? What would have happened if they only received 60 cents on the dollar from AIG? They would still be around, but their stock would be swimming in the same toilet as BofA and Citi, where they belong.

9/11 created a huge opportunity for friends of the bush/cheney administration to make billions of dollars from the ensuing invasion of Iraq and the “war on terror”. This is even worse. The financial meltdown has created a huge opportunity for friends of the treasury and fed (I can’t blame Obama yet, for much of this boondoggle was done before he took office) to make tens of billions of dollars “saving the economy”. It’s like the Moore’s law of finance – the scale of corruption doubles every three years. The economy did need to be saved, but not by handing over gifts that were orders of magnitude greater than ever before.

Posted by KenG | Report as abusive

We need to get Goldman Sachs–and all the other banks–out of our government, the same way we need to get all the health care corporations out of our government negotiations for the health care system. They’re in everything for themselves only–they’re not in the meetings to do what’s right for the country.

What everybody isn’t getting is… Paulson appointed Ed Liddy to take charge of AIG. Liddy was on the board of Directors for Goldman Sachs. Both Paulson and Liddy were from Goldman Sachs. Paulson, now Treasury Secretary, appoints Liddy to use the government’s money to bailout their old firm. Suddenly Goldman Sachs makes a $3.3 BIL profit last quarter.

Posted by keith | Report as abusive

Take a look at this:

http://blogs.wsj.com/economics/?s=produc tivity&x=19&y=15

“Job Losses Outpace GDP Decline
Posted by Sudeep Reddy

We’ve found plenty of ways to say the job market is in the dumps. Alliance Bernstein economist Joseph Carson today offers one more.

In a research note, Carson says job losses in prior downturns have been roughly proportional to the decline in gross domestic product. But in the current recession, the proportion of jobs lost is running about a third greater than the drop in real GDP.”

I talked about this happening in October based on reading Irving Fisher. If you believe that we’ve just avoided a Debt-Deflationary Spiral, then imagine these figures being far worse. I don’t know why Lehman wasn’t saved, but it should have been. I feel the same way about AIG. Allowing Collateral Calls to cascade was a sure ticket to a Debt-Deflationary Spiral. I called it a Calling Run, to suggest an analogy with the more common concept of a Bank Run.

I want to try and make one other point. Liddy called the govt money a bridge loan, which it was. The reason is that AIG could have, in theory, liquidated assets to raise capital. The thing is that doing that could add to the likelihood of a Debt-Deflationary Spiral. So, the govt’s aid was justified on two fronts, in my view.

The reason that the govt paid what it did was that it hoped to stop a spiral by seeming to guarantee all assets.It was trying to close a gate that it had just opened. The real question is why they didn’t follow Geithner’s advice and say that we’re guaranteeing everything, since that’s basically what was going on.

But look at those unemployment, real GDP, and productivity numbers again. If you follow Fisher, this was the bottom line. In a Debt-Deflationary Spiral, there’s no natural stopping point for unemployment. It could have gotten far worse than what we’ve faced.

So, in this instance, I don’t care about Goldman. I do care about Narrow Banking and taxing the size of banks, which I doubt that Goldman would like. Maybe I’m wrong.

Don, I can accept the need to avoid letting the collateral calls cascade, but did the govt have to make the AIG counterparties (like Goldman) whole? Couldn’t they just have said “we are co-signing on AIG’s collateral”, giving them time to sell subsidiaries or raise capital to meet those collateral needs? why did the collateral calls have to be answered with outright grants to AIG’s CDS customers?

Posted by KenG | Report as abusive

Liddy’s career was previously defined by his role at Allstate, where he retired I believe from the CEO function in early 2000′s. Not casting any dispersion to his role on the Goldman board…but it seems running an INSURER in a previous stint may have also influenced that choice, by Paulson, to select Liddy as a quick choice to lead AIG.

Posted by Griff | Report as abusive

“but they would have been better off if the govt didn’t insist on making their counterparties like GS whole, they should have forced them to file for bankruptcy and negotiate.”

How would AIG going bankrupt — which in the case of a financial company means that you disappear from existence — been better for AIG than staying in business?

Posted by P. Ridle | Report as abusive

@P.Ridle, AIG is a holding company, if they filed for bankruptcy, they could re-organize, or liquidate. They have lots of valuable, profitable assets they have been selling, which they could have done to raise enough cash to met their collateral calls. Effectively, the government provided enough capital to buy 80% of AIG, and the capital was used to pay off those counterparties like Goldman. However, if that happened, the counterparties would have been forced to take less than 100 cents, and the government wouldn’t be holding 80% of AIG and a bunch of the debt that the swaps were insuring.

Posted by KenG | Report as abusive

“AIG is a holding company, if they filed for bankruptcy, they could re-organize, or liquidate. ”

Again, how would this have been better for AIG — that is, for the shareholders who owned the company. 20% of something is better than 100% of nothing. You said “AIG got taken out and shot” — as far as I can tell, its shares still have a modicum of value, which they would not have had had the company gone under.

Posted by P. Ridle | Report as abusive

GOLDMAN SACHS Wrote To The President…. A LETTER of THANKS.

http://pacificgatepost.blogspot.com/2009  /07/goldman-sachs-thank-you-mr-presiden t.html

……. And the circus continues, with Taxpayer singing the tune.

p.ridle, I think the AIG shareholders would have ended up with more than 20%. At the time when the govt stepped in and paid off Goldman et al, none of the underlying debts they had sold swaps on were actually in default. AIG’s CDS customers would not have wanted AIG to declare bankruptcy (I don’t know who said it, but it’s true: when you owe a little money, you have a creditor, when you owe a lot, you have a partner), so they would have negotiated some settlement, for they didn’t want to have to mark their allegedly hedged debts (allegedly hedged because the hedge was with AIG) down to near zero. IF the govt would have provided six months of back-up collateral, it would have given AIG time to sell assets, secure more equity capital, and renegotiate terms of swaps. Their equity would have been diluted (but probably not by 80%), and their customers would have had losses, but none of them would have gone out of business.

Posted by KenG | Report as abusive

Pretty old news here. Several sources came out weeks after the AIG bailout to reveal that Goldman and I think Merrill Lynch were the beneficiaries of a significant part of the proceeds given to AIG. And the saddest part is that the best were naked credit default swaps where the owner of the swaps doesn’t own the thing insured: like if the person who built your house unbeknown to you bought fire insurance on your house. It’s hard to prove that the person who built the house was negligent. There are so many little parts and pieces and when they are all burned and in a pile of chaos, it’s difficult to pinpoint a cause and the series of events that gave rise to it. Goldman Sachs buying default swaps on MBS that they sold is like a doctor who did a bypass surgery on you buying a big life insurance policy on you. The doctor might know a bit more than you or the insurance company about where the risks lie and in many cases may feel pressure to help along the loss to collect the claim. That’s the problem with naked credit default swaps.

Posted by Sean | Report as abusive

“I was on a radio show a few weeks back with a hedge-fund manager, a Goldman apologist, who insisted on the air that Goldman would actually have made more money if AIG hadn’t been rescued, because the bank was properly hedged against AIG’s collapse… it wasn’t until the show was over that I realized the proper response to that argument was just, “Bullshit!” …”

To which I would say bullshit right back at you. This is something Goldman Sachs can easily prove; otherwise, they wouldn’t be claiming it. They ain’t that stoopid.

Posted by JCH | Report as abusive

The idea that Goldman had hedges that would protect it if AIG went down is bullshit. The quality of those hedges is the issue. It is unlikely that they would have been paid. GS is clearly the vampire squid as described in the Rolling Stone article. A group of the most unethical people on a Street that is filled with some of the greediest people in the world. That is quite an accomplishment.

Goldman Sachs organizes the most unethical traders on Wall Street and makes them a corrupt force to be reckoned with. It needs to be closed down, and its traders scattered to the winds.

If AIG had been allowed to fail, it is true that the Wall Street financial system, consisting of rampant speculators and greedy bankers, would have tumbled. But, Main Street, USA, would have been better off without them. Bank deposits would have been repaid through FDIC, although the government probably would have needed to print money to do it. Stocks would have fallen deeply, and a lot of insurers would have been bankrupted.

Instead of allowing a minor depression, we have delayed the day of reckoning, and kept the most corrupt among us in power. The final crisis, as a result, will be 2-3 years from now. It will be a Crisis of such magnitude that the USA and, probably, the world, will not recover for a century. It may end up putting the world into a second dark ages, as it decays into the chaos of civil strife.