Inside Job
Page 16
But now, back to Goldman Sachs, because their best trick was yet to come.
Goldman Sachs and AIG
AFTER GOLDMAN HAD sold off its lumps of coal to various fools, they knowingly put the global financial system at risk. They had played AIG for such a massive sucker while shorting the mortgage market that by 2008 they knew that their shorts alone could precipitate AIG’s collapse. And what did Goldman do about that? Push even harder, while shorting AIG, of course. And while doing this, did they call up their pal and former CEO, Henry Paulson aka the Treasury secretary, to warn him that the shit was about to hit the fan?No, it seems that they neglected to do that.
Although no single firm or government agency knew the entire extent of the market’s exposures, or even AIG’s, Goldman was much better positioned than most, for several reasons. First, Goldman had sold $17 billion of the $62 billion in mortgage CDOs that AIG had insured through its London-based credit default swap (CDS) business, AIG Financial Products.31 In some cases, Goldman had helpfully referred investors to AIGFP, so that CDS insurance could help reassure potential investors that Goldman’s CDOs were essentially riskless. In some cases Goldman even had the right to change the mortgages underlying these securities after their sale, and there have been allegations that Goldman deliberately used this capability to off-load even more of its toxic assets. This capability gave Goldman even more information and control over the performance of its CDOs, and therefore also of AIGFP’s CDSs. But second, Goldman was also a huge direct buyer of CDS protection from AIG, in some cases on the very same securities that it had earlier sold. (Some of Goldman’s CDOs turned out to be the worst in AIG’s CDS portfolio.) Third, Goldman had also created and sold some of the $75 billion in mortgage CDOs that another part of AIG, its securities investment and lending business, had foolishly purchased, and that had started to decline sharply in value. Fourth, as the bubble unravelled, Goldman knew that AIG was being rapidly weakened by cash demands from the holders of the insurer’s CDSs. Goldman knew this better than anyone, because as we saw earlier, Goldman was the most aggressive firm on Wall Street in marking down its toxic assets. Because it marked them down earlier than others, it was therefore the earliest and most aggressive in demanding money from AIG based on those markdowns. Goldman knew that its own demands alone could soon reach tens of billions of dollars. And finally, Goldman’s equity research organization also covered AIG and regularly provided research reports on AIG’s financial condition.
Starting in 2007, when Goldman was implementing its massive short, it quickly purchased over $20 billion in CDS protection on mortgage securities and related indexes from AIGFP. The protection was cheap to buy, because the securities were still highly rated and marked at or near full value, both by the wider market and on Goldman’s own books. Soon afterwards, however, having locked in the CDS protection, Goldman began aggressive markdowns of the securities’ value—and with every markdown, it demanded immediate corresponding cash payments from AIG. In February 2008, partly as a result of Goldman’s demands, AIG was forced by its increasingly panicked external auditor to announce losses and also a “material weakness” in its accounting, pertaining to the valuation of its CDS portfolio. Throughout 2008, Goldman radically accelerated its demands, leading to fierce disputes between Goldman and AIG over the securities’ value and, therefore, the size of the required payments.
By mid-2008 and perhaps even earlier, Goldman knew that its CDS payment demands alone could easily cause AIG to collapse. Added to this would be further losses from other securities owned by AIG and/or insured via AIG’s CDS business. Goldman possessed far more detailed knowledge of many of these securities, and the likelihood of their failure, than AIG did, because Goldman had created and sold them. With this combined knowledge, Goldman unquestionably knew that AIG was in dire straits. Goldman did not warn any regulators, much less its customers or AIG, but it did take action. First, it became ever more aggressive in demanding payment on its CDSs, so that it could get its money out ahead of others and before AIG’s failure. And second, it spent about $150 million buying $2.5 billion in CDS protection on AIG, which it would collect in the event of an AIG default or bankruptcy. At a minimum, this insulated Goldman from risk; and depending upon precise contract terms and events, it could even have given Goldman an affirmative incentive to cause AIG’s collapse. If, for example, Goldman could get paid fully for its mortgage CDSs just before AIG went bankrupt, it would actually make more money from AIG’s actual or feared bankruptcy than from its continued health. And, in the end, this was very close to what happened, although Goldman could not have predicted that in advance.
It was only on 18 August 2008, that a Goldman Sachs research analyst issued the first public comment by Goldman on the catastrophic nature of AIG’s condition. The report said that AIG was a major credit risk, likely to be downgraded, and in dire need of raising additional capital. Well, Goldman would have known. By 12 September 2008, shortly before AIG’s collapse, AIG had already been forced to pay out $18.9 billion on its mortgage CDSs—of which $7.6 billion, over 40 percent, had gone directly to Goldman, which was demanding even more. Then, a few days later, after paying Goldman several hundred million dollars more, AIG ran out of money and collapsed. It was bailed out through $85 billion in “loans” that gave the US government 79.9 percent ownership of AIG.32
Shortly afterwards, under directions from the US Treasury Department and the New York Federal Reserve, AIG used over $60 billion of the bailout money to pay the holders of its mortgage CDSs in full, via contracts that also barred AIG from later suing anyone for fraud. Goldman received $14 billion. Ever since, the New York Federal Reserve and the Treasury Department, under both the Bush and Obama administrations, have fiercely resisted providing information about these payments and their contractual terms. Ironically, it was AIG’s new management that pressed for disclosure.
It is not publicly known what Goldman did with its $2.5 billion of CDS protection on AIG, but it almost certainly sold it at a significant profit, probably over $1 billion, sometime in late 2008 or early 2009.
In April 2010, after both the SEC lawsuit and a Senate investigation, US Senator from Michigan Carl Levin’s Permanent Subcommittee on Investigations held hearings on Goldman’s conduct, focusing on Goldman’s shorting strategy of 2006–2007. Here are some excerpts, beginning with testimony by head mortgage trader Dan Sparks. They speak for themselves; as several of the senators noted, the witnesses proved to be stunningly confused and ill-informed, with very poor memories about the business they had been running so well, and about which they had been so focused and ruthlessly clear in their internal communications.
SENATOR LEVIN: Don’t you also have a duty to disclose an adverse interest to your client? Do you have that duty?
MR SPARKS: About?
SENATOR LEVIN: If you have an adverse interest to your client, do you have the duty to disclose that to your client?
MR SPARKS: The question about how the firm is positioned or our desk is positioned?
SENATOR LEVIN: If you have an adverse interest to your client when you are selling something to them, do you have the responsibility to tell that client of your adverse interest?
MR SPARKS: Mr Chairman, I am just trying to understand what the adverse interest means—
SENATOR LEVIN: No, I think you understand it. I do not think you want to answer.
A little later:
SENATOR LEVIN: I am just asking you, look at the bottom paragraph there, the last two lines. “[F]remont [a subprime lender supplying Goldman with loans] refused to make any forward looking statements so we really got nothing from them on the crap pools that are out there now.” Do you see that?
MR SPARKS: Yes, sir.
SENATOR LEVIN: OK. Now, were you aware of Fremont’s poor reputation at the time?
MR SPARKS: This email—
SENATOR LEVIN: Do you remember whether you were aware at the time of their poor reputation? Do you remember?
MR SPARK
S: Whether they had a poor reputation in November?
SENATOR LEVIN: Yes, with high default rates.
MR SPARKS: Fremont originated subprime loans. People understood that.
SENATOR LEVIN: Yes or no, were you aware of their poor reputation and high default rate.
MR SPARKS: I do not recall at that time.
And then:
SENATOR LEVIN: Look what your sales team was saying about Timberwolf: “Boy that Timberwolf was one shi**y deal.” They sold that shi**y deal.
MR SPARKS: Mr Chairman, this e-mail was from the head of the division, not the sales force. This was—
SENATOR LEVIN: Whatever it was, it is an internal Goldman document.
MR SPARKS: This was an email to me in late June.
SENATOR LEVIN: Right. And you sold—
MR SPARKS: After the transaction.
SENATOR LEVIN: No. You sold Timberwolf after as well.
MR SPARKS: We did trades after that.
SENATOR LEVIN: Yes, OK. The trades after—
MR SPARKS: Some context might be helpful.
SENATOR LEVIN: The context, let me tell you, the context is mighty clear. June 22 is the date of this email: “Boy, that Timberwolf was one shi**y deal.” How much of that shi**y deal did you sell to your clients after June 22, 2007?
MR SPARKS: Mr Chairman, I do not know the answer to that, but the price would have reflected levels that they wanted to invest at that time.
SENATOR LEVIN: You did not tell them you thought it was a shi**y deal?
MR SPARKS: Well, I did not say that.
And David Viniar, the CFO:
SENATOR LEVIN: If your employee thinks that it is crap, that it is a shi**y deal, do you think that Goldman Sachs ought to be selling that to customers, and when you were on the short side betting against it? I think it is a very clear conflict of interest and I think we have got to deal with it. Now, you don’t, apparently.
MR VINIAR: I do not necessarily think that is—
SENATOR LEVIN: And when you heard that your employees in these emails and looking at these deals said, “God, what a shi**y deal,” “God, what a piece of crap,” when you hear your own employees or read about those in emails, do you feel anything?
MR VINIAR: I think that is very unfortunate to have on email. [Laughter].
SENATOR LEVIN: On email?
MR VINIAR: Please don’t take that the wrong way.
SENATOR LEVIN: How about feeling that way?
MR VINIAR: I think it is very unfortunate for anyone to have said that in any form.
And finally we have Mr Blankfein, the CEO:
SENATOR LEVIN: Do you think they know that you think something is a piece of crap when you sell it to them and then bet against it? Do you think they know that?
MR BLANKFEIN: Again, I don’t know who the “they” is and—
SENATOR LEVIN: We went through it today.
MR BLANKFEIN: No, I know. I know, Senator, and there were individual emails that were picked out and some people thought something. But I will tell you—
SENATOR LEVIN: I am just asking you a question. Do you think if your people think something is a piece of crap and go out and sell that, and then your company bets against it, do you think that deserves your trust?
MR BLANKFEIN: Senator, I want to make one thing clear. When you say we sell something and then our customer bets against it—
SENATOR LEVIN: No. You bet against it.
MR BLANKFEIN [CONTINUING]: We bet against it, we are principals. The act of selling something is what gives us the opposite position of what the client has. If the client asks us for a bid and we buy it from them, the next minute, we own it. They don’t. If they ask to buy it from us, the next minute, they own it and we don’t. We could cover that risk. But the nature of the principal business and market making is that we are the other side of what our clients want to do.
SENATOR LEVIN: When you sell something to a client, they think, presumably, you are rid of it. It is no longer in your inventory.
MR BLANKFEIN: Not necessarily.
SENATOR LEVIN: . . . Is there not a conflict when you sell something to somebody and then are determined to bet against that same security and you don’t disclose that to the person you are selling it to? Do you see a problem?
MR BLANKFEIN: In the context of market making, that is not a conflict.
Later:
SENATOR LEVIN: You don’t believe it is relevant to a customer of yours that you are selling a security to that you are betting against that same security. You just don’t think it is relevant and needs to be disclosed. Is that the bottom line?
MR BLANKFEIN: Yes, and the people who are selling it in our firm wouldn’t even know what the firm’s position is and—
SENATOR LEVIN: Oh, yes, they did.
MR BLANKFEIN: Senator, we have 35,000 people and thousands of traders making markets throughout our firm. They might have an idea, but they might not have an idea.
SENATOR LEVIN: They have an idea, more than an idea in these cases. But putting that aside, what do you think about selling securities which your own people think are crap? Does that bother you?
MR BLANKFEIN: I think they would—again, as a hypothetical—
SENATOR LEVIN: No, this is real.
MR BLANKFEIN: Well, then I don’t—
SENATOR LEVIN: We heard it today. This is a shi**y deal. This is crap.
MR BLANKFEIN: Well, Senator—
SENATOR LEVIN: Four or five examples. What is your reaction to that?
MR BLANKFEIN: I think there are a lot of opinions about how a security will perform against the market it is in.
A little later:
SENATOR LEVIN: And where you take a short position, do you think that should be disclosed? Where you are betting against that same security you are selling—yes or no, do you think that ought to be disclosed or not?
MR BLANKFEIN: Senator, you keep using the word “betting against”—
SENATOR LEVIN: Yes. You are taking the short position and you are staying. You intend to keep it. That is a bet against that security—
MR BLANKFEIN: If somebody bought—
SENATOR LEVIN [CONTINUING]: Succeeding.
MR BLANKFEIN: As a market maker—
SENATOR LEVIN: No, just try my question.
MR BLANKFEIN: I have to be able to—
SENATOR LEVIN: No, just try my question. In a deal where you are selling securities and you are intending to keep the short side of that deal, which is what happened here in a lot of these deals, do you think you have an obligation to tell the person that you are selling that security to in that deal that you are keeping the short position in that deal?
MR BLANKFEIN: That we are not going to cover it in the market?
SENATOR LEVIN: That is—
MR BLANKFEIN: Well, no—
SENATOR LEVIN: That you intend to keep that short position. Not forever. It is your intention to keep that short position.
MR BLANKFEIN: No, I don’t think we would have to tell them. I don’t even know that we would know ourselves what we were going to do. Even if we intended—
SENATOR LEVIN: I said, where you intend to keep a short position.
MR BLANKFEIN: I don’t think we would—I don’t think we would disclose that, and I don’t know—again, intention for a market maker is a very—
Isn’t it wonderful how confused someone can be when testifying before Congress. But enough about Goldman. Let’s turn to the government.
Amateur Hour Meets Let Them Eat Cake: American Tax Dollars Put to Work
THE BUSH ADMINISTRATION’S handling of the emerging crisis was bizarre and frightening even when it was competent, which was rarely. On the one hand, the year 2008 was marked by unquestionably deep, sincere concern for financial stability on the part of Henry Paulson and Ben Bernanke, who both worked inhumanly hard to forestall global collapse. Yet the administration’s response was also marked by a stunning obliviousness to the causes, severity, and consequenc
es of the crisis on the part of the very same Henry Paulson and Ben Bernanke; a completely clueless president who made Jimmy Cayne on the golf course look like an obsessively detail-oriented micromanager; total disregard on the part of the Bush administration for the effects of financial sector and government conduct on the bottom 99.9 percent of the population; and financial sector elites oscillating between fear and greed.
But we must pause for a moment of gratitude that the crisis did not come under the tenure of Alan Greenspan or, worse, that of John Snow, who was Treasury secretary from 2003 until mid-2006. Mr Snow isn’t stupid in the narrow academic sense; he has a PhD in economics and a law degree. But he had zero working experience in finance. After his academic work he became a lawyer, then an assistant secretary of transportation, then CEO of CSX, a railroad company, from which position George W. Bush plucked him to run Treasury.
There is no evidence that Snow had the faintest clue about a bubble. He resigned in 2006 only because it was revealed that he had not paid any taxes on $24 million in income from CSX, which had forgiven Snow’s repayment of a gigantic loan that the company had made to him. Upon leaving Treasury, Snow became chairman of Cerberus Capital Management, a huge private equity fund. Cerberus also employs former vice president Dan Quayle, and several of its portfolio companies have benefited from US government contracts dependent upon political influence. The principal hallmark of Cerberus’s first major new investments under Mr Snow was not corruption, as that might seem to imply; it was breathtaking stupidity. Cerberus purchased half of GMAC, General Motors’ financing division, and 80 percent of Chrysler. Both collapsed immediately after the crisis erupted, wiping out most of Cerberus’s investment by mid-2009 and requiring over $20 billion in emergency government assistance.
But even under Bernanke and Paulson, it still wasn’t good. They continued to deny the existence of a bubble or potential crisis until the bitter end, and for two years Bernanke continued Greenspan’s refusal to regulate the mortgage industry. Only in late 2007 did the US Federal Reserve create draft regulations under the 1994 HOEPA law, and the regulations were not issued until mid-2008, which was just a teeny bit late. By early 2008 warnings of impending crisis were coming from almost everywhere. In addition to Bill Ackman’s mid-2007 presentation and Allan Sloan’s October 2007 article in Fortune, there were warnings by New York University economist Nouriel Roubini; Charles Morris’s book The Trillion Dollar Meltdown, published in February 2008; verbal warnings by the leadership of the IIMF, including its then managing director, Dominique Strauss-Kahn; and warnings by Christine Lagarde (then France’s minister of economics and finance, and later StraussKahn’s successor at the IMF) at the G8 meetings in February 2008.