Saturday, March 21, 2009

Tangled Webs: Goldman Sachs, AIG and the Feds

Goldman Sachs Chief Financial Officer David Viniar held a conference call with journalists yesterday in an effort to calm a growing storm over the company's relationship with AIG. Goldman, like other investment banks, invested in and marketed "mortgage-backed securities," which AIG "insured" with "credit-default swaps."

The implosion in mortgage-related financial instruments, however, caused AIG to suffer enormous losses. The company ultimately required a massive governmental bailout because it lacked the resources to cover other companies' investment risk.

Goldman, AIG and TARP
After refusing to do so for many months, AIG recently released the names of companies it paid using TARP assistance. According to the disclosure, AIG has paid Goldman $12.9 billion.

Seeking to mute speculation that the federal government bailed out AIG in order to funnel billions of dollars in TARP assistance to Goldman, Viniar insists that even if AIG had entered into bankruptcy, Goldman would not have suffered financially. Viniar says that Goldman hedged its market exposure through agreements with third parties and had already received $7.5 billion in collateral from AIG prior to the company's insolvency.

But Viniar's comments raise other concerns. First, even though Goldman hedged its risks using third parties and had received collateral from AIG, it is possible that it would have received less money in a bankruptcy proceeding. Second, the close relationship between financial regulators and Goldman will undoubtedly create a wall of suspicion around the company, regardless of whether it benefited from the bailout. This suspicion will only grow deeper if it turns out that the government's decision to keep AIG alive helped Goldman, just as its decision to let Lehman Bros. implode necessarily helped Goldman because it removed one of the company's chief competitors from the market.

Bankruptcy versus Bailout
AIG avoided bankruptcy because of the federal bailout. If AIG had entered into bankruptcy, it is unclear whether Goldman would have recovered the same amount of money. For example, the government financed AIG's purchase of $5.6 billion in securities related to its agreements with Goldman. At the time of the purchase, however, the market value of the securities was 1/2 less than the contract price. Had AIG been in bankruptcy, it is highly unlikely that a judge would have allowed AIG to pay Goldman a price that greatly exceeded market value.

Also, a bankruptcy judge could invalidate (as a "voidable preference") the transfer of collateral or money from AIG to Goldman if the transfer took place within 90 days of the filing of the bankruptcy petition. Bankruptcy law disfavors payments to creditors on the eve of bankruptcy because they tend to benefit more powerful creditors and frustrate the underlying policies of bankruptcy law, which include the distribution of the debtor's assets to all creditors in proportion to the debt owed them. Early payments to an individual creditor could drain the debtor's resources and make them unavailable for a proportional distribution. It is unclear whether Goldman could have recovered from third-parties the same amount of money it obtained from AIG, but it is definitely debatable whether it could have extracted the same amount from AIG had the company entered into bankruptcy.

Tangled Web
Viniar's conference call will likely lead to greater scrutiny of Goldman's relationship to AIG because many influential politicians and banking industry executives have connections to Goldman and to the Treasury Department -- the federal agency that administers TARP.

Henry Paulson, Secretary of Treasury during the Bush administration, is a former Chairman of Goldman Sachs. Paulson was responsible for administering TARP, and he had a large role in structuring the legislation.

Robert Rubin, Secretary of Treasury during the Clinton administration, was a Co-Chairman of Goldman (along with Stephen Friedman -- see below) before he earned a Cabinet post. Although Rubin does not have a formal position in the Obama administration, he has served as an informal economic advisor to the President. Also, current Secretary of Treasury Tim Geithner worked as an assistant to Rubin (and later to Lawrence Summers -- former Secretary of Treasury and current head of Obama's National Economic Council) when he headed the agency. Paulson was also a partner at Goldman when Rubin was Co-Chairman.

Mark Patterson, Geithner's Chief of Staff, is a former lobbyist for Goldman. Obama waived his anti-lobbying rules in order to secure the job for Patterson.

Tim Geithner, current Secretary of Treasury, served as the President of the Federal Reserve Bank of New York until his current position. In that capacity, he helped to structure the federal bailout of AIG. Geithner, unlike many of the other individuals listed in this article, never worked at Goldman, but he worked for Rubin during the Clinton administration and for Summers, who replaced Rubin. Summers heads Obama's National Economic Council.

Stephen Friedman, the current Chairman of the Federal Reserve Bank of New York, was the Co-Chairman of Goldman with Rubin, and he has held several other executive positions at the company. In his current position, Friedman presumably will have a significant role in the ongoing federal bailout of AIG. Friedman also sits on the board of directors of Goldman.

Update: After discussing this issue with a friend of mine, I have an additional comment. Assume that the AIG bailout was a wise policy decision that coincidentally benefited Goldman. This still does not explain the differential treatment of Lehman Bros.

Although I mention the disparate treatment of Lehman Bros. in the original essay, I primarily discuss why bailing out AIG helps Goldman. But allowing Lehman Bros. to collapse helped Goldman tremendously, because it eliminated one of its main competitors. The deeper story may lurk behind this issue.


Sal said...

Thank you for this information. I just took one name, Stephen Friedman, and put it in the database. I was just overwhelmed by the relationships. He's the chair of hedge fund among other things. I'm afraid that the tax payer will lose to a high degree on anything that comes from the latest plan. I see the current administration gaming COLA increases to people living on fixed incomes as the Reagan admin. did to play with the numbers.

Darren Lenard Hutchinson said...

Sal - I remember the "COLA" crisis. Hopefully, they won't try to classfiy ketchup as a vegetable for school lunches!

Roy Lofquist said...


Question. If AIG had not paid up on its insurance policies could the other policy holders have forced them into bankruptcy?


Leo Kolivakis said...

Professor Hutchinson,

Good work exposing the main players and their ties to Goldman Sachs. Interestingly, Paulson et al. would have never let Goldman go under if it was in deep trouble.

There was a hedge fund manager who once wrote "wherever there was trouble, Merrill was there". I think the new mantra will be "wherever there is a disaster, Golman was there".


Leo Kolivakis
Pension Pulse

Rich888 said...

To be precise, Mr. Friedman is the Chairman of the NY Fed. The current President is William Dudley, who attained that position when Mr. Geithner moved to the Treasury. Mr. Dudley is a former Goldman employee.

Darren Lenard Hutchinson said...

Thanks, Rich -- for correcting the error and for finding another Goldman person. I have always known that Goldman was a major player, but this strikes me as fairly large.

Bob said...

Don't forget that these guys who worked for GS were able to sell their Goldman Sachs stock worth millions and pay no tax on said monies due to the move to the public position.

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