WASHINGTON — Reversing its oft-repeated position that it was acting only on behalf of its clients in its exotic dealings with the American International Group, Goldman Sachs now says that it also used its own money to make secret wagers against the U.S. housing market.
A senior Goldman executive disclosed the "bilateral" wagers on subprime mortgages in an interview with McClatchy, marking the first time that the Wall Street titan has conceded that its dealings with troubled insurer AIG went far beyond acting as an "intermediary" responding to its clients' demands.
The official, who Goldman made available to McClatchy on the condition he remain anonymous, declined to reveal how much money Goldman reaped from its trades with AIG.
However, the wagers were part of a package of deals that had a face value of $3 billion, and in a recent settlement, AIG agreed to pay Goldman between $1.5 billion and $2 billion. AIG's losses on those deals, for which Goldman is thought to have paid less than $10 million, were ultimately borne by taxpayers as part of the government's bailout of the insurer.
Goldman's proprietary trades with AIG in 2005 and 2006 are among those that many members of Congress sought unsuccessfully to ban during recent negotiations for tougher federal regulation of the financial industry.
A McClatchy examination, including a review of public records and interviews with present and former Wall Street executives, casts doubt on several of Goldman's claims about its dealings with AIG, which at the time was the world's largest insurer.
For example:
_ The latest disclosure undercuts Goldman's repeated insistence during the past year that it acted merely on behalf of clients when it bought $20 billion in exotic insurance from AIG.
_ Although Goldman has steadfastly maintained that it had "no material exposure" to AIG if the insurer had gone bankrupt, in fact the firm could have lost money if the government hadn't allowed the insurer to pay $92 billion of American taxpayers' money to U.S. and European financial institutions whose risky business practices helped cause the global financial collapse.
_ Goldman took several aggressive steps — including demanding billions in cash collateral — against AIG that suggest to some experts that it had inside information about AIG's shaky financial condition and therefore an edge over its competitors. While former Bush administration officials said AIG was financially sound and merely faced a cash squeeze at the time of the bailout, McClatchy has reported that the insurer was swamped with massive liabilities and was a candidate for bankruptcy.
A spokesman for Goldman, Michael DuVally, said that the firm followed its "standard approach to risk management" in its dealings with AIG.
"We had no special insight into AIG's financial condition but, as we do with all exposure, we acted prudently to protect our firm and its shareholders from the risk of a loss. Most right-thinking people would surely believe that this was an appropriate way for a bank to manage its affairs."
He said that Goldman didn't have "direct economic exposure to AIG."
The relationship between Goldman and AIG has drawn intense scrutiny over the past year because several Goldman alumni held senior Treasury Department jobs when the Bush administration guaranteed as much as $182 billion to bail out AIG, $12.9 billion of which AIG paid to Goldman, the most money it paid any U.S. bank.
On Wednesday and Thursday, a congressional panel investigating the causes of the financial crisis plans to question current and former senior Goldman and AIG officials, including Joseph Cassano, the former head of the London-based AIG unit that covered $72 billion in bets against risky home mortgages — wagers that cost U.S. taxpayers tens of billions of dollars when the housing bubble burst.
The proprietary trades at issue were carried out using private contracts known as credit-default swaps, essentially bets on the performance of designated securities and traded in murky, loosely regulated markets with little disclosure about who placed wagers, who won and who lost.
Documents emerging from the AIG bailout and a Senate investigation of Goldman's secret bets against the housing market while it sold off tens of billions of dollars in mortgage-backed securities — first reported by McClatchy in November — have provided a window into some of these dealings.
Until now, however, Goldman has said that the insurance-like contracts it bought from AIG from 2004 to 2006 — deals that have cost the insurer some $15 billion — were made to offset similar swaps the investment bank had written for clients who wanted to bet on a housing downturn.
The companies have revealed few details of some $6 billion in so-called synthetic deals, in which the parties bet on the performance of designated securities that neither side purchased.
A person familiar with the matter, who declined to be identified because of its sensitivity, said that additional synthetic swap contracts between AIG and Goldman with a face value of $3 billion have yet to be unwound by the teams of specialists tasked with scaling down AIG's more than $2 trillion in exotic risks.
The proprietary trades occurred in the same Abacus series of synthetic securities that Goldman bundled offshore, according to the senior Goldman official. Another one of those 16 deals prompted the government to sue Goldman on civil fraud charges in April.
Goldman also has long asserted that it was holding $10 billion in collateral and "hedges" and thus had "no material exposure" in the event that the government had allowed AIG's parent to go bankrupt in the fall of 2008, rather rescuing it.
The emerging details of Goldman's offshore dealings, however, also call that into question.
AIG doled out tens of billions of dollars of the bailout money to pay off mortgage-related swaps with U.S. and European financial institutions at their full face value, a decision made by the Federal Reserve Bank of New York that triggered a public furor.
The bailout enabled major financial institutions to honor billions of dollars in swap bets that they'd made with each other, especially in offshore deals that were pegged to the performance of loans to homebuyers with shaky credit.
DuVally declined to say how much money Goldman had at stake if the value of these securities sank further and the big banks couldn't make good on their bets amid frozen credit markets.
According to court documents and a person who's seen records of some of the offshore deals, investment banks Morgan Stanley and Merrill Lynch, as well as large European banks, wrote protection for Goldman on these deals totaling hundreds of millions of dollars.
In addition, The New York Times reported earlier this year that Goldman cut a deal with the Societe Generale in which the French bank paid Goldman a portion of the $11 billion it collected from the AIG bailout.
DuVally denied that Societe Generale and Goldman had a deal regarding the French bank's payout from AIG, but he declined to say whether Goldman collected a large sum from the French bank.
Because Goldman was holding $7.5 billion in collateral from AIG and had placed $2.5 billion in other hedges, DuVally said, it "did not have direct economic exposure to AIG" in the event that the insurer's parent had been left to bankruptcy.
"That said, we have always acknowledged that if a failure of AIG had resulted in the collapse of the financial system, we would have suffered just like every other financial institution," he said.
DuVally declined to say who selected the securities for Goldman's Abacus deals with AIG.
AIG's chief executive, Robert Benmosche, was asked at the company's recent annual meeting whether it would seek to sue any banks for loading swap deals with securities on junk mortgages likely to default.
Benmosche said that the firm is reviewing "all activities from that period" and, "to the extent we find something wrong that harmed AIG inappropriately, our legal staff will take appropriate action."
It's unclear when Goldman first suspected that AIG was at risk of a colossal meltdown, but the storied investment bank moved more nimbly than any other financial institution to shield itself.
As the home mortgage securities lost value over a 14-month period beginning in the summer of 2007, Goldman's huge swap portfolio gained value. Under the terms of the contracts, Goldman began in July 2007 to demand that AIG post billions of dollars in cash as collateral.
DuVally said that Goldman had no inside information about AIG's finances, and merely protected itself by enforcing contract language that required the insurer to post cash whenever the mortgage securities underlying the bets lost value.
"Our direct knowledge of AIG's financial condition was limited to the company's public disclosures," DuVally said.
However, some experts are skeptical of that, especially because Goldman responded to AIG's refusal to meet all its demands for $10 billion in collateral by placing $2.5 billion in hedges — most of them bets on an AIG bankruptcy.
Sylvain Raynes, an expert on structured securities of the types that AIG insured, said it's "implausible that Goldman can say 'I had no idea that AIG was in dire straits or in weak financial condition.'"
Raynes, a co-author of the newly published book "Elements of Structured Finance" and a former Goldman employee, said that a standard clause in the swaps contracts left open to discussion whether the company writing protection must post collateral. The buyer of coverage typically could demand to see financial information, including the number of similar positions held, he said.
"If you see the (company) has entered into 150 credit-default swaps totaling $65 billion, and that all of them are the same type as your credit-default swaps, you know that they have taken huge amounts of risk and have very little capital to back that up," Raynes said.
"Unless you really want to close your eyes, you have to know what their condition is. If you don't know, then you're not doing your job, and I have too much respect for Goldman to say they are not doing their job."
DuVally said, however, that Goldman wasn't told about other swaps that AIG had written and didn't have access to AIG's internal financial information.
Goldman had served as an investment adviser for the insurer since as far back as 1987 and as recently as 2006, setting up offshore companies affiliated with AIG that served as loosely regulated reinsurers.
AIG's insurance subsidiaries shined up their balance sheets by shifting hundreds of millions of dollars in liabilities to reinsurers, including some of those formed with Goldman's assistance.
Federal prosecutors and state regulators eventually nailed AIG for falsifying its financial statements and for using so-called "sidecar" companies to help Pittsburgh-based PNC Financial Corp. and an Indiana firm, Brightpoint Inc., hide liabilities. AIG paid more than $1.7 billion on to settle those and other charges in 2004 and 2006. Goldman wasn't implicated.
For years, Goldman and AIG have shared the same auditor, PricewaterhouseCoopers, a firm that AIG retained even after the SEC in 2006 directed it to find "an independent auditor."
They're also represented by the same New York law firm, Sullivan & Cromwell, which boasted on its website of its "significant experience in offshore reinsurance matters." The firm's senior chairman, Rodgin Cohen, is known as one of Wall Street's most formidable attorneys.
In August 2008, weeks before the rescue, AIG's newly installed chief executive, Robert Willumstad, invited senior officials of several major banks, including Goldman, Deutsche Bank, Lehman Brothers and Credit Suisse, to a meeting to see whether there was any way to reduce the insurer's huge portfolio of mortgage-related swaps.
Documents from Blackrock, a financial services firm that was assisting the Federal Reserve Bank of New York with the bailout, show that Goldman offered to negotiate a settlement on some of the swaps, but the two sides were too far apart on valuation of the securities to cut a deal.
DuVally said that Goldman offered only to settle for payment of its estimate of the market value of the swaps, which had appreciated sharply due to the securities' decline in value. To do so would have required AIG to book a massive loss.
On Aug. 18, 2008, Goldman's equity research department delivered another blow to AIG, issuing a sharply negative report on the insurer and lowering its target price for AIG shares to $23 from $30. The Goldman report heightened concerns among credit ratings agencies about AIG's condition, Willumstad said in an interview.
By September 2008, AIG was besieged with a chorus of collateral demands from other banks and a threat from credit ratings agencies to downgrade the insurer, an action that triggered more collateral calls and prompted Treasury Secretary Henry Paulson, a former Goldman chief executive, and Federal Reserve Chairman Ben Bernanke to initiate a bailout to prevent a meltdown of the global financial markets.
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