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Spitzer, Partnoy, Black Call for AIG Open Source Investigation (and Goldman Implications)

by twolf1

by twolf1

An op-ed in the Sunday New York Times by former investigators and prosecutors Eliot Spitzer, Frank Parnoy, and William Black calls for AIG to put non-privileged e-mails, accounting documents, and financial models on line to allow for an “open source” investigation. The questions they want to examine include:

As fraud investigators, we would like to examine the trading patterns of A.I.G.’s financial products division, and its communications with Goldman Sachs and other bank counterparties who benefited from the bailout. We would like to understand whether the leaders of A.I.G. understood that they were approaching a financial Armageddon, and whether they alerted their counterparties, regulators and shareholders to the impending calamity.

We would like to see how A.I.G. was able to pay huge bonuses to its officers based on the short-term income they received from counterparties for selling guarantees that, lacking adequate loss reserves, the companies would never be able to honor. We would also like to know what regulators knew, and what they did with the information they had obtained.

This idea no doubt will strike most readers as quixotic. But the authors point out that three individuals have the power to force this to take place:

A.I.G.’s board of directors, a distinguished group of senior business executives, holds the power to decide whether to publish the e-mail messages and other documents. But those directors serve at the behest of A.I.G.’s shareholders. And while small shareholders of public corporations generally do not have the right to force publication of internal documents, in this case one shareholder — the taxpayer — holds an 80 percent stake. Anyone with such substantial ownership has effective control over corporate decisions, even if the corporation is a large public one.

Our stake is held by something called the A.I.G. Credit Facility Trust, whose three trustees are Jill M. Considine, a former chairman of the Depository Trust Company and a former director of the Federal Reserve Bank of New York; Chester B. Feldberg, a former New York Fed official who was chairman of Barclays Americas from 2000 to 2008; and Douglas L. Foshee, chief executive of the El Paso Corporation and chairman of the Houston branch of the Federal Reserve Bank of Dallas.

Ultimately, these three trustees wield all the power at A.I.G., and have the right to vote out the 11 directors if the directors are unwilling to publish the e-mail messages. In other words, if these three people ask A.I.G.’s board to post the messages and other documents, the board will have no choice but to comply. Ms. Considine, Mr. Feldberg and Mr. Foshee have the opportunity to be among the most effective and influential investor advocates in history. Before A.I.G. escapes, they should demand the evidence.

This is a good proposal, but I have a far more basic question: why was no forensic work done as a requirement of the bailouts? The Swiss Federal Banking Commission required UBS to perform an extensive investigation of exactly what it did so wrong that it needed a government handout, and it hired (presumably at the insistence of the regulators) third parties to conduct the investigation. It provided considerably more detail than any bank has provided so far of how a firm with a solid franchise drove itself into an abyss.

Why has there been NO serious investigation of ANY kind of the recipient of such extraordinary taxpayer largesse? Why has virtually NOTHING been demanded of them? Why the unseemly rush to let them off the hook and let them “pay back the TARP”? This is completely unwarranted in the case of AIG, which has had its deal with the government retraded in AIG’s favor a full four times. Why has AIG at every turn gotten a better and better deal, each time at the public’s expense, and is now allowed to lobby that it should be freed of its obligations? No private sector lender would allow a troubled borrower that could not meet its commitments to renegotiate and get IMPROVED terms. The inability to meet the terms of the original funding (one on terms private sector lenders were willing to consider, and that per Sorkin, AIG itself proposed) only strengthens the case to continue with the original plan, which is to break up AIG and sell the pieces for what they can fetch. This is the course that would yield the highest returns to the public, and that program will not produce a systemic event, which should be the ONLY offsetting consideration. There is no business rationale to have an agglomeration of diverse insurance businesses, particularly one that has been as badly managed as AIG (Sorkin’s account also reveals a shocking lack of financial and operational controls).

So why have there been no investigations? In AIG, the Goldman conspiracy theorists have a real case. Consider this commentary from a reader who was a senior executive at a monoline, on an article that looked like a PR effort to get ahead of a possible source of trouble for Goldman. The Wall Street Journal story noted that Goldman guaranteed $23 billion of CDOs with AIG and allegedly made a mere $50 million…. which is utter bullshit. Normal CDO originating spread are 1.25% to 1.5%. Its profits on these deals, separate on how it might have booked its trades with AIG, was at least $287.5 million. Even more important, a some of these trades were part of its Abacus program, which was a series of synthetic CDOs that it used to lay off its real estate risk (both RMBS and CMBS). In other words, the “short subprime” trade that everyone has lauded Goldman for was in part, if not in significant measure, borne by taxpayers.

The most curious part of this pattern is that Goldman used ONLY AIG for its CDO guarantees; all other banks also used the monolines to a significant degree. So Goldman would benefit far more than other firms from an AIG rescue; they would all still lose out on their monoline exposures.

The monolines started hitting the wall before Goldman did; in fact, their wobbly state played a direct role in the failure of the auction rate securities market (Feb 2008), when it became clear that Eric Dinallo’s efforts to create a bailout for Ambac and MBIA were likely to come to naught (the monolines were major guarantors of municipal paper, and municipalities were major issuers of ARS). Both retail investors and municipalities suffered as a result (retail investors who needed access to their funds but could not get liquidity; issuers who had to pay penalty rates because their maturing paper could not be rolled). The monolines, who Goldman had not used, were allowed to twist in the wind, but AIG was rescued. And Goldman hands are far from clean. From a reader who was a senior executive at a monoline on the WSJ story:

I find it amazing that after stuffing AIG with $23 billion of CDOs, which lead to AIG failing, Goldman’s spokesman has the audacity to blame the problem on AIG. meanwhile, Goldman researchers and CFO were criticizing Merrill and Citi for taking on so much exposure to the other bond insurers and insisting that these insurers not get bailed out. It also highlights again how outrageous it was that Goldman and the others gold paid off at par for taking a combination of CDO and AIG risk while the rest of the world (investors and insurers) got burned for taking CDO risk. The Goldman spokesperson acts indignant at the suggestion that somehow they shouldn’t have gotten this. This was the scam they played with the Fed.

While the subprime deals and CDOs were obviously going bad, an argument was made by many people at the time that the aggressive mark downs by AIG acelerated the death spiral for the market. It is pretty clear, here and elsewhere, that Goldman was the one that initiated the mark downs of collateral value. it would be interesting to explore this all the way through. Though not discussed in this article, Goldman shorted subprime through the Abacus deals, and perhaps elsewhere. this gave them an incentive to force mark downs. the intermediation deals described in the article, combined with AIG’s collateral posting, gave them another incentive to be agressive with mark downs. they were acting like they wanted to grab the money before anyone else could get their hands on it. this would have raised some issues in an AIGFP bankruptcy. (note – Hank Greenberg suggested that this was going on in his october 2008 testimony but there was a chorus of attacks on him for being a crook and unreliable, thanks to his problems with Spitzer.)

So here we have the pattern:

  1. Goldman creates or sells $23 billion (or more) of CDOs and
    stuffs them into AIG.
  2. Goldman proclaims to the world they have
    no exposure to CDOs and warns that banks and insurers with CDO
    exposure will get downgraded.
  3. Goldman initiates the mark downs
    of CDOs with AIG and others, acelerating the market’s downward
  4. Huge mark to market losses lead insurer and bank
    credit to freeze, short term markets to lock up, ABCP to
  5. AIG posts as much collateral as it has to Goldman,
    who has more aggressively marked down the exposure.
  6. Bond
    insurers are downgraded, banks begin commutations with
  7. AIG fails, Fed steps in, Goldman gets bailed out at

Yves here. This looks like no accident. I suspect it was no accident. And no one in authority wants to find out,

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Yves Smith

Yves Smith

A recovering investment banker, now management consultant with nearly thirty years of experience in and around the financial services industry. Blogs at Naked Capitalism, with a book ECONNED: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism coming out in March.