I see that Gretchen Morgenson has another ridiculous article about Goldman's (mythical) involvement in the AIG bailout. The article focuses on the fact that Hank Paulson talked to Lloyd Blankfein more times than he talked to other CEOs in the week after Lehman failed. The article is misleading in extremis, and relies heavily on innuendo and misdirection. The clear suggestion is that Paulson bailed out AIG to save Goldman. The obvious problem with that argument is that AIG was bailed out by the Fed, not Treasury. But I want to address a premise of the article: that Goldman had substantial exposure to AIG. Of course, Morgenson takes it as a given that Goldman had substantial exposure to AIG—since, hey, she's the one who started that rumor in the first place! Unfortunately, it's just not true: Goldman had hedged its exposure to AIG. But since there's apparently not a journalist in the country who understands what it means to be "hedged" (other than Shannon Harrington of Bloomberg, who is top-notch), I'm going to break down the Goldman-AIG trading relationship as clearly as I possibly can. Now, I've never had a talent for explaining complex issues in clear, easy-to-understand terms, so bear with me. The most important thing to understand is this: "Exposure" in credit derivatives is equal to the cost of replacing a credit derivative in the market, not the notional amount of the transaction. Think about it: the total notional amount of CDS that Goldman bought from AIG was roughly $20 billion, but AIG didn't "owe" Goldman $20bn. It had merely promised to protect Goldman against future losses on certain CDOs up to $20 billion. If AIG had failed, Goldman would have lost that protection, and would have had to buy the same CDS contracts from someone else to replace the lost protection. Therefore, Goldman's "exposure" to AIG was equal to the cost of replacing the CDS trades it had on with AIG. Now we can break down the Goldman-AIG trading relationship, which Goldman CFO David Viniar laid out in this conference call:

  • Goldman bought roughly $20 billion of total CDS protection on various CDOs from AIG.
  • In September 2008, the cost of replacing the CDS protection that Goldman had bought from AIG was $10 billion. [Direct exposure to AIG = $10 billion]
  • Against this $10 billion, Goldman held $7.5 billion in collateral, the vast majority of which was in the form of cash. [Direct exposure to AIG = $2.5 billion]
  • The remaining $2.5 billion was hedged via CDS on AIG—that is, Goldman bought CDS protection on AIG from a third party. [Direct exposure to AIG = $0]
Goldman's claim that it held $7.5 billion in collateral when AIG almost failed is supported by this 8-K filing by AIG, which shows that Goldman held $8.4 billion in collateral by late November 2008. Now, we can argue about whether the counterparties that sold Goldman CDS protection on AIG would have been able to pay if AIG had been allowed to fail—I'm perfectly willing to have that debate. Unfortunately, we don't know who those counterparties were. Standard single-name CDS are collateralized and marked-to-market every day, though, which means that as the CDS spread rises, the protection seller has to post more and more collateral. So it's likely that by the time AIG collapsed, Goldman's counterparties had already posted most of the $2.5 billion in collateral. So there you go: $10 billion of exposure, hedged by $7.5 billion in collateral and $2.5 billion in CDS on AIG. I don't think I can make it any clearer than that.

15 comments:

Anonymous said...

I have no desire to defend Gretchen Morgensen, but am not sure the case is as open-and-shut as you imply.

The problem is that the amount of AIG CDS they need to hedge their residual exposure to the CDOs changes with the price of those CDOs.

You posted a couple of months ago an AIG doc that showed GS had $23 bn of CDO notional protected by AIG.

These CDOs almost certainly went down substantially further in Q4 2008 and Q1 2009. It is doubtful that GS could have obtained new hedges for RMBS CDOs during that time period.

Even having to report the $13 bn in net RMBS CDO exposure at the next scheduled reporting date would have been a major issue for GS.

They could not have been indifferent to AIG default...

While GS risk mgmt showed itself to be very good during this crisis, allowing $23 bn in exposure to a single counterparty was not its shining moment.

M said...

Bravo for trying to bring some details and common sense to the discussion. However, I am afraid you are up to a crowd that just doesn`t mind the facts and will always somehow bend it to show that their believe is true, Goldman is evil and they used their puppet at treasury to bail them out.
Anyhow, I agree with you that Goldmans exposure to AIG was most likely much lower than people claim, however at the same time I am sure they had an interest to see AIG survive, as had many other financial institutions, most notably on the notion that many others, not as hedged as Goldman, might have come into trouble. But it was not a pure Goldman bailout and it was not just Goldman who benefitted by it, I agree with you there.

JCH said...

Maybe my memory is wrong, but I thought I read that GS "bought" the backstop CDS to the AIG deficit a fair amount of time before the AIG bailout - for 100 million dollars.

I think EoC arguments are compelling.

One thing that bugs me. After AIG got the TARP money, they paid AIG 12.9 billion. What did GS do with the 8.4 billion? You say they did not owe 20 billion, and I agree, but it sounds like they ended up with 12.9 plus 8.4 plus any collateral called from the AIG backstop CDS sellers - a total oddly close to 20 billion. Or did they have to return some of the collateral calls?

JCH said...

SB: paid GS 12.9 billion.

TRADEBUM said...

What would have happened to the collateral that GS held if AIG was not rescued?
No one knows how much exposure GS actually had what with all of their holding companies.
The key here is that GS knew for quite some time that things were not kosher at AIG and bought themselves a hedge. But maybe they bought that hedge from AIG. All of these jokers were selling and reselling the same CDS.
If we hadn't bailed out AIG, GS surely would have fallen based on their exposure to CDS that they issued to other parties. And if GS had not gotten a free 4Q ride from losses, I could have picked up their stock for $20.

jck said...

JCH:
The total notional of ABS CDOs held by GS was around $14 bn, a total of $8.4 bn in collateral was posted *including* the $2.5bn provided by the AIG bailout, later these CDOs were bought by Maiden Lane III, for $5.6 bn, GS kept the collateral $ 8.4 + payment from MLIII $5.6 = $14bn.
In addition received $4.8bn to settle the AIG securities lending positions (which have nothing to do with AIG FP or CDS).

JCH said...

jck,

That clarifies my confusion. Thank you.

18.8 billion, the total of what you say they got, minus 12.9 billion, the total the media says they got, equals 5.9 billion, which is what you get when you net out the 2.5 billion of AIG bailout from the 8.4 billion of posted collateral. They already had the 5.9 billion.

Not being bright, I like to see numbers balance. Old-school accounting.

Anonymous said...

Dear Mr. Contempt

Yours is one of the few blogs that I read that generally contradicts much of what else I read. From which I generally conclude that we have become a corrupt, crony capitalist country that has a fiat money system that is destroying the future of the average American.

Having said that I would have a question about the GS CDS issue. When AIG made full completion of the CDS contract was the collateral returned to AIG (ie the taxpayer) and where is this documented.

JCH said...

"Yours is one of the few blogs that I read that generally contradicts much of what else I read. ..."

And, IMO, for extremely good reasons. Most of what is available is uninformed garbage.

Between jck and eoc's numbers, some things that seem to call for clarification. First, the notional of 20, EoC, and 14, jck. What happened to 6 billion notional?

This odd thing, which is probably just a coincidence, but people wonder why things are bouncing around. All numbers in play here: 7.5 - 5.9 = 1.6. 8.4-7.5= 1.6. 10-8.4 =1.6.

Is this 1.6 a coincidence? 1.6 plus 1.6 plus 1.6 is 4.8, which equals the securities lending positions.

In Saddam Sachs world, that's also 666. Eek!

Lastly, had AIG gone under, would GS have gotten the 4.8 billion securities lending position? Not that I think this matters as I think GS would have simply borrowed more TARP and been in a somewhat deeper hole, and the Treasury would have less than 190 billion in idle TARP authority.

jck said...

JCH:
the $20 billion notional probably comes from the first article on the GS "bailout" by Gretchen Morgenson, where she did not discriminate between the CDOs and the securities lending program and just summed everything up. You can check the $14 billon number for CDOs as it is reported in the 8 K/A form linked to in the post.

anne said...

I enjoy reading your blog because you provide information that I simply do not have, as someone who's not worked in finance.

Can you explain why Goldman got the biggest portion of the federally subsidized AIG bailout if they didn't need it - and if their exposure to AIG failure was zero? What seems obvious to people in finance is blurry to me....

Also - I do not agree that the phone calls between Paulson and Blankfein were irrelevant (though I absolutely do not believe they were plotting Goldman's overthrow of the economy. I believe the American titans of commerce are, after all, human and that Paulson viewed the economic crisis through a Goldman-centric prism - how could he not?)

Transpose this situation to a courtroom. Let's say you were trying a case in front of a judge and the opposing counsel happened to be a former colleague of the judge - and in fact, happened to have assumed the position vacated by the judge when he went on the bench.

Let's say that during your trial, you learned the judge and opposing counsel had numerous phone calls. No idea what they talked about - but you know the opposing counsel - he's not a clown - if he's going to talk to the judge during a stressful time, it's not about the weather.

If the judge ruled in favor of the opposing counsel, would you feel your client had gotten a fair shake? Would a dozen calls that take place between judge and opposing counsel fly in the legal world? Would love your thoughts....

Anonymous said...

Anne,

I think you confusing the link between exposure and need. They needed the money. They were not exposed because they could get the money either from AIG or from somebody else.

Say your house burns down and you have no insurance. To replace your house, you have to carve that money out of yourself. Say you are fully insured for replacement. You are unexposed, but you still need the money. Say there is a 30% deficit between insurance proceeds and replacement cost. You would have to carve the 30% out of your own flesh, so your exposure to a fire would be 30%.

GS was fully protected, but still needed the replacement money.

To be exposed to an AIG default, an entity would have only one place to get the money it needed: that place would be itself. It would have to cut off a pound of its own flesh.

Because they could get the money they needed either from AIG or somebody else, they were never in a position where they were going to have to cut off a pound of their own flesh.

That is essentially why he is saying it is preposterous to think AIG/the government had any power whatsoever to force GS to take less - the haircut spoken of so often. The hair is the pound of flesh.

JCH said...

off topic:

What happens to a MBS when a series of foreclosures on its underlying mortgages/pieces thereof occur?

Wouldn't it eventually be a curative process on MBS that are held to maturity, thus allowing a financial institution to move their "toxic" asset to their trading inventory and to sell it at a very attractive price?

Anonymous said...

Who are you?
Are you working for GS?

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