How the Big Dogs Run—the Financial Meltdown Revisited


Did I Read This Right? According to a front-page article in the Times in early 2010, the SEC and various Congressional agencies were investigating whether a dispute with Goldman Sachs pushed AIG to the near collapse that got the bailout ball rolling in the waning days of the Bush administration. The gist, as I get it after three readings, is this:

AIG started sometime in the 90s insuring good-quality bonds that had been “securitized,” by Goldman Sachs, among others. But in 2003, AIG began insuring securitized subprime mortgages, and the payout rules changed. In 2007, as subprime mortgage securities began to tank, Goldman collected $2 billion in insurance payouts from AIG. But by early 2008, AIG was saying that Goldman was inflating its losses on the debt obligatons, much in the way someone might inflate their damage estimates after an accident or flood in order to collect a higher insurance payout.

AIG wanted $1.46 billion of the $2 billion payout back. Goldman said no, the securities were worth even less than they were earlier, and AIG should therefore pay out even more. AIG wanted a third-party evaluation of the securities. AIG says Goldman refused. Goldman says they just disagreed on the methodology.

While insuring itself against losses on its investments in CDOs and securitized subprimes, Goldman was also, on its trading desk, betting against those same investments. Thus, when the investments went down in value, Goldman would profit twice: on the short sales AND on the insurance payout. Neat. AIG was insuring Goldman for losses on trades in securities that Goldman expected to decline. Wanted to decline.

Goldman was using client money to make some of its trades. For example, it earned fees from Société Générale for purchasing mortgage bonds from Merrill Lynch. The Société Générale cash expanded the pool of money for bad mortgages even more, which contributed to the eventual housing meltdown. And Société Générale, in its turn, was insuring those investments with AIG. Indeed, if you put it all together, it seems that Goldman was simultaneously pouring money—its own and clients’—into CDO and subprime mortgage investments, insuring those investments against price declines, and then selling them short.

Here’s where it gets really interesting. Everyone now admits that AIG had sold more insurance on subprimes than it could possibly pay off, should the worst—i.e., a meltdown in the housing market—occur. This couldn’t have escaped the notice of as sophisticated a player as Goldman Sachs. And yet Goldman, while demanding ever bigger payoffs from AIG on its own behalf, also called Société Générale and urged it to demand payoffs from AIG as well.

So why would Goldman, dependent on AIG payouts, attack the company by bleeding it of cash? In fact, why would Goldman continue to insure its risk with a company that couldn’t possibly meet its obligations if the housing market got worse? And clearly Goldman believed the housing market was going to get worse. Why else would it put the muscle of its trading desk into betting against it? Was Goldman perhaps counting on an even bigger windfall profit: access to the federal Treasury through a taxpayer bailout of its insurance company?

The timing of the AIG bailout—a scant six weeks before the presidential election—has always intrigued me. Cynics had been predicting another terrorist attack to swing the vote to the Republicans. Instead we had an economic crisis requiring government intervention.

But if it was a plan to rally voters to the party of business, it backfired.

Or did it? I mean, what’s one election when you’re planning for the long term? Was it just plain good luck for Goldman Sachs that the Bush Administration decided AIG, with its global clientele (Société Générale included) was too big to fail? The taxpayers’ bailout of AIG to the tune of $180 billion was certainly profitable for Goldman Sachs: In addition to the $7 billion it had already collected from AIG in claims payouts, it got $12.9 billion of the AIG bailout money for additional claims, and another $11 billion from AIG payouts to Société Générale, with whom Goldman Sachs had a side deal. The architect of the AIG bailout was Treasury Secretary Hank Paulson, formerly of—wait for it—Goldman Sachs.

So if I understand the Times correctly, while millions of Americans were losing their jobs and their homes, and hundreds of thousands of small businesses were unable to meet their payrolls or get credit, Goldman Sachs was getting taxpayer money by the boxcarful to protect it from the consequences of a crisis it played a large role in creating—not by accident, but at best carelessly and at worst deliberately, for its own profit.

But not to worry, Nation. Goldman Sachs shareholders are being made whole, and Goldman Sachs executives are getting their bonuses. And to ensure that stability is maintained at Goldman Sachs, another Goldman Sachs guy, shifty-eyed Tim Geithner, is at the helm at Treasury in the new administration, just as he was at the elbow of Hank Paulson in the old one. Talk about bipartisanship. Give them a goal to rally around—the preservation of big corporate campaign contributions—and Republicans and Democrats lie down with each other like the lion and the lamb.

Why won’t the Right give credit where it’s due? The bailout ball was pushed over the lip of the hill by the Bush administration, which was simply playing to the base, as W defined it at the Alfred Smith memorial dinner in 2000. Remember? He looked out at the assembled white-tie diners and quipped, “This is an impressive crowd: the haves, and the have-mores.” Then he smirked. “Some people call you the elite. I call you my base.”

Well, gotta go work on my taxes. Come April 15, I have to pay up or be charged a hefty penalty. Wouldn’t want the have-mores to belly up to the public trough next time and find it empty.