[Infowarrior] - Secret AIG Document Shows Goldman Sachs Minted Most Toxic CDOs

[Richard Forno]

Secret AIG Document Shows Goldman Sachs Minted Most Toxic CDOs
By Richard Teitelbaum

http://www.bloomberg.com/apps/news?pid=20601087&sid=ax3yON_uNe7I#

Feb. 23 (Bloomberg) -- When a congressional panel convened a hearing  
on the government rescue of American International Group Inc. in  
January, the public scolding of Treasury Secretary Timothy F. Geithner  
got the most attention.

Lawmakers said the former head of the New York Federal Reserve Bank  
had presided over a backdoor bailout of Wall Street firms and a  
coverup. Geithner countered that he had acted properly to avert the  
collapse of the financial system.

A potentially more important development slipped by with less notice,  
Bloomberg Markets reports in its April issue. Representative Darrell  
Issa, the ranking Republican on the House Committee on Oversight and  
Government Reform, placed into the hearing record a five-page document  
itemizing the mortgage securities on which banks such as Goldman Sachs  
Group Inc. and Societe Generale SA had bought $62.1 billion in credit- 
default swaps from AIG.

These were the deals that pushed the insurer to the brink of  
insolvency -- and were eventually paid in full at taxpayer expense.  
The New York Fed, which secretly engineered the bailout, prevented the  
full publication of the document for more than a year, even when AIG  
wanted it released.

That lack of disclosure shows how the government has obstructed a  
proper accounting of what went wrong in the financial crisis, author  
and former investment banker William Cohan says. “This secrecy is one  
more example of how the whole bailout has been done in such a  
slithering manner,” says Cohan, who wrote “House of Cards” (Doubleday,  
2009), about the unraveling of Bear Stearns Cos. “There’s been no  
accountability.”

CDOs Identified

The document Issa made public cuts to the heart of the controversy  
over the September 2008 AIG rescue by identifying specific securities,  
known as collateralized-debt obligations, that had been insured with  
the company. The banks holding the credit-default swaps, a type of  
derivative, collected collateral as the insurer was downgraded and the  
CDOs tumbled in value.

The public can now see for the first time how poorly the securities  
performed, with losses exceeding 75 percent of their notional value in  
some cases. Compounding this, the document and Bloomberg data  
demonstrate that the banks that bought the swaps from AIG are mostly  
the same firms that underwrote the CDOs in the first place.

The banks should have to explain how they managed to buy protection  
from AIG primarily on securities that fell so sharply in value, says  
Daniel Calacci, a former swaps trader and marketer who’s now a  
structured-finance consultant in Warren, New Jersey. In some cases,  
banks also owned mortgage lenders, and they should be challenged to  
explain whether they gained any insider knowledge about the quality of  
the loans bundled into the CDOs, he says.

‘Too Uncanny’

“It’s almost too uncanny,” Calacci says. “If these banks had insight  
into the underlying loans because they had relationships with banks,  
originators or servicers, that’s at the least unethical.”

The identification of securities in the document, known as Schedule A,  
and data compiled by Bloomberg show that Goldman Sachs underwrote  
$17.2 billion of the $62.1 billion in CDOs that AIG insured -- more  
than any other investment bank. Merrill Lynch & Co., now part of Bank  
of America Corp., created $13.2 billion of the CDOs, and Deutsche Bank  
AG underwrote $9.5 billion.

These tallies suggest a possible reason why the New York Fed kept so  
much under wraps, Professor James Cox of Duke University School of Law  
says: “They may have been trying to shield Goldman -- for Goldman’s  
sake or out of macro concerns that another investment bank would be at  
risk.”

Poor Performers

Goldman Sachs spokesman Michael DuVally declined to comment.

Schedule A also makes possible a more complete examination of why AIG  
collapsed. Joseph Cassano, the former president of the AIG Financial  
Products unit that sold the swaps, said on a December 2007 conference  
call that his firm pulled back from selling swaps on U.S. subprime  
residential CDOs in late 2005. The list shows that the $21.2 billion  
in CDOs minted after 2005, mostly based on prime and commercial  
mortgages, performed as badly as or worse than the earlier subprime  
vintages.

A lawyer for Cassano declined to comment.

As details of the coverup emerge, so does anger at the perceived  
conflicts. Philip Angelides, chairman of the Financial Crisis Inquiry  
Commission, at a hearing held by his panel on Jan. 13, questioned how  
banks could underwrite poisonous securities and then bet against them.  
“It sounds to me a little bit like selling a car with faulty brakes  
and then buying an insurance policy on the buyer of those cars,” he  
said.

‘Part of the Coverup’

Janet Tavakoli, founder of Tavakoli Structured Finance Inc., a Chicago- 
based consulting firm, says the New York Fed’s secrecy has helped hide  
who’s responsible for the worst of the disaster. “The suppression of  
the details in the list of counterparties was part of the coverup,”  
she says.

E-mails between Fed and AIG officials that Issa released in January  
show that the efforts to keep Schedule A under wraps came from the New  
York Fed. Revelation of the messages contributed to the heated  
atmosphere at the House hearing.

“What date did you know there was a coverup?” Republican Congressman  
Brian Bilbray of California demanded of Geithner. Lawmakers used the  
word coverup more than a dozen times as they peppered Geithner with  
questions.

Geithner said that he wasn’t involved in matters of disclosure and  
that his former colleagues did the best they could. In a Jan. 19  
statement, the New York Fed said, “AIG at all times remained  
responsible for complying with its disclosure requirements under the  
securities laws.”

The government has committed more than $182 billion to AIG and owns  
almost 80 percent of the company.

Document Withheld

In late November 2008, the insurer was planning to include Schedule A  
in a regulatory filing -- until a lawyer for the Fed said it wasn’t  
necessary, according to the e-mails. The document was an attachment to  
the agreement between AIG and Maiden Lane III, the fund that the Fed  
established in November 2008 to hold the CDOs after the swap contracts  
were settled.

AIG paid its counter parties -- the banks -- the full value of the  
contracts, after accounting for any collateral that had been posted,  
and took the devalued CDOs in exchange. As requested by the New York  
Fed, AIG kept the bank names out of the Dec. 24 filing and edited out  
a sentence that said they got full payment.

The New York Fed’s January 2010 statement said the sentence was  
deleted because AIG technically paid slightly less than 100 cents on  
the dollar.

Paid in Full

Before the New York Fed ordered AIG to pay the banks in full, the  
company was trying to negotiate to pay off the credit- default swaps  
at a discount or “haircut.”

By March 2009, responding to a request from Christopher Dodd, chairman  
of the Senate Committee on Banking, Housing and Urban Affairs, AIG  
released the names of the counterparty banks. In a filing later that  
month, AIG included Schedule A, showing bank names while withholding  
all identification of the underlying CDOs and the amounts of  
collateral each bank had collected. The document had more than 800  
redactions.

In May 2009, AIG again filed Schedule A, this time with about 400  
redactions. It revealed that Paris-based Societe Generale got the  
biggest payout from AIG, or $16.5 billion, followed by Goldman Sachs,  
which got $14 billion, and then Deutsche Bank and Merrill Lynch. It  
still kept secret the CDOs’ identification and information that would  
show performance.

‘Right to Know’

“This is something that belongs in the public domain because it was  
done with public money,” Issa says. “The public has the right to know  
what was done with their money and who benefited from it.” Now, thanks  
to Issa, the list is out, and specific information about AIG’s  
unraveling can be learned from it.

At the Jan. 27 hearing, the New York Fed was still arguing that the  
contents of Schedule A shouldn’t be fully disclosed. Thomas Baxter,  
the New York Fed’s general counsel, testified that divulging the names  
of the CDOs could erode their value: “We will be hurt because traders  
in the market will know what we’re holding.”

Tavakoli calls that wrong. With many CDOs, providing more information  
to the market will give the manager a greater chance of fetching a  
realistic price, she says.

Jack Gutt, a spokesman for the New York Fed, declined to comment, as  
did AIG’s Mark Herr.

Bad to Worse

Tavakoli also says that the poor performance of the underlying  
securities (which are actually specific slices or tranches of CDOs)  
shows they were toxic in the first place and were probably replenished  
with bundles of mortgages that were particularly troubled. Managers  
who oversee CDOs after they are created have discretion in choosing  
the mortgage bonds used to replenish them.

“The original CDO deals were bad enough,” Tavakoli says. “For some  
that allow reinvesting or substitution, any reasonable professional  
would ask why these assets were being traded into the portfolio. The  
Schedule A shows that we should be investigating these deals.”

Among the CDOs on Schedule A with notional values of more than $1  
billion, the worst performer was a tranche identified as Davis Square  
Funding Ltd.’s DVSQ 2006-6A CP. It was held by Societe Generale,  
underwritten by Goldman Sachs and managed by TCW Group Inc., a Los  
Angeles-based unit of SocGen, according to Bloomberg data. It lost  
77.7 percent of its value -- though it isn’t in default and continues  
to pay.

SocGen spokesman James Galvin and TCW spokeswoman Erin Freeman  
declined to comment.

Documentation Needed

Ed Grebeck, CEO of Tempus Advisors, a global debt market strategy firm  
in Stamford, Connecticut, agrees that more digging is necessary. “You  
need all the documentation and more than that, all the e-mails,” he  
says. “That would allow us to understand what went wrong and how to  
fix it going forward.”

Neil Barofsky, the special inspector general for the Troubled Asset  
Relief Program, who delivered a report on the AIG bailout in November,  
says he’s not finished. He has begun a probe of why his office wasn’t  
provided all of the 250,000 pages of documents, including e-mails and  
phone logs, that Issa’s committee received from the New York Fed.

Schedule A provides some answers -- and raises questions that need to  
be tackled to avoid the next expensive bailout.

To contact the reporter on this story: Richard Teitelbaum in New York  
at rteitelbaum1 at bloomberg.net

Last Updated: February 23, 2010 00:01 EST