Monday, December 14, 2009

Goldman’s collateral damage

Cast your mind back to that SigTarp report, published last month.

Readers will recall there’s been a persistent stink over whether the efforts of the Federal Reserve and the US Treasury to prop up AIG had the effect of bailing out Goldman Sachs — its largest trading partner. Goldman Sachs always denied that idea, saying its exposure to AIG was collateralised and hedged against the mega-insurers’ fall. Others, were not so sure.

Last week the Wall Street Journal continued that particular line of thought with an article titled “Goldman fueled AIG gambles“, which examined GS’s role in acting as a middleman between the insurer and other banks. In short, Goldman offered banks protection on some of their investments (for instance on CDOs of home loans), which it in turn hedged with AIG in the form of CDS.

The other issue with Goldman and CDOs was its position as originator.

From the article:

Goldman’s other big role in the CDO business that few of its competitors appreciated at the time was as an originator of CDOs that other banks invested in and that ended up being insured by AIG, a role recently highlighted by Chicago credit consultant Janet Tavakoli. Ms. Tavakoli reviewed an internal AIG document written in late 2007 listing the CDOs that AIG had insured, a document obtained earlier this year by CBS News.

The Journal analysis of that document in conjunction with ratings-firm reports shows that Goldman underwrote roughly $23 billion of the $80 billion in mortgage-linked CDOs that AIG agreed to insure.

One such deal was called Davis Square Funding VI. That CDO, assembled by Goldman in March 2006, contained mortgage securities underpinned by subprime home loans originated by firms such as Countrywide and New Century Mortgage Corp., one of the first subprime lenders to fail in 2007.

A big investor in Davis Square’s top layer was Société Générale, which bought protection on it from AIG, according to the internal memo. The French bank was the largest beneficiary of the New York Fed’s Nov. 2008 move to pay off banks in full on their AIG insurance contracts.

A company financed largely by the New York Fed ended up owning both the Davis Square and South Coast CDOs. Société Générale received payments from AIG and the New York Fed totaling $16.5 billion.

Goldman received $14 billion for its trades that were torn up, including $8.4 billion in collateral from AIG.

A representative of Société Générale declined to comment.

The special inspector general for the Troubled Asset Relief Program, which recently reviewed the New York Fed’s effort to stanch collateral calls last year, said Goldman officials said the company believed it would have been fully protected had AIG been allowed to fail because of collateral it had amassed and the additional insurance it had bought against an AIG default.

The auditor, however, questioned that conclusion. The report said Goldman would have had a difficult time selling the collateral and that the firm might have been unable to actually collect on the additional insurance.

What the WSJ probably means is that Goldman would have had a difficult time collecting on the hedges it bought to protect itself against an AIG bankruptcy. That’s a fair point, given that the failure of AIG could easily have knocked out the counterparty to Goldman’s hedges, whoever it might have been.

And on the collateral issue — Janet Tavakoli notes in some recent commentary:

if A.I.G. had gone bankrupt, a sensible liquidator would have clawed back collateral that A.I.G. had already given to Goldman due to the extraordinary circumstances. After it saved the day by extending the credit line, the FRBNY should never have settled for 100 cents on the dollar. In August 2008, one month prior to the FRBNY providing A.I.G. with an $85 billion credit line to pay collateral to its counterparties, Calyon, a French bank that bought protection from A.I.G. (including on some Goldman originated CDOs) settled a similar $1.875 billion financial guarantee with FGIC UK for only ten cents on the dollar.

And for a glimpse into the underlying collateral of those Goldman-underwritten CDOs, Ms Tavakoli has also provided us with this link. Click it and you can see the collateral breakdown of Abacus 2005-2, part of Goldman’s supposedly subprime-shorting CDO series, and Davis Square Funding IV — the one mentioned in the WSJ article.

They are full of goodies like Blackrock-managed Tourmaline CDO 2005-1, which won deal of the year in 2005, and then hit an event of default and went into acceleration in April 2008. There’s also tons of that Countrywide goodness mentioned in the WSJ article — the same Countrywide stuff that ended up as collateral of CDOs against which monoline insurers MBIA and Ambac sold protection.

1 comment:

Czech-Netz said...

Hm... I see
I wonder what Goldman is going to do.