New Documents Show Goldman Sachs Would've Lost Billions in AIG Collapse

Last Updated Jul 29, 2010 10:57 PM EDT

Goldman Sachs (GS) has always insisted that it wouldn't have lost a nickel if AIG had failed in 2008. The investment bank claims that it was fully insured against the risk that the financial giant could collapse under the weight of its credit derivative-related losses.

That story is now officially hokum. New documents turned up in a congressional probe show conclusively that Goldman had, in fact, purchased insurance against the possibility that AIG might go bankrupt -- from financially troubled firms that were in no position to make good on their obligations.

For instance, one company that that would've had to make a payment to Goldman if taxpayers hadn't saved AIG is Lehman Brothers, which went bankrupt in September 2008. It would've owed $175 million, according to information that Sen. Charles Grassley, R-Iowa, forced Goldman to provide last week. Citigroup (C), itself the recipient of a government bailout, owed Goldman $402 million if AIG failed. Indeed, the list of companies that had sold credit default insurance to Goldman on AIG, which includes numerous foreign players, is riddled with firms that had been severely damaged by the financial crisis.

Said bank analyst Chris Whalen of financial industry research firm Institutional Risk Analytics:
This illustrates that the Goldman version of reality is not entirely accurate. They did have exposure to AIG, and that is what drove their behavior in the bailout.
"Not entirely accurate" is putting it mildly. If there are any lingering doubts that Goldman was on the hook, consider this: The bank stood to collect an insurance payout of $1.7 billion if AIG failed; after the feds showed unusual largess by paying 100 cents on the dollar to save AIG, Goldman got $12.9 billion from AIG, including $8.1 billion linked credit default swaps. Do the math.

Or in other words, Goldman exploited its and AIG's status as companies that were "too big to fail" to make the U.S. government an offer it couldn't refuse. Then New York Federal Reserve Bank chief Tim Geithner and other government regulators who brokered the deal with Goldman quickly caved, either in panic over the disintegrating financial system or knee-jerk deference to Wall Street (and probably both). As investment analyst Joshua Rosner puts it:
Clearly Goldman's calculation was more tied to their expectation of the political dynamics of forcing moral hazard than the fundamental realities of the financial strength of counterparties.
The AIG bailout is also an object lesson in how interdependency in financial markets stacks up like a house of cards. Because of course it wasn't only Goldman that was made whole when the government came to AIG's aid -- it was all of the insurer's credit insurance counterparties. When taxpayers paid through the nose to prop up AIG, we were also absorbing losses that Wall Street firms like Citi, Bank of America (BAC), JPMorgan Chase (JPM) and Morgan Stanley (MS) would've suffered on the credit default contracts they'd sold to Goldman.

When the Financial Crisis Inquiry Commission pressed Goldman CFO David Viniar earlier this month about whether the company was fully hedged against an AIG default, he echoed the company line. Members of the congressional panel and federal officials now have proof that he and Goldman CEO Lloyd Blankfein, who made the same claim, have been lying. What are they going to do about it?

Image from Flickr user Serge Meiki
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  • Alain Sherter On Twitter»

    Alain Sherter is an award-winning business journalist who has written for The Deal, MarketWatch and Thomson Financial Media.

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