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You remember how this story began: Over the years, AIG (NYSE: AIG ) sold billions of dollars worth of credit default swaps -- derivative insurance on pieces of debt -- to banks and investors around the globe. When that underlying debt turned into confetti, AIG was on the hook for more money than it could ever dream of having. Taxpayers jumped in, making the banks and investors whole, to the tune of about $62 billion.
Goldman Sachs (NYSE: GS ) happened to a top beneficiary, receiving $12.9 billion. This was fodder like no conspiracy theorist had ever imagined possible, planting the seeds for a nonstop tar-and-feathering session between the public and Goldman's ties to Washington.
Goldman, for its part, insists we have no idea what we're talking about. See, Goldmanites are smart. They took out hedges on the hedges -- buying credit default swaps on AIG itself -- just in case things blew up. Even if AIG went down, Goldman would have yawned, smiled, and moved on, it claims. Goldman CFO David Viniar explained the whole thing earlier this year, saying the benefits the bank received from taxpayers "rounded to zero."
Ergo, the billions funneled in from taxpayers wasn't a bailout; it was simply what we owed them for being awesome. Or, as ubercolumnist Michael Lewis quipped:
People who don't work at Goldman Sachs, of course, find this implausible: How could $12.9 billion round to zero? Easy, but you just need to understand the mathematics … at Goldman we always round to the nearest $50 billion, so anything less than $25 billion rounds to zero.
Nice. To settle the matter, the Special Inspector General of TARP -- last fall's bank bailout plan -- conducted an audit of AIG's counterparties. He dug deep into Goldman's claim that taxpayer backing on its AIG exposure wasn't necessary, and came to a quick conclusion: Bullbutter.
The details of Goldman's argument goes like this: As the CDOs (securities backed by things like mortgages) AIG sold insurance on fell in value, Goldman received $8.4 billion in collateral from AIG. Even so, Goldman thought this collateral wasn't sufficient, and bought credit default swaps on AIG from a third party (worth $1.2 billion), which would have paid Goldman had AIG defaulted. Add in what the CDOs were already worth ($4.3 billion), and Goldman says its back was covered by roughly the same amount it received from taxpayers.
But as the audit points out, the flaws in this argument are epic:
- Had AIG collapsed, the default protection Goldman purchased from third parties may not have been worth the paper it was written on. Why? Because if AIG imploded, those third parties may have gone up flames as well. That's the nature of being "too big to fail." Failure spreads like wildfire. Insurance is only as good as the insurer backing it. Isn't that what the whole AIG debacle was about?
- Goldman's claim rests on the underlying CDOs already being worth $4.3 billion. But had AIG collapsed, the market for these securities would have gone berserk. If Goldman stuck to its proud claim of marking these assets to market, losses would have been immense. As the audit puts it, with, "an illiquidity that likely would have been exacerbated by AIG's failure … it is far from certain that the underlying CDOs could have easily been liquidated, even at the discounted price of $4.3 billion."
- As the Wall Street Journal points out, Goldman itself sold credit default swaps, too. Had AIG defaulted and markets imploded, it would have had to make payments to its counterparties as well.
In English, Goldman's argument boils down to something like this: "Had AIG not collapsed, its collapse wouldn't have hurt us in the slightest." It's taking prices and assumptions from a healthy-AIG world and assuming they'd hold in a collapsed-AIG world. But no sober person believes this to be true. It's akin to valuing your house at the same price after it's been hit by an atomic bomb.
Plus, remember the details of that week last fall? Lehman Brothers had just gone bankrupt. Merrill Lynch was sold to Bank of America (NYSE: BAC ) . There was a run on money-market funds. Citigroup (NYSE: C ) , JPMorgan Chase (NYSE: JPM ) … everyone was in dire straits. Hell broke loose.
AIG was bailed out on Tuesday; by Thursday, both Goldman and Morgan Stanley (NYSE: MS ) were quite literally hours away from collapse themselves. Creditors, terrified and confused, were running like mad.
To assume AIG's collapse wouldn't have pushed this panic into lethal overdrive, nuking everyone on Wall Street in their entirety, is laughably optimistic. The sincerity of Goldman's argument holds as much weight as, oh … let's just say it "rounds to zero."