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Goldman Sachs Responds to Questions from The New York Times about the SIGTARP Report on AIG

Background
On November 19, 2009, The New York Times informed the firm of its intention to write a story about Goldman Sachs in conjunction with the report of The Office of the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) entitled, “Factors Affecting Efforts to Limit Payments to AIG Counterparties” (November 17, 2009). Below is background on the relevant parts of the report, the questions posed by The New York Times and our responses.

SIGTARP Report
The report runs 43 pages including appendices; Goldman Sachs is the focus of just three paragraphs. The “Conclusions and Lessons Learned” sections of the report (pages 28 to 31) do not mention Goldman Sachs.

We have consistently stated our belief that a collapse of AIG would have had a very disruptive effect on the financial system and that everyone benefited from the rescue of AIG.

However, many of the statements that have been made about the AIG situation, including some in the SIGTARP report, are, by their nature, speculative. AIG did not collapse and no one knows what would have happened if it had. As an example, the SIGTARP report states that an AIG collapse “might have made it difficult for Goldman Sachs to collect on the credit protection it had purchased” (emphasis added) – however, it might not, and it is our belief that it ultimately would not have done so.

What has been lost in the discussion of Goldman Sachs’ relationship with AIG is that, following the government’s takeover of the company, for the vast majority of the money received from AIG, Goldman Sachs delivered assets of equivalent value. It was an exchange, not a one-sided payment. And, since that time, those assets have in many cases increased in value.

Questions from The New York Times
What follows are the questions posed to Goldman Sachs by The New York Times reporter and the answers we provided. Please note that we have edited the questions only for ease of the reader; they are complete in substance.

As you know, the SIGTARP report differs with the Goldman Sachs contention that it was not imperiled by the potential collapse of AIG. The report details three reasons for its view. According to recent news reports, Goldman Sachs disagrees with this assessment. Is that accurate? If so, could you provide specific responses to the three arguments offered by SIGTARP.

First, the report cites the fact that the illiquid market for CDOs at the time of the rescue meant Goldman Sachs could not have easily liquidated its holdings, even at the discounted price of $4.3 billion.

Our $4.3 billion mark-to-market of the underlying securities reflected our view – as all our marks do – of the price at which the securities could be sold. These marks reflected circumstances at the time, including the illiquid market conditions, and the possibility that AIG might fail. We were and remain comfortable with our marks in that context.

Second, the report said, had AIG collapsed, Goldman Sachs might have had difficulty collecting on the credit protection it had bought on AIG.

The SIGTARP report states that an AIG collapse “might” have made it difficult for us to collect on the credit protection – not that it would. That is an important distinction. We believe, in contrast, that the vast majority if not all of the financial institutions providing us with credit protection would have continued to perform, and thus the protection would have been effective.

Our credit protection arrangements were with a diversified group of large financial institutions. By the terms of our agreements with these institutions, we received or paid collateral daily to reflect the value of our credit protection on AIG. Even ignoring the collateral, it would have required multiple failures of large financial institutions for Goldman Sachs to have lost material amounts of money through lack of performance of our credit protection.

Finally, SIGTARP said, had AIG not been rescued, Goldman Sachs would have had to bear the risk of further declines in the CDOs that it transferred to Maiden Lane III.

This is accurate in concept; however, Goldman Sachs has significant experience in adeptly managing this form of market risk. We were prepared to do so in this circumstance as well. It is worth noting that we participated in the transfer of assets to the Maiden Lane III vehicle at the request of the New York Federal Reserve.

SIGTARP's view that Goldman Sachs was more vulnerable to an AIG failure than the firm contends is of interest for several reasons. First, it disputes comments made by David Viniar, Lucas van Praag and other Goldman officials last year that Goldman's exposure to an AIG failure was "immaterial." Second, SIGTARP's assessment that the firm was likely to have been hurt by an AIG collapse supports a view represented in a New York Times article on AIG of September 28, 2008, "Behind Biggest Insurer's Crisis, a Blind Eye To a Web of Risk." Goldman Sachs disputed the contention that it had reason to be concerned about AIG's financial troubles. The firm expressed this view both in the article and elsewhere after it appeared.

Does Goldman Sachs maintain, as it did in September 2008 after the September 28 Times article was published, that it had no reason to be concerned about AIG's financial troubles and had no "economic interest in the outcome" of the rescue?


First, the SIGTARP report does not state that Goldman Sachs was more vulnerable to an AIG failure than the firm contends. It raises three general “what if” scenarios, which our collateral arrangements, risk management and accounting practices took into account.

We have consistently stated our belief that a collapse of AIG would have had a very disruptive effect on the financial system and that everyone benefited from the rescue of AIG.

On the narrow question of our direct economic exposure to AIG, at the time of the meeting to which The New York Times September 2008 article referred, our exposure was close to zero. This is because of the collateral and hedging arrangements which we have repeatedly described:

Starting in the mid-90s, we bought credit default swaps from AIG to protect our firm from the risk of a decline in the value of risk we had assumed on behalf some of our clients, (i.e., assets to which we had exposure).

In July 2007, underlying asset values began to decline and we started to make collateral calls under the terms of our agreement with AIG. To the extent that AIG disputed our valuations, we hedged the difference principally by buying credit default protection from other major financial institutions. And we insisted on having collateral requirements in place with them, too. Because financial institutions net their positions with each other every day, we had the cash value of the credit default swaps on our books.

When the US Government decided that a failure of AIG posed a risk to the stability of the entire financial system, it stepped in to bailout the company. By definition, that meant bailout funds would be used to allow AIG to meet its obligations.

If AIG had failed, our direct exposure to loss was essentially zero. That was because of the cash collateral we held and the hedging we used to cover shortfalls. We spent more than $100 million to buy that additional protection. It is worth noting that our hedges would only have worked if there have been an event of default, i.e. AIG being unable to meet its obligations when they fell due.

At the time AIG was bailed out, our exposure was as follows:

  • $20 billion of notional exposure against an underlying portfolio of CDOs;
     
  • Approximately $10 billion gross exposure reflecting the mark-to-market on the underlying portfolio;
     
  • Approximately $7.5 billion of cash collateral paid to Goldman Sachs by AIG;
     
  • Approximately $2.5 billion of credit protection on AIG we had bought from large financial institutions which covered the shortfall in collateral received against the $10 billion.
     

Finally, the figure of $12.9 billion that AIG paid to GS post bailout is made up as follows:

  • $2.5 billion that AIG owed us in collateral (see above). This amount was part of AIG's obligations that had to be met to avoid an event of default. It is worth noting that 86% of AIG's collateral payments were made to firms other than Goldman Sachs.
     
  • $5.6 billion that, post bailout, AIG and the New York Federal Reserve decided to pay to buy the assets they were protecting against, so they didn't have to meet any more collateral calls. AIG and the New York Federal Reserve also bought back assets they were protecting against from other banks. These transactions were executed through a special purpose vehicle called Maiden Lane III, set up by AIG and the Federal Reserve.
     
  • $4.8 billion for highly marketable US Government Agency securities that AIG had pledged to Goldman Sachs in return for a loan of $4.8 billion. They gave us the cash, we gave them back the securities. If AIG hadn't repaid the loan, we would simply have sold the securities.

If so, how does that square with SIGTARP's conclusions that Goldman Sachs benefited from Maiden Lane III and the rescue of AIG?

It is clear that the financial system as a whole benefited from the rescue of AIG.

On Maiden Lane III – at the time this vehicle was created, the government was already providing backing for all of AIG’s obligations, including those that were transferred to the new vehicle. As the report states in respect of the $5.5 billion of positions not included in Maiden Lane III, “continued Government backing of AIG provided Goldman Sachs with ongoing protection against an AIG default on the remaining $5.5 billion.” It is illogical to argue that we were protected against the $5.5 billion, but not against the $4.3 billion that was included in Maiden Lane III.

Did we benefit from Maiden Lane III then? In one sense, yes – there was a timing benefit in terms of money received sooner than might otherwise have been the case. But we were already protected by our collateral and hedging arrangements. However, since that time, those assets have in many cases increased in value.

On another point, email traffic between Goldman Sachs and the New York Federal Reserve in the early afternoon of Sept. 28, 2008 indicates that David Viniar and Timothy Geithner spoke about The New York Times article on AIG. What was the nature of their discussion?

David Viniar gave a summary of the protection provided to Goldman Sachs by AIG through credit default swaps, the cash collateral AIG had posted to Goldman Sachs and the amount of protection we had bought on AIG from other financial institutions.

Can you give some perspective about the reasons behind Lloyd Blankfein's recent apology for the firm's practices that contributed to the credit crisis? What was Mr. Blankfein referring to when he said that Goldman Sachs had "participated in things that were clearly wrong and have reason to regret"? What were the key factors prompting his decision to apologize now?

Lloyd has expressed regret in various different forums, including a speech to the Council of Institutional Investors in April and one at the Handelsblatt Conference in September. He has stated that the financial services industry collectively neglected to raise enough questions about whether some of the trends and practices that became commonplace really served the public’s long-term interests. In particular, the industry let the growth and complexity in some new instruments outstrip their economic and social utility as well as the operational capacity to manage them.

Finally, how does Goldman Sachs respond to those who contend that, given the firm's return to profitability, it should repay the money provided to Goldman Sachs by the taxpayers in the AIG rescue before it pays out bonuses to its executives and employees?

What has been lost in the discussion of this issue is that for the vast majority of the money received from the government, Goldman Sachs delivered assets of equivalent value. For the remainder, we received collateral as part of AIG’s ongoing contractual obligations. Significant amounts of collateral have since been returned to AIG as the underlying assets have increased in value.

The assets of equivalent value included underlying CDOs from our clients as well as the securities lending portfolio we had obtained from AIG. These CDOs and other securities currently are in Maiden Lane II and Maiden Lane III and over time may well continue to recover value.

Finally, there is no linkage between the AIG rescue and compensation.


Related links:

Section of SIGTARP Report Related to Goldman Sachs

SIGTARP report

Remarks by Lloyd Blankfein at Handelsblatt Banking Conference

Remarks by Lloyd Blankfein to the Council of Institutional Investors

The New York Times, Gretchen Morgenson piece on AIG in September 2008

Other Viewpoints materials on AIG:

Overview of Goldman Sachs’ Interaction with AIG and Goldman Sachs’ Approach to Risk Management

Goldman Sachs Protected Its Clients From AIG's Weakness

Dean Baker’s piece “The GM Bailout Makes the Most of a Bad Situation” is irresponsibly misinformed.