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A Few Deep Breaths On The Aig-goldman Conspiracy

A few important addenda to my earlier item about the links between Goldman and AIG, which the Times editorial page took up today. First, a thoughtful item from Portfolio's Felix Salmon casting doubt on the theory that the AIG bailout was conceived as a Goldman bailout:

I do think that Geithner should be asked about the firms threatened by an AIG collapse, however, and I do think that he should reply in detail. Yes, Goldman Sachs was a big AIG counterparty, but it has stated repeatedly -- and credibly -- that its AIG exposure was hedged.

But Goldman is a trading shop, with risk managers who hedge anything they can measure on a real-time basis. The real damage of an AIG collapse would not have been at trading shops but rather larger, slower, commercial banks which had large CDO portfolios and less-assiduous risk-management systems.

The lion's share of AIG's losses have come from the credit default swaps that it wrote on banks' CDOs. If those swaps were to become worthless -- or even just worth less -- then any counterparties who hadn't hedged their AIG exposure would have to have taken enormous further write-downs on CDO holdings they thought they'd hedged.

My gut feeling is that if AIG had failed, there's a good chance that Citigroup would have become insolvent overnight. And since Citi is far too big to fail, it was much easier for the Fed to bail out AIG than it would have been for the Fed to bail out Citi and some unknown number of other banks who had also hedged their CDO positions with AIG.

Of course, none of this would have been good for Goldman Sachs -- the insolvency and/or bailout of one or more major banks would have had collateral damage on Goldman just like it did on the rest of the financial system and the economy as a whole. And there's a good chance that Goldman's AIG hedges would turn out to have been with counterparties who were themselves exposed to AIG, and therefore not worth as much as Goldman had thought.

But there's no real evidence supporting the NYT's implication that Tim Geithner bailed out AIG because he wanted to do a special favor for Lloyd Blankfein. I do hope that he can put this meme to rest at his confirmation hearings, if not before.

Obviously Goldman would benefit from the absence of a global financial meltdown, as Salmon says. But that's not the same thing is a direct sop to Goldman.

Also, Bloomberg has reported a few mitigating details (these come via the blog Economics of Contempt):

First, while it's true that Goldman CEO Lloyd Blankfein was the only CEO to attend a September conclave at the New York Fed to discuss AIG, he was not, as the Times editorial alleges, the only executive there. According to Fed spokesman interviewed by Bloomberg: "representatives of other firms were present."  

Second, it's worth pointing out that the Fed hired Goldman rival Morgan Stanley to help it think through its dealings with AIG. This would seem to check any outright gift-giving to Goldman (unless you believe the big Wall Street investment houses scratch each others' backs in these cases, which is certainly possible...).

--Noam Scheiber