It's Official: Goldman Sachs, AIG Played Taxpayers for Fools

by: Linus Wilson

It is official. In their annual report via Business Week Goldman Sachs (NYSE:GS) says their employees are innocent as lambs. (The implicitly government guaranteed company, Goldman Sachs, is full of lambs doing ‘God’s work’ with seven figure bonuses!) GS says that it did nothing wrong in its credit default swap bets with American International Group (NYSE:AIG). There is a funny thing about the too big to fail (TBTF) problem. The dummy at the poker table isn’t even in the casino. AIG and Goldman Sachs (and most of the other major investment banks) were playing with the money of U.S. taxpayers.

Sure, Joe Casano was a brutish idiot, according to Micheal Lewis (on page 86 and here). Casano’s team at AIG Financial Products was dumb enough to think that the normal distribution could be used to predict extreme events. Anyone who was not entirely asleep in the last twenty-five years knew that the extreme events, black swans, were much more frequent in the financial markets than the normal (Gaussian) distribution predicted. Cases in point were the 1987 stock market crash and the blow up of the normal distribution fanatics’ at the failed hedge fund, Long-Term Capital Management (LTCM). Everybody but the super geniuses at AIG who deserved $168 million guaranteed bonuses, which Tim Geithner failed to stop at the New York Fed, knew that the normal distribution could not be used to predict catastrophic events in financial markets. (Yet, I still wonder why the blow up of teaser loans given to people with no job, no income, and no assets, so-called NINJA loans, constituted an “extreme event.”)

As my joint work outlines, both the counterparty (Goldman Sachs) and the bad bank (AIG) are banking on a taxpayer bailout. That is what they got. Moreover, the argument that GS had bought insurance on AIG’s demise does not mean GS was not part of the too big to fail game. That insurance that Goldman bought on AIG’s default was much cheaper because other market participants thought that AIG was too big to fail.

Goldman Sachs under Blankfein (and, I guess, Hank Paulson from Washington D.C.) has suffered from a bad case of foot-in-mouth disease. When you enter the U.S. from the abroad, soon you will have to disclose to customs officials if you walked in any pastures with livestock or if ever worked for Goldman Sachs, at this rate.

Click to enlarge

Description of the figure: The loan amounts of $110 billion from the Federal Reserve are the peak loan amounts and lines of credit from the AIG bailout. Those credit lines and loans outstanding have been reduced to $35 billion by improving business conditions and asset sales. (Only $17 billion in Fed Loans are outstanding now.) The preferred stock values are based on the U.S. Treasury’s estimates of the value of their preferred stock issued to AIG through September 30, 2009. AIG received $40 billion plus a lifeline of $29.8 billion in exchange for taxpayer preferred stock that it can draw down at its discretion. It drew down $2.3 billion from the preferred stock facility by September 30, 2009, and has drawn down $7.5 billion by March 2010. AIG has never paid a preferred stock dividend. The counterparty payments are from SIGTARP.

Disclosure: I only have long positions in broad-based index funds. I do not own individual securities in the companies mentioned.