February 7, 2010
Testy Conflict With Goldman Helped Push A.I.G. to Edge
By GRETCHEN MORGENSON and LOUISE STORY
Billions of dollars were at stake when 21 executives of Goldman Sachs and the American
International Group convened a conference call on Jan. 28, 2008, to try to resolve a
rancorous dispute that had been escalating for months.
A.I.G. had long insured complex mortgage securities owned by Goldman and other firms
against possible defaults. With the housing crisis deepening, A.I.G., once the world’s
biggest insurer, had already paid Goldman $2 billion to cover losses the bank said it
might suffer.
A.I.G. executives wanted some of its money back, insisting that Goldman — like a
homeowner overestimating the damages in a storm to get a bigger insurance payment —
had inflated the potential losses. Goldman countered that it was owed even more, while
also resisting consulting with third parties to help estimate a value for the securities.
After more than an hour of debate, the two sides on the call signed off with nothing
settled, according to internal A.I.G. documents and an audio recording reviewed by The
New York Times.
Behind-the-scenes disputes over huge sums are common in banking, but the standoff
between A.I.G. and Goldman would become one of the most momentous in Wall Street
history. Well before the federal government bailed out A.I.G. in September 2008,
Goldman’s demands for billions of dollars from the insurer helped put it in a precarious
financial position by bleeding much-needed cash. That ultimately provoked the
government to step in.
With taxpayer assistance to A.I.G. currently totaling $180 billion, regulatory and
Congressional scrutiny of Goldman’s role in the insurer’s downfall is increasing. The
Securities and Exchange Commission is examining the payment demands that a number
of firms — most prominently Goldman — made during 2007 and 2008 as the mortgage
market imploded.
The S.E.C. wants to know whether any of the demands improperly distressed the
mortgage market, according to people briefed on the matter who requested anonymity
because the inquiry was intended to be confidential.
In just the year before the A.I.G. bailout, Goldman collected more than $7 billion from
A.I.G. And Goldman received billions more after the rescue. Though other banks also
benefited, Goldman received more taxpayer money, $12.9 billion, than any other firm.
In addition, according to two people with knowledge of the positions, a portion of the $11
billion in taxpayer money that went to Société Générale, a French bank that traded with
A.I.G., was subsequently transferred to Goldman under a deal the two banks had struck.
Goldman stood to gain from the housing market’s implosion because in late 2006, the
firm had begun to make huge trades that would pay off if the mortgage market soured.
The further mortgage securities’ prices fell, the greater were Goldman’s profits.
In its dispute with A.I.G., Goldman invariably argued that the securities in dispute were
worth less than A.I.G. estimated — and in many cases, less than the prices at which other
dealers valued the securities.
The pricing dispute, and Goldman’s bets that the housing market would decline, has left
some questioning whether Goldman had other reasons for lowballing the value of the
securities that A.I.G. had insured, said Bill Brown, a law professor at Duke University
who is a former employee of both Goldman and A.I.G.
The dispute between the two companies, he said, “was the tip of the iceberg of this whole
crisis.”
“It’s not just who was right and who was wrong,” Mr. Brown said. “I also want to know
their motivations. There could have been an incentive for Goldman to say, ‘A.I.G., you
owe me more money.’ ”
Goldman is proud of its reputation for aggressively protecting itself and its shareholders
from losses as it did in the dispute with A.I.G.
In March 2009, David A. Viniar, Goldman’s chief financial officer, discussed his firm’s
dispute with A.I.G. in a conference call with reporters. “We believed that the value of
these positions was lower than they believed,” he said.
Asked by a reporter whether his bank’s persistent payment demands had contributed to
A.I.G.’s woes, Mr. Viniar said that Goldman had done nothing wrong and that the firm
was merely seeking to enforce its insurance policy with A.I.G. “I don’t think there is any
guilt whatsoever,” he concluded.
Lucas van Praag, a Goldman spokesman, reiterated that position. “We requested the
collateral we were entitled to under the terms of our agreements,” he said in a written
statement, “and the idea that A.I.G. collapsed because of our marks is ridiculous.”
Still, documents show there were unusual aspects to the deals with Goldman. The bank
resisted, for example, letting third parties value the securities as its contracts with A.I.G.
required. And Goldman based some payment demands on lower-rated bonds that A.I.G.’s
insurance did not even cover.
A November 2008 analysis by BlackRock, a leading asset management firm, noted that
Goldman’s valuations of the securities that A.I.G. insured were “consistently lower than
third-party prices.”
To be sure, many now agree that A.I.G. was reckless during the mortgage mania. The
firm, once the world’s largest insurer, had written far more insurance than it could have
possibly paid if a national mortgage debacle occurred — as, in fact, it did.
Perhaps the most intriguing aspect of the relationship between Goldman and A.I.G. was
that without the insurer to provide credit insurance, the investment bank could not have
generated some of its enormous profits betting against the mortgage market. And when
that market went south, A.I.G. became its biggest casualty — and Goldman became one
of the biggest beneficiaries.
Longstanding Ties
For decades, A.I.G. and Goldman had a deep and mutually beneficial relationship, and at
one point in the 1990s, they even considered merging. At around the same time, in 1998,
A.I.G. entered a lucrative new business: insuring the least risky portions of corporate
loans or other assets that were bundled into securities.
A.I.G.’s financial products unit, led by Joseph J. Cassano, was behind the expansion. To
reduce its own risks in the transactions, the company structured deals so that it would not
have to make early payments to clients when securities began to sour. That changed
around 2003, however, when A.I.G. began insuring portions of subprime mortgage deals.
A lawyer for Mr. Cassano said his client would not comment for this article. A.I.G. also
declined to comment.
Alan Frost, a managing director in Mr. Cassano’s unit, negotiated scores of mortgage
deals around Wall Street that included a complicated sequence of events for when an
insurance payment on a distressed asset came due.
The terms, described by several A.I.G. trading partners, stated that A.I.G. would post
payments under two or three circumstances: if mortgage bonds were downgraded, if they
were deemed to have lost value, or if A.I.G.’s own credit rating was downgraded. If all of
those things happened, A.I.G. would have to make even larger payments.
Mr. Frost referred questions to his lawyer, who declined to comment.
Traders loved Mr. Frost’s deals because they would pay out quickly if anything went
wrong. Mr. Frost cut many of his deals with two Goldman traders, Jonathan Egol and
Ram Sundaram, who had negative views of the housing market. They had made A.I.G. a
central part of some of their trading strategies.
Mr. Egol structured a group of deals — known as Abacus — so that Goldman could
benefit from a housing collapse. Many of them were actually packages of A.I.G.
insurance written against mortgage bonds, indicating that Mr. Egol and Goldman
believed that A.I.G. would have to make large payments if the housing market ran
aground. About $5.5 billion of Mr. Egol’s deals still sat on A.I.G.’s books when the
insurer was bailed out.
“Al probably did not know it, but he was working with the bears of Goldman,” a former
Goldman salesman, who requested anonymity so he would not jeopardize his business
relationships, said of Mr. Frost. “He was signing A.I.G. up to insure trades made by
people with really very negative views” of the housing market.
Mr. Sundaram’s trades represented another large part of Goldman’s business with A.I.G.
According to five former Goldman employees, Mr. Sundaram used financing from other
banks like Société Générale and Calyon to purchase less risky mortgage securities from
competitors like Merrill Lynch and then insure the assets with A.I.G. — helping fatten
the mortgage pipeline that would prove so harmful to Wall Street, investors and
taxpayers. In October 2008, just after A.I.G. collapsed, Goldman made Mr. Sundaram a
partner.
Through Société Générale, Goldman was also able to buy more insurance on mortgage
securities from A.I.G., according to a former A.I.G. executive with direct knowledge of
the deals. A spokesman for Société Générale declined to comment.
It is unclear how much Goldman bought through the French bank, but A.I.G. documents
show that Goldman was involved in pricing half of Société Générale’s $18.6 billion in
trades with A.I.G. and that the insurer’s executives believed that Goldman pressed
Société Générale to also demand payments.
Goldman’s Tough Terms
In addition to insuring Mr. Sundaram’s and Mr. Egol’s trades with A.I.G., Goldman also
negotiated aggressively with A.I.G. — often requiring the insurer to make payments
when the value of mortgage bonds fell by just 4 percent. Most other banks dealing with
A.I.G. did not receive payments until losses exceeded 8 percent, the insurer’s records
show.
Several former Goldman partners said it was not surprising that Goldman sought such
tough terms, given the firm’s longstanding focus on risk management.
By July 2007, when Goldman demanded its first payment from A.I.G. — $1.8 billion —
the investment bank had already taken trading positions that would pay out if the
mortgage market weakened, according to seven former Goldman employees.
Still, Goldman’s initial call surprised A.I.G. officials, according to three A.I.G.
employees with direct knowledge of the situation. The insurer put up $450 million on
Aug. 10, 2007, to appease Goldman, but A.I.G. remained resistant in the following
months and, according to internal messages, was convinced that Goldman was also
pushing other trading partners to ask A.I.G. for payments.
On Nov. 1, 2007, for example, an e-mail message from Mr. Cassano, the head of A.I.G.
Financial Products, to Elias Habayeb, an A.I.G. accounting executive, said that a payment
demand from Société Générale had been “spurred by GS calling them.”
Mr. Habayeb, who testified before Congress last month that the payment demands were a
major contributor to A.I.G.’s downfall, declined to be interviewed and referred questions
to A.I.G. The insurer also declined to comment for this article. Mr. van Praag, the
Goldman spokesman, said Goldman did not push other firms to demand payments from
A.I.G.
Later that month, Mr. Cassano noted in another e-mail message that Goldman’s demands
for payment were becoming problematic. “The overhang of the margin call from the
perceived righteous Goldman Sachs has impacted everyone’s judgment,” he wrote to five
employees in his division.
By the end of November 2007, Goldman was holding $2 billion in cash from A.I.G.
when the insurer notified Goldman that it was disputing the firm’s calculations and
seeking a return of $1.56 billion. Goldman refused, the documents show.
In many of these deals, Goldman was trading for other parties and taking a fee. As the
mortgage market declined, Goldman paid some of these parties while waiting for A.I.G.
to meet its demands, the Goldman spokesman said. But one reason those parties were
owed money on the deals was that Goldman had marked down the securities.
Adding to the pressure on A.I.G., Mr. Viniar, Goldman’s chief financial officer, advised
the insurer in the fall of 2007 that because the two companies shared the same auditor,
PricewaterhouseCoopers, A.I.G. should accept Goldman’s valuations, according to a
person with knowledge of the discussions. Goldman declined to comment on this
exchange.
Pricewaterhouse had supported A.I.G.’s approach to valuing the securities throughout
2007, documents show. But at the end of 2007, the auditor began demanding that A.I.G.
provide greater disclosure on the risks in the credit insurance it had written.
Pricewaterhouse was expressing concern about the dispute.
The insurer disclosed in year-end regulatory filings that its auditor had found a “material
weakness” in financial reporting related to valuations of the insurance, a troubling sign
for investors.
A spokesman for Pricewaterhouse said the company would not comment on client
matters.
Insiders at A.I.G. bridled at Goldman’s insistence that they accept the investment bank’s
valuations. “Would we call bond issuers and ask them what the valuation of their bonds
was and take that?” asked Robert Lewis, A.I.G.’s chief risk officer, in a message in
January 2008. “What am I missing here, so I don’t waste everybody’s time?”
When A.I.G. asked Goldman to submit the dispute to a panel of independent firms,
Goldman resisted, internal e-mail messages show. In a March 7, 2008, phone call, Mr.
Cassano discussed surveying other dealers to gauge prices with Michael Sherwood,
Goldman’s vice chairman. At that time, Goldman calculated that A.I.G. owed it $4.6
billion, on top of the $2 billion already paid. A.I.G. contended it only owed an additional
$1.2 billion.
Mr. Sherwood said he did not want to ask other firms to value the securities because “it
would be ‘embarrassing’ if we brought the market into our disagreement,” according to
an e-mail message from Mr. Cassano that described the call.
The Goldman spokesman disputed this account, saying instead that Goldman was willing
to consult third parties but could not agree with A.I.G. on the methodology.
Trouble Grows at A.I.G.
By the spring of 2008, A.I.G.’s dispute with Goldman was just one of its many woes. Mr.
Cassano was pushed out in March and the company’s defenses against the growing
demand for payments faltered. By the end of August 2008, A.I.G. had posted $19.7
billion in cash to its trading partners, including Goldman, according to financial filings.
Over that summer, A.I.G. had tried, unsuccessfully, to cancel its insurance contracts with
the trading partners. But Goldman, according to interviews with former A.I.G.
executives, would allow that only if it also got to keep the $7 billion it had already
received from A.I.G. Goldman wanted to keep the initial insurance payouts and the
securities in order to profit from any future rebound.
In addition to offering to cancel its own contracts, Goldman offered to buy all of the
insurance A.I.G. had written for several other banks at severely distressed prices,
according to three people briefed on the discussions.
Negotiating with Goldman to void the A.I.G. insurance was especially difficult, Federal
Reserve Board documents show, because the firm did not own the underlying bonds. As a
result, Goldman had little incentive to compromise.
On Aug. 18, 2008, Goldman’s equity research department published an in-depth report
on A.I.G. The analysts advised the firm’s clients to avoid the stock because of a
“downward spiral which is likely to ensue as more actual cash losses emanate” from the
insurer’s financial products unit.
On the matter of whether A.I.G. could unwind its troublesome insurance on mortgage
securities at a discount, the Goldman report noted that if a trading partner “is not in a
position of weakness, why would it accept anything less than the full amount of
protection for which it had paid?”
A.I.G. shares fell 6 percent the day the report was published. Three weeks later, the
United States government agreed to pour billions of dollars in taxpayer money into the
insurer to keep it from collapsing.
The government would soon settle the yearlong dispute between Goldman and A.I.G.,
with Goldman receiving full value for its bets. The federal bailout locked in the paper
losses of those deals for A.I.G. The prices on many of those securities have since
rebounded.