The AIG Deal Keeps Smelling Worse

(Via CJR and RealClearMarkets)

The Goldman Sachs-AIG scandal may be worse than we think. Former New York Fed President and current Treasury Secretary Timothy Geithner is being castigated for paying off AIG's counterparties - Goldman foremost among them - 100 cents on the dollar and then keeping these payments secret. But it seems likely that Goldman actually got much more than 100%. What is worse, Goldman may have received this windfall by trading on information that was deliberately withheld from the public.

The short version of the story is that Goldman Sachs had a 2.5 billion dollar I.O.U. from A.I.G. Being careful trading types, they had bought insurance (via a Credit Default Swap) on this I.O.U. with other banks - meaning Goldman pays these other banks so that if A.I.G. went under, the other banks would pay Goldman 2.5 billion dollars.

James Keller is saying that when the government announced it's A.I.G. loan - it was giving off all the signals that A.I.G. was going to be liquidated. And liquidation = default on Goldman's I.O.U.

In that scenario, A.I.G. can't pay - so the other banks will cough up $2.5 billion to Goldman.

But Keller alleges that Goldman was part of a very select circle that knew that the government wasn't going to liquidate AIG. In that scenario, the Government props up A.I.G., so A.I.G. pays Goldman $2.5 billion of taxpayer money.

But here's the bonus round:

Goldman is paying for insurance on that $2.5 billion - this is money that Goldman now knows is wasted. They cannot collect on the CDS "insurance policy" because the A.I.G. is going to survive.

But the rest of the world thinks A.I.G. is going to default, so the market for CDS insurance against AIG is skyrockting. The prevailing wisdom is (if you can get somebody dumb enough to sell you their swap) is that you would make a few payments, A.I.G. would go under, and you'd get paid the full value of the swap.

In this market, (again, according to Keller) Goldman offers to sell their $2.5 billion dollar swap at a whopping markup. They don't tell their prospective buyers what they know (that the CDS "policy" is worthless), they just charge as much as they can and sell.

Keller's estimating that the CDS rates for AIG between September 2008 and March 2009 (when Goldman sold their protection) would net Goldman another $1.5 billion dollars.

So, not only are Goldman getting federal dollars directly - not only are they getting their A.I.G. bets covered to the tune of 100 cents on the dollar by taxpayers, but they are using their inside access to federal officials to pull another $1.5 billion out of customers, without disclosing what they know.

That Goldman works for itself is no surprise, but the extent to which Treasury works for Goldman is just mind-boggling.