On Saturday, The New York Times published an article called "Testy Conflict With Goldman Helped Push A.I.G. to Edge", which reveals an extremely interesting fact about the nature of Goldman's deals with AIG. The key paragraph is located on page four:
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.
'The firm did not own the underlying bonds.’ This admission blows the cover off the financial meltdown. It tells us that the high rollers on Wall St were not purchasing insurance on their own assets, as is commonly asserted. They were betting on the failure of their rivals.
The nature of the agreement is that one party (Goldman) pays the other (AIG) to make a low probability bet, such as that 9 AAA companies out of a list of 100 will fail.
The credit instruments were called synthetic collateralized debt obligations (CDOs), investments bundled with naked credit default swaps (CDSs), designed to profit off the demise of others.
[S]ynthetic CDOs are securities that are not based on actual loans but on credit default swaps (CDS). That is, they are derivatives of derivatives.
The CDO entity writes CDS with the issuing bank covering a large number of unrelated companies. This can be anything from 50 to several hundred – some banks, some industrials. The deal is that if a certain number of those firms default – usually between seven and nine – the money invested in the CDO goes to the bank.
It’s essentially an insurance contract – otherwise known as a bet.
In what was thought to be the unlikely event that the referenced companies failed, the 'insurer' would be required to make a large payout. While the players selling and buying these deals have been reported, it has seldom been said who was being bet against. However, a financial journalist in Australia released a partial list of these companies.
Here are some of the companies that are on all of the synthetic CDO reference lists: the three Icelandic banks, Lehman Brothers, Bear Stearns, Freddie Mac, Fannie Mae, American Insurance Group, Ambac, MBIA, Countrywide Financial, Countrywide Home Loans, PMI, General Motors, Ford and a pretty full retinue of US homebuilders.
Shockingly, by the end of 2008 nearly every one had approached bankruptcy.
The three Icelandic banks have defaulted, as has Countrywide, Lehman and Bear Stearns. AIG has been taken over by the US Government, which is counted as a part-default, and Freddie Mac and Fannie Mae are in "conservatorship".
Ambac, MBIA, PMI, General Motors, Ford and a lot of US home builders are teetering.
When Goldman Sachs first wrote the deals few believed it was possible that these companies would fail. Nevertheless, in 2007 major losses began rolling in after the housing bubble popped.
GS got out its blood funnel and jammed it into the heart of AIG. Each company's downfall meant bigger cash payouts for the great vampire squid.
By the time Lehman Brothers went under, AIG had been sucked dry. So Goldman sent its top goon, Hammerin’ Hank Paulson to Congress, demanding the remainder of its treasure.