Mr. William C. DudleyGoldman Sachs: Reasonable Doubt
President
Federal Reserve Bank of New York
33 Liberty Street
New York, NY 10045
Dear Mr. Dudley:
As Ranking Member of the Committee on Oversight and Government Reform, I
am deeply concerned by news reports that the Federal Reserve Bank of New York (�FRBNY�) may have unnecessarily cost the American taxpayers billions of dollars.1
As you know, in late 2008 American International Group (�AIG�) was attempting to negotiate a haircut for banks that held $62 billion in credit default swaps (�CDS�) from AIG. AIG was reportedly seeking to persuade the banks to accept haircuts of as much as 40 cents on the dollar in order to retire these CDS contracts.
On September 16, 2008, the FRBNY extended AIG an $85 billion line of credit,
effectively nationalizing it. According to news reports, late in the week of November 3, then-FRBNY President Timothy Geithner, along with the U.S. Department of the Treasury and the Federal Reserve Board in Washington, took over negotiations with AIG�s counterparties.
News reports indicate that Mr. Geithner�s team circulated a draft term sheet to set the terms under which AIG would settle its CDS obligations, including a blank space in which the haircut for creditors was to have been inserted. However, the haircut provision was reportedly crossed out and, after less than a week of secret negotiations between the FRBNY and the banks, FRBNY ordered AIG to pay its creditors at par � 100 cents on the dollar � not 60 cents as AIG had been attempting to negotiate.
Thus, behind closed doors and with no approval from Congress, the FRBNY may have added an additional $13 billion of debt on the backs of taxpayers.
These allegations, if true, amount to nothing less than a backdoor bailout of AIG�s creditors, including Goldman Sachs, Merrill Lynch, Soci�t� G�n�rale and Deutsche Bank.
The lack of transparency and accountability in this transaction is disturbing enough. However, there is evidence that this $13 billion expenditure was entirely unnecessary. According to Janet Tavakoli of Tavakoli Structured Finance, �There�s no way they should have paid at par. AIG was basically bankrupt.�
Another expert has said that the typical outcome in cases like this involves counterparties being forced to accept haircuts of anywhere from 30 to 50 cents on the dollar.
This suggests that the FRBNY may have paid AIG�s counterparties at par to surreptitiously provide another bailout for large financial institutions. According to Donn Vickrey of Gradient Analytics, �Some of those banks needed 100 cents on the dollar or they risked failure.�
However, another source close to the transaction suggested the FRBNY may have paid AIG�s counterparties at par out of pure expediency: �[S]ome counterparties insisted on being paid in full and the [FRBNY] did not want to negotiate separate deals.�
Furthermore, many of AIG�s counterparties reportedly hedged their exposure to the troubled insurance giant, obviating any need for a taxpayer bailout of these large financial institutions. According to Goldman Sachs� Chief Financial Officer, �There would have been no credit losses [at Goldman Sachs] if AIG had failed.�
All of this begs the question why the FRBNY would not drive a better bargain for the American taxpayer. If the FRBNY thought it was necessary to provide another taxpayer bailout of AIG�s counterparties, it should have come to Congress and made its case that this action was necessary. However, if the FRBNY simply paid AIG�s counterparties at par out of expediency, it raises serious questions about its judgment and motives.
It is also disturbing that, at the time this secret deal was made, FRBNY Chairman Stephen Friedman, a member of the board of Goldman Sachs, purchased more than 50,000 shares of Goldman Sachs before knowledge of the FRBNY�s bailout of Goldman Sachs and other AIG counterparties became public knowledge.
According to news reports, this transaction has earned Mr. Friedman over $5 million in profit.
Finally, according to one AIG executive quoted in news reports, the FRBNY may have attempted to manage public disclosure of its decision to pay AIG�s counterparties at par by pressuring the company not to file pertinent documents with the U.S. Securities and Exchange Commission (�SEC�):
They�d tell us that they don�t think that this or that should be disclosed. They�d say, �Don�t you think your counterparties will be concerned?� It was much more about protecting the Fed.
These allegations raise serious questions about the transparency, accountability and wisdom of the FRBNY�s actions. The American people have a right to know the full details behind the FRBNY�s decision to stop negotiations with AIG�s counterparties and pay them billions of dollars of taxpayer money.
To assist the Committee with its investigation of this matter, please provide the following information no later than close of business on Friday, November 13, 2009:
All records and communications referring or relating to the FRBNY�s negotiations with AIG�s CDS counterparties, including but not limited to:
a) Emails, phone logs and meeting notes of the following people: Timothy Geithner, Stephen Friedman, Tom Baxter, and Sarah Dahlgren;
b) Term sheets, including drafts, relating to AIG�s payments to its CDS counterparties;
c) Emails, phone logs and meeting notes referring or relating to public disclosure of AIG�s payments to its CDS counterparties including disclosure to the SEC.
Please note that, for purposes of responding to this request, the terms �records,� �communications,� and �referring or relating� should be interpreted consistently with the attached Definitions of Terms.
Thank you for your cooperation in this matter. If you have any questions regarding this request, please contact Christopher Hixon or Brien Beattie with the Committee staff at (202) 225-5074.
Sincerely,
Darrell E. Issa
Ranking Member
cc: Hon. Edolphus Towns, Chairman
In case you have not yet seen it, please read Goldman Sachs: Reasonable Doubt by Janet Tavakoli. Here is the beginning:
In August 2007, I publicly challenged the fact that AIG took no write-downs whatsoever for its credit default swaps on underlying mortgage related �super senior� positions. I used the example of its aggregate $19.2 billion in credit default swaps on super senior positions backed by BBB-rated tranches of residential mortgage backed securities. I spoke with Warren Buffett, but only about what I had already told the Wall Street Journal (Dear Mr. Buffett Pp. 164-165, 246).Janet Tavakoli is kicking ass. It's good to see someone do it.
I met with Jamie Dimon, CEO of JPMorgan Chase, adding that the difference was material. JPMorgan Chase�s credit derivatives positions exceeded those of all other U.S. banks combined at the time. JPMorgan was not a participant in the problematic deals, and it was not a recipient of AIG�s settlement payments, but stability in the credit derivatives markets was an important issue. Dimon was dismissive of my concerns. In August of 2007, a potential implosion of AIG was too horrible to contemplate.
Unbeknownst to me, in July 2007, Goldman Sachs and AIG began a prolonged battle over prices and collateral payments for pre-2006 vintage deals on which Goldman had bought protection.
Fraud Audit
Was the risk that Goldman hedged with AIG as bad as Goldman Sachs Alternative Mortgage Products� GSAMP Trust 2006-S3? Any risk manager worth their salt would have reasonable doubt about this deal and conduct a fraud audit. A fraud audit doesn�t mean you are accusing anyone of fraud, only that the audit will be thorough, because there are indications of grave problems. If there is fraud, however, the audit should be rigorous enough to uncover it.
If the aggregate $19.2 billion CDS position were derived from BBB rated tranches similar to one from GSAMP Trust 2006-3, the supposedly super safe �super senior� tranche would be worth zero. Every underlying BBB tranche would have permanent value destruction and zero value. AIG would owe a credit default swap payment for the full amount $19.2 billion. Since there is doubt about the collateral of every deal of this ilk, super senior tranches of mezzanine CDOs in the secondary market are currently valued at zero.
No wonder Goldman Sachs bought protection from AIG on mortgage backed deals�and then bought protection on AIG. ....
It would be nice to see her publicly comment specifically on how Ron Paul's bill has been gutted by Mel Watt, a Democrat from North Carolina, whose district includes Charlotte, headquarters of Bank of America Corp., the biggest U.S. lender.
For more details please see Audit the Fed Bill Gutted: What You Can Do.
I will email her to see what if anything she can do. It can't hurt.
Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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