By Mark Pittman
Sept. 29 - As much as $37 billion from federal bailout loans to American International Group Inc. has gone to investment banks including Goldman Sachs Group Inc., the firm Treasury Secretary Henry Paulson used to run.
Without the government money, Goldman, Merrill Lynch & Co., Morgan Stanley, Deutsche Bank AG and other firms could have become some of the biggest creditors in a bankruptcy filing by AIG, the world's largest insurer, because of its billions in losses on subprime bonds and corporate debt.
It was the biggest crisis ever -- if you're an investment bank,'' said Joshua Rosner, a managing director at investment research firm Graham Fisher & Co. in New York. We didn't just save AIG. We saved the counterparties, the banks. It's true that it would have been a disaster, but it would have been a disaster for them.''
The firms received cash as AIG borrowed from a Federal Reserve credit line endorsed by Paulson, Goldman's former chief executive. The insurer had borrowed $44.6 billion from the credit line as of Sept. 25, the Federal Reserve reported that day.
Paulson's successor at Goldman, Lloyd Blankfein, was the only chief executive at a meeting Sept. 15 at the New York Federal Reserve Bank at which the troubles at AIG were discussed, although representatives of other firms were present, a Fed spokesman said.
The same day, when its credit rating was downgraded, AIG needed as much as $37 billion to pay collateral calls from Wall Street firms and others because the value of its holdings had declined, Standard & Poor's said in a report that evening.
"Mark-to-market losses from mortgage-related investments and swap exposures have placed significant pressure on AIG's ability to access capital and liquidity," the report said.
Borrowing from Fed
The next day, AIG began borrowing money -- $14 billion -- from the Fed and continued borrowing for three more days, receiving loans totaling $37 billion, it disclosed in a financial filing on Sept. 26. AIG then met its collateral calls to its Wall Street trading partners, S&P analyst Rodney Clark said in an interview.
The payments show how bailouts engineered by Paulson and Federal Reserve Chairman Ben Bernanke are beginning to shift money to Wall Street firms involved in subprime mortgage trading.
As Congress prepares to vote on a broader $700-billion bailout, the AIG credit line is one indication of how it might work.
The money is changing hands because AIG provided $441 billion in backing for Wall Street trades involving credit- default swaps, or transactions in which one party agrees to pay another to accept the risk of default. Those bets are packaged into larger securities called synthetic collateralized debt obligations. AIG's business was to insure the top-rated, safest part of those CDOs, also known as super-senior, from default.
Stand in Line
An AIG bankruptcy would have forced these counterparties to stand in line with other creditors and wait for perhaps years to be paid through the courts.
"There wasn't time to look real closely at what really happened at AIG," said Rep. Brad Miller, a North Carolina Democrat on the House Financial Services Committee that is holding hearings on the bailout plan. "What created the problem is the unregulated exotic transaction, collateralized debt swaps. Almost certainly, there will be a forensic examination of what happened to AIG."
The Fed's loans to AIG were followed by Paulson's and Bernanke's proposal of a $700 billion package to buy mortgage assets that's now being debated by Miller and the rest of Congress. While Paulson originally demanded the authority to buy any asset without judicial or administrative oversight, Congress has pledged to rein in the Treasury secretary's power.
"What AIG did with its money, you should call AIG,'' said Fed spokesman Calvin Mitchell. I doubt that we will be talking about AIG's CDO portfolio.''
AIG spokesman Nicholas Ashooh said the company would not disclose its counterparties or the contents of the CDO portfolio.
He declined further comment.
Paulson said Sept. 16 that he talked with lawmakers about AIG and on Sept. 17 endorsed the AIG financing package. The Fed appointed a member of Goldman's board, Edward Liddy, to run AIG, replacing Robert Willumstad. Liddy resigned Sept. 26 from Goldman's board.
Treasury spokeswoman Brookly McLaughlin said, The Fed had the lead on this one: It's their loan. I don't know how I could be more clear.''
Laying Off Risk
AIG has been helping firms lay off their financial risk for years by writing swap contracts, or transactions in which two parties enter into an agreement in which one agrees to assume the other's risk. Joseph Cassano, the former head of AIG's financial products unit, co-founded it in 1987 and turned it into a business providing financial guarantees on more than $500 billion of assets at year end, including $61.4 billion in securities tied to subprime mortgages.
AIG's need for immediate cash was triggered at 6:31 p.m. on Sept. 15, when Fitch Ratings dropped AIG's credit rating to A from AA-. Standard & Poor's and Moody's Investors Service followed within hours.
The reason: AIG had sold $441 billion in contracts protecting against default for securities originally rated AAA.
The most troublesome were the $57.8 billion in multisector collateralized debt obligations that are structured debt securities backed by subprime loans. About 64 percent had since been downgraded and six were in default, the insurer said Aug. 9.
AIG didn't have the money and couldn't sell enough of its own securities in time to meet the terms of the contracts and its other obligations, so it would have had to declare bankruptcy, putting the banks in line with the rest of the creditors fighting it out in court.
S&P analysts led by Clark said in the firm's report on its three-level downgrade of AIG that credit default swaps on CDOs were causing most of the strain as well as holdings of residential mortgage-backed securities.
S&P estimated that AIG had market-value losses of more than
$37 billion as of Sept. 15. While it is possible that those CDOs are undervalued, S&P said it is unlikely that any gains will be recorded before late 2009 or 2010.''
Estimated recoveries in liquidations of mortgage-tied CDOs average 8 percent for super-senior classes of those made up of low-rated bonds; 33 percent for CDOs of originally high-rated bonds; and 4 percent for CDOs of CDOs, according a report this month by New York-based JPMorgan Chase & Co.
"Overall, the most considerable level of exposure was held by the Wall Street banks," said S&P's Clark in an interview.
"However, it was very diversified and contained some European banks."
Last week, Goldman raised $10 billion in a stock offering, including an endorsement and a $5 billion cash infusion from billionaire investor Warren Buffett of Omaha, Nebraska.
Paulson last week hired former Goldman colleague Edward C.
Forst to advise him on the government's $700 billion rescue plan.
Forst left Goldman Sachs in June to become executive vice president at Harvard University.
"We have said many times on the record that our exposure to AIG was, and is, not material," said Lucas van Praag, a spokesman for New York-based Goldman. "Our exposure to AIG is offset by collateral and hedges and is not material to Goldman Sachs in any way."
Those hedges included derivative contracts that would pay Goldman if AIG defaulted, van Praag said.
Merrill was the biggest underwriter of CDOs in 2004 with
$15.9 billion and the second-biggest underwriter in 2005 with $27 billion when AIG was the most active in writing credit default swaps, according to Asset-Backed Alert, a trade magazine.
Citigroup was the biggest underwriter of CDOs in 2005 with
$27.1 billion, rising from $7.1 billion the year before. Goldman was fifth both years with $13.1 billion and $7.3 billion in 2004.
Merrill spokeswoman Jessica Oppenheim, Morgan Stanley spokesman Mark Lake and Deutsche Bank spokeswoman Michele Allison declined comment.
"There have been calls for a sweeping investigation of exactly what happened," said Congressman Miller. "I'm not sure many people who are inside the policy loop on all this really knows what went wrong."
By Mark Pittman
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