Ian Welsh

The horizon is not so far as we can see, but as far as we can imagine

Tag: AIG

Goldman Sachs is a Problem and the Symptom of a Worse Problem

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On July 15, 2009

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Let’s chat about Goldman Sachs profits, why they’re making so much money, and why it’s a problem rather than a case of “good for them”.

Market Manipulation Zero Hedge has made the case that Goldman could be using their program trading to move the markets in the direction they prefer, as the largest program trader in the market, twice as large as the next biggest. The case was reasonably strong, but was made stronger when the New York Stock Exchange suddenly decided to stop releasing the data on program trading which made it possible to track what Goldman was doing. Coincidence? Possibly. It is also possible that you may wish to purchase this fine bridge I have for sale, only ever driven over by a little old lady.

Government Bailout Money Through AIG Goldman received 13 billion from AIG, after receiving 5.9 billion before the bailout, which caused AIG to collapse (not that it wouldn’t have eventually).  The 13 billion is a straight government giveaway, since if AIG had been allowed to go under, GS would have received cents on the dollar, at best.

Goldman Sachs is now a bank. And that means they get money at bank rates from the Fed, which means their cost for money is as low as it is possible to be, which increases their profits.

Goldman Sachs has contacts at the highest levels of government. Glenn Greenwald laid this out best, with a stunning list of occasions in which Goldman was present for decisions or where Goldman Sachs employees (the most significant of whom was Hank Paulson) were hired for key spots in the Treasury department.  He also notes that Goldman’s executives were the top campaign donors for the year.  I’d say they’ve gotten their money’s worth.

Privatize the Profits, Socialize the Losses.  Or, as a friend put it “Golman trades high volatility”.  Which is to say, they take risks.  Big risks.  If those risks fails (as when they were AIG’s largest customer), well then, they get bailed out by the government.

Heads Goldman Sachs wins. Tails the taxpayer loses

It’s a good game, if you can be in on it.  And this is only an overview.  For example there is some speculation that Goldman may have been front running other traders (knowing what trades were coming up and putting in their orders first to take advantage of it.)

The larger issues are simpler.  Goldman was bailed out by government money and is now making lots of money.  They’ve paid back the money from TARP, but they haven’t paid back the 18 million paid to them through AIG.  They should.

Worse than that is the possibility that they are manipulating the market.  I make no claims that they are, but the evidence is that they could be.  The market is thin enough, and dominated enough by program trading that they could move the market if they chose.  It may just be coincidence that they’re having their best year ever, while normal traders who rely on normal market correlations got slaughtered:

The last few days the the market has traded “organically.”  I and many other market participants have noted that prior to the week before July 4th the market had been acting “very odd” – normal correlations between interest rate, foreign exchange the the stock markets had been on “tilt” for the previous couple of months, with the amount of “tiltage” increasing dramatically in the last three or four weeks.  In fact, many of my usual indicators that I use for daytrading had become completely useless.  Suddenly, just before the July 4the weekend, everything started correlating normally again.  I have no explanation for this “light-switch” change but it aligned almost exactly with the day the NYSE had “computer problems” and extended trading by 15 minutes. Was there a configuration change made to their networking infrastructure, one asks?

Again, this could be nothing but an odd market, and have nothing to do with Goldman Sachs.  Sometimes indicators do go haywire, and this is an unusual period.

But the perception amongst market participants and the general public is increasingly that the market is crooked and working to the benefit of insiders, especially Goldman Sachs.  Given Goldman’s clout, both financially and politically, this is not an unreasonable belief when the market is trading so thinly. But normal investors aren’t going to want to get back into the market if they believe that it is being manipulated.

The SEC, Fed and the New York State Attorney General Andrew Cuomo need to do a full investigation.  The results need to be revealed.  The US is already, in its economic policies, which preferentially bail out the rich and important, leaving ordinary people in the dust, trending towards becoming a bannana republic.  Lack of certainty about market manipulation on the flagship New York Stock Exchange is the sort of thing which will keep investors out.

And, to put it simply, the US needs foreign investors, the deep liquidity, back, and it needs them back in a big way.  There are policies which would not require them to come back, but those policies have not been followed.  If the US wants to run these huge deficits (not just government, but trade and monetary), money needs to recycle back to the US.  Yes, the balance of payments deficit is lower than in the past, and the savings rate is up, but the deficit is not down enough and the savings rate is not up enough, especially given the huge debt overhang.

Goldman is a problem, but more than that it is a symptom of the deeper malaise in the US, where the system works for connected rich insiders and doesn’t work for ordinary people.

Did AIG Never Intend to Pay Off Most Collateralized Debt Swaps?

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On April 3, 2009

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There’s an interesting article going around which notes the widespread use of side-letters in the insurance industry. Side letters were used to say “even though you’ve said that you’ll take on X amount of risk on this insurance policy, we won’t hold you to that.”  The letters were generally buried off to one side, only to come to light if things did go wrong.  Insurance companies did this because if they bought say 1 million of reinsurance for $100,000, they freed up $900,000 of regulatory capital which they could continue to use for further insuring or lending and so on.

Think of this as essentially the same as fractional lending.  Insurers have to have enough assets on book to cover their liabilities—policies they may have to pay off on.  If somene else is going to pay off on that risk because you bought reinsurance from them, you don’t need that capital.  So buying reinsurance frees up capital.  As for the seller of reinsurance, they get money in exchange for no risk, if there’s a side letter.  Win, win.

The article goes on to suggest that many Credit Default Swaps (CDSs) AIG sold may have had similiar side letters, which since AIG was never seized, may have been destroyed.  I don’t know if such side letters existed, but my take is that neither side, in many cases, expected to every have to collect on CDSs, or pay on them.

But when everything went to hell, they certainly tried to.  The key fishy problem with AIG wasn’t the bonuses, it was that counterparties were getting paid 100% of the value of CDSs with government money, something they had no right to expect from what amounts to a bankrupt company.  In such a case, either as AIG or the counterparty, why would you bring up the side letters, if they exist?  The counterparties are getting money and AIG is paying out with money that isn’t theirs anyway.

As for the government, the reason all that money was given to AIG was specifically so they could pay off counterparties—it was a way of getting money to various damaged financial firms, including overseas ones, who needed the money, without it being obvious that the government was giving that money away, especially to foreign firms, which would have caused a firestorm

So, I don’t know if these side letters existed, and it’s worth finding out because if they did, that makes all the transactions fraudulent and we can insist on all the money back and prosecute.  But the bottom line is that the government, AIG and the counterparties all wanted the money to be paid out, whether there was a legal obligation or not.  So don’t expect anyone to look too hard, unless Congress really gets the bit between its teeth.

The AIG Bonus Clawback Bill Won’t Work But Here’s What Will

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On March 23, 2009

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Historical top tax ratesLast week the House passed a bill designed to claw back bonuses over $250K from recipients of TARP money.

Now I’m a class warfare guy on the side of regular folks (as opposed to the rich, who are winning the current war and won the last one), but this bill is counterproductive and won’t work.  It is too easy to work around and it is targeting the wrong people.

  1. The clawback only affects bonuses, leaving a loophole where TARP recipients can just recategorize bonuses as salaries.
  2. If the clawback applied to all income, then employees would be moved to contract status or to companies which haven’t received TARP money (even if artificial companies have to be created for the purpose).
  3. The threshold of $250K of household income is not that high, as Henry Blodgett points out.  Don’t get me wrong, no family making that amount is poor, but they are still affluent.  (I’ve never made anything close to it, so this isn’t a personal thing.) At the same time, they aren’t filthy rich, either, and they shouldn’t be taxed as if they were.

But concentrating on bonuses for employees at firms which have been bailed out misses the point.  It’s not just those firms whose employees need to be taxed more heavily, it’s everyone.

The logic for increasing taxes is simple enough. For the last 20 years, American executives have been able to pay themselves such large bonuses that in 3 to 5 years they could amass enough money that hey would never need to work again.  This executive compensation system created the incentive to do whatever was required in order to get those bonuses—leading to flagrant risk taking and outright fraud.  It also led to a short-term focus on the business.  When executives know that it doesn’t matter to their personal financial well-being if their firm exists in 5 years, they don’t worry about the long term consequences of their decisions.  All that matters is booking “profit” now, so you can get money now, and become rich now.

Wall Street and the banks didn’t make any money in the last 10 years, for all that they booked record profits.  The combined losses of the financial firms is larger than their entire reported profits.  What they did was sell synthetic securities based on dubious assumptions about the future—that the housing bubble would continue forever, there would never be another recession,  and defaults wouldn’t cluster; and book the entire calculated future profits of these securities as profit in the year they were created.  Of course, those future profits were fictional, but the bonuses based on them were in real money.

In order to make sure this never happens again compensation needs to be restricted in every firm, not just in the US, but in the industrialized world.  Executives and salespeople and auditors and loan officers (if banks decide to rehire any) need to know that ten years from now if a loan goes bad that they’re going to be on the carpet for it, that they might lose their job for it, and that they will still need a job in 10 years.

I recommend 7 measures to restrict compensation:

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