TSF Opinion Commentary - November 2, 2009
By Janet Tavakoli
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).
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.
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. Goldman may not have contributed to the aggregate $19.2 billion position, but this mezzanine super senior risk was visible to all of AIG’s counterparties.
Sophisticated counterparties like AIG are supposed to protect themselves, and have little chance for recovering damages. But now the American taxpayer has stepped in to make payments for AIG. U.S. taxpayers have a right to recover money paid out for derivatives on deals that include phony collateral.
Maiden Lane III now owns the underlying CDOs for AIG’s cancelled credit default swaps. One can now investigate them—and all of the underlying collateral.
The government’s 100% payout to AIG’s counterparties was a gift, and the negotiations were done in secret. The monoline insurers were in a similar situation with a variety of deals from a variety of counterparties. (Structured Finance Pp. 405-427) For example, in 2008, Citigroup Inc. accepted about 60 cents on the dollar from New York-based bond insurer Ambac Financial Group Inc. to retire protection on a $1.4 billion CDO. Ambac said the underlying “super senior” was worth about zero, and the protection payment would otherwise have been near the full $1.4 billion. Citigroup got a relatively huge payout, since other “high grade” deals have been settled for as low as ten cents on the dollar.
The irony is that Goldman Sachs may not have been involved in the worst of the deals, but its officers had unusually high profile in AIG’s damage control. Goldman’s deals with AIG may have all been completely proper, but deals like GSAMP Trust 2006-3 indicate that Goldman should not be exempt from the general fraud audit of mortgage securitizations that all of the former investment banks [Lehman, Bear Stearns, Morgan Stanley, Goldman Sachs, Merrill Lynch, and some foreign banks going business in the U.S. (DMB Pp. 97-107.)] should undergo.
Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008).
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