Goldman wasn't the only contributor to the systemic risk that nearly toppled the global financial markets, but it was the key contributor to the systemic risk posed by American International Group, Inc.'s (AIG) near bankruptcy in September 2008.
When it came to the credit derivatives AIG was required to mark-to-market, Goldman was the 800-pound gorilla. Calls for billions of dollars in collateral pushed AIG to the edge of disaster. The entire financial system was imperiled, and Goldman Sachs would have been exposed to billions in devastating losses.
A Goldman spokesman told me its involvement in AIG's trades was only as an "intermediary," but Goldman underwrote some of the collateralized debt obligations (CDOs) comprising the underlying risk of the protection Goldman bought from AIG. Goldman also underwrote many of the (tranches of) CDOs owned by some of AIG's other trading counterparties.
Goldman was AIG's largest counterparty, and its trades made up one-third of AIG's approximately $62.1* billion in transactions requiring market prices. Societe Generale (SocGen) was AIG's next largest counterparty with $18.7 billion. SocGen, Calyon, Bank of Montreal, and Wachovia bought several (tranches) of Goldman's CDOs and hedged them with AIG.
On November 27, 2007, Joe Cassano, the former head of AIG's Financial Products unit, wrote a memo about the collateral AIG owed to its counterparties. Goldman, Soc Gen, Calyon and others required more than $4 billion. Goldman asked AIG for $3 billion of the $4 billion required in collateral calls. (Click here to view the nine-page memo uncovered by CBS News in June 2009.) By September 2008, Goldman had called $7.5 billion in collateral from AIG.
SocGen bought protection from AIG on two tranches of Davis Square VI, a deal Goldman underwrote. According to AIG's documentation, SocGen got its prices for marking purposes for Goldman's deals from Goldman. As of November 2007, Goldman marked down these originally "AAA-rated" tranches to 67.5%, down by almost one-third. SocGen's list includes other deals underwritten by Goldman: Altius I, Davis Square II, Davis Square IV, the previously mentioned Davis Square VI, Putnam 2002-1, Sierra Madre, and possibly more. SocGen hedged this risk by purchasing protection from AIG.
Calyon had $4.5 billion of transactions with AIG. Calyon and Goldman were co-lead on at least two deals: Davis Square II and Davis Square V. According to AIG's memo, Calyon got its prices for these deals from Goldman.
Bank of Montreal had $1.6 billion in negative basis trades with AIG, and at least two Goldman transactions (Davis Square I and Putman 2002-1) made up 6 of its 9 positions with AIG. Wachovia had 6 trades with AIG, all related to Davis Square II, a deal that Goldman underwrote.
Goldman was right to question the prices, make calls for collateral, and protect itself. Goldman may not have been an arsonist buying fire insurance, but its trading activities with AIG and others were accelerants of AIG's problems.
During AIG's bailout, Goldman had influence over the decision to use public funds to pay 100 cents on the dollar for these CDOs (the underlying risk of the credit derivatives), but none of the information about the volume of Goldman's trades with AIG--or the Goldman CDOs hedged by AIG's other counterparties--was made public.
Goldman's public disclosures in September 2008 obscured its contribution to AIG's near bankruptcy and the need to bailout Goldman's trading partners in AIG related transactions. Goldman's trading activities played a starring role in the near collapse of the global markets.
*The Cassano memo referred to in this post included transactions for which AIG was being asked to produce more money. In December 2009, the Wall Street Journal analyzed the TARP Inspector general's November 2009 report and determined that Goldman Sachs originated or bought protection on $33 billion out of $80 billion, or around 41%, of AIG's transactions of this type.