Friday, April 3, 2009

AIG: Allocation In Goldman

When I first heard about the bus tour organized by angry protesters of the now widely publicized AIG executive bonuses, I thought it was somewhat silly. After all, what exactly was looking at people's houses from outside their mansion gates going to do? Especially after most of the executives had already announced their willingness to give back their bonuses after they were publicized? Perhaps instead of complaining about being out of work when these careless executives were getting bonuses with taxpayer money, these protesters should instead be out looking for jobs of their own. Or, perhaps they should have been outside Lloyd Blankfein, and other top Goldman Sach's executives houses instead.

Why? Because of all the counterparties AIG insured in their derivatives deals, Goldman Sachs was their largest customer. And because all of that massive $60 billion dollar prop up given to AIG, with the exception of the executive bonuses, didn't even go to AIG. It went straight to the counterparties they had insured, and made them whole.

Goldman Sachs purchased $20 billion in credit default swaps from AIG. Goldman then turned around and sold these credit default swaps for a small profit. However, if AIG failed, went bankrupt, and therefore did not deliver on the $20 billion in credit default swaps and financial instruments, Goldman would have owed $20 billion to the firms that had purchased these credit default swaps from them. This would have resulted in a massive loss for Goldman, instead of a small gain. While distressed real estate is currently trading between 10-90 cents on the dollar, and many other banks and companies are taking huge losses, investment banks like Goldman are being made whole. They are miraculously getting 100 cents on the dollar. And might I remind you that its the taxpayers paying them.

As ridiculous as it may seem, that's not even the shiestiest part. The man responsible when the AIG bailout was announced, former Treasury Secretary Hank Paulson, also used to be the former CEO of Goldman Sachs.

For those of you unfamiliar with the workings of investment banks, there is often a vesting period associated with partners/employees compensation. This is done to incent bankers not to simply leave the firm for greener pastures because they have been given a huge financial incentive to stay. If they leave before their equity fully vests, they might be leaving hundreds of thousands, or even millions of dollars on the table.

Now to be fair, this was not the case with Hank Paulson. Since Goldman went public ten years ago in 1999, most of the vesting equity for executives has been in the form of company stock. Paulson however, who as a stipulation in working for the federal government when he took the Treasury Secretary position in 2006, was forced to sell his Goldman shares so there was no potential conflict of interest. However, just because there may not have been a direct personal financial incentive for Paulson to orchestrate the bailout of Goldman, masked publicly by calling it a bailout for AIG, to think their was no incentive for him to do so is downright farcical.

There is, and has always been a great corporate culture in investment banking, but especially at Goldman. To think, despite any internal power struggles, that most executives aren't looking out for their cohorts and allies who helped get them to the position they are in, is silly. In fact, most investment bank CEO's have wrested such control of the company through strategic internal alliances from potential internal detractors, that most (unless their errors are both public and egregious, and are therefore forced out, a la Jon Corzine) are successful in determining who their eventual heir apparent will be. Such was the case with Hank Paulson and current Goldman CEO Lloyd Blankfein, who remained loyal to the "my way or the highway" style of Paulson despite their contrasting personalities and styles.

As proof, in 2003, when Paulson was initially up for the potential Treasury Secretary job that was eventually taken by John Snow, his two assumed succesors, then Goldman Co-Presidents John Thornton and John Thain, both left Goldman. Thornton and Thain, who were widely assumed to receive advancement when Paulson was assumed to relinquish his reign over the company in 2003, left once Hank decided to pull the old, "nah, I think I'll stick around for an indefinite amount of time longer and screw you guys over." Blankfein, the newly appointed number two thereafter, on the other hand, was patient enough to bide his time as the new number two, and was rewarded for that patience when Paulson finally did decide to leave for the Treasury Secretary position in 2006.

Rumor has it that Lloyd Blankfein was in the room with Hank Paulson on September 13th when Paulson was orchestrating the propping up of AIG. That notion, in and of itself is unsettling given where the "AIG" bailout money was really going. It has a "Wizard of Oz" feel of "pay no attention to the man behind the curtain." The AIG executive bonus hullabaloo just furthers the shadiness of the AIG bailout, just as the Iraq War masked the fact that George Bush was giving government war contracts to companies run by his old oil buddies, like Blackwater.

When you are about to lose your job, whose the first person you call? A friend or former colleague in a position of power to help you out would be a good start. So is it really a conspiracy theory, or common sense to suggest that when Goldman was faced with losing $20 billion dollars that Lloyd Blankfein would call up Hank Paulson, his former colleague in a position of power to help him out? Most people don't burn bridges because its simply a bad business principle. Paulson knew he wasn't going to be Treasury Secretary forever, and he knew he likely wasn't going to become CEO of Goldman again after his government stint was over. Helping an old friend, and loyal number two, save $20 billion dollars for a bunch of old colleagues and friends was probably a wise financial decision for Hank Paulson, regardless of whether he was going to see any direct financial incentive from doing so.

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