Capitalism, Goldman, and Corruption


The capitalist system is supposed to generate value. Let’s go through the latest Goldman activity resulting in the SEC complaint. Someone named Paulson pays Goldman Sachs $15 million to develop and market a financial instrument that Paulson wants to fail. Goldman gets ACA (we will soon hear a lot more about ACA) to make Paulson’s package more marketable. Goldman sells it, knowing it was designed to fail. In the meantime, Paulson gets someone to insure the package for himself. The SEC indicts Goldman for fraud for not informing potential buyers of Paulson’s involvement and intentions. The instrument loses all value. The buyers lose $1 billion and Paulson makes $1 billion. In the near future, there will probably more legal activity as the buyers sue Goldman for fraud.

What is wrong with this picture? The capitalist system is supposed to produce value. Where is the value in this sad set of actions? There is absolutely none.

And look at the reward to Paulson for not creating value. Looking forward, could lawyers come up with anything potentially more lucrative than this event?

Goldman and Corruption

In the above case, Goldman was indicted for breaking the law. Let me recount an earlier event in which no law was broken that appears to be corruption on a grand scale (much of what follows comes from reports by Gretchen Morgenson, the excellent New York Times writer).

  1. In 1987, AIG launches a new unit in London called AIG Financial Products, or AIGFP. Operating as a semi-autonomous unit, it started insuring asset-backed securities (see Morgenson report). It became a very profitable business: it amounted to more than 17% of AIG’s operating income in 2005. Goldman was a major client of the office.
  2. On July 10, 2006, Henry Paulson (no relation to the afore-mentioned Paulson) left his job as CEO of Goldman and became US Treasury Secretary.
  3. Summer, 2008 –the global market for asset backed securities starts drying up, big banks reluctant to lend to each other – The Global Credit Freeze Starts. And AIGFP is overwhelmed by insurance claims.
  4. In mid-September 2008, Treasury Secretary Paulson, Geithner, then head of the Federal Reserve Bank of New York (FRBNY) met with senior executives of AIG and the Bank’s headquarters in New York. The only outsider in that meeting was Lloyd Blankfein who replaced Paulson as CEO of Goldman Sachs.
  5. As I reported, Goldman had a large stake in AIG’s survival: an insurance claim for guaranteed asset-backed securities of almost $13 billion.
  6. That meeting resulted in an $85 billion credit line from the FRBNY Fed later in September 2008. Why the FRBNY and not TARP? The FRBNY had to be used because TARP was not enacted until October 3, 2008. AIG later got $40 billion from TARP on November 25.

Ultimately, the government pledged $182 billion to save AIG.

In the October-November 2008 period, claims against AIG mounted. Inasmuch as AIG was effectively insolvent without massive government backing, the AIG staff believed it could settle claims at 60 cents on the dollar and were prepared to move ahead on that basis.

But then, two things happened:

  • The FRBNY instructed AIG to pay off claims in full;
  • The FRBNY did everything it could to keep the names of who was getting paid off out of the AIG reports to the SEC. It hoped the SEC would accept a total amount paid without the names of who got paid. (Bloomberg did an excellent job following this story see their report here.)

The SEC did not accept the report submitted by AIG without the names and amounts paid. On December 30, 2008, Jeffrey P. Riedler, Assistant Director of the SEC, send a letter to AIG requesting the details on who got paid.

The e-mails reveal considerable efforts of the part of the government advisors and their lawyers to keep payment details private. They were able to keep the details from being released until March 15, 2009.

The following table details who got paid what from AIG (billions of US$):

  Securities Direct Maiden  
Recipient Lending Support Lane Total
Goldman Sachs 4.8 2.5 5.6 12.9
Societe General 0.9 4.1 6.9 11.9
Deutsche Bank 6.4 2.6 2.8 11.8
Barclays 7.0 7.0
Merrill Lynch 1.9 1.8 3.1 6.8
Bank of America 4.5 0.2 0.5 5.2
UBS 1.7 0.8 2.5 5.0
BNP Paribus 4.9 4.9
HSBC 3.3 0.2 3.5
Citigroup 2.3 2.3
Calyon 1.1 1.2 2.3
Dresdner Kleinwort 2.2 2.2
ING 1.5 1.5
Wachovia 0.7 0.8 1.5
Barclays 0.9 0.6 1.5
Morgan Stanley 1.0 0.2 1.2
Bank of Montreal 0.2 0.9 1.1
Rabobank 0.5 0.3 0.8
Royal Bank of Scotland 0.2 0.5 0.7
DZ Bank 0.7 0.7
AIG International Inc. 0.6 0.6
KFW 0.5 0.5
Credit Suisse 0.4 0.4
JP Morgan 0.4 0.4
Banco Santander 0.3 0.3
Reconstruction Finance Co. 0.2 0.2
Paloma Securities 0.2 0.2
Citadel 0.2 0.2
Other 4.1 1.5 5.6
Total 43.6 22.2 27.2 93.0


As I reported, Goldman was one of the banks that got paid in full: $12.9 billion.

Analysis – My Interpretation

What was going on here? The FRBNY did not act on its own. Henry Paulson was in charge.

Why pay off the banks in full? It could be argued that Paulson feared a collapse of the entire banking system if they did not receive the full amount they were owed. This does not hold up. Goldman and other recipients said they would have survived if they got less.

Paulson’s ties with Goldman remained tight even after he became Treasury Secretary. Remember, Lloyd Blankfein who replaced Paulson as head of Goldman, was the only non-governmental official in the initial meeting with AIG. Goldman wanted to get its money back from AIG. And it wanted to get it all back.

Why try to keep the payments secret? From e-mails obtained by Congressman Issa, it is certainly clear that the FRBNY staff and its attorneys did everything they could to keep this information secret. You only attempt a cover up like this if you feel you are doing something wrong.

In short, the banks, lead by Goldman, wanted to get paid in full. They did, and that will probably end up costing the American taxpayer $93 billion rather than the $55.8 billion it would have cost if AIG had been allowed to negotiate settlements at 60 cents on the dollar.

Legal corruption on a grand scale? Are the American people being represented in DC? Certainly the banks are. According to Open Secrets, the finance, insurance and real estate sector spent $459 million on Washington lobbying in 2008. In 2008, Goldman spent $3.4 million lobbying in DC and $5.9 million in campaign contributions.

The content above was saved on the old Morss Global Finance website, just in case anyone was looking for it (with the help of
This entry was posted in Global Economics, Global Finance. Bookmark the permalink.