Paulson’s Envelope

Fortunately my credit card banks are constantly sending me “important information” in envelopes that don’t have printing all over them.  Thus I have a steady supply when I want to do “back of the envelope” figuring.

But Hank Paulson needed a much larger envelope than a simple #10 when he was figuring what a collapse at AIG would do to the net worth of his former firm.   Not that he had to worry, because he got a “get out of jail free” card, and a special tax exemption, that let him sell his Goldman stock without paying $200 million in capital gains taxes back in 2006 when he took the job in the Bush Administration.

Like Goldman CEO’s before him, Paulson took the shuttle down to Washington and “served” the nation in a high political appointment beginning in 2006.  His large position in Goldman stock was put into a blind trust no doubt, and he was prohibited from trading it, given the policymaking role he had, and the highly sensitive non-public information he would see as Secretary of the Treasury.

Throughout September and October of 2008, Paulson spent every weekend putting together shotgun marriages among financial giants, setting new records for uncontrolled spending (together with Bernanke), and getting no sleep at all.

He even presented a three-page plan to take over the financial world with no legal liability.  I loved the section on judicial or administrative review:

Sec. 8. Review.

Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.

Goldman’s role in financial disasters and government intervention afterward is a long-established tradition.  Even JK Galbraith’s classic study of the panic that set off the Depression has a chapter with the title “In Goldman Sachs, We Trust”  (The Great Crash 1929).

When the Paulson-sponsored AIG bailout took down its first major pile of money, the fed wire was still warm when the transfers back out of AIG started those electrons going the other direction.  $12.9 billion ended up at Goldman, as a payment against a margin call on CDS that Goldman had bought from AIG.

It seems likely that at least some of those CDS were insurance against Goldman-arranged CDO deals like the Abacus series.  At the time, most of us in the business were horrified that the taxpayer was effectively paying off at 100 cents on the dollar on a gambling debt that the market probably thought was worth around a dime.

Today that value got confirmed when Ambac disclosed the terms of their settlement of CDS contracts tied to ABS CDOs.  Even though Ambac was arguably a company that was not as badly insolvent as AIG was last year, Ambac was able to convince their counterparties on over $5 billion in contracts to settle for just $520 million.

Applying similar ratios to the AIG CDS obligations would have resulted in nearly $100 billion less taken out of taxpayers’ hides by now, and, of course, far less lucre for the likes of Goldman, Deutsche and Calyon, three of the biggest recipients of the first round of CDS payouts.

Back to that envelope:

Goldman’s market cap at the end of today’s trading was $93.461 billion.  It sported a 1.6 price-to-book ratio using Q3 2009 book values, implying a $58.4 billion book value after the rally we’ve seen stocks and bonds this year.  $12.9 billion is still 22% of that capital base.  So, on my envelope, I see a rough estimate that 20% of Goldman’s capital was a pure gift from the taxpayers, arranged by Hank Paulson.  At least that’s how much my estimate is for the overpayments above what a normal market would have accepted.

Last year’s envelope (the one I imagine Paulson really looking at)  had  smaller numbers, with book value hovering around $98 a share, and 456 million shares outstanding, even after that $12.9 billion transfer.  Capital as of last November was $44.7 billion.  No doubt that $12.9 billion extra saved the day, and the year, at 85 Broad.

If the credit default swaps weren’t paid in full, Goldman would have a major hole in its balance sheet.  They might even have to cut paychecks.  Imagine not being able to pay out the full $16.7 billion they’ve set aside for compensation in the first three quarters this year.

Since I don’t believe they pay their administrative assistants and back office clerks anything remotely resembling the $700,000 per employee that they have budgeted, my guess is that “normal” pennies-on-the-dollar payout on those ill-fated AIG CDS might have knocked down the senior people’s pay from $2 million for 2009 down to $1 million (or $20 down to $10 for the superstars).

Even at that they would doing far better than the ordinary employees of AIG’s regular insurance businesses or Lehman and Bear’s brokerages that are now looking for jobs.

Hey, let’s look at the bright side:  without those nasty competitors in the business, Goldman can really make some serious money in the CDS business.  The Zero Hedge trader’s blog that looked at the recent Goldman report was quite upbeat about the profit potential.

hh

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3 Responses to Paulson’s Envelope

  1. SRG says:

    The margin calls paid off at 100% on the dollar are one issue , another issue I don’t hear much about is what would have happened to GS and their hedges on with AIG if AIG did go under. Goldman had hedged billions of their credit risk with AIG via swaps. If AIG went under, suddenly GS’s hedges are ineffective. Oh sure they could have kept them on with a bankrupt AIG, but they would have effectively been been unsecured creditors for any add’l margin calls – in reality GS’s credit book would have been massively underhedged and in the environment that existed at that time GS would have never been able to replace them with other counterparties. When GS says they were fully collaterized vs AIG, they are not telling the full story.

    • hhill51 says:

      Give that man a kewpie doll!
      You have it exactly right. At the time I thought they were getting ten times what the market would pay, and now that Ambac got others to settle for 10 cents on the dollar, we have a data point that verifies that guess.
      If GS had gotten $1.3 billion (after months of haggling) vs. getting $12.9 billion immediately, their results for 2009 certainly would not have been as good. After all, the really serious payoff was from having cash when the world had a firesale.
      Much more likely they would have been sellers into the disaster, rather than buyers.

  2. JCH says:

    I am a non-financial person who is trying understand this issue. Hopefully somebody can help get a better grip on this. As I understand it, GS had was at risk for 14 billion dollars on the CDOs that ended up in Maiden Lane III. Prior to the Federal Reserve making a loan of 85 billion to the Federal Reserve, AIG had turned over 5.9 billion in collateral to GS. At that point GS realized AIG was/would be having problems producing 2.5 billion in additional collateral, so GS purchased a CDS for 2.5 billion to cover the shortfall. On the backstop CDS, GS had taken in 1.4 billion in collateral. So prior to the bailout, they had 7.3 billion in collateral and a CDO marked at 5.6 billion, and there was a 1.1 billion-dollar shortfall in collateral.

    After the Fed loaned AIG 85 billion, AIG sent GS the 2.5 billion. I assume at that time GS returned the 1.4 billion to the unknown CDS maker. So they had a 5.6 billion-dollar CDO (marked to market), and 8.4 billion in collateral from AIG – their 14 billion essentially covered.

    At that point the Fed purchased the GS CDO for 5.6 billion to stop the collateral calls on AIG, which was then fully funded and would have been able to continue making its collateral commitments on their CDS agreements.

    So in other words, had the Fed not purchased the CDO, AIG would have had to produce collateral all the way down to your ten cents.

    How am I wrong? From an AIG not in bankruptcy, meaning a bailed-out AIG, they were going to get par no matter what. if AIG had gone into bankruptcy, they would have collected an additional 1.1 billion from the backstop CDS maker, and still have owned the CDO. From the Maiden Lane III financial statement, that CDO is still producing fairly significant income, which is being used to pay off the 25 billion loaned to Maiden Lane III.

    Also, on the 12.9 billion they got after the bailout, they returned assets – 4.8 billion in agency securities to AIG and they sent the CDOs to Maiden Lane III. What they got in 12.9 billion, was 2.5 billion in collateral, which they ended up keeping. They gave up 10.4 billion in assets and collateral.

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