Friday, March 20, 2009

Preliminary Goldman Call Observations

In a nutshell - Goldman had bought billions in AIG CDS in the 2004 to 2006 timeframe. Whether this was predicated by their expectation that subprime would blow up, or their very early understanding just how bad things at AIG were, one will never know, especially not the SEC. However, one look at the CDS chart below shows what prevailing levels for AIG's CDS was in that time frame. As one can see, AIG 5 yr CDS traded in a range of 4 bps to 52.50 bps between October 1, 2004 (only goes back so far) and December 31, 2006. Indicatively 5 yr CDS closed yesterday at a comparable running spread equivalent of 1,942 bps.



Purchasing $10 billion in CDS (roughly in line with what Viniar claims happened) at a hypothetical average price of 25 bps (and realistically much less than that) and rolling that would imply that at today's AIG 5 yr CDS price of 1,942 bps, the company made roughly $4.7 billion in profit from shorting AIG alone! This would more than make up for the $2.5 billion collateral shortfall (out of $4.4 billion total) GS claims AIG had with Goldman Sachs... If AIG had filed for bankruptcy, and assuming Lehman is any indication, the P&L would have likely hit $6+ billion.



Implicitly, one could say GS was incentivized to see AIG fail. Does that maybe answer some of the questions of why GS allegedly pulled AIG's collateral and started the avalanche that lead to its bailout? However, a fine point - if AIG had really tanked none of the CDS would be collectible as the entire CDS market would have likely imploded... Thus demonstrating the need for a zombie bank system: not totally dead (systemic collapse) but barely alive to pocket a nice little CDS annuity from daily cash collateral posts as it leaks wider (and taxpayers foot the bill).

Full preliminary conference call transcript here.

Disclosure: Zero Hedge has no position in any Goldman Sachs securities. Sphere: Related Content
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21 comments:

Anonymous said...

hedging counterparty risk?

Anonymous said...

ok, so if goldman is net short AIG, someone else must be net long AIG and headed for a huge hit if AIG has a 'credit event'.

Tyler Durden said...

unless AIG sold GS AIG CDS

Anonymous said...

yes i was thinking of that when i was typing

Anonymous said...

but hey, this way they get to keep the collateral from AIG and get paid some more when AIG finally defaults

vk said...

I listened to the call. Out of the $10B, $7.5B had collateral against it and only the rest ($2.5B) was hedged by CDS.

I also very much doubt that all the hedges were placed in 2007 - it must have been a fraction at that time and must have increased in Fall '08.

Tyler Durden said...

Don't forget there was $20 billion in gross CDS notional outstanding which from GS's POV was a one way short street. And DV said the bulk was put on in 2004-2006

Anonymous said...

"$2.5 billion collateral shortfall (out of $4.4 billion total) GS claims AIG had with Goldman Sachs... If AIG had filed for bankruptcy, and assuming Lehman is any indication, the P&L would have likely hit $6+ billion"

viniar said those profits were negated by the widening b/a spread on other hedges they took out.

vk said...

"Don't forget there was $20 billion in gross CDS notional "

When was that mentioned? I don't think DV mentioned the hedge notional that they had on - all he said was that $2.5B was hedged.

Are you referring to the initial clarification of the Llyod Blankfein $20B number that was clarified as GS "notional" exposure to AIG?

But What do I Know? said...

Thanks for putting that out there in terms even a Congressman could understand (alright, not all of them). Goldman wanted to suck out AIG's lifeblood but didn't want them dead--is there a movie or a book in there? :>)

They're getting closer--time to distract the masses with something else. . .

El Rider said...

This reminds me of a story I once heard about the Hunt brothers silver debacle. Because the Hunt's futures margins were so large (mostly with Bache as I recall) they borrowed money from a large Chicago futures trader (he owned an FCM) who later started to sell silver futures on a scale-up basis over $40 per oz.

When silver went over $50 per oz. the trader in question was feeling some pain so he called the loan leaving liquidation as the only way for the Hunts to obtain funds, they already owned 1 1/2 years usage of the metal. The liquidation collapsed the market and the trader in question cleaned up on his scale-up sales. The silver market has yet to return to those lofty levels.

Anonymous said...

this math fails to recognize the declining value of the hedge. These were put on in 04 (at best) and have little time left. Your calculation just measures how out of the money a current, 5-year maturity CDS would cost if your carry costs were 25bps instead of the current market carry cost of 1942 bps

Anonymous said...

What are the odds that someone(s) at GS was shorting AIG all the way down...........

Tyler Durden said...

ergo why I assumed it rolled (and knowing GS traders it did). If the spread was 25 bps, the cost of the roll would have been about 1bp. They put it on at 25 and keep rolling until it exploded. the only real cost here is carry which at 25 bps on $10bn is 25mm a year, which for GS was peanuts as six sigma insurance.

Anonymous said...

tyler, forgive me for the stupid question, but a) how do you go from a current ~10bp spread to a "comparable running spread equivalent" of 1,942bp? and b) how does one figure the cost of the roll? you say 1bp for 25bp cost...not sure where the 1bp comes from

thanks so much man

Tyler said...

the 1,942 bps spread is how much protection would cost if you bought now... alternatively how much you would receive if you sold. Bberg's CDSW screen is the best calc for this. b) the standard 5 year CDS contract consists of 20 leftward shifting points (5 yrs times 4 qtrs). If you want to constantly have on the run 5 year protection you need to buy a little extra every quarter when the "roll occurs". For tight names like AIG was, the roll would cost roughly 25/20 every quarter. To be absolutely precide, it would likely be a little more due to the convexity of the standard upward sloping curve. for all standard queries i recommend this site: http://www.classiccmp.org/transputer/finengineer/

Anonymous said...

but the avg spread of 25bp that you talk about comes directly from the first graph; the value today, from that first graph, is 10bp - not 1,942. am i missing something?

Tyler Durden said...

note the ending date on the first chart. 10.5 was the price at Dec 31 2006. today's price is what is inputted on the cdsw screen: 1,942.

Anonymous said...

like i said, stupid question. i can't believe i missed the date.
thanks for replying anyway.
btw, your site beats anything out there by miles.

Anonymous said...

why would anyone sell anything for 4bp per year? that doesn't even pay for postage.

Anonymous said...

You are really missing the point here. The CDS (around 2.5bn) is used to hedge the counterparty risk. GS had bought protection from AIG on various trades, as markets blew up these were now heavily in the money. If AIG went down, GS would then lose out on all these trades, hence buys protection on AIG. They should be net flat MTM, as the value of their AIG hedges increase, while they have to mark down the value of the trades they have done with AIG (as their counterparty risk deteriorates).