1 Goldman Sachs: Sustaining the Franchise1 In mid-April 2010, the US Securities and Exchange Commission accused Goldman Sachs of civil fraud during the financial crisis, alleging that the firm had failed to disclose to clients serious conflicts of interest and violation of its fiduciary obligations in the sale of a Collateralized Debt Obligation (CDO) called ?Abacus.? On the news, Goldman shares slid by 12.8 percent within a few hours, closing at $160.70 and representing a fall of over $12 billion in the firm?s market value. Within two weeks, the stock was down 21 percent and had lost nearly $21 billion in market value (Figure 1). A few months later, Goldman Sachs agreed to pay $550 million in fines and penalties to the Securities and Exchange Commission, one of the largest ever paid by a Wall Street firm, to settle charges of securities fraud linked to mortgage investments. Under the terms of the deal, Goldman paid $300 million in fines to the Treasury Department and $250 million in restitution to investors in the Abacus deal, without admitting to wrongdoing. Goldman did admit that its marketing materials for the investment ?contained incomplete information.? The firm also agreed to change several business practices, including the way it developed marketing materials for complex mortgage-related securities and the way it educated employees in that part of its business. The monetary settlement was small compared to the firm?s reported $39 billion in revenues and $8.35 billion net income for 2010. A civil fraud settlement was one thing. An indictment on a criminal charge was quite another. With persistent public and political resentment of the role banks and bankers played in the global financial crisis – yet ?nobody went to jail? and contrition was virtually non-existent – it was only a matter of time before pressure to bring criminal charges materialized. If laws were in fact broken and people or financial firms knowingly broke the law, the public expected criminal charges to be filed. Goldman was a prime target for a Department of Justice criminal probe. But evidence ?beyond a reasonable doubt? and ?mens rea? (intent to commit) had to be met in order for a grand jury to indict and for a criminal jury to convict ? an extraordinary high set of standards. ÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿ 1 Teaching case written by Professor Ingo Walter, Stern School of Business, New York University, assisted by Sohail Rana, New York University Abu Dhabi. Based exclusively on public information. For classroom use only. Copyright ? 2012 New York University. Beta version 30 August 2012. 2 Despite the political pressure, the US Department of Justice decided not to criminally charge Goldman or any of its employees with a criminal offense. This followed a high-profile investigation of the bank?s subprime mortgage deals – including the ?Abacus? transaction – based on information provided in an April 2011 US Senate report. In August 2012 the Department of Justice concluded that (based on the law and evidence as they existed at the time) there was no viable basis to bring criminal prosecution against the firm. Goldman responded ??we are pleased that this matter is behind us.? Nevertheless, Senator Carl Levin, who commissioned the 2011 report, commented that ?Goldman?s actions did immense harm to its clients, and helped create a financial crisis that nearly plunged us into a second Great Depression?. Whether the decision by the Department of Justice is the product of weak laws or weak enforcement, Goldman Sachs? actions were deceptive and immoral.?2 He promised unrelenting regulatory pressure on Goldman and its competitors. With a stellar track record, highly talented employees, close relationships with policymakers and regulators, and a peerless franchise with clients, Goldman had long been a leader in global investment banking. The firm claimed a unique risk management culture that seemed to execute superbly during the global financial crisis, outperforming most competitors under severe stress conditions and coming out of the episode firing on all cylinders. In the process, Goldman was forced to convert to a bank holding company and thereby accept tighter regulatory burdens in order to obtain access to Federal Reserve financing as financial markets melted down following the failure of competitor Lehman Brothers. The Heritage Goldman Sachs was founded in New York in 1869 by Marcus Goldman, a German immigrant. The firm adopted the name Goldman Sachs Co. after Goldman?s son-in-law, Samuel Sachs, joined the firm in 1882. From the start, the business was organized as a partnership, with all key decisions and commitments undertaken by the firm?s partners. Ownership and management were one and the same. The partnership mindset came to define the firm?s culture, and persisted over the ensuing decades more durably than any of its investment banking competitors, all of which likewise started as partnerships. The early Goldman Sachs partnership was both resourceful and innovative. It was one of the first firms to introduce the use of commercial paper to raise funds for corporations in the 1890s, giving clients an alternative to bank credit lines. The firm was invited to join the New York Stock Exchange (NYSE) in 1896. It was a player in establishing the initial public offering (IPO) market in the early 20th century, and in 1906 ÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿÿ 2 http://www.politico.com/news/stories/0812/79566.html 3 managed one of the largest IPOs for Sears, Roebuck and Company. There were misses as well as hits along the way. In the early 1920s Goldman established a closedend fund, Goldman Sachs Trading Corp, which collapsed in the Stock market crash of 1929 and the Depression that followed in the 1930s, creating reputation problems that took time to overcome.. The Depression was a difficult period for Goldman Sachs, as it was for its Wall Street competitors. The volume of business was at a low ebb for close to a decade. It was during the worst of this period that the Goldman partners selected one of the firm?s most charismatic leaders, Sidney Weinberg, as senior partner in 1930. Weinberg shifted focus away from trading and toward investment banking ? raising capital and providing advisory services for corporate clients. Weinberg was a very social individual, and maintained contact with key people in the business and government communities. He effectively welded Goldman?s partnership culture to a corporate finance service culture. Client interests were the primary focus, and this long defined the Goldman Sachs approach to the business. Under his leadership, Goldman was lead advisor on the Ford Motor Company?s IPO in 1956, a major coup on Wall Street at the time, made possible by Weinberg?s contacts with the family of Henry Ford. Weinberg was also responsible for creating an investment research division and a municipal bond department, as well as establishing risk arbitrage as a distinct line of business. Weinberg?s eventual successor, Gus Levy, joined the firm in the 1950s as a securities trader. Levy was a pioneer in block trading, in which the firm risked a large amount of capital to provide trading clients with liquidity and effective low-cost execution by buying large blocks of securities at a fixed price and then selling them in the market, hopefully at a profit. Competitors were slower or more risk averse in adopting the practice, so Goldman was able to gain market share, notably with large institutional investors. As he rose through the firm, Levy was influential in gradually changing the profile of Goldman Sachs and the balance between its two powerful divisions, investment banking and securities trading. Levy took over from Weinberg as Goldman?s senior partner in 1969, and continued to build the firm?s trading franchise. He famously introduced the term ?longterm greedy? to the Goldman vocabulary – denoting a focus on making money in the long term while helping clients meet their objectives. Short-term trading losses happened from time to time, but were to be tolerated as a cost of doing business. Goldman partners reinvested almost all of their earnings in the firm, except for a ?draw? needed to live a reasonable lifestyle, and the focus was firmly on the future and 4 not the present. In a sense, the firm was married to its clients and the partners were married to the firm, in what became an uncommonly successful business model. Like its competitors, Goldman suffered a financial setback in 1970, when Penn Central Transportation Company went bankrupt with over $80 million in commercial paper outstanding, much of which had been underwritten by Goldman Sachs. In the face of large investor losses, Goldman was forced to mount a sustained defense of its due diligence practices and underwriting standards, and rebuild its reputation with investors. Like its American rivals, Goldman Sachs had plenty of business opportunities in the US domestic market during the high-growth 1950s and 1960s, having been protected in the securities business by the Glass-Steagall provisions of the Banking Act of 1933, which kept out the large commercial banks with much bigger balance sheets and much larger capital-bases. At the same time, especially in the 1970s, new opportunities were emerging in Europe, Japan and elsewhere that offered US investment banks a chance to migrate their financial know-how into markets mainly dominated by big local universal banks. Most of these banks were extremely entrenched, with close connections to industry and resistant to importing disruptive new ideas that could threaten their long-standing business models. So creating a viable competitive footprint abroad was a long slog for the American investment banks, but one with a potentially massive payoff as companies and markets globalized. Goldman opened its first international office in London in 1970, creating a private wealth division along with a fixed income division in 1972. In the market for corporate restructuring in the US and abroad, Goldman tended to focus on the defense ? adviser to the target ? both because fees were highly likely to get paid and because conflicts associated with hostile takeovers could be avoided. This was important for the firm with the most impressive client list in the industry. Goldman famously created a ?white knight? strategy in 1974 during its defense of Electric Storage Battery against a hostile takeover bid from International Nickel (advised by rival Morgan Stanley) an innovation that burnished the firm?s advisory reputation. Two capable partners led the firm at the time – John L. Weinberg (son of Sidney Weinberg) and John C. Whitehead. Both were named co-senior partners in 1976. With Weinberg?s trading background and Whitehead?s leadership in corporate finance, this arrangement avoided internecine battles for power across divisions and set a pattern of co-leadership that was to last for some time. Weinberg and Whitehead defined much of the culture of Goldman Sachs, including the firm?s 14 business principles (see Annex 1). 5 With corporate finance earnings under pressure during the recession of the early 1980s, Goldman once again ramped-up its reliance on trading. In 1981 the firm acquired J. Aron & Company, a commodities trading business that merged with Goldman?s fixed income division to create Fixed Income, Currencies, and Commodities (FICC). The Aron acquisition also spawned important Goldman Sachs leaders in later years. Business in the 1980s was good. Goldman underwrote the largest REIT offering in history for Rockefeller Center. Deals like Microsoft?s IPO, major advisory assignments for GE and admission to the Tokyo Stock Exchange had propelled Goldman Sachs to the top echelons of the investment banking league tables by the late 1980s.The firm launched a lucrative privatization practice as Margaret Thatcher privatized whole sectors in the UK, German reunification brought sell-offs of state-owned enterprises to East Germany, and various governments in continental Europe and emerging markets followed suit. There was plenty to privatize, and Goldman Sachs got more than its share of the advisory work. To help rebalance the firm on the buy-side of the market Goldman Sachs Asset Management was formed in 1986 to manage in-house mutual funds and hedge funds offered to clients. Continuing under a dual leadership structure, Robert Rubin and Stephen Friedman became co-senior partners in 1990, and built on the firm?s string of successes and innovations. For example, Goldman introduced paperless trading to the NYSE, and lead-managed the first global debt offering by a US corporation. It launched the Goldman Sachs commodity index (GSCI) and opened a Beijing office in 1994. Mexico?s $20 billion bailout during the Tequila Crisis with the involvement of Robert Rubin stopped-out significant potential losses for Goldman, although the Fed?s abrupt turn in 1994 toward a much tighter monetary policy wreaked havoc on the firm?s fixed income portfolio and left partners to take large losses in their capital accounts. Accustomed to consistently growing personal wealth intended to be harvested at retirement, many Goldman partners were shocked by the losses they had to bear, even if only temporarily. Jon Corzine assumed sole leadership of Goldman Sachs in 1994 with Robert Rubin?s move to the US Treasury and Stephen Friedman?s effective retirement. The collapse of Long Term Capital Management and the financial crisis of 1998 posed significant but not cataclysmic challenges for the securities industry, and Goldman weathered them better than most others. The IPO For years the Goldman Sachs partners periodically debated the pros and cons of going public. All of its major competitors had already taken the decision to go public, 6 notably Morgan Stanley, Merrill Lynch and Lehman Brothers, leaving Goldman Sachs as the last partnership holdout. Several points seemed to argue in favor of going public: ? Partners could finally cash-out in what looked to be a favorable market for financial stocks, instead of remaining locked-in until retirement and subject to a five-year withdrawal schedule. Diversification made sense for partners? wealth, and an IPO would make this possible. ? Glass-Steagall repeal in 1999 allowed the model of universal banking to be introduced into the United States and ended the protected status of the fullservice investment banks. The big commercial banks were already entering investment banking aggressively using their enormous balance sheets, which was likely to produce erosion of margins and force greater use of leverage. ? Failure of LTCM and the earlier bond losses left many partners concerned about the value of the firm?s capital account in the case of any future financial crisis. In extremis, and given their limited wealth diversification and partnership liability, they could be wiped-out financially. As shareholders in a listed company, their losses would be limited to the value of the stock. ? The partnership form constrained Goldman?s strategic alternatives, since any acquisitions would have to be paid for in cash as opposed to shares as a form of acquisition currency. ? Since Goldman as a partnership could not be acquired by another firm, it was not ?contestable,? which could place a lid on the value of the company in the market for corporate control. Arrayed against these arguments were a number of points, strongly defended by some of the partners, that going public even at attractive valuations would be the wrong thing to do. ? Loss of control by the partners. Even with limited distribution of IPO shares to friendly hands, former partners and other senior executives were unlikely to retain their dominant role in shaping the firm going forward. ? As a public company, Goldman could be slower to respond to challenges and opportunities, possibly a critical issue in a fast moving business like investment banking. 7 ? With the public disclosure requirements of a listed company, the competitive freedom allowed by financial and operational confidentiality could be lost, while the cost of regulatory requirement would certainly rise. ? As a public company whose key people were no longer ?married to the firm,? a key element of Goldman?s culture would eventually dissipate, including the firm?s fierce loyalty to its clients. An extraordinary firm would soon become an ordinary firm, losing much of its distinctiveness. After rounds of sometimes bitter debate, on May 4th 1999 Goldman Sachs gave up the partnership form of organization and went public. The IPO raised $3.6 billion, the second largest IPO in US history at that time. The stock issue was offered at $53 per share, and was fully subscribed. This put Goldman?s market capitalization at $33 billion. The first shares to be traded at the secondary market sold at $76 and the stock reached a first-day high of $77 before closing at $70.37. For 133 years, Goldman Sachs had been owned and managed by its partners. Following the IPO there were 221 ?managing partners,? the top echelon of executives with profit participation rights. They retained 48.3% of the outstanding shares, while 8.5% went to retired partners and 21.2% went to non-partner employees. Two investors in Goldman?s subordinated debt, Sumitomo Bank of Japan and the Kamehameha Activities Association of Hawaii received 9.4% of the shares. So only 12.6% was sold to the general public in the IPO, and most were sold to clients, primarily loyal and wealthy customers. No shares were allocated to the syndicate managing the IPO and hence the general public. Leadership of the newly public company was vested in Henry Paulson, a strong advocate of the IPO and instrumental in ousting his predecessor, Jon Corzine, after bruising policy disagreements. Paulson reverted to the classic Goldman ?long-term greedy? view of the conduct of business and focused on The Weinberg-Whitehead?s 14 basic business principles. Still, not long after its own IPO in 1999 Goldman Sachs became enmeshed in an industry-wide scandal involving biased research and underwriting practices during the dot-com bubble. With one of the largest IPO market shares, Goldman had underwritten 56 new tech issues in 1998-1999. Of these, 40% fell below their offering price shortly after issuance and some soon lost as much as 75%. All had been touted as ?strong buys? by the firm?s analysts, who faced the impossible task of providing unbiased opinions to investors while at the same time under pressure to help move the paper for IPO clients who paid the bills. Again, Goldman was not unique in facing this conflict. Aggressive legal action was brought against the investment banks by New York State 8 Attorney General Elliott Spitzer, leading to a civil settlement of $1.435 billion against the securities industry, of which Goldman Sachs paid $110 million. Building-out the Firm Potholes aside, a key motivation for the IPO has been to allow Goldman Sachs to expand its business platform across high-potential clients, financial products and techniques, and geographies, calibrated to take optimum advantage of the firm?s evolving competitive capabilities. Trading for clients (market making) and for its own book (proprietary trading) had seen large profits prior to 1999, amplified by the earlier acquisition of J. Aron in 1981. The IPO was a way to raise the capital to further expand trading, and this once again refocused the firm?s balance towards trading and positioning and away from corporate finance and advisory work and institutional asset management. Increasingly, Goldman served as both principal and agent in its evolving competitive profile, with its agency role in the ?flow? businesses for major clients providing a useful information edge for its proprietary trading business. Goldman made three additional acquisitions designed to support trading. One was the July 1999 $531 million purchase of the Hull Group Inc., a leading electronic trading company. This signaled Goldman?s view that profitable trading growth would increasingly require electronic, high-frequency, algorithm-driven platforms. In 2001 Goldman acquired the specialist assets of TFM Investment Group, LLC, a leading options specialist firm. And in 2000 Goldman purchased the NYSE market-maker Spear Leeds & Kellogg LP for $6.5 billion in stock and cash. To compete in the evolving trading environment with the investment banking divisions of the massive US and foreign financial conglomerates like Citigroup, UBS and Deutsche Bank, a much larger balance sheet and increased leverage would be needed. One option was to merge with J.P.Morgan & Co. – itself the product of Chase Manhattan?s acquisition of the legacy J.P. Morgan in 2000 – which was working to build its own investment banking and trading capability, sometimes with mixed success. Some considered this a match made in heaven, and Goldman looked set to join with Morgan in 2003. The deal never happened, reportedly due in part to reservations of CEO Henry Paulson. In an effort to ?rent? a large balance sheet, Goldman instead created a strategic alliance with Sumitomo of Japan. This facilitated a market positioning for Goldman that combined agency functions for clients with an active capital-intensive proprietary trading and investment book of its own. In 2006 Henry Paulson was named US Secretary of the Treasury by President George W. Bush and was succeeded by Lloyd Blankfein, who had joined the firm with the highly successful acquisition of J. Aron some 25 years earlier. Blankfein was 9 supportive of a workable balance between agency business, trading and principal investing that had earlier originated with Friedman and Rubin and gathered force with Paulson. Under both leaders the persistent swing toward trading as a source of earnings continued, as against investment banking and asset management, to the point that uncharitable observers sometimes characterized Goldman Sachs as ?a hedge fund with some investment banking activities attached.? Nevertheless, investors were amply rewarded by Goldman?s impressive stock price performance in the mid 2000s (see Exhibit 1). Surviving the Financial Crisis Unlike most of its competitors, Goldman Sachs was able to profit from the collapse in subprime mortgage securities and their derivatives in the spring and summer of 2007 by shorting the impacted asset classes. Adroit risk management on the part of the firm and its CFO, David Viniar, together with two Goldman traders, Michael Swenson and Josh Birnbaum, was credited with this success. Goldman had turned in a gain of $4 billion by betting on the market?s collapse while others, including some of its competitors and its own clients, held disastrous long positions which then had to be written down ? a difficult exercise in the absence of a viable secondary market for the toxic assets. Goldman?s performance during the onset of the global financial crisis was widely celebrated in the media, although it did not come without collateral damage. As losses of financial intermediaries and institutional investors mounted in the second half of 2007 and into 2008, it became increasingly difficult for firms to profit from the market turbulence, conditions that worsened dramatically after the collapse of Lehman Brothers in September 2008 in a Chapter 11 bankruptcy filing. Mortally wounded, Merrill Lynch was soon taken over by Bank of America in a controversial transaction. With two independent investment banks gone, that left Goldman Sachs and Morgan Stanley still standing. On September 21, 2008, both firms confirmed that they would convert to traditional bank holding companies in order to obtain access to the Federal Reserve for liquidity, and both ultimately obtained funding under the government?s Troubled Asset Relief Program (TARP) program for injecting taxpayer capital into banks. This brought an end to 75 years of independent investment banks on Wall Street. Goldman Sachs received a $10 billion TARP investment of preferred stock from the U.S. Treasury in October 2008. All of its US competitors were likewise forced to accept TARP funds, although Goldman and its wholesale banking competitors needed hefty doses of additional private capital to stabilize the firms and the system as a whole. Various options were available, but all were expensive. Goldman Sachs turned to Warren Buffet and Berkshire Hathaway. On September 23, 2008, Berkshire agreed to purchase $5 billion of Goldman preferred stock paying 10% interest, accompanied by 10 warrants to buy another $5 billion of Goldman’s common stock exercisable over a fiveyear term. In June 2009 ,Goldman Sachs repaid the government?s TARP investment with 23% interest (in the form of $318 million in preferred dividend payments and $1.418 billion in warrant redemptions). The US TARP exercise was highly unpopular politically and remained so for years, perceived as taxpayers wallowing in the deepest and longest recession in memory bailing out the ?fat cats? of Wall Street ? socializing risk and privatizing returns. Goldman Sachs did not help build the banks? political credibility by rewarding 953 employees more than $1million each immediately after receiving its share of TARP funds, followed by announcements of impressive earnings rebounds and a year later. Meanwhile, Goldman took a hard media line that it had not in fact needed any government bailout at all. But given the possibility of a global financial melt-down, this argument struck most people as disingenuous. Besides Treasury capital injections, the Federal Reserve in 2008 introduced a number of short-term credit and liquidity facilities to help stabilize financial markets and institutions. Some of the transactions under these facilities provided liquidity to banks whose failure could have severely stressed an already fragile financial system. Goldman Sachs was one of the heaviest users of the Fed?s loan facilities, with large borrowings between March 18, 2008 and April 22, 2009. The Primary Dealer Credit Facility (PDCF), the first Federal Reserve facility ever to provide overnight loans to investment banks, lent Goldman Sachs a total of $589 billion against collateral such as corporate debt instruments and mortgage-backed securities. The Term Securities Lending Facility (TSLF) additionally allowed primary dealers to borrow liquid Treasury securities for one month in exchange for less liquid collateral. TSLF lent Goldman Sachs a total of $193 billion during this period. In all, Goldman Sachs’s borrowings from the Federal Reserve totaled $782 billion in 2008 and 2009. All loans were fully repaid and the collateral returned. Sustaining a Hard-Earned Reputation Prior to its IPO, Goldman Sachs was revered as a firm with an overriding fiduciary focus on clients. Ownership and management were the same, and the firm could afford possible short-term costs to reap the benefits of long-term relationships. The IPO seemed to shift the goalposts, elevating the importance of fiduciary obligations to public shareholders on the part of management and the board ? at a time when Goldman increasingly served as both principal and agent as a key element of its competitive strategy. Combined with the aggressive push of commercial banks into investment banking, technology advances in financial products and processes, and financial 11 globalization, the likelihood of conflicts of interest increased accordingly. The issue was not whether conflicts of interest existed in the Goldman business model. They did. The issue was how conflicts of interest could be managed in ways that safeguarded the Goldman core franchise. Risk governance rose ? or should have risen ? to the top of the agenda in a politically-charged post-crisis environment that was unlikely to spend a great deal of time listening to excuses for future slip-ups. Unfairly or not, Goldman Sachs was the target of a range of allegations across a number of its business lines which seemed to call into question regarding the firm?s overall business model and its market conduct. Regulatory capture. Numerous Goldman Sachs partners and employees served in the US government, and vice versa, in a relatively uncontroversial combination of public service and business motivations. But Goldman?s uncommon success in navigating the financial turbulence of 2008 and 2009 generated much criticism of an alleged revolving door in which Goldman employees and consultants moved in and out of high government positions. Critics suggested a troubling potential for conflicts of interest involving three axes at once – Goldman?s interest, clients? interests and the public interest. See Exhibits 2 and 3. Treasury Secretary Paulson had been CEO of Goldman, as had former Treasury Secretary Robert Rubin. The firm?s lobbyist Mark Patterson served as chief of staff to Treasury Secretary Timothy Geithner. Stephen Friedman, a former senior Goldman partner, was named Chairman of the Federal Reserve Bank of New York in January 2008, although he continued to own Goldman stock and was a member of the board. Former Goldman partner William Dudley became President of the Federal Reserve Bank of New York. Goldman’s conversion from a securities firm to a bank holding company meant that its primary regulator was now the Fed and not the SEC. Former Goldman partner Gary Gensler became head of the Commodities Futures Trading Commission (CFTC), a key financial regulator. In Europe as in the United States, commentators noted the close relationship between Goldman Sachs and government officials in many countries as well as the EU and Eurozone levels. Examples included Lucas Papademos, Greece’s prime minister, who was in charge of the Greek central bank when a swap deal with Goldman Sachs allowed Greece to hide public debt, while Petros Christodoulou, head of Greece’s debt management agency, began his career at Goldman Sachs. Mario Monti, Italy’s prime minister and finance minister, was an international adviser to Goldman Sachs, and Mario Draghi, head of the European Central Bank, was formerly Managing Director of Goldman Sachs International. Ant¢nio Borges, former head of the IMF’s European Department, served as vice chairman of Goldman Sachs International. Peter Sutherland, former Attorney General of Ireland and head of the World Trade 12 Organization, was a non-executive director of Goldman Sachs International. Karel van Miert, former EU Competition Commissioner was an ex-international adviser to Goldman Sachs. With a reported gross exposure of some $33.6 billion to Portugal, Italy, Ireland, Greece and Spain in mid-2012, peerless European contacts couldn?t hurt. Goldman?s tradition seemed to encourage successful employees to ?give back? in the form of public service, and Goldman offered uncommonly remunerative career opportunities to former public employees. Nothing suggested exploitation of conflicts of interest, but when assembled as a montage by industry critics suggesting hijacking of public policy, there was plenty of raw meat. Optics matter. Nor did it help that CEO Lloyd Blankfein once reportedly described conditioning the public policy environment as ?our seventh line of business.? Doing well in the AIG bailout. American International Group (AIG) was famously rescued by the US Treasury and Federal Reserve in September 2008. AIG was heavily exposed to credit default swaps (CDSs) linked to mortgage-related securities through an affiliate of the AIG holding company, AIG Financial Products (AIGFP) in London. The AIG holding company itself was lightly regulated by the US Office of Thrift Supervision. Although AIG?s insurance business remained sound – regulated by the New York State Insurance Department – the impending collapse of the holding company was deemed to threaten the financial system. Counterparties of CDSs written by AIG successively demanded additional capital to secure their interests. Absent sufficient capital, the Federal Reserve initially lent AIG $85 billion to stay afloat. To the extent the banks avoided haircuts on their AIG CDS exposures, the Fed was indirectly supporting the banks by bailing-out AIG. US and foreign banks received billions during the unwinding of AIG credit default swap contracts including $12.9 billion from funds provided by the US Federal Reserve.3 See Exhibit 4. This triggered considerable controversy in the media and among politicians as to whether counterparty banks benefited excessively from the massive bailout, and whether they had been overpaid. In a looming
