Did Goldman gain AIG insight from Timberwolf?

The blow-up of a $1 billion subprime mortgage-linked security called Timberwolf 1 may have provided Goldman Sachs Group with an early clue about trouble to come at insurance giant American International Group.

It may be just coincidence, but there is some overlap between the underlying subprime-backed securities the Timberwolf deal tracked and some of the toxic collateralized debt obligations that AIG had guaranteed payment by writing credit default swaps.

Critics have long complained that Goldman unfairly benefited from the federal government's $180 billion bailout of AIG because it was a major trading partner of the insurer.

This week the Timberwolf transaction gained a degree of infamy when a U.S. Senate subcommittee investigating Goldman's role in the mortgage mess released an email in which a former executive summed up the transaction as "one shitty deal."

A review of the so-called reference portfolio for Timberwolf finds that 25 percent of the 56 securities supporting that Goldman-backed transaction are pieces of the same CDOs on which AIG had written guarantees.

AIG's inability to make good on the nearly $70 billion in guarantees it had written on portions of 178 CDOs held by Goldman and 15 other big banks led the federal government to put together a $180 bailout for the insurer in September 2008. As part of the bailout, the New York Federal Reserve negotiated deals with the banks that enabled it to move the rotting CDOs off AIG's books and into a new entity called Maiden Lane III.

Goldman was the underwriter and sole marketer of the Timberwolf deal, which lost 80 percent of its value within five months of its March 2007 closing. The so-called hybrid collateralized debt obligation was liquidated in early 2008, months before the U.S. government averted an AIG bankruptcy.

'Huge Red Flags'

Almost all of the underlying portfolio in the Timberwolf transaction were pieces of other CDOs issued in either 2005 and 2006, some of them underwritten by Goldman. Think of Timberwolf as the structured products version of a restaurant sampler, but this one containing slices of some of the worst CDOs.

The poor performance of those deals may have alerted Goldman early on that AIG was sitting on a soon-to-explode mountain of toxic subprime-backed debt, derivatives consultant Janet Tavakoli said.

"They had a huge red flag on deals that were protected by AIG," said Tavakoli, who has been an outspoken Goldman critic.

A person close to Goldman said the firm would not have been aware if other banks had purchased insurance from AIG on pieces of CDOs that were more senior to the ones Goldman put in the Timberwolf deal.

The investment firm previously has said it only was aware of the credit default swaps it had purchased from AIG.

Of the 178 troubled CDOs that AIG sold guarantees on, about 21 percent were on securities held by Goldman or one of its customers. Most of the 14 CDOs in the Timberwolf deals which are more junior to the ones insured by AIG were not among the list of securities Goldman had purchased guarantees on.

The AIG bailout, long controversial, effectively shifted tens of billions of dollars of taxpayer money to banks like Goldman, Societe General and Deutsche Bank.

In summer 2008, Goldman was one of the most aggressive banks in pushing AIG to post billions of dollars in cash as collateral as the value of the insured CDOs plummeted. In the bailout of AIG, Goldman received a $13 billion payout.

Greywolf Role

Goldman has said much of that money was then passed onto clients to settle related trades. Goldman also has said it hedged itself against AIG, implying the firm may have purchased credit default swaps, or insurance, on AIG's corporate debt.

Goldman was the underwriter on the Timberwolf deal, which was designed to permit Goldman to short, or bet against, pieces of the securities it was selling to institutional investors.

On Tuesday, members of the Senate Permanent Subcommittee on Investigation accused Goldman of taking unfair advantage of its customers by shorting the same subprime mortgage debt it was peddling to institutional investors in early 2007.

Several Goldman officials told the panel that investors knew the firm might be shorting deals like Timberwolf and in doing so the firm was merely hedging itself.

In all, Goldman sold some $600 million worth of the Timberwolf securities to investors. The now-defunct Bear Stearns hedge funds were the biggest buyer, gobbling up a $300 million slug. Another busted hedge fund, Australia's Basis Yield Alpha Fund, bought about a $100 million piece of the deal.

The other buyers are not known.

Goldman worked on the Timberwolf deal with Greywolf Capital Management, a firm formed by former Goldman employees.

Around the time Timberwolf's value was plunging, Greywolf Capital was gearing up to do a second Timberwolf deal with Fortis Securities leading the transaction. But the deal was eventually nixed.

[Source: By Mathew Goldsein, Analysis, Reuters, NY, 29Apr10]

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