Forget Galleon: What about Goldman's ex-boss?

"The deal contributed to the more than $14 billion that over 18 months was handed to Goldman Sachs, whose former chairman, Stephen Friedman, was chairman of the board of directors of the New York Fed when the decision was made. Friedman, 71, resigned in May, days after it was disclosed by the Wall Street Journal that he had bought more than 50,000 shares of Goldman Sachs stock following the takeover of AIG. He declined to comment for this article.

In his resignation letter, Friedman said his continued role as chairman had been mischaracterized as improper. Goldman Sachs spokesman Michael DuVally declined to comment.

AIG paid Societe General $16.5 billion, Deutsche Bank $8.5 billion and Merrill Lynch $6.2 billion."

via New York Fed's Secret Choice to Pay for Swaps Hits Taxpayers ? Bloomberg.com.

It's kind of amazing that with all the uproar over the Galleon business, nobody is making much hay over the recent revelations about the AIG bailouts, which make former Goldman chief and former New York Fed chairman Stephen Friedman look every bit as guilty of insider machinations as Raj Rajaratnam of the Galleon fund.

It's impossible to grasp the totality of Friedman/Goldman's grossness with regard to the AIG story without a little context. Remember the basic timeline. In the middle of the mortgage bubble, Goldman Sachs found a patsy-buffoon named Joe Cassano at a little corner of AIG called AIG Financial Products, or AIGFP. Cassano was recklessly writing hundreds of billions of dollars worth of credit default swaps for banks like Goldman and Deutsche, essentially insuring certain investments for these banks, including extremely risky mortgage-backed deals.

Goldman took out billions of these CDS positions with Cassano, who had written upwards of $440 billion of these CDS without having even a fraction of the money he would have needed to cover that bet in the event of a disaster of the type that actually ended up taking place, specifically a downgrade of AIG's credit rating that forced Cassano to pony up wads of cash to cover those positions.

The important thing to remember about all of this is that just because Goldman was buying "insurance" from Cassano, that doesn't mean they were being responsible. On the contrary: Goldman was creating well over ten billion dollars worth of exposure to a guy that they must have known was an absolute idiot. Now, in a world where actual capitalism existed, Goldman should then have been highly invested in making sure that AIG did not go under. A dead and bankrupt AIG should not have been good news to a company like Goldman Sachs, which had billions of dollars riding on AIG's financial health.

But if anything Goldman behaved throughout the runup to AIG's collapse like it couldn't care less if the company died. In fact Goldman accelerated AIG's demise by making margin calls against AIG, for both the CDS deals and for deals it had done with Win Neuger, who was running AIG's securities lending business. What really sank AIG was the fact that the downgrade of its credit rating permitted companies like Goldman to demand large sums of money from AIG in the form of these margin calls, and AIG could not get its hands on enough cash to meet its demands, resulting in the death spiral situation we all witnessed last September. Of all the firms making such demands against AIG, Goldman was the most aggressive (I have more on this coming out in a forthcoming book) and my sources who were involved in the AIG bailout bunker scene of a year ago almost to a man report that Goldman and its chief Lloyd Blankfein took an extremely hard line with AIG.

Why would it act like that? Well, in a normal capitalistic situation, it wouldn't. But Goldman, it turned out, had an ace in the hole. It seems that when the state stepped in and decided to bail AIG out, its former director, Stephen Friedman, was among those making the decision that AIG's counterparties should be paid 100 cents on the dollar for its CDS debts. It never made sense that AIG/AIGFP would decide on its own to pay its creditors 100 cents on the dollar for its debts, but now we know, thanks to reporting from Bloomberg, that it wasn't AIGFP and its CFO Elias Habayeb who was making that decision.

It was, instead, a group of people from the New York Fed who gave that order a group that included Tim Geithner and Friedman. Goldman ended up getting almost $14 billion from AIG after the bailout. And Friedman, we later found out, bought 50,000 shares of Goldman stock after this deal was struck. He resigned in May from the Fed, a few days after the Wall Street Journal broke the story about Friedman's stock purchases.

Friedman surely had information about key moves involving the bank ? like Goldman getting paid off at par in the AIG bailout, or Goldman getting a federal bank charter overnight so that a mountain of cheap Fed money could save it from bankruptcy ? before the market got it. That he bought 50,000 shares in Goldman after the AIG bailout and is not in jail right now is sort of amazing, until you consider that it will be a cold day in hell before a former head of Goldman Sachs is arrested for insider trading, even when he gets caught doing it red-handed.

All of this matters for two reasons. One, it's yet another example of how Goldman's success isn't attributable to how "smart" the bank and its employees are.

Instead of working something out with a company it had stupidly become overexposed to, Goldman instead hastened AIG's demise because it was, perhaps, the one way it could cash in fully on its reckless deals ? by forcing it into the arms of the government and getting the taxpayer to pony up for Cassano's dumb calls.

Had AIG proceeded to an ordinary bankruptcy, had the company's downfall happened via normal market procedures, Goldman might have gotten 40, 50, maybe 60 cents on the dollar. If that! Instead it got completely paid off, among other things because its connections to the government actually incentivized it to cripple a company to which it was exposed to the tune of billions.

Second, the non-punishment of Friedman just stands out like a hairy, golf-ball-sized mole on the face of the American capital markets. No question about it, it's interesting that Galleon and Raj Rajaratnam are getting perp-walked by the FBI (note that it's the FBI, and not the castrated and seemingly completely captive SEC, that's going to be pushing these enforcement actions). Galleon isn't small potatoes and from what I understand there are other hedge funds with even higher profiles that may fall later on. These are surprising and meaningful moves and and it suggests that the enforcement community is not yet completely corrupted.

But Goldman's continued impunity leaves a mighty stink-cloud over American business, no matter how many Raj Rajaratnams get dragged off to jail.

Thanks again to Eric Salzman over at MonkeyBusiness, by the way ? and good luck with your new thing.

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