Introduction by Matt Taibbi:
By now, most people who have followed the financial crisis know that the bailout of AIG was actually a bailout of AIG's "counterparties" -- the big banks like Goldman Sachs to whom the insurance giant owed billions when it went belly up.
What is less understood is that the bailout of AIG counter-parties like Goldman and Socie'te' Ge'ne'rale, a French bank, actually began before the collapse of AIG, before the Federal Reserve paid them so much as a dollar. Nor is it widely understood that these counterparties actually accelerated the wreck of AIG in what was, ironically, something very like the old insurance scam known as "Swoop and Squat," in which a target car is trapped between two perpetrator vehicles and wrecked, with the "mark' in the game being the target's insurance company -- in this case, our government.
This may sound far-fetched, but the financial crisis of 2008 was very much caused by a perverse series of (still legal) incentives that often made failed investments worth more than thriving ones. Our economy was like a town where everyone has juicy insurance policies on their neighbors' cars and houses. In such a town, the driving will be suspiciously bad, and there will be a lot of fires.
AIG was the ultimate example of this dynamic. At the height of the housing boom, Goldman was selling billions in bundled mortgage-backed securities -- often toxic crap of the no-money-down, no-identification-needed variety of home loan -- to various institutional suckers like pensions and insurance companies, who frequently thought they were buying investment-grade instruments. At the same time, in a glaring example of the perverse incentives that existed and still exist, Goldman was also betting against those same securities -- a practice that one government investigator compared to "selling a car with faulty brakes and then buying an insurance policy on the buyer of those cars."
Goldman often 'insured' some of this garbage through AIG, using a virtually unregulated form of pseudo-insurance called credit-default swaps. Thanks in large part to deregulation pushed by Bob Rubin, former chairman of Goldman, and Treasury secretary under Bill Clinton, AIG wasn't required to actually have the capital to pay off the claims made against it. As a result, banks like Goldman bought more than $440 billion worth of bogus insurance from AIG, a huge blind bet that the taxpayer ended up having to eat."
While Goldman's CEO, Hank Paulson had his company buy large amounts of collateralized debt obligations (CDOs) backed by largely fraudulent "liar's loans." He then became U.S. Treasury Secretary and launched a successful war against securities and banking regulation. His successors at Goldman saw the looming disaster and began to "short" (bet against) these CDOs. Mr. Blankfein, Goldman's current CEO, recently said Goldman was doing "God's work." If true, then we must wonder what God had against Goldman's customers. Goldman designed a rigged trifecta: 1)it turned a massive loss into a material profit by selling deeply underwater, toxic CDOs that it owned but desperately wanted to get rid of, 2)it helped make John Paulson (CEO of a huge hedge fund that Goldman wanted as an ally, and no relation to Treasury Secretary Hank Paulson) a massive profit in a business where reciprocal favors are key, and . . 3)it, Goldman, then betrayed its customers that purchased the CDOs. Paulson and Goldman were shorting the CDOs because they knew the liar's loans on which the CDOs were based were greatly overrated by the rating agencies, who, desperate to keep Goldman's business, had given them artificially "good' ratings. Goldman then let John Paulson design an all-encompassing "synthetic' CDO in which he was able to place the nonprime packages that he had picked as being the most overrated (and, therefore, overpriced, and also the most likely to soon go belly up as housing prices stagnated).