Friday, February 26, 2010

New York Fed accused of "worst scandal in US history"

L. Randall Wray at the University of Missouri - Kansas City, sifts through the complexities of the how the Federal Reserve Bank of New York used AIG as a channel to secretly bailout Goldman Sachs in September 2008, and concludes that it is the worst scandal in American history.

Worst Revelation Yet in the On-going Goldman-AIG-NYFed Scandal

By L. Randall Wray

Richard Teitelbaum reported today (here) that Timothy Geitner's New York Fed hid the smoking gun that proves Goldman played the key role in bringing down AIG. The only plausible explanation for hiding the document is that Geithner were protecting Goldman. Is this the worst scandal in US history? To ask the question is to answer it.

In brief, here is the story. Recall that securitization of mortgages was supposed to be a risk-reducing innovation that would move mortgages off the books of banks and into well-diversified portfolios of those better able to absorb risks. Mortgage originators would do the underwriting (verify credit-worthiness), securitizers would do the packaging, credit raters would do the rating, and investors would buy the securities and take the risks. Ah, but Wall Street was too clever for all that. So here is how it really worked. Banks owned mortgage lenders who made NINJA loans (no income, no job, no assets), then worked with credit raters to get the ratings desired. The raters did not actually examine any of the loans because the banks bought Credit Default Swap (CDS) "insurance" from AIG to guarantee safety of the Collateralized Debt Obligation (CDO) issued against the mortgages. Goldman and other banks would then either sell the CDO while using a CDS to bet on default; or they would hold the CDO and use the CDS bet against it to hedge risk. Of course, since Goldman had securitized toxic waste, the bet was not a gamble at all. It knew the CDOs would fail. But meanwhile, it got to book all sorts of fees and income so that it could reward its management with outsized bonuses.
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