Full text of Financial Crisis Inquiry Commission : Documents Relating to the Financial Crisis of 2007-2009 : Official Transcript : Hearing on "The Role of Derivatives in the Financial Crisis.", Thursday, July 1, 2010, Dirksen Senate Office Building, Washington, D.C.

View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

1
2

FINANCIAL CRISIS INQUIRY COMMISSION

Official Transcript

4
5

Hearing on "The Role of Derivatives

in the Financial Crisis."

Thursday, July 1, 2010, 9:00am

Dirksen Senate Office Building, Room 538

Washington, D.C.

10
11

COMMMISSIONERS

PHIL ANGELIDES, Chairman

HON. BILL THOMAS, Vice Chairman

BROOKSLEY BORN, Commissioner

BYRON S. GEORGIOU, Commissioner

SENATOR BOB GRAHAM, Commissioner

KEITH HENNESSEY, Commissioner

DOUGLAS HOLTZ-EAKIN, Commissioner

PETER J. WALLISON, Commissioner

20
21

Reported by:

PAGES 1 - 313

JANE W. BEACH, Hearing Reporter

2
1

Session 1:

Goldman Sachs Group, Inc.:

STEPHEN J. BENSINGER, Former Executive Vice President

Chief Financial Officer, American International

Inc.

ANDREW FORSTER, Former Executive Vice President

7
8
9

American International Group, Inc. and

Group,

American International Group, Inc.
ELIAS F. HABAYEB, Former Senior Vice President and
Chief Financial Officer, AIGFP

DAVID LEHMAN, Managing Director, Goldman Sachs Group,

DAVID VINIAR, Executive Vice President and Chief

Financial Officer, Goldman Sachs Group, Inc.

Session 2:

ERIC R. DINALLO, Former Superintendent,

New York State Insurance Department

16
17
18

Derivatives:

Supervisors and Regulators

GARY GENSLER, Chairman,
Commodities Futures Trading Commission
CLARENCE K. LEE, Former Managing Director for

Complex and International Organizations,

Office of Thrift Supervision

21
22
23
24
25

and

Inc.

3
1

P R O C E E D I N G S

(9:04 a.m.)

CHAIRMAN ANGELIDES:

Good morning.

I would like

to now call the meeting of the Financial Crisis Inquiry

Commission to order.

We have two sessions today as part of our public

hearing on derivatives and their role in the financial

crisis.

Goldman before us.

This morning we will have folks from both AIG and

This morning we will be examining, as part of our

larger look at derivatives, how these instruments were used

in the marketplace and the interrelationships between the

companies that utilized these instruments.

So today, following up on yesterday's hearing, we

have asked representatives of these two companies to come

before us.

derivatives, and particularly perhaps in this instance

credit derivatives, worked in the marketplace, particularly

during the 2007-2008 time period.

It is a chance for us to explore how

This afternoon we will have a panel with

regulators, which will include Mr. Gary Gensler from the

Commodities Future Trading Commission, as well as Eric

Dinallo who was the Superintendent of Insurance, the

insurance regulator in the State of New York, as well as a

representative from the Office of Thrift Supervision that

4
1

oversaw AIG.

With no further ado, we will begin the

proceedings.

Thomas has some comments?

5
6

But I would like to ask first if Vice Chairman

VICE CHAIRMAN THOMAS:
Mr. Chairman.

No, thank you,

I am looking forward to today's panels.

CHAIRMAN ANGELIDES:

Terrific.

With that,

welcome panelists to this first session of our hearing

today.

I would like to ask you to all rise and do what is

customary for all witnesses in public session, which is to

be sworn in.

your right hand, and I will read the oath and you will

affirm.

And so if you would please stand and raise

Do you solemnly swear or affirm under penalty of

perjury that the testimony you are about to provide the

Commission will be the truth, the whole truth, and nothing

but the truth, to the best of your knowledge?

MR. BENSINGER:

Yes.

MR. FORSTER:

Yes.

MR. HABAYEB:

Yes.

MR. LEHMAN:

Yes.

MR. VINIAR:

Yes.

(Witnesses duly sworn.)

CHAIRMAN ANGELIDES:

Thank you very much.

Gentlemen, we have received your written

5
1

testimony and appreciate getting that.

Commission, everyone on this Commission has had an

opportunity to read that and review it.

And knowing this

This morning we would like to ask if each of you

would provide us with an oral statement.

it be no more than five minutes.

of you that has a timer on it.

yellow, that means there is one minute left.

goes to red, that means time is up.

We would ask that

There is a device in front
When the light moves to
And when it

So what we are going to do this morning is go

from my left to right, starting with Mr. Bensinger of AIG,

then to Mr. Forster, then to Mr. Habayeb, then Mr. Lehman,

and then Mr. Viniar.

14
15

So, Mr. Bensinger, if you would please start.
Terrific.

WITNESS BENSINGER:

[Off microphone.]

CHAIRMAN ANGELIDES:

And the other thing I would

ask you to do is to please turn your microphones on.

Vice Chair would say, they are very directional.

that mike facing your lips.

WITNESS BENSINGER:

As the

So have

Thank you.
Good morning.

Chairman

Angelides, Vice Chairman Thomas, and distinguished Members

of the Commission:

24
25

My name is Stephen J. Bensinger.

I appreciate

the opportunity to testify before the Commission today.

6
1

I would like to begin briefly discussing my

background.

Financial Officer of AIG.

I will then discuss my tenure as Chief

I graduated from New York University with a

double major in accounting and computer application systems

in 1976.

partner in 1985.

the property and casualty insurance industry.

I then joined Coopers & Lybrand, becoming a
While at Coopers & Lybrand, I focused on

It was through my work at Coopers & Lybrand that

I became involved with AIG, which was a client.

11 years at Coopers & Lybrand, I left that firm to become

the Chief Financial Officer of a property and casualty

reinsurance company which had also been a client.

After about

After five years with that firm, I left and held

senior positions at several other insurers and reinsurers

until I joined AIG in the fall of 2002.

2002, I became the Treasurer of AIG.

primary responsibilities were overseeing the rating agency

relationships, monitoring cash flows, and becoming involved

in the company's financings as necessary.

Upon joining in

In that role, my

I had no financial reporting responsibilities in

that position.

I remained in that role until 2005.

Beginning in 2004, AIG became the subject of investigations

by various authorities in connection with certain

reinsurance transactions.

7
1

In addition, AIG and other insurance companies

were subject to an investigation into, among other things,

bid rigging and contingent commission claims by New York's

then-Attorney General Eliot Spitzer.

In late 2004, in the midst of these

investigations, Howard Smith, AIG's CFO at the time, and

Hank Greenberg, AIG's then-CEO, discussed with me the

possibility of my becoming Controller of AIG.

Treasurer position, the role of the Controller included

Unlike the

responsibility as the company's chief accounting officer,

and particularly included responsibility for overseeing the

preparation of AIG's SEC filings.

In January of 2005, I became Controller of AIG,

while also continuing as Treasurer.

developed, a decision was made by the AIG Board to replace

Mr. Smith as CFO.

10K was filed, I was asked by the Board to take over Mr.

Smith's job as CFO of AIG.

As the investigations

Thus, in March of 2005, before AIG's 2004

Martin Sullivan was also asked at that time to

replace Mr. Greenberg as CEO of AIG.

was stepping into an extremely complex and highly pressured

environment in light of the challenges and investigations

that AIG was then facing, I accepted the job as CFO.

24
25

Although I knew that I

Thereafter, I helped lead a thorough
investigation of the company's financial accounting and

8
1

control environment which resulted in a restatement of AIG's

prior year's financial statements in May of 2005.

During the course of the closing of the September

30th, 2007, quarterly financial statements, I became aware

of certain collateral calls that had been made by

counterparties.

Along with company management expert in these

areas, and also including the company's outside auditors, I

attempted to ensure that the valuation and disclosure around

AIG Financial Products super senior CDS portfolio was

appropriate given the information available to the company

at the time.

We continued to update our valuations and

disclosures in ensuing periods as market conditions

continued to deteriorate.

until October 2008 when I left the company.

I continued to serve as AIG's CFO

With that background, I stand ready to answer any

questions the Commission may have concerning my tenure at

AIG.

20
21

Thank you.
CHAIRMAN ANGELIDES:

Thank you, Mr. Bensinger.

Mr. Forster?

WITNESS FORSTER:

Chairman Angelides, Vice Chairman Thomas, and

24
25

Thank you.

distinguished Members of the Commission:
Good morning.

My name is Andrew Forster.

9
1

appreciate being given the opportunity to testify before

this Commission and provide my perspective regarding AIG and

its use of complex financial products, particularly the

transactions that made up our multi-sector super senior

credit default swap portfolio.

By way of background, I am an Executive Vice

President of Banque AIG London, part of AIG Financial

Products.

Desk, which manages AIGFP's cash investment book and

Since 2003, I have been in charge of the Asset

undertakes trading and investment activities on behalf of

AIGFP, including credit default swaps.

From 2003 until 2008 I was one of roughly 13

executive vice presidents at FP who reported directly to Mr.

Cassano.

helping to reduce AIGFP's credit risk by winding down its

remaining credit portfolios and maximizing the returns for

AIG and its shareholders.

In my current position, I am responsible for

In an effort to conserve the Commission's

valuable time, I will refrain from reading the written

testimony that I submitted.

Commission's questions on the topics that I understand you

would like me to focus on today--those including the

increase in the size of FP's multi-sector super senior credit

default swap portfolio transactions during 2005; the process

for approving the transactions that made up the multi-

I hope to be able to answer the

10
1

sector super senior default swap portfolio; the decision in

early '06 by FP to exit the multi-sector CDS market that

deals with subprime exposure; and the disputes that FP had

with various counterparties, including Goldman Sachs,

concerning collateral calls that were made in 2007 and early

2008.

From my years working at AIG, I have a fair

amount of experience with credit default swaps and the markets

in which they are traded.

Being based in London, my work in

this sector was focused primarily on what we called our

regulatory capital credit default swap portfolio.

to 2005, I had limited involvement in our then-much smaller

multi-sector super senior CDS portfolio.

typically directly involved in originating or negotiating

the credit default swap transactions that formed the multi-

sector book.

And prior

And I was not

However, as the multi-sector portfolio grew

during 2005, after discussions with Mr. Cassano, I became

more actively involved in the multi-sector book.

point forward, I began to play a more active role in

evaluating the risks that portfolio created for FP's overall

credit exposure across all of the markets in which we

traded.

24
25

From that

After the dislocation of the credit markets began
in the summer of 2007, I was one of a number of individuals

11
1

at FP who were tasked by Mr. Cassano with helping to deal

with various aspects of the collateral calls that started

coming in from our counterparties.

My involvement continued through the first

quarter of '08 until senior management at AIG took over

direct responsibility for the collateral call process.

I recognize the important work of this

Commission, and I sincerely hope that my testimony will help

the Commission better understand the events.

10
11

CHAIRMAN ANGELIDES:
Habayeb?

WITNESS HABAYEB:

CHAIRMAN ANGELIDES:
or "An-ge-lidis".

15
16

Thank you, Mr. Forster.

Yes.
Kind of like "An-ge-leedes"

All right, thank you.

WITNESS HABAYEB:

Chairman Angelides, Vice

Chairman Thomas, and Members of the Commission:

Thank you for the invitation to appear before you

today.

Senior Vice President and Chief Financial Officer of the

Financial Services Division of AIG.

Mr.

Am I pronouncing that correctly?

Thank you.

From September 2005 until May of last year I was

AIG's subsidiaries within the Financial Services

Division engaged in a diverse range of activities.

One of

the subsidiaries is AIG Financial Products Corp., or FP.

you know, FP is the unit that wrote credit default swaps on

multi-sector CDO bonds that had exposure to the U.S.

12
1

subprime market.

I understand that today's panel has been

assembled to address Goldman Sachs' calls for the posting of

collateral under the swap contracts with FP during 2007 and

2008.

of AIG gave me some insight into the collateral calls.

My position as CFO of the Financial Services Division

Beginning in 2008, I also participated in

discussions with certain counterparties, including Goldman

Sachs, about the collateral call disputes.

Because the bonds underlying the FP swaps were

not trading, it was difficult to determine the appropriate

value of the bonds and thus the amount of collateral

required to be posted.

FP and its counterparties, including Goldman,

engaged in ongoing discussions in an effort to come to some

agreement as to the amount of collateral to be posted.

August 31, 2008, FP had posted about $19 billion in

collateral to FP swap counterparties, including $6.8 billion

to Goldman Sachs.

And by the beginning of September 2008, FP's

collateral payment obligations and cash requirements in

certain of AIG's other businesses were placing increasing

stress on AIG's liquidity.

24
25

On September 15th, 2008, the rating agencies
downgraded AIG's credit rating, triggering an onslaught of

13
1

new collateral calls.

or meet its liquidity needs, it was at this point that AIG

received emergency government assistance.

4
5
6
7

Unable to access the capital markets

I am happy to answer any questions the Members of
the Commission may have.

Thank you.

CHAIRMAN ANGELIDES:

WITNESS LEHMAN:

CHAIRMAN ANGELIDES:

11
12

Mister "Lay-man"

or "Lee-man"?

Thank you.

WITNESS LEHMAN:

"Lay-man."
Mr. Lehman.

Thank you.

Chairman Angelides,

Vice Chairman Thomas, and Members of the Commission:
Good morning.

My name is David Lehman.

I am a

Managing Director at Goldman Sachs and the Co-Head of the

Structured Products Group Trading Desk, a position I have

held since 2006.

I understand that the Commission is interested in

my role in connection with the collateral dispute between

Goldman Sachs and AIG.

and AIG were counterparties in a number of credit default

swap transactions referencing collateralized debt

obligation, or CDO, securities.

As the Commission is aware, Goldman

The value of these transactions began to decline

as a result of a significant dislocation in mortgage markets

that occurred starting in the summer of 2007.

Beginning in late July 2007, a dispute arose

14
1

between Goldman Sachs and AIG concerning the amount of

collateral that AIG needed to post as a result of a decline

in the market value in these transactions.

I became involved in the collateral dispute with

AIG in late July 2007.

My role focused on providing Goldman

internally, and ultimately AIG, with pricing for these

transactions and the rationale for such pricing, as well as

to try to gain an understanding from AIG of their pricing and

the rationale for that pricing.

Goldman made a collateral call to AIG in late

July 2007 that demanded that AIG post approximately $1.8

billion in collateral.

calls issued to AIG in late July and thereafter, I and

others from my trading desk were involved in Goldman's

pricing of the CDO positions.

In connection with the collateral

Goldman's prices were formed by diligently

observing and reviewing the best available information from

the market through its role as market maker.

Shortly after the initial collateral call, I

participated in a telephone conference with AIG in which

both sides discussed the dispute.

July, AIG questioned our lower prices, not believing their

securities had lost much value.

24
25

Despite a very volatile

We were firmly of the belief that the marks
should represent as accurately as possible the market prices

15
1

of these transactions based on our experience, expertise,

and the market information that was available to us.

A market price is simply the price at which a

security could be bought or sold in the market.

the stock market where there are frequent transactions in

stocks for the various companies that trade on an exchange,

certain mortgage instruments trade infrequently even when

the market is considered liquid.

But unlike

Because there were infrequent or no trades in the

particular credit default swaps between AIG and Goldman, we

based prices for these positions on two main sources.

12
13

First, the prices of comparable transactions that
were trading in the market.

And second, pricing information we could obtain

from market participants through bid or offer requests for

similar securities or credit derivatives to the extent that

those bid or offers constituted real actionable prices at

which market participants were willing to trade.

As an example of a comparable transaction,

Goldman Sachs might observe a trade in a security with a

similar risk profile, similar structure, and containing

similar but not exactly the same mortgages.

executive a transaction in otherwise similar derivatives but

backed by mortgage loans from a different time period--for

example, loans from 2006 versus 2005.

Or we might

16
1

We would collect the information generated by

these comparable transactions.

variety of analyses on the collected comparables in order to

gain a sense of the market value of the Goldman-AIG swaps

from the pricing reflected in actual market transactions in

similar derivatives.

Then we would perform a

Crucial to the pricing process is having accurate

market information.

the quoting participant is not willing to trade, are not

10
11

Non-actionable prices, prices at which

indicative of the market.
Our marks were based on actionable prices

informed by market information from comparable transactions.

At various times during the dispute, Goldman was willing to,

and did, receive less than it was entitled to from AIG as a

partial payment of its collateral demand.

The firm did not, however, reduce its collateral

demands to levels AIG posted, but instead kept its demand at

the levels established by pricing determinations.

Indeed, for most of the AIG transactions, Goldman

entered into swaps with other parties that offset the risk

that the firm had taken through its transactions with AIG.

These offsetting trades meant that Goldman was itself

required to post collateral to counterparties to whom it

sold credit protection, just as Goldman expected AIG to post

collateral to it.

17
1

Throughout the collateral dispute, we continued

the process of pricing our positions and demanding

collateral from AIG consistent with that pricing.

AIG continued to dispute our marks, but for

almost six months AIG refused to provide Goldman Sachs with

its marks on these same positions.

same time period our dialogue with AIG often focused on

third-party marks that were neither actionable nor

indicative of the market.

In addition, during this

The collateral call dispute between Goldman Sachs

and AIG continued throughout most of 2008.

various time to transact with AIG or other interested market

participants that AIG was aware of at prices consistent with

those that we were using to calculate the collateral

amounts.

We offered at

AIG never took us up on the offer.

Personally, I

remain very confident that the prices we used represented

accurate market prices for those transactions at that time.

Mr. Chairman, thank you again for the opportunity

to appear before you and the Commission today, and I will

gladly answer any questions that you have.

CHAIRMAN ANGELIDES:

WITNESS VINIAR:

24
25

Mr. Viniar.

Chairman Angelides, Vice

Chairman Thomas, and Members of the Commission:
I appreciate the opportunity to appear before you

18
1

and contribute to the Commission's work on understanding

some of the causes of the financial crisis.

I will focus my comments on our risk management

practices, including the use of derivatives, and how we

managed our exposure to AIG.

As a global investment bank and financial

intermediary, Goldman Sachs integrates advice, financing,

market-making, co-investing, and asset management with its

risk management capabilities to serve a broad range of

10
11

largely institutional clients.
When we commit capital to buy or sell financial

instruments or extend credit, we accumulate both long and

short positions that have implications for our liquidity,

credit, and market risks.

Derivatives are a very important part of managing

those risks.

and currency exposures on our long-term borrowings and

certain short-term borrowings, and to manage currency

exposure on a net investment in non-U.S. operations.

We use derivatives to manage the interest rate

We also enter derivatives contracts to help

clients manage their interest rate, currency, equity,

commodity, or credit exposures, and then to manage our own

positions as we take the other side of contracts on our

clients' behalf.

It is important to underscore that we generally

19
1

do not have a derivatives business.

risk-management instruments integrated into many businesses.

Rather, derivatives are

As a result, we do not divide revenue or profit

between derivative and non-derivative products, or track or

report our financial results that way.

risk exposures we take on through derivatives as part of an

integrated set of trading businesses.

derivatives positions at fair market value net of collateral

paid or received.

And we manage the

We carry all

I know the Commission is interested in the role

of derivatives in causing or amplifying the effects of the

financial crisis.

losses that financial institutions sustained over the course

of the financial crisis can be traced back to bad credit

decisions in general, and most of those can be traced back

to bad real estate loans.

We believe the vast majority of the

Securities like CDOs and associated derivatives,

including synthetics, embedded what were essentially

concentrated credit risk emanating from bad lending

decisions.

More broadly, whether in derivatives or in the

most basic activities such as bank loans or mortgages, there

also appear to have been failures of risk management across

the industry.

With respect to AIG, our relationship was

20
1

governed by the same client service and risk management

focus described above.

To put our relationship with AIG in context, our

clients first came to us to help them manage credit exposure

to super senior CDO positions on their books.

into credit derivative swap contracts, or sold positions, to

them to help hedge against a fall in the value of their

super senior CDOs.

We entered

We then entered into offsetting contracts, or

bought protections, from AIG to manage the resulting

exposure on our books.

consistent with those extended to other major counterparts,

including collateral arrangements that we tightly managed.

We established credit terms with AIG

In particular, we established a predetermined

hedging program which provided that if the aggregate

exposures moved above a certain threshold, CDS and other

credit hedges would be obtained.

In July 2007 we began to significantly mark down

our super senior CDO risk.

prompted us to mark our positions down on a real-time basis.

This resulted in collateral disputes with AIG.

Rigorous fair-value accounting

We believe our marks reflected the realistic

value markets were placing on these securities, and events

eventually proved those marks to be correct.

Over subsequent weeks and months, we continued to

21
1

make collateral calls consistent with the deterioration in

the housing market.

that were consistent with the prices we had on similar

securities in our inventory on which we posted collaterals

to clients on the other side of the AIG transactions.

We made those calls based on prices

We also offered to buy from and sell to AIG at

our marks.

We collected significant amounts of collateral

and hedged any gaps between what we were paid and what we

believed we were owed primarily through the purchase of

collateralized CDS such that we had no material residual

risk.

In mid-September, prior to the government's

investment in AIG, our total exposure was roughly $10

billion.

collateral.

Against this, we held roughly $7.5 billion in

The remainder was fully covered through hedges.
I believe the way we managed our exposure to AIG

demonstrates the importance of systematically marking

positions to market, paying attention to what the market

tells us, and maintaining a disciplined approached to risk

management.

During the course of the financial crisis we made

our fair share of mistakes.

We lost a considerable amount

of money through our exposure to leveraged loans and

mortgages.

institutions that focus on the fundamentals of measuring,

We learned once again that financial

22
1

monitoring, and dynamically managing their risks make

themselves much more resilient to uncertain and

unpredictable market behavior.

4
5

Thank you very much, and I am happy to answer any
of your questions.

CHAIRMAN ANGELIDES:

Thank you, Mr. Viniar.

will now begin the questioning.

begin the questioning, and followed by the Vice Chair, and

then we will move to the Commissioners who led this portion of our

10
11

As is our custom, I will

inquiry.
So let me start with you, Mr. Forster.

What I am

going to try to do in my time this morning is try to get a

better understanding of how this marketplace worked.

And just an observation, obviously unlike the publicly

traded markets, this was not a marketplace that was visible

to view, and so I am trying to get my best understanding of

how transactions occurred, and how pricing occurred

particularly during the 2007-2008 time period.

I want to talk to you a little, Mr. Forster, just

about kind of pricing.

have been in transit yesterday so if you don't--yesterday we

had entered into the record a chronology of events as

between Goldman and AIG with respect to this pricing

dispute, the collateral call disputes.

As you may know--and I think you may

That chronology included the calls, the postings,

23
1

as well as communications with participants at this table.

And clearly, Mr. Forster, you were involved in this back and

forth.

In the wake of Goldman's first collateral call on

July 27th, there's a phone call between you and a guy named,

I guess, John Leivergal (phonetic) in which you talk about

how Goldman's margin call hit out of the blue.

number that is well bigger than we ever planned for.

Goldman's prices were ridiculous.

It's a blank

On August 1st you indicate that Goldman's, quote,

"not budging and are acting irrational."

On August 2nd,

you do indicate that Goldman realized they needed to use

mids not bids, which I assume refers to the fact that their

collateral calls had used bid prices not the midway between

bid and ask.

Is that a fair assumption?

WITNESS FORSTER:

Yes.

CHAIRMAN ANGELIDES:

And they later revised their

collateral call down significantly.

On August 8th--I'm just

trying to set the plate here--there's an e-mail I believe

from you, which I'll enter into the record, yes, it's from

you to Mr. Frost, I believe, where you talk about the

pricing.

of things in the market to generate price discovery and can

influence how a dealer decides to determine a mid price

going forward."

You talk about that Goldman, quote, "can do a lot

24
1

You also wrote that that was, quote, "a very

credible threat" and that, quote, "you'd never seen"--no,

I'm sorry, the e-mail is to you.

Mr. Frost.

and despondent about amicably resolving any debate or

conflict between our firms.

I apologize.

This is from

He had never seen Mr. Dableman more discouraged

You responded, quote, "What do they expect us to

do?

Just give them a whole lot of cash because they are

Goldman Sachs?"

And then on August 16th, you wrote in an e-mail:

I have heard several rumors now that GS is aggressively

marking down asset types that they don't own so as to cause

maximum pain to their competitors.

it's the sort of thing that GS would do.

It may be rubbish, but

So clearly you are at the front end of this

dispute.

comment on Mr. Lehman's observations about how they priced

these products?

pricing, and how you were looking at pricing at the same

time?

Here's what I wanted to ask you:

Could you

What you thought was deficient about that

WITNESS FORSTER:

Sure.

My understanding was

that there were sort of two processes in terms of Goldman

coming up with their pricing.

24
25

One part of it was talking about "other
observable transactions," which I have to say I thought

25
1

really wasn't discussed in any great detail until later on

in the process, until we got into I think sometime in

November where they talked about other observable

transactions.

Our discussions with other investment banks at

the time, however, suggested that there was very little if

any trading going on.

Sachs the different transactions that they said had been

transacted in the markets, they did seem to be very sporadic,

And when we discussed with Goldman

very few, and it was debatable how closely aligned or linked

they were with our transactions.

CHAIRMAN ANGELIDES:

Well let me probe that.

when you say they were sporadic, very few?

market volume?

trading at maybe half the volume it was before?

talking about a market that's essentially frozen up by this

time period in which there's only anecdotal information?

In terms of

Are we talking about a market now that's

WITNESS FORSTER:

Or are we

Well our view clearly was that

it was pretty much essentially completely frozen up, and

that it was anecdotal information.

information about three or four different transactions, all

in fairly small size, and as I said, questionable how

closely aligned and related they were to our transactions.

24
25

CHAIRMAN ANGELIDES:
other pricing information?

And I think we got

All right.

Did you have

Or was it your view that you

26
1

just couldn't price this market at this point?

WITNESS FORSTER:

We did have some other pricing

information.

other dealers, and that pricing information again was at

odds with what Goldman Sachs had told us.

significantly higher.

We had pricing information from some of the

CHAIRMAN ANGELIDES:

It was

And was that based on real

trades?

Quote/unquote, "actionable trades"?

estimates by those other counterparties?

WITNESS FORSTER:

Or were they

At the time the counterparties

that were providing us with these valuations told us it was

their best-efforts valuation.

came up with their individual prices, I couldn't speak to

that I’m afraid.

15
16

I mean, how they actually

CHAIRMAN ANGELIDES:

Did you provide any

valuations?

WITNESS FORSTER:

To Goldman Sachs?

CHAIRMAN ANGELIDES:

Yes.

Basically was it just,

no, we don't accept these?

are, and here's the basis on why we think they're here?

WITNESS FORSTER:

Or here's where we think they

Well we explained, pretty much

as I've just explained.

We explained to them in terms of

why we didn't think their pricing was accurate at the time.

At the very outset I don't think we provided them with

absolute levels for them in terms of our positions.

27
1

We didn't have an internal pricing system at that

time, and that is something obviously that we then decided

to construct, and that's what we start in September and then

takes us through till December till we have what we think is

a particularly accurate methodology.

So we didn't have that to go back with specific

prices.

thought the prices, given what we could see from other

counterparties, were at least above the thresholds and hence

10
11

But clearly we went back and articulated that we

wouldn't require a collateral call.
CHAIRMAN ANGELIDES:

All right.

At a number of

points along the way there's discussions about doing dealer

surveys, or dealer polls.

WITNESS FORSTER:

CHAIRMAN ANGELIDES:

That's correct.
Did that ultimately happen

at any point?

WITNESS FORSTER:

No, it did not.

CHAIRMAN ANGELIDES:

Tell me why not.

I mean,

I'm just curious why it never got to that point.

because neither party wanted this to emerge into the public?

Was it that both parties had firm positions and they didn't

want to move off them?

the fact around why, or why not, you both didn't just go to

the market and do your best survey as to what was happening

out there from third parties?

What's your perception?

Was it

Or what's

28
1

WITNESS FORSTER:

As I said, our view--and

corroborated by talking to the different investment banks--

was there was very little going on in the market.

trades, transactions occurring.

whilst it was in the contract that we could go and try and

resolve the situation by doing a dealer poll, we at AIG

didn't think that that dealer poll would ultimately be

successful because we didn't think we would get prices from

that.

Very few

And so we thought that

Our assumption was that Goldman Sachs also agreed

with that, and hence the reason why neither party really

pushed to get a dealer poll.

having a dealer poll, but ultimately a dealer poll never

occurred.

There were discussions about

CHAIRMAN ANGELIDES:

So you thought it really

wouldn't be much added value beyond what you already knew in

the marketplace from talking to the participants of a market

that wasn't active in any respect?

WITNESS FORSTER:

That's correct.

CHAIRMAN ANGELIDES:

I do want to press you on a

couple things.

I mean, obviously in a couple of your e-

mails here you in a sense to go motivation of Goldman Sachs,

and I just want to ask:

lot of my life, I mean sometimes negotiations are just tough

and hard.

Having been in the private sector a

But what do you mean exactly by "Goldman can do a

29
1

lot of things in the market to generate price discovery,"

and "they can influence how a dealer decides to determine a

mid-price going forward"?

I mean, are you saying that--explain that to me.

WITNESS FORSTER:

I'm not sure I can explain it

to you, I'm afraid, because I think that--

CHAIRMAN ANGELIDES:

WITNESS FORSTER:

9
10

That was from Mr. Frost.

That's from Mr. Frost, and I

must admit I'm not quite sure what he meant at that time.
CHAIRMAN ANGELIDES:

And I guess I know what you

meant, but when you said:

just give them a whole bunch of money?

What do they expect us to do,

At another point you do talk about how they're

aggressively making down asset types they don't own so as to

cause maximum pain to the competitors.

they were trying to deliberately move prices down?

WITNESS FORSTER:

Was it your view

Well I mean we had heard, you

know, nothing more than rumors from different--I mean, I

don't remember the specific instances why we said that in

the e-mail, but I think general we had heard from other

dealers that Goldman Sachs' pricing was very aggressively

marked down in many different products.

23
24
25

CHAIRMAN ANGELIDES:

All right.

I'm going to ask

you, Mr. Lehman, a couple of questions here.
WITNESS LEHMAN:

Can--Mr. Chairman?

30
1

CHAIRMAN ANGELIDES:

WITNESS LEHMAN:

Yes.

If possible, I'd just like to

respond--

CHAIRMAN ANGELIDES:

Sure.

Wait one second.

Hold that thought.

to ask Mr. Forster one other question.

been in real estate and having been in both good times and

bad times, a lot of transactions I've been in have buy/sell

provisions.

I do want you to come back.

But I want

And again, having

Now the fact is, they sound great but when you

are in a market with very little liquidity, when no one is

anxious to buy, I'm going to ask you from your perspective,

when Goldman is saying to you, well, these are actual prices

and you could transact at those prices, did you think that

was kind of a credible offer in the sense that here's a

market where people don't have a lot of liquidity, so you're

not really looking to buy into the market?

Give me your response to their contention:

Well,

we gave you actionable prices at which we were willing to

trade?

WITNESS FORSTER:

I guess our general view was

that, whilst it was a kind offer, we were clearly not going

to be selling the transactions at that point; so the

actionable bid really wasn't that helpful to us.

fairly clear by the time that I recall them talking about

And it was

31
1

actionable prices, that no one really wanted to add risk at

this point, especially not in these sorts of products, and

it was fairly clear to us that we were never going to be

adding more risk.

5
6

So, again, the offer to be able to trade was kind
but not one we were ever going to take up.

CHAIRMAN ANGELIDES:

All right, Mr. Lehman, why

don't you make a comment that you were going to make, and

then I want to follow up on that line.

WITNESS LEHMAN:

Sure.

Just briefly, I think it

is important to remember a few things when we're talking

about the summer of 2007.

First and foremost, July was an incredibly

volatile month for mortgage, in particular subprime related,

but mortgage and CDO products.

decline as a result, in my view, of rating agency downgrades

shortly after July 4th, and increased loss estimates for the

product.

You saw a rapid price

In addition to that, fundamentals were

deteriorating.

this product.

subprime products, in addition to certain CDO products, were

going down very fast in July.

24
25

Home prices, and ultimately delinquencies on
So prices for the most observable RMBS, or

The second point that I would make is, we're
talking about Goldman and AIG.

This was a very big market,

32
1

a market that is much bigger than Goldman Sachs and AIG.

there are a lot of other participants in the market.

And here I am talking about more than just the

specific CDOs that AIG transacted on, but the mortgage

market or the subprime market in the United States.

think that’s important when we are talking about Goldman

impacting prices.

that had views that were transacting in the market at this

point in time.

So I

There were a lot of other participants

The third point that I would like to make is:

large part--and I mentioned this in my testimony--the trades

we had on with AIG, when we reduced our prices we were

posting collateral on the other side.

motivation--

15
16

CHAIRMAN ANGELIDES:

There was not a

Can I ask--finish that

thought quickly.

WITNESS LEHMAN:

No, I'm just--

CHAIRMAN ANGELIDES:

Were they parallel

transactions?

contracts with your counterparties mirror the AIG?

In the sense, did your terms of your

WITNESS LEHMAN:

So I'm not personally familiar

with all of the specific transactions, but what I do know is

that the--

24
25

CHAIRMAN ANGELIDES:
makes sense.

If they mirrored them, it

But if they don't mirror them, the collateral

33
1

call analogy doesn't wash.

WITNESS LEHMAN:

No, but by and large the posting

that we were doing did mirror and was consistent with the

prices that we had with AIG.

5
6

CHAIRMAN ANGELIDES:

provide us that information, would you, please?

WITNESS LEHMAN:

CHAIRMAN ANGELIDES:

9
10

Well perhaps you could

Sure.
Because I think it depends

on, you know, what the terms of the collateral posting were,
not just the prices themselves.

Let me ask you a couple of questions.

WITNESS LEHMAN:

CHAIRMAN ANGELIDES:

Sure.
So I want to pick up on one

of the things you just said, which is that there were other

participants in the market.

information we have, you were consistently low versus other

folks who were providing pricing to AIG.

So why was that?

WITNESS LEHMAN:

From looking at least at the

I can't speak for other dealers.

I guess the pricing that we were providing to AIG and other

clients around this time was, as I mentioned in my opening

testimony, consistent with where we viewed the market given

the transactions that we were doing, what we were observing

in other products, risk premium around this period of time.

So the other thing that I mentioned in my

34
1

testimony was--

WITNESS LEHMAN:

What was the volume in trading

at this time?

of level of trading are we looking at during this time

period?

6
7

I mean, if 100 was a robust market, what kind

WITNESS LEHMAN:

In the particular products, the

specific products--

CHAIRMAN ANGELIDES:

WITNESS LEHMAN:

Yes.

--we had with AIG?

I don't know

that offhand.

CHAIRMAN ANGELIDES:

WITNESS LEHMAN:

Okay.

I think it's important in this

market, the mortgage market, while it's big you have a lot

of discrete securitization.

might not trade on any given day, but a lot of very

comparable securitizations certainly in RMBS were trading.

17
18

So the exact securitization

CHAIRMAN ANGELIDES:

request yesterday to try to get us--

WITNESS LEHMAN:

CHAIRMAN ANGELIDES:

21
22
23
24
25

And you probably heard my

Yes.
--more granular information

so we could take a look at how you priced these things?
WITNESS LEHMAN:

Yes.

And I'm happy to work with

the Commission to that end and explain our pricing.
CHAIRMAN ANGELIDES:

I would just make an

observation, which is the whole notion of the buy/sell, the

35
1

actionable, again from my own experience in an illiquid

market telling someone you've got the right to buy this, you know, I

mean I've been in land and housing transactions.

ability to buy more even at a really low price in an

illiquid market ain't much of an offer, because you're not

looking to add to your risk position.

not, you know, willing to sell during that illiquid time

period.

The

And, often you're

But I want to ask about a couple of things.

As I know, or you know, Goldman Sachs right now

is subject to litigation by, you know, the Basis Yield Alpha

Fund who contends that they were one of the purchasers of

Timberwolf; that they bought in June.

at about 80.

warranted prices would be stable.

I guess they bought

Part of their contention is that you had

Do you know if the marks you're giving AIG

aligned with what you were selling securities at to folks in

the marketplace like at Timberwolf?

selling to people in the marketplace securities like the

BYAFM Fund.

WITNESS LEHMAN:

CHAIRMAN ANGELIDES:

In other words, you're

Yes.
Would your prices at which

you're selling to folks have aligned with the marks you're

giving them?

24
25

WITNESS LEHMAN:

Yes.

So the trade we did with

Basis and Timberwolf was a very different instrument than

36
1

what we had on with AIG.

recollection, the trades that we were executing with Basis

or other counterparties, or trades we were doing throughout

this time period, were consistent with both our marks as

well as the prices we were providing to all clients, not

just AIG.

But to the best of my

CHAIRMAN ANGELIDES:

Were you involved in

providing the marks to Bear Stearns for the BSAM Funds in

May?

10
11

WITNESS LEHMAN:

Do you know on what specific

products?

CHAIRMAN ANGELIDES:

Let me return to you when I

return to my question.

Were you involved in providing any

marks to Bear, the BSAM Funds in May?

WITNESS LEHMAN:

So the desk that I co-head was

responsible for the trading of ABS, CMBS, as well as CDOs.

So if it's the prices on those products, then they would

come off the desk.

driven by the desk.

that provides pricing.

from us.

But the pricing process itself is not
There's a separate group at Goldman
But the prices themselves would come

CHAIRMAN ANGELIDES:

And I'm going to ask Mr.

Viniar this, and then I'm going to defer the balance of my

questions to the end.

Of course in December of '06 it is well known

37
1

that the decision is made to get closer to home.

instructions down the line are to begin to mark things down,

adjust positions.

The

Is there a view that--tell me a little about,

just bluntly, if you are net short during this period--and,

you know, Mr. Blankfein says I think in 12/06, I think

sometime in--well, he doesn't say it then, but Mr. Blankfein

says at one point:

mess.

10
11

Of course we didn't dodge the mortgage

We lost money.

And then made more than we lost

because we were short.
How do you answer this?

Look, you guys are net

short and you're driving down prices.

creating a self-fulfilling prophesy?

the observation that the market--you were eventually proved

right, but of course what really matters is not what prices

turned out to be, but were you in fact pushing the market

down at the time?

WITNESS VINIAR:

things you said.

mark things down.

Are you in fact
I mean, you just made

Let me just clarify one of the

You said that the instructions came to

We never instruct people to mark things down.

mark things where the market is.

know, you've heard us talk about this a lot--we're pretty

passionate about fair value accounting.

And we're--as you probably

We believe that we're not smarter than the

38
1

market, and that the market tells us a lot of things, and

that should pay attention.

now it's worth 90, all we know is that today it is worth 90.

It might be worth 100 someday, and it might be worth 80

some day.

We don't know.

If something was worth 100 and

And we don't ignore that.

And we spend a lot of time trying to figure out

what the market prices are, and to mark our books exactly

where--

9
10

CHAIRMAN ANGELIDES:

But sometimes when markets

are illiquid, they're illiquid.

WITNESS VINIAR:

They are illiquid.

And on

probably 90 or 95 percent of our positions, it's easy to

mark them.

doesn't mean you can't do it.

positions, then it's very hard to manage your risk.

know how you manage your risk if you don't know the value of

your positions.

And on 5 to 10 percent, it's hard.

But that

If you can't mark your
We don't

We have 1000 people in our Controller's

Department.

Probably half of them are responsible for

verifying the prices of marks.

time on the less liquid positions because those are the hard

ones, and you use comparable positions, you deconstruct

positions into their different risks and look at other

positions that trade.

mark things to market.

Most of them spend their

But we don't believe that you can't

39
1
2

If you can't mark them to market, you can't
manage your risk.

CHAIRMAN ANGELIDES:

So but here's my basic

question.

end.

market.

necessarily that everyone else is so stupid.

8
9
10

It's an illiquid market and you're at the low

I mean, there's a bunch of other participants in the
I mean, you guys may be smart, but it's not

I mean, it's an illiquid market and you're at the
low end consistently on all these marks.
WITNESS VINIAR:

So what is--

Chairman Angelides, I can't

respond to why other people did not mark their positions

where the market was.

CHAIRMAN ANGELIDES:

Did you go out and look at

all their other marks and their methodology to say maybe we

are wrong here?

WITNESS VINIAR:

We talked with other people

periodically throughout, especially when we had disputes,

and we fundamentally believed that our marks were right.

Mr. Lehman said, we're willing to trade at our marks.

although I know you say that may be hollow and--

CHAIRMAN ANGELIDES:

WITNESS VINIAR:

CHAIRMAN ANGELIDES:

And

Yes, I think it's--

--we were--- personal experience in that kind of

market, people just, I don't care what you price some of

this stuff at unless it's extraordinary--

40
1

WITNESS VINIAR:

said, we had positions on both sides.

transactions, for example, we did have many of the

transactions, not all, were exactly the same as we had on

the other side.

And we also, again as Mr. Lehman
On the AIG

When we asked them for collateral, we posted

collateral.

So in our collateral disputes, we were actually

out cash because we were posting the amount of collateral we

were asking for.

But we think that the--

CHAIRMAN ANGELIDES:

Is it likely that it was

parallel?

WITNESS VINIAR:

Yes.

CHAIRMAN ANGELIDES:

In amounts?

I mean, you

struck the same economic deal with your counterparties as

you had with AIG?

17
18
19

WITNESS VINIAR:

As far as posting collateral and

getting collateral, many of them were parallel.
CHAIRMAN ANGELIDES:

All right, we would like to

get that information.

more information, as I said, on this pricing.

22
23
24
25

And we'd particularly like to get

Let's do this.

I'm going to stop right now, and

what I'm going to do is go to Mr. Thomas.
VICE CHAIRMAN THOMAS:

Thank you.

Thank you, Mr. Chairman.

I would just ask all of you to verbally respond, and

41
1

hopefully in the affirmative, that if as we go forward we

have additional questions based upon this or any other

information we have, that you would be willing to respond to

written questions with written answers in a timely fashion?

WITNESS BENSINGER:

WITNESS FORSTER:

Yes.

WITNESS HABAYEB:

Yes.

WITNESS LEHMAN:

Yes.

WITNESS VINIAR:

Yes.

10
11

Yes.

CHAIRMAN ANGELIDES:
you said something.

Okay.

Say something so she can say

Thanks.

One of the things that Goldman keeps telling me

is that you're market makers.

obviously you create a product.

until you create it.

modeling, or estimating structure to figure out where you

start.

You create markets.

There's no market value

So you've got to have some kind of

And if I ask questions to Goldman, I don't care

who answers.

want, and the same thing with AIG.

Well

You guys can figure out whichever one you

How do you start when you have a quote/unquote

"new product" asked for?

I know you folks don't market, you

don't sell, you're not creative, you simply respond to your

customers asking for something, and that you meet their

request is what I got out of the testimony yesterday.

42
1

The way I just said it probably doesn't mean I'm

a 100 percent believer in that, but let's start with that.

So how do you price it initially?

4
5

WITNESS LEHMAN:

Sir, I can speak to that, to the

best of my knowledge.

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

8
9
10

Sure.

In my specific seat at Goldman,

but-VICE CHAIRMAN THOMAS:
WITNESS LEHMAN:

Well, have you done it?

Well creating a new product like

derivatives, for example--why don't we talk about

derivatives—

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

that reference both RMBS and CMBS,

so what we call first-order securitizations,--

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

19
20

Alright.

Sure.

and then CDOs are securitizations of-We don't need to go all

the way down the trail to synthetics right now.
WITNESS LEHMAN:

I say that because that's a good

example of talking about a new product and how that's

started to price.

to the best of my knowledge.

client demand for synthetics referencing these products.

25
26

And this was probably around 2003-2004,
You started a--there was

For example, the first inquiry that I had was I
think the summer of 2004 by a money management firm that

43
1

they wanted exposure to double-B rated CMBS or commercial

real estate backed securities.

And they couldn't buy it in

44
1
2

the cash market.

It just wasn't available.

So they asked if Goldman would provide that to

them, effectively buy protection synthetically.

portfolio of $80 million across different vintages that were

actually seasoned.

It was a

So it was very hard to find.

So this was a trade that we ultimately ended up

executing in August of 2004, providing a mutual fund with a

product that they wanted, an exposure that they wanted.

VICE CHAIRMAN THOMAS:

When you say "execute",

was there discussion between you and the person who was

interested in the product as to what the price would be?

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

15
16
17
18

There was.
So you negotiate prices?

There was.

We had a view,

similar to-VICE CHAIRMAN THOMAS:

But there's no market

basis for determining what the product was going to pay at?
WITNESS LEHMAN:

Well I think we had a view as to

where the securities, to the extent they would be available

in cash form, could trade and what the value of that was on

an unfunded basis.

price, extrapolating from what we see in--

23
24
25

And that's how we came up with our

VICE CHAIRMAN THOMAS:

And was that based upon

market data?
WITNESS LEHMAN:

It was, but it was not the most

45
1
2

observable market data, is my opinion.
VICE CHAIRMAN THOMAS:

No, no.

So what you

basically did was extrapolate from, adjust for--you put in

various metric factors to come up with what you thought was

a fair price.

Your purchaser would look at it and say, well, we

don't think it's necessarily--adjust here, adjust there.

you had a kind of a negotiated, or a mediated arrangement

that you both finally came to an agreement on?

WITNESS LEHMAN:

Correct.

As a general rule, you

are taking as much as you can from the observable market

because that's where the market is.

adjustments that need to be made--

14
15

VICE CHAIRMAN THOMAS:
wants to buy it.

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

It's pretty--

That's right.

And we agreed on

a price, and we executed the trade with them.
VICE CHAIRMAN THOMAS:
desk that did certain things.

do on the desk?

Or not well?

And from the person who

That's right.

And then if there

I understand all that.

You said you were on a

Does Goldman observe how you

Do you get paid if you do well on the desk?

WITNESS LEHMAN:
how I'm compensated, or--

Well are you saying in terms of

46
1

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

So Goldman and Mr. Viniar can

speak at more length about this, but--

4
5

VICE CHAIRMAN THOMAS:

You don't know how you're

paid?

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

Yes.

I'm about to tell you.
Oh.

But the--but certainly I have

regular--

VICE CHAIRMAN THOMAS:

There are a lot of folks

who made millions of dollars in the panel yesterday who had

no idea--not only no idea how much they made, but whether

they made it or not.

to ask my questions differently than I normally do with

people.

Oh, hundreds of--I've found out I have

WITNESS LEHMAN:

No problem.

performance reviews at Goldman--

VICE CHAIRMAN THOMAS:

19
20

We have regular

I don’t know if that’s a

problem or not, so--go ahead.
WITNESS LEHMAN:

We have regular performance

reviews at the firm, and I've been there a little over six

years now, so that's part of it.

performance, the division's performance--

24
25

VICE CHAIRMAN THOMAS:
over how you did at your desk?

In addition, the firm's

So the performance review was

47
1

WITNESS LEHMAN:

There are several criteria that

are part of the performance review, both quantitative and

qualitative.

4
5

VICE CHAIRMAN THOMAS:
performance at the desk?

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

Was part of it your

Yes.
Okay.

But as I was mentioning before,

the firm's overall performance, the division's performance,

the department's performance, as well as my individual

performance are all part of the formula, if you will, in

terms of compensation.

VICE CHAIRMAN THOMAS:

But as soon as you were

able to get some kind of a handle on a product that went in

the market, notwithstanding the fact you had some degree of

modeling to create it, you kept tabbing it back to the

market because your goal is to make sure that whatever you

have is what's viable and available?

How do you do that if you've got a product that

you got started originally in which the market then changes?

That's where you start swapping money? -- Collateral

22
23
24
25

WITNESS LEHMAN:

I'm sorry?

I'm not sure I

understand the question, Vice Chairman.
VICE CHAIRMAN THOMAS:
a product that was negotiated.

Okay, you started off with

48
1
2

WITNESS LEHMAN:

But then the product became more--

3
4

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

I'm not sure about that specific

trade, but my guess would be, yes.

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

But usually you would?

Yes.
How else do you get it

adjusted to the market?

11
12

And do you have in that a

need to post collateral if there's an adjustment?

5
6

The first trade was negotiated.

WITNESS LEHMAN:

By and large, lateral posting

was part of all of the trades we were doing in derivatives.

VICE CHAIRMAN THOMAS:

Right.

Adjusted to the

market.

So then once you get it started, you have to

inevitably use a model of some sort, or negotiated position,

which may not be modeling.

WITNESS LEHMAN: No, I think what maybe I didn't

articulate very well previously is, that was the first

trade.

The market then grew immensely--

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

Sure.

and became more standardized,

and there was observable pricing for these

products.

VICE CHAIRMAN THOMAS:

Oh, absolutely.

And

that's why you had the adjustments based upon marking to

market.

That is how you folks--that's the sine qua non of

49
1

your operation, I'm told.

50
1

WITNESS LEHMAN:

mark to market prices.

we used for pricing.

So at that point in time, we

There was not a specific model that

VICE CHAIRMAN THOMAS:

And negotiations after

that are easier because you have a market price around which

you can quibble, and there's a whole lot less quibbling when

you've got reality every day than when you're trying to

create reality.

9
10

WITNESS LEHMAN:

That's correct.

The market is

what the market is.

VICE CHAIRMAN THOMAS:

Okay.

And so sometimes if

you couldn't exactly mirror--and to me "mirror" is like

isomorphic, it's exactly the same.

that.

trying to price something.

And you can't always do

So it's kind of like in real estate when you're

There are comparables.

And of course what you do then is negotiate out

the difference between a comparable and a mirror, or an

isomorphic position, and that's just part of the adjusting

as you go.

So you folks are constantly trying to adjust to

what is the reality of the market, or at least an agreed-

upon position of what the market is.

guys do basically all the time.

24
25

WITNESS LEHMAN:

Correct.

And that's what you

Listening to the

market and what the market is telling us as it relates to

51
1

risk is very, very important.

tool we have.

Perhaps the most important

VICE CHAIRMAN THOMAS:

And you were up and

running '04 to -05, and I guess part of the problem was that

by '07 some of those interest rates that were part of the

mortgage deals came up for readjustment, and that's when you

started to have to start making all kinds of adjustments

based upon what the real world was doing and the price on

the market.

10
11

WITNESS LEHMAN:
familiar.

I'm sorry?

Again I'm not

You're saying in 2007?
VICE CHAIRMAN THOMAS:

Well didn't you notice a

lot of your products with higher defaults and other things

happening--

WITNESS LEHMAN:

Okay.

VICE CHAIRMAN THOMAS:

--in large part because

the mortgages that began to be folded in in '05, '06, '07,

were mortgages that were going to deteriorate because more

and more of them had no docs and they had short-term

interest rate only, or adjustable ARM rates,

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

23
24

So-and they began

changing, and that's when the degradation began showing up?
WITNESS LEHMAN:

So while I'm not a residential

mortgage market expert, certainly in 2007 you saw prices

declining in the observable mortgage products because

52
1

perhaps of the resets that you're talking about,

53
1

underwriting standards--

2
3

VICE CHAIRMAN THOMAS:
your belief--

4
5
6

Well then tell me what was

WITNESS LEHMAN:

--higher LTDs, and home prices

going down.
VICE CHAIRMAN THOMAS:

--as to the increased

activity in your desk segment of the market?

was getting a lot of increased activity.

WITNESS LEHMAN:

In and around--

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

You said it

In building new products?

In and around 2007,

specifically?

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

Yes.

I don't recall, outside of more

and more participants, both on the long side of the market

and the short side of the market in derivatives were getting

more involved in the market around that time period.

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

20
21

So it's continuing--

Increased involvement for market

participants, is my view.
VICE CHAIRMAN THOMAS:

Okay.

So really almost

all your activity is kind of mono-e-mono.

You never give it

to a third party mediation?

third parties or other sources to come to an agreement, but

it's always kind of a one-on-one to come to an agreement?

You try to bring in data from

54
1
2

WITNESS LEHMAN:

Well these are generally

bilateral trades, the derivatives trades.

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

Yeah.

So--and there was in large part

an observable market.

market again was what it was, and people posted there and we

transacted there.

8
9
10
11
12
13

So it wasn't a negotiation.

VICE CHAIRMAN THOMAS:

The

Or to the best of your

ability you were where you thought the market was, or should
have been?
WITNESS LEHMAN:

In the absence of a specific

trade in that security or derivative, yes.
VICE CHAIRMAN THOMAS:

So you came up with an

amount of money, or the $1.8 billion, or whatever.

the other party gets to say that's an outrageous amount, or

whatever it is they're quoted, the Chairman has quoted as

their saying.

What do you do then?

WITNESS LEHMAN:

And then

I think what we did, and we did

this with AIG in this situation, we got on the phone and

tried to share information, talk about what we're seeing and

why we think the market price is what we suggested, and have

a point/counterpoint and try to reach agreement.

24
25

VICE CHAIRMAN THOMAS:

Whoever wants to speak

here, I don't know if you're the designated spokesman, Mr.

55
1

Forster, but if the others want to defer to you.

So you get the call.

And it's been described as

an outrageous amount.

You folks basically took one side of

the bet repeatedly over and over, and you felt comfortable.

And to a very great extent this is testimony based upon

Mr. Cassano yesterday, and so you can add whatever you might

want to add, but my guess is that if you're going to take

one side, which is on the short side, you did quite a bit of

modeling in looking at the product and getting some

comfort level for exposing yourself as much as you were

exposed if things went bad?

WITNESS FORSTER:

VICE CHAIRMAN THOMAS:

Yes.
Because you were in the

market.

say we need X amount of collateral based upon market

position?

we think we should be?

models to be comfortable with where you are?

19
20
21
22
23
24
25

So what were you looking at when Goldman would then

You say "what market position?" based upon where
Are you relying primarily on your

Or do you--I know that there wasn't a lot of
market data, but what were you seeing in the market data?
WITNESS FORSTER:

Perhaps I could take a quick

step back and help.
VICE CHAIRMAN THOMAS:

Oh, sure.

I need all the

help I can get.
WITNESS FORSTER:

I think perhaps what someone

56
1

like Mr. Cassano was talking about yesterday, there's the

initial process when we entered into the transaction--

VICE CHAIRMAN THOMAS:

WITNESS FORSTER:

Yeah.

and the modeling that we did

then--

VICE CHAIRMAN THOMAS:

Well the same thing they

have to do when they get started, to a certain extent, but I

think you were a little heavier into it.

fair statement, --

WITNESS FORSTER:

VICE CHAIRMAN THOMAS:

12
13

Would that be a

Sure.
in terms of relying on

models?
WITNESS FORSTER:

True.

I think the important

thing to try to explain to you is that at the beginning

what we were doing was using a model to evaluate the

ultimate credit risk that we were taking in the

transactions, making sure that the risk position that we

took on for the firm was one that we felt was appropriate.

As we get into 2007, the issue was that what you

then need if there were no observable market prices is some

way to evaluate what the market price would be, as opposed

to what the--the credit risk, you could still view the

credit risk as being there is no credit risk here in terms

of our ultimate losses, in terms of a credit model, but

there may be a change in the market value.

And we at that time did not have an internal

57
1

model to calculate a market value, or attempt to estimate

some sort of market value.

tried to construct and put together in the fall of 2007.

And that is of course what we

So absent of that at that time, until we get to

58
1

the stage probably something around December 2007 where we

have something that we think is more robust and useful, then

we are relying on--

VICE CHAIRMAN THOMAS:

useful?

collected?

confidence level in?

8
9
10

Which is more robust or

Based upon market data that you then eventually
Or adjusted modeling which you have a high

WITNESS FORSTER:

Building the model and then

using market data within the model, what available market
data we can get, to try and come up with a valuation.

VICE CHAIRMAN THOMAS:

Did you use any of the

Goldman numbers that they provided to you, which they

thought were the market, in your modeling?

WITNESS FORSTER:

Not within the modeling itself.

The modeling that we used, and the model that we built,

tried to look at the underlying assets within the CDO and

come up with price estimates for those.

And then the model would then try and calculate

an overall CDO price, and we would look at that final output

versus the outputs we had, or the information that we had

from the likes of Goldman Sachs, and we would compare the

two.

VICE CHAIRMAN THOMAS:

I've bought and sold a lot

of old cars, a lot of English cars, MG-TF, a TR2, a Austin

Healey BJA, all of that stuff.

I had to walk away from a

59
1

lot of cars because, frankly, the people who owned them

thought they were worth a whole lot more than what a buyer--

me--was willing to pay for them.

So I'm trying to figure out how you model,

without actually looking at what someone is willing to pay

for it.

turn back toward Goldman and talk about taking another

position, or going out in the market and covering yourself?

And at some point don't you have the ability to

What was the worst possible consequence of your

accepting Goldman's statement as to what the market price

was at the time that you, the quote, whatever it was, it was

ridiculous, outrageous, or whatever?

WITNESS FORSTER:

Well I guess there would be a

few consequences.

of cash that would go out the door from AIG to Goldman

Sachs.

One, there would be a significant amount

Two, I guess up to the point where we had an

alternative source of valuation, I would imagine that people

like the accounting folks, both at AIG and our external

auditors, would use that as a data point.

And if we believed those prices to be inaccurate,

then I think it would be wrong to have the company use that

as a data point to mark its books.

24
25

VICE CHAIRMAN THOMAS:

And your argument for

believing that the stated required capital posting was that

60
1

your model said that it wasn't worth what Goldman Sachs

it was?

WITNESS FORSTER:

said

I think we can say that later

on in the period, but not at the beginning.

So as I said,

right at the beginning we didn't have that.

All we had was

some other prices from, you know, we had anecdotal--

VICE CHAIRMAN THOMAS:

And did you know that you

had to make margin payments?

yesterday who said they weren't aware that that was part of

the contract.

11
12

There were some folks

WITNESS FORSTER:

Right.

I mean, I realized

that--

VICE CHAIRMAN THOMAS:

WITNESS FORSTER:

Were you aware of it?

I realized it was in the

contract.

I think it's a fairly standard feature of pretty

much every derivative contract.

issue.

So I didn't see it as a big

I knew it was there.

VICE CHAIRMAN THOMAS:

Would it bother you that

people who were above you in the structure seemed very

surprised and didn't know that that was the kind of

arrangement they had, that they were going to have to meet

margin?

WITNESS FORSTER:

speak for them.

to others.

I guess I'm not sure I can

It was clear to me.

I thought it was clear

61
1

VICE CHAIRMAN THOMAS:

I'm asking you to speak

for yourself, if you would be surprised that someone in your

business above you stated yesterday under oath that they had

not idea that that was part of the contract.

WITNESS FORSTER:

As I said, I think it's a

fairly standard feature of a derivative contract, so I guess

to that extent I would be surprised.

8
9

VICE CHAIRMAN THOMAS:

Okay.

Did you want to say

something?

CHAIRMAN ANGELIDES:

Just on that point, Mr.

Bensinger, in the interview with our staffs you apparently

indicated that you weren't aware--you were the CFO of the

company, correct?

WITNESS BENSINGER:

CHAIRMAN ANGELIDES:

I was.
You stated in interviews

with our staff you were not aware of the collateral call

provisions.

Correct?

WITNESS BENSINGER:

collateral provisions as it--

20
21

CHAIRMAN ANGELIDES:

As it pertained to mark to

market?

WITNESS BENSINGER:

declines.

rating triggers.

I was not aware of the

--pertained to market pricing

I was aware of collateral provisions relating to

CHAIRMAN ANGELIDES:

Right.

So you weren't aware

62
1

of the mark to market.

And, Mr. Habayeb, you were the CFO of the

Financial Services Division, and you told our staff you

weren't aware of them until third quarter of '07.

WITNESS HABAYEB:

CHAIRMAN ANGELIDES:

remarkable.

8
9

Correct?

That's correct.
Okay.

Which I found

But I just wanted to clarify your question.
VICE CHAIRMAN THOMAS:

Mr. Chairman, we both find

it remarkable.

CHAIRMAN ANGELIDES:

VICE CHAIRMAN THOMAS:

Yes.

All right.

You'll get some time.

All

I'm trying to do is to try to understand the way in which,

if you have a product which is determined by the market--

because ultimately, don't you agree, Mr. Forster or anyone

on AIG's side--is that no matter how good you think your

modeling is, eventually what you have is worth what someone

else is willing to pay for it?

isn't it?

WITNESS FORSTER:

market.

the time.

I mean, that's the market,

I mean ultimately that's the

But that relies on actually having market prices at

If you're in a liquidity gap and for a period of

time where people just do not want to add risk, personally I

don't think you should then mark all your positions to zero.

VICE CHAIRMAN THOMAS:

No, I understand that.

63
1

But, you know, if I was going out looking for Austin Healey

1967 BJH, which was the last year that they imported them

into the U.S., I'd love to have 100 to choose from.

up having one to choose from.

was asking was the price of a lot on Flathead Lake in

Montana.

frankly appreciated significantly over a period of time.

8
9

I wound

And fortunately the price he

And so I could meet that price, and got a car that

So sometimes the market isn't what you want the
market to be.

The market is what the market is.

And if you

say you had very little ability to determine what the market

is, that's the market.

someone was buying or selling, or trying to--did you

negotiate in terms of what a comparable would be in terms of

saying there's limited options on the market, but we think

there are the adjustments that should be made?

16
17

But you were not relying on what

Because after all, they did come back with a
lower collateral statement, didn't they?

WITNESS FORSTER:

They did, yes and I think--

VICE CHAIRMAN THOMAS:

Did you negotiate with

them to reach that point?

with themselves and come back with the position that you

accepted?

WITNESS FORSTER:

Or did they go back and negotiate

Well I think, as I understand

the chronology, the change from 1.8 to 1.2 was purely a--it

was just in the contract that it needed to be reduced by

64
1

that amount.

point.

There wasn't any real negotiation at that

And then, you know, we did enter into, you know,

what I saw was fairly friendly negotiations with Goldman

Sachs, and we came up with a compromise agreement in terms

of posting that amount of money.

thought that solved the situation; it didn't.

accepted each other's prices, but as part of a business

negotiation we came up with a compromise number for the

Neither side

short period of time.

VICE CHAIRMAN THOMAS:

Back to Goldman.

1.8 to 1.2?

I don't think either side

Last round for right now.

What happened in terms of you going from

WITNESS LEHMAN:

So to the best of my

recollection, what drove that change--one thing, I think

it's important that we're mindful of this was a $15 or $20

billion portfolio.

18
19
20
21
22

So it is a very big number.

VICE CHAIRMAN THOMAS:
WITNESS LEHMAN:

But what I recall we did, was

we refined our pricing after we got more information-VICE CHAIRMAN THOMAS:
you're using market?

How do you refine it if

So you added adjustments to it--

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

Yeah.

No
which weren't market based?

What we did is there were a few

of the specific CDS contracts that we didn't have the

65
1

offering docs to, so we needed to get increased information

66
1

as relates to the structure and the performance of those

deals.

3
4
5

And after a more thorough review of that, we put
forth a new price.
VICE CHAIRMAN THOMAS:

So you took a decent stab.

You couldn't pull it off, so you sharpened your pencil, went

back and decided that you would look at something.

8
9

If you went back and sharpened your pencil and
redid it and it was a higher number, would you--do you

think--I mean, let's just, I know I'm asking the question

and you don't have to answer in any way you want--if you

came back with a higher price, would you have gone back with

a higher price?

WITNESS LEHMAN:

Our prices always represented

the best prices, our best view of market prices, given the

information we had at that time.

changed the number from 1.8 to 1.--

VICE CHAIRMAN THOMAS:

And that's what I believe

So when they rejected it,

you went back and got a finer, or a better price of what you

thought the market was?

WITNESS LEHMAN:

I don't recall it being

contingent upon their rejection.

to provide better pricing, and we asked for it.

24
25

VICE CHAIRMAN THOMAS:

We needed more information

And had they rejected it,

would you have gone back and looked for a different price,

67
1

which probably would have been lower?

WITNESS LEHMAN:

If we felt like there was more

information out there that AIG had that could help us

provide better pricing, we would always ask for it.

5
6

VICE CHAIRMAN THOMAS:

Okay.

Mr. Chairman, I

will--

WITNESS LEHMAN:

Higher or lower.

VICE CHAIRMAN THOMAS:

CHAIRMAN ANGELIDES:

--I will reserve my time.
I was going to defer the

rest of my questions, but I've got to just follow up very

quickly on this on two points.

Number one is, when you spoke you made this sound

like a science.

analysis.

make a capital call of $1.8 billion.

Within a matter of

days, you reduce it to $1.2 billion.

You ask for 50 percent

more initially than your quote/unquote "refined estimate."

You know, we do all this quantitative

But I just want to point out for the record, you

It seems to me, I mean that's pretty much a stab

in the dark.

business, and you're being aggressive.

motivations.

You're just trying to protect your position.

put it in perspective, you're in a disrupted market.

24
25

I mean, that's you guys--and, look, you're in

Maybe you're short.

There may be many

Maybe you guys have cash.
But just to

You're saying you have this fine methodology, but
one day you're saying it's $1.8 billion, and a few days

68
1

later you're saying $1.2 billion.

spread.

It's not like--and you're divergent with other people in the

marketplace.

That's pretty damn big.

That's a $600 million
Let's be frank about it.

And by the way, it is 400 percent more than what

you settle for.

Now I know you had a standstill agreement,

but just to put it in perspective, it seems to me like you

guys are going in and being as aggressive as you can.

not exactly, gee, here's where we see the market is.

It's
It's

you're marking positions I assume for your benefit in the

business environment.

Isn't that fair to say?

WITNESS VINIAR:

No, it's not fair to say.

CHAIRMAN ANGELIDES:

So, so, okay, okay, I know I

just barely--you say no, but if you really have good market

data, how the heck is it $1.8 billion on day and $1.2 a few

days later?

WITNESS VINIAR:

I think one thing you said is

fair, which is for illiquid assets like this it's not a

science.

continue to refine our judgment.

continued to move, which is why the collateral calls changed

constantly over time--

23
24
25

And that there is judgment involved.

CHAIRMAN ANGELIDES:

And the market also

Yes, but it didn't move--it

didn't move that much in a few days.
WITNESS VINIAR:

And we

Let's be blunt.

I said it's not a--it's not an art,

69
1

it's not a science.

used our best estimate at all times of what the market was.

There is judgment involved.

CHAIRMAN ANGELIDES:

But we

Okay, but just to put it in

perspective, one day you thought it was $1.8 billion--and I

want to just say.

that goes to Lester Brafman, that comes to you, Mr. Lehman.

And right at the same day the capital calls are made, he's

saying the extent of the collateral calls being generated

overnight is embarrassing for the firm, $1.9 billion for

AIGFP alone.

off.

get it.

off.

There's an e-mail here from Ram Sunderahm

We need to focus on developing a--it's cut

I have to get the full e-mail here.
It's coming.

Hang on a second.

Sorry.

I will

Mine is just cut

Thank you.
"We need to focus on developing a process for

ensuring accuracy of all marks, especially those which are

being sent to clients, and those are the basis for margining

open transactions."

So I just want to point out, your own folks are

saying, hey, we'd better be accurate about this stuff.

the capital calls--the collateral calls are already gone.

But

Here's the other thing I want to just visit with

you briefly, which is:

You mentioned that you lay off your

risks to other counterparties on parallel terms.

got to just ask you, I mean you're really not, you know,

you're not just solely in the feed business.

But I've

I mean, I

70
1

assume you're making money on the spread here, correct?

WITNESS VINIAR:

Yes.

CHAIRMAN ANGELIDES:

I mean, it's just not

credible to me--you know, you wouldn't be doing very well if

it--okay, good.

WITNESS VINIAR:

I'm sorry.

CHAIRMAN ANGELIDES:

Good.

I said, yes.
Okay.

And just to

amplify the "yes," obviously if there were parallel terms,

you guys wouldn't be doing very well?

WITNESS VINIAR:

The parallel terms I was talking

about were the collateral terms.

so we had--

13
14

CHAIRMAN ANGELIDES:

Parallel collateral terms

Yes, but then collateral is

a subset of the economic terms of the whole deal, too.

WITNESS VINIAR:

No, Not necessarily.

The parallel

terms are the collateral terms, which mean that we had to

post or receive if they declined.

writing protection, or got for getting protection, could be

different.

What we charge for

And that's where the spread-CHAIRMAN ANGELIDES:

We'll look at those when you

provide them.

And the last thing I want to do at this

moment is enter into the record the e-mail I referred to

earlier, which is an e-mail string, the last item of which

is an e-mail from Mr. Athan to Mr. Frost dated August 8,

2007.

71
1

All right, Ms. Born.

COMMISSIONER BORN:

Thank you very much,

Mr. Chair, and thank you all for appearing before us.

Mr. Viniar, you state in your testimony, and I'm

quoting, quote:

important to underscore that we generally do not have a

derivatives business."

8
9
10

"With regard to revenues and profits, it is

End quote.

You have also repeated under oath today that
Goldman Sachs, quote, "generally does not have a derivatives
business."

Is that correct?

WITNESS VINIAR:

Yes.

COMMISSIONER BORN:

Didn't you tell the

Commission staff that Goldman Sachs is one of the top five

derivatives dealers in the world?

WITNESS VINIAR:

I don't know if I said we were

one of the top five.

participants in derivatives markets in general.

I might have.

COMMISSIONER BORN:

We're one of the bigger

Is the Office of the

Comptroller of the Currency correct when it reports that

Goldman Sachs held $48.9 trillion in notional amount of

derivatives at the end of 2009?

22
23
24
25

WITNESS VINIAR:

I don't know.

I'd have to go

look at our financial statements.
COMMISSIONER BORN:

It also says that Goldman

Sachs has the third largest derivatives position among any

72
1

of the U.S. bank holding companies.

WITNESS VINIAR:

COMMISSIONER BORN:

Does that surprise you?

It could be.
We also have learned from our

investigation of Goldman that Goldman currently holds more

than a million contracts in derivatives.

WITNESS VINIAR:

That's possible.

COMMISSIONER BORN:

When you say that Goldman

doesn't have a derivatives business, I would like to explore

what you mean by that.

If a customer comes to Goldman and says it wants

to buy an interest rate swap, do you say, no, we generally

don't have a derivatives business?

WITNESS VINIAR:

COMMISSIONER BORN:

No.
Would you sell them an

interest rate swap, or not?

WITNESS VINIAR:

Yes, we would.

Let me--can I

clarify what I meant by we don't have a derivatives

business?

COMMISSIONER BORN:

WITNESS VINIAR:

Yes.

We don't separate out

derivatives and cash businesses.

So we would have an

interest rate business.

that would include both cash and derivatives.

wouldn't separate them out.

a desk if they wanted to buy a Treasury, or an interest rate

We could have a credit business
And we

And so we might have someone on

73
1

swap, it could be the same person.

If they wanted to buy a bond or a CDS contract,

it would all be part of the same business.

meant when I said we don't have the derivatives business, is

that they're integrated into the cash businesses.

6
7

COMMISSIONER BORN:

But it is an enormous portion

of your business?

8
9

That's what I

WITNESS VINIAR:

Derivatives are a very big part.

Derivatives and cash are both very big parts of what we do.

COMMISSIONER BORN:

And in fact Mr. Lehman has

said on the Structured Products Group Trading Desk you trade

not only cash products but also derivatives products,

correct?

14
15
16

WITNESS VINIAR:

That's correct.

We trade both

cash and derivatives mortgage instruments.
COMMISSIONER BORN:

Then, Mr. Viniar, in your

testimony you go on to say, and I'm quoting:

divide revenues or profits between derivative and non-

derivative products, or track or report our financial

results that way."

Is that your position?

WITNESS VINIAR:

COMMISSIONER BORN:

That's accurate.

"We do not

Yes.

Since early this year, the

Commission has asked Goldman to provide to us its revenues

and earnings from its enormous over-the-counter derivatives

74
1

operation, and we have not yet received that information.

I would like to reiterate that request.

WITNESS VINIAR:

I know this was discussed a lot

yesterday, as well, and we're happy to sit down with your

staff and go through what we have, what we don't have.

don't keep our books and records that way because the

businesses are integrated.

8
9

Again, if we have a long cash position and a
short derivatives position, we'd look at integrated.

Even

more complicated, you could have for example a commodities

derivative that is settled physically.

derivative and you end up with the physical asset at the

end.

Where's the profit?

that way.

go through exactly what we have and what we don't have to

show you that.

18
19

So is that a derivative?

So you have a

Is it not a derivative?

So we don't keep your books and records

And we're happy to sit down with your staff and

COMMISSIONER BORN:

But you do keep financial

data from which this could be derived, don't you?

WITNESS VINIAR:

We keep financial data.

I'm not

sure that we actually could derive exactly what derivatives'

profits or loss are.

staff and go through exactly what we have and what we don't

have.

But we're happy to sit down with your

COMMISSIONER BORN:

Well as I pointed out

75
1

yesterday, the Office of the Comptroller of the Currency has

reported that commercial banks' 2009 revenues from

derivatives' trading were $22.6 billion.

reported that Goldman's commercial bank had $41.6 trillion

in notional amount of derivatives.

6
7

Do you know whether you have reported to the
Office of the Comptroller of the Currency?

8
9

And it also

WITNESS VINIAR:

Notional amounts of derivatives-

COMMISSIONER BORN:

WITNESS VINIAR:

No--

--we have, and we can give you--

12
13
14

COMMISSIONER BORN:

--revenues.

They are

reporting revenues of commercial banks.

WITNESS VINIAR:

I don't believe we have reported

to anybody revenues of derivatives, because we don't keep

them.

derivatives and cash.

The report to the OCC that I've seen is combined

19
20

COMMISSIONER BORN:

Well we would like copies of

that, whatever reports you've given to OCC as well.

WITNESS VINIAR:

Sure.

COMMISSIONER BORN:

Aren't you aware of whether

particular kinds of transactions are profitable or not

profitable?

said:

I mean, if Lloyd Blankfein came to you and

Are we really making money on our interest rate swaps

76
1

transactions?

dealer in over-the-counter interest rate swaps?

say:

Should we go out of the business of being a
Would you

Sorry, Lloyd, I can't tell you?
WITNESS VINIAR:

I would have a hard time looking

at just swaps, particularly.

a good business for us, but it's very combined with

derivatives and cash.

want to go out of the business is because it would be very

hard to manage the cash risk, and it would be very hard to

help our clients if we could only do one side, if we could

only deal the cash and not handle derivatives.

The interest rate business is

And so one of the reasons I wouldn't

COMMISSIONER BORN:

If you're not aware of the

profitability of that aspect of the business, how is it that

you price the spread?

I mean, let me ask Mr. Lehman.

How is it you decide what the prices are that you

should bid and ask for CDS contracts, for example, if you

don't know whether or not the business you're doing in that

is profitable?

WITNESS LEHMAN:

Well I think just to underscore

the point that Mr. Viniar made, you know, the business--and

I can speak to the mortgage trading business specifically--

you know, ourselves, our competitors, our clients think

about it holistically.

securities bid and offer, we're pricing derivatives in a

similar manner.

So similar to how I price cash

And in a lot of these securities, certainly

77
1

in this day and age, there are liquid observable markets

that we're looking at to, you know, assess risk and make

trading decisions.

4
5

But we're looking at cash and derivatives
holistically in these businesses, by and large.

COMMISSIONER BORN:

Well I am asking you to try

and look at them separately.

not in a swaps transaction, say a CDS that you purchase or a

CDS that you sell, whether that turns out to be profitable

So you don't know whether or

or a losing proposition for the company?

WITNESS LEHMAN:

I think maybe a good example is

if we have a CDS transaction where a client wants to be

short risk, and they want to be long cash securities, you

know, if we facilitate that transaction for the client, if

we're just merely looking at one leg of the transaction

that's not indicative of the whole picture in terms of that

business for Goldman Sachs.

COMMISSIONER BORN:

Well some of the business

that you do is just the one leg, isn't it?

lot of over-the-counter derivatives contracts where you are

not managing your counterparties' cash exposure.

correct?

WITNESS LEHMAN:

You enter into a

Isn't that

You're suggesting if the client

merely just wants to trade a derivative and not the cash

security?

78
1

COMMISSIONER BORN:

WITNESS LEHMAN:

Yes.

The client might want to do

that, but that trade is going to be in the holistic,

integrated book that I mentioned by product, as opposed to

meaning the sector itself, like commercial real estate, or

residential mortgages, as opposed to derivatives versus

cash.

8
9

COMMISSIONER BORN:

So if you can't ascertain the

profitability of particular kinds of instruments, I thought

you marked them all to market, including, I assume, your

derivatives book?

WITNESS LEHMAN:

We do.

COMMISSIONER BORN:

Correct, we do.

But if you can't determine

profitability of for example your interest rate swaps, how

do you protect as a business against a rogue trader like

Nick Leeson was at Barclays going in and losing a great deal

of money on interest rate derivatives?

kind of just be subsumed in your overall fixed income?

that right?

WITNESS VINIAR:

Because that would
Is

We would mark all of the traders

positions to market, whether they had cash or derivatives,

and we would see where they are.

23
24
25

COMMISSIONER BORN:

So you would see that you

were taking enormous losses on your derivatives?
WITNESS VINIAR:

It--it, it would likely be a

79
1

combined cash and derivatives.

2
3

COMMISSIONER BORN:
Leeson's trading was.

4
5

I don't know what Nick Leeson

was trading in.
COMMISSIONER BORN:

He was at Barclays in the

early '90s--

8
9

Well I don't think Nick

He was trading in derivatives only.

WITNESS VINIAR:

6
7

We'd look at both sides.

WITNESS VINIAR:

No, I know where he was. No, I

know that.
COMMISSIONER BORN:

And so I wouldn't expect you

to exactly notice.

question has to arise as to whether or not Goldman would be

capable, if it has no idea of its profits or revenues on its

derivatives operation to manage that kind of enormous

business properly.

Well, I think it makes it appear very--a

Your Chief Risk Officer yesterday said that you

can't manage something you can't measure.

I am very skeptical that you really can't measure these

revenues and profits.

the information we've been asking for.

about six months that we've been asking for it.

And I suggested--

I think I urge you to provide us with
I think it's been

And it makes one wonder also why Goldman has the

incentive, or impetus not to reveal this information.

You're suggesting you don't reveal it to your regulators.

You don't give it to OCC.

financial reports, so you don't give it to the market.

You don't give it in your
You

80
1

don't give it to any forum in which your customers over-the-

counter derivatives counterparties can see what you're

making on this aspect of the business, and you're refusing

to give it to us.

5
6

I hope very much that we will see this very
shortly.

WITNESS VINIAR:

Commissioner, again, we are not

refusing anything.

We are happy to sit down with your staff

and go through exactly what we have and try and accommodate

as best we can.

business.

And I'm not aware of any other firm that in their financial

statements has derivatives revenues broken out.

We don't have a separate derivatives

It's integrated into the rest of our businesses.

COMMISSIONER BORN:

They don't, but some other

firms have provided us with that data when we've asked for

it.

And Goldman Sachs hasn't.

Yes?

CHAIRMAN ANGELIDES:

Just on my time for one

minute, because you've made a couple of narrow statements.

I noticed in your statement, your written testimony, and

just there where you say "in our financial statements."

That's not what we're asking you.

Look, I ran a

very small business.

I didn't have, let's put it this way,

I didn't have the asset base Goldman Sachs had.

pretty simple when you run a business that if you have

But it's

81
1

contracts, you know, the way it tends to work is you enter

those contracts into your system.

You can track your contracts.

So you have a 1.2

million contracts.

your company that tracks revenues or assets of contracts and

liabilities and payments under contracts?

track any--you have no management reports, no financial

reports that track these contracts?

Are you telling me you have no system at

WITNESS VINIAR:

So you don't

I've never seen one that adds up

our derivative revenues.

And again, derivatives are

somewhat complicated in that--

CHAIRMAN ANGELIDES:

Well you may not have seen

it, but you're telling me you don't have that kind of

management system where you can--you get management reports

to see, not just in these divisions but in other ways how

information can be displayed horizontally, vertically,

saying, hey, tell me how we're doing on those contracts?

WITNESS VINIAR:

the derivatives?

meaningful.

No.

Where we would just break out

We do not.

Because it's not

COMMISSIONER BORN:

Back on my time?

Thanks.

Mr. Lehman and Mr. Viniar, you said that Goldman

marked to market the CDOs underlying the credit default

swaps it bought from AIG in order to determine the

collateral calls that you were making to AIG.

Is that

82
1

correct?

WITNESS LEHMAN:

That's correct.

COMMISSIONER BORN:

And were those marks an

accurate measure of the value of those CDOs in your

estimation?

6
7

WITNESS LEHMAN:
were.

8
9

COMMISSIONER BORN:

Was the value you arrived at

below the par value of the CDOs?

10
11

In my estimation, yes, they

WITNESS LEHMAN:

Yes.

These securities were

trading at a discount at that period of time.

COMMISSIONER BORN:

When the government bailed

out AIG, it arranged to purchase a number of those CDOs from

Goldman Sachs into the Maiden Lane III special purpose

vehicle.

Isn't that right?

WITNESS VINIAR:

Yes.

COMMISSIONER BORN:

Did the government pay your

mark to market values of those CDOs?

par value of the CDO?

20
21

WITNESS VINIAR:

24
25

It paid the full par value to

purchase the underlying securities from the CDOs.

22
23

Or did it pay the full

COMMISSIONER BORN:

It bought the CDOs from you

at-WITNESS VINIAR:
underlying the CDOs.

It bought the securities

83
1
2

COMMISSIONER BORN:
they?

WITNESS LEHMAN:

COMMISSIONER BORN:

WITNESS LEHMAN:

Well those were CDOs, weren't

Yes, they were.
so--

And simultaneously tearing up

the contract, the derivatives contract, as I understand it.

COMMISSIONER BORN:

Right.

In order to cancel

the credit default swap, you sold in effect, or returned to

Maiden Lane III the CDOs that the credit default swaps had

been written on.

And those were the same CDOs that you had

been making to market, correct?

CHAIRMAN ANGELIDES:

COMMISSIONER BORN:

WITNESS LEHMAN:

15
16

I will yield five minutes.
Thank you.

I believe it was a portion of

them, yes.
COMMISSIONER BORN:

So you got 100 cents on the

dollar for those CDOs form the government through Maiden

Lane III, even though you had valued them at a discount?

that correct?

WITNESS LEHMAN:

So, Commissioner, on the desk

that I worked I was not privy to or involved in the Maiden

Lane III conversations.

long this risk synthetically, and they were long it at par,

and the prices went down to 50, 60 cents on the dollar.

not sure the exact price.

But as I understand it, AIG was

And as opposed to maintaining

I'm

84
1

that risk position synthetically, they decided to purchase

the securities and have it in what we would term "funded

format," in cash format, instead.

4
5

COMMISSIONER BORN:
decision, did it?

WITNESS LEHMAN:

COMMISSIONER BORN:

I'm not familiar with-Isn't that the Government of

the United States making that decision?

9
10

AIG didn't make that

WITNESS LEHMAN:

I don't know who exactly made

that decision.

COMMISSIONER BORN:

WITNESS VINIAR:

COMMISSIONER BORN:

Do you know, Mr. Viniar?

No.
But there was no kind of

compromise or negotiation for, between the full par value

and the value that Goldman Sachs put on the CDO?

the full value, not any discounted value?

correct?

WITNESS VINIAR:

COMMISSIONER BORN:

You got

Isn't that

That's correct.
Do you know if anyone at

Goldman did speak to the Government about the price that it

would get for the CDOs?

22
23

WITNESS VINIAR:

We had one conversation, either

the day or two days before the Maiden Lane transaction.

COMMISSIONER BORN:

WITNESS VINIAR:

COMMISSIONER BORN:

Who was that—

I’m Sorry?
with?

Was that between you and--

86
1

WITNESS VINIAR:

COMMISSIONER BORN:

WITNESS VINIAR:

Not me, personally no.

It was a senior person in our

Fixed Income area.

COMMISSIONER BORN:

WITNESS VINIAR:

Who was it?

The name is Harvey Schwartz, ran

the division.

8
9

Who was it?

COMMISSIONER BORN:

And was there any negotiation

in that conversation about whether Goldman's valuation or
the full par value is what you'd be paid for the CDOs?

WITNESS VINIAR:

There was no negotiation.

The

representative of, I believe it was--I think it was New York

Fed, but I'm not sure, said we'd like you to think about a

discount.

senior people, and we never had another conversation.

next thing we got were the documents from Maiden Lane.

17
18
19
20
21

Mr. Schwartz said that he had to talk to more

COMMISSIONER BORN:

The

So he never got back to the

Government?
WITNESS VINIAR:

There were no other

conversations.
COMMISSIONER BORN:

Goldman had insured itself by

purchasing CDS from third counterparties, third parties,

against the losses that it might suffer on the CDOs that it

had credit default swaps from AIG on, correct?

WITNESS VINIAR:

We insure ourselves on the

87
1

difference between the collateral we believed we were owed

by AIG and the collateral they had posted.

3
4

COMMISSIONER BORN:

Correct.

And did you

exercise or get payment on those CDSs?

WITNESS VINIAR:

No.

You can only exercise the

CDS, actually deliver, if the counterparties--if the

underlier, who is AIG, actually defaults.

never a payment under the CDS because AIG did not actually

default.

10
11

COMMISSIONER BORN:

So, no, there was

Because the Government had

paid you 100 cents on the dollar.

WITNESS VINIAR:

The Government basically came in

and prevented AIG from defaulting on any of their

obligations.

COMMISSIONER BORN:

So you took none of the

losses, just the American Taxpayer took the losses on your

dealing with AIG.

Isn't that correct?

WITNESS VINIAR:

We had, as we've said, no

exposure to AIG because of the collateral and the CDS

contracts.

protection.

22
23

So we were paid in full, and we had full

COMMISSIONER BORN:

You were paid in full by the

Government.

WITNESS VINIAR:

On those transactions.

COMMISSIONER BORN:

On those transactions, and

88
1

you didn't have to exercise--make a claim on the CDSs, on

the insurance you had bought on losses

WITNESS VINIAR:

Well we couldn’t.

COMMISSIONER BORN:

because you suffered

no loss, because the American Taxpayer paid your loss on

those deals.

WITNESS VINIAR:

were due under a contract.

of course we never collected under, so we had whatever the

All we were paid was what we
We had paid for insurance, which

cost was of buying the insurance.

COMMISSIONER BORN:

recompensed on that dealing.

dollar--

You got 100 cents on the

WITNESS VINIAR:

COMMISSIONER BORN:

16
17
18

So you were 100 percent

We were paid what we were owed.
--and the only people who

were out money was the American public.
WITNESS VINIAR:

All I can comment on is we were

paid what we were owed under our contract.

COMMISSIONER BORN:

Thank you.

WITNESS VINIAR:

CHAIRMAN ANGELIDES:

VICE CHAIRMAN THOMAS:

You're welcome.
Mr. Thomas.
Okay, I'm second in line.

I mean, the U.S. talked about what they were going to pay.

What would I have had to pay for it if you're dealing with

me on the mark to market basis for the same piece of paper

that the U.S. paid 100 cents on the dollar for?

89
1

WITNESS VINIAR:

I'm not sure I understand the

90
1

question.

VICE CHAIRMAN THOMAS:

If I wanted to buy what

the U.S. bought, what would it have cost me?

market price?

What was the

WITNESS VINIAR:

We--I'm sorry, I'm confused.

WITNESS LEHMAN:

I think the--and maybe--

VICE CHAIRMAN THOMAS:

underlying security.

9
10

WITNESS LEHMAN:

I don't know the specific price,

Vice Chairman, but--

VICE CHAIRMAN THOMAS:

WITNESS LEHMAN:

VICE CHAIRMAN THOMAS:

If I wanted to buy the

Try 48 cents.

--it was at a discount.
Try 48 cents on November,

early November of '08.

WITNESS LEHMAN:

that I was making before--

Understood.

VICE CHAIRMAN THOMAS:

No, I'm just asking the

question.

security for 48 cents on the dollar?

I think the point

So if I was second in line, I could get that

WITNESS LEHMAN:

Correct, if you did not--if you

were not already owning that risk synthetically, which is

what I was trying to articulate.

VICE CHAIRMAN THOMAS:

24
25

But did the U.S. already

own that risk synthetically?
WITNESS LEHMAN:

No.

AIG did.

91
1

VICE CHAIRMAN THOMAS:

Okay, so the U.S. paid 100

cents for a security that if I were second in line and I

said I want what they just bought, it would cost me 48 cents

on the dollar?

WITNESS LEHMAN:

If you did not have any

contractual arrangement and you just decided to purchase it

in the market, that's correct.

8
9

VICE CHAIRMAN THOMAS:

Did the U.S. have any

contracts or arrangements when they purchased that security?

WITNESS LEHMAN:

Not that I'm aware of.

VICE CHAIRMAN THOMAS:

Okay, so they paid 100

cents--back to Ms. Born's point--they paid 100 cents on the

dollar for something that the next person in line could by

for 48 cents for.

WITNESS VINIAR:

sorry I'm slow, but what--

17
18

VICE CHAIRMAN THOMAS:

(Laughter.)

WITNESS VINIAR:

22
23
24
25

You're not slow.

I'm

You work

for Goldman Sachs.

I'm a little confused.

What the Government did, the

Government stepped-VICE CHAIRMAN THOMAS:

Your problem is not

answering my question the only way it can be answered.
WITNESS VINIAR:

No, the Government stepped into

AIG's shoes to perform under their contract.

And in order

92
1

to perform under their contract, they owed 100 cents on the

dollar.

VICE CHAIRMAN THOMAS:

Yeah, but if it was not in

that situation and you negotiated, just like you went at

them initially on those earlier arguments for $1.8 billion,

and you wound up settling at $1.2 [billion], so you're going

to come at me as the U.S. Government saying you owe me 100

cents on the dollar.

your data and say what's it selling for in the marketplace

today?

I'm going to come back at you and use

Let's mark to market.

So I'd offer you 48 cents, and you'd take it

because that's what the price was, wouldn't you?

not now buying and selling at market price?

14
15

WITNESS VINIAR:
and oranges.

16
17

No, I think you're mixing apples

If you came and said to me I want to--

VICE CHAIRMAN THOMAS:
a salad?

Or are you

Have you ever tried it in

It's really not bad.
WITNESS VINIAR:

If you came up to me and said, I

would like to sell you protection on a similar instrument,

then we would have looked at what the market price was at

the time.

It might have been 48 cents on the dollar.
But what you were saying was, I want to settle a

contract that I already have with you that was written at

different time.

had to pay 100 cents on the dollar.

And in order to settle that contract, you
So I think they are

93
1

different questions.

2
3

VICE CHAIRMAN THOMAS:
cents on the dollar?

4
5

You had to sell at 100

WITNESS VINIAR:

In order to settle that

contract.

VICE CHAIRMAN THOMAS:

All right.

The Government

paid 100 cents on the dollar for something that was going

for 48 cents at the same time.

statement?

WITNESS VINIAR:

Is that a totally inaccurate

As I said, I think it's, with

all due respect to the salad, I think it is mixing apples

and oranges.

they had on which they had posted collateral, in which they

owed 100 cents on the dollar.

I think they tried to settle a contract that

VICE CHAIRMAN THOMAS:

WITNESS VINIAR:

VICE CHAIRMAN THOMAS:

Who is "they"?

AIG.
No, but I'm buying it.

I'm the Government.

WITNESS VINIAR:

Government was step into AIG's shoes.

Right.

VICE CHAIRMAN THOMAS:

What you did is, the

I don't want to step into

AIG's shoes.

I want to take on the obligation which is

something that's bought and sold in the marketplace.

wouldn't I pay the marketplace price?

WITNESS VINIAR:

Why

But then we would of still had a

94
1

contract with AIG.

VICE CHAIRMAN THOMAS:

WITNESS VINIAR:

If the Government wanted to start a

fresh con--

5
6

Yeah?

VICE CHAIRMAN THOMAS:

Were you going to collect

from AIG?

WITNESS VINIAR:

We had collateral.

Yes, we

would have collected the 50 cents, because we had the

collateral.

10
11

VICE CHAIRMAN THOMAS:

Okay.

So the U.S.

Taxpayer paid more than the value.

WITNESS VINIAR:

I'm sorry, I don't think so.

VICE CHAIRMAN THOMAS:

CHAIRMAN ANGELIDES:

You don't think so?
All right.

return to that at the end, but Mr. Wallison.

Mr. Hennessey.

17
18

COMMISSIONER HENNESSEY:

Okay.

I'm going to
Oh, I'm sorry,

That's okay.

Not a

problem.

Thank you, Mr. Chairman.

I think we're--

[Having trouble with the microphone.)

CHAIRMAN ANGELIDES:

COMMISSIONER HENNESSEY:

It's a deal over there.
Doug did this yesterday.

Okay, I think we're way off track here.

Our job is to

understand the causes of the financial crisis, and I think

that we are suffering from two big cases of selection bias

here.

95
1

One is that we have structured these two days of

hearings around derivatives, which as I said yesterday I

believe are an instrument rather than a causal factor

themselves.

pick particular firms, but we have chosen two particular

firms which seem to represent, I don't remember Peter's

word, outliers, I was going to say extremes.

in terms of how they operate, and in particular how they

used derivatives.

And two is, and you have to do this when you

But outliers

And so I see certain commonalities with respect

to derivatives:

lack of transparency in certain cases.

commonality that we heard from the experts, and I believe a

common policy problem going throughout this whole other

area.

the lack of capital requirements, and the
I see it as a

But everything that I keep hearing reaffirms to

me that different firms are using these instruments in

different ways.

repeatedly shove this square peg into this round hole saying

why doesn't this particular firm look at derivatives the way

that I do?

looking at these different ways.

And it feels like some of us are trying to

And it may be the case that different firms are

To come back to my hammer analogy from yesterday,

I am imagining us bringing K.B. Homes up here and saying

tell us how much of your income you earn from hammers.

And

96
1

I wouldn't be surprised if they said, you know, we don't

know.

you how many nails we buy, and how much income we get from

building homes with those hammers.

Homes, the hammers themselves may not be an important

element of this.

We can tell you how many hammers we use.

We can tell

But in the case of K.B.

Also, I think it is really dangerous, as Peter

was saying, to draw conclusions about derivatives generally

as a causal factor in the crisis from the two particular

firms in the cases that we are seeing here.

And I find it is hard for me to really care that

much about the negotiations between these two firms as one

of them was in the process of failing.

a cause of the crisis.

of the crisis.

I do not see that as

I see this, I believe, as an effect

And so I have just one question with respect to

sort of the negotiations, which is for the AIG team.

Goldman was not your only counterparty with which you were

having these kinds of negotiations.

of, was Goldman 80 percent of your counterparty dealings

during this time of stress?

six others?

Can you give us a sense

Or were there four, five, or

Give me a feel for that?
WITNESS FORSTER:

Sure.

Goldman was certainly

the first, I believe, and they were certainly the largest.

But we did, as time went on through the fall of '07, we did

97
1

start to get collateral calls from other people.

I think, I'm not perfect with my recollection, but I think

you're probably talking more like November and December time

till we had, you know, relatively significant calls from

other people as well.

COMMISSIONER HENNESSEY:

Typically,

And obviously there are

going to be specific differences in each one of these

discussions with the different firms.

Qualitatively, were the discussions all of a

similar nature?

model in terms of how much they thought was appropriate, and

then the other firms were saying, no, we want more

collateral?

14
15
16

Which is, that AIGFP was sticking to their

I mean, did they all have the same sort of feel
to them?
WITNESS FORSTER:

Broadly they had the same sort

of feel to them.

certainly that I talked to understood the lack of

transparency in the market, the difficulty in actually

coming up with observable prices.

Goldman Sachs, to be fair, was willing to sort of work

together to try and come up with negotiations.

23
24
25

I think everyone we talked to, everyone

And everyone, including

I think the negotiations with everyone were, you
know, fairly friendly to that extent.
COMMISSIONER HENNESSEY:

And in each case it

98
1

sounds like what you've got here is a negotiation between

parties.

can on market data, but there really isn't that much market

data available.

Each of you has your model, relying as best you

And then you're just getting down to sort of the

relative strength in the negotiations?

WITNESS FORSTER:

I think that is a fair

statement.

9
10

Is that--

COMMISSIONER HENNESSEY:
characterize it?

--a fair way to

Okay.

So let me zoom out here.

And I understand that

the question I am going to ask is broader than any of your

particular portfolios, but I found myself even more

disturbed by what I heard yesterday from the AIG senior

folks panel yesterday after I went home.

16
17

Why do you think AIGFP failed?
you to comment on that.

I'll ask each of

Maybe start with Mr. Bensinger.

WITNESS BENSINGER:

I believe that the ultimate

cause of its failure was the lack of anticipation that the

market conditions could deteriorate so significantly to

create a liquidity strain on the corporation that it could

not handle.

ultimate factor.

And I believe that was really the ultimate, the

COMMISSIONER HENNESSEY:

WITNESS BENSINGER:

So it was a--

It was a liquidity issue that

99
1
2

ultimately-COMMISSIONER HENNESSEY:

A failure to manage

liquidity risk, triggered by a mis-estimation of some other

kind of risk?

One of the senses I got was that Mr. Cassano was

saying, look, if they had just left me in as the negotiator

I would have been able to cut a better deal with Goldman and

we wouldn't have had any of these problems.

my model was still right, and is still right.

And by the way,

Whether or not his model was right and is right,

clearly someone missed the possibility that there might be

more collateral calls that they'd be forced to do, or he

might of just missed the possibility that he would have been

replaced as the negotiator, which meant that AIGFP was

dependent entirely upon him being in that position to do the

negotiations.

So if we move one step back in the chain, what

was the error in judgment, or the error in just probability

assessment that led to the liquidity crisis happening?

WITNESS BENSINGER:

Perhaps I can amplify.

you go back to the third and fourth quarter of 2007, once

the collateral calls began coming in, there was a

significant effort made by the corporation to model--to try

to anticipate how much liquidity would be needed in stress

scenarios in the event that the market continued to

100
1
2

deteriorate.
Using what my--the experts that we had in the

corporation, you know, explained were highly stressed

scenarios, I think ultimately that once you got into, I have

to estimate some timing here, but I think into the spring of

2008, we became concerned that the market was deteriorating

more significantly than we had anticipated even in our

liquidity stress scenarios.

And we were having consistent dialogue with our

Board, and with the Finance Committee of the Board about the

liquidity situation, and monitoring that with them.

We made a decision in the spring or so of 2008

that, given the continued deterioration in the marketplace,

that we needed to shore up our balance sheet from a

liquidity standpoint, and also try to replace some of the

capital that had been eroded by the unrealized valuation

losses that were being taken principally on these

instruments.

And so

in May of 2008 we completed a capital

raising of approximately $20 billion.

time, our best estimate, based upon any reasonable set of

stressed assumptions that we could make, was that that

additional liquidity within the corporation would be able to

carry us through whatever might happen in the market.

And at that point in

And if you fast forward, unfortunately, to the

101
1

September of '08 time frame, you saw conditions deteriorate

to the extent that they were unfortunately well beyond what

we had anticipated, and I think well beyond what many market

participants had anticipated.

cash flow addition and monitoring and trying to do

everything we could to stem the cash outflows, market events

overtook us.

8
9

And even with all of that

COMMISSIONER HENNESSEY:

Okay.

I think I

understand that, and I think I understand what you are

saying that part of it was that there was a decrease in the

available supply of liquidity in September of 2008.

WITNESS BENSINGER:

There was.

COMMISSIONER HENNESSEY:

Was there also an

unexpected surge in the demand for liquidity from your

counterparties in the fall of 2008, or any other point in

time?

WITNESS BENSINGER:

I'm not really the expert in

the market in this particular area, but I think what you saw

was sort of a vicious cycle of marks bringing down the value

of those securities, calling for more collateral, generating

losses--

COMMISSIONER HENNESSEY:

Got it.

I understand

that as a general matter.

My problem is that lots of

financial firms experienced a similar decline in the supply

of available liquidity, right?

But they didn't all fail.

102
1

So what I am trying to figure out is, were you

all just hypersensitive to that?

Or was it also the case

that people were looking at AIG or AIGFP and saying, you

know what, I'm nervous about them because I don't trust

their model.

side of their model, and they fired Cassano, and PWC has

given them a black mark, et cetera, et cetera, so I'm trying

to figure out do you actually think that, for instance, the

model that was used earlier was in fact being played out as

And because everybody else is on the other

wrong?

Or that you were on the wrong side of that, and that

that was encouraging your counterparties to show up and

knock on your door and say give me money?

WITNESS BENSINGER:

Well I think toward the

September time frame there was certainly an element of what

I'll call a run on the bank, where the market was getting

more nervous about what was going on because of the market

conditions and our well known exposures to the mortgage

market.

19
20

So I think market forces certainly had a lot to
do with it.

COMMISSIONER HENNESSEY:

Let me ask you about

that run.

Sometimes a run is unjustified because there's a

false rumor that the bank is unhealthy, and sometimes

there's an element of truth that the bank really is out of

money or has done something wrong.

And I think that's the

103
1

claim that's made often about AIG, is, you know what, their

models were so wrong, these guys really are insolvent, or

they may not be able to pay us back.

Do you believe that any of those arguments made

by others--let me ask it the other way--Mr. Cassano seemed

to be suggesting that he still stands by the model.

agree with that?

8
9

WITNESS BENSINGER:

Do you

I think maybe if I could

separate it into two places?

COMMISSIONER HENNESSEY:

WITNESS BENSINGER:

Please.

One is ultimate credit losses

on this product.

designed to be able to withstand very significant stressed

economic scenarios.

these were underwritten, but I've seen a number of

presentations to show that the underlying collateral

supporting the super senior positions that AIGFP insured

contained significant elements of AAA protection, as well as

protections below that.

These products, as you've heard, were

And again, I'm not the expert on how

So there was a lot of subordination.

I don't

want to put words into Mr. Cassano's mouth, but I think what

he's saying is he believes that ultimately when this whole

story plays out, that the actual credit losses in those

instruments will be far lower than the actual market prices

that caused the collateral calls and I think that--

104
1

COMMISSIONER HENNESSEY:

That I got.

And I

remember similar conversations, which is, look, if we just

hold this MBS for 30 years, the stream of mortgage payments

are going to come in and we're going to get 98, 99, 100

cents on the dollar.

but we're not going to hold it for 30 years.

sell it sometime within the next 6 to 12 months.

can we get for it now, when others don't have that same

confidence?

And then someone is replying, yeah,
We need to
How much

Do you believe that there was a failure at AIGFP

to correctly anticipate what the sellable market value of

those securities would be?

describing the transaction right, but setting aside what the

long-term value would be of this contract in reality based

on the cash flows, do you think that there was an error in

anticipating for instance the counterparty calls?

Or I'm not sure if I'm

WITNESS BENSINGER:

With hindsight,

COMMISSIONER HENNESSEY:

WITNESS BENSINGER:

Yeah

I believe that the ultimate

cause of the issues was the liquidity issue that

arose because the assumptions, even the stressed assumptions,

that the experts were using around how significantly

a market can deteriorate, how significantly an

entire global market can effectively shut down, become

completely illiquid and opaque and lack of transparency and

inability to fund oneself in a multi-trillion dollar global

105
1

market, I think the assumptions that were used simply were

106
1

overtaken by the unbelievable deterioration that ultimately

occurred in the market.

COMMISSIONER HENNESSEY:

Okay, I am going to

shift and ask similar questions over to one of your biggest

counterparties.

Mr. Viniar, you had the broader portfolio of the

two of you here.

Understanding that you are not an expert

in the finances of AIGFP, given that they were such a large

counterparty to Goldman, I assume that ya'll were having

some sorts of discussions about, you know, how healthy are

they?

Are they going to be there?

12
13

Can you give me your thoughts and observations as
to what happened to cause AIGFP to collapse?

14
15

WITNESS VINIAR:
am not inside AIGFP.

Well that would be very hard.

I don't really--

COMMISSIONER HENNESSEY:

you know.

think?

I'm not asking you if

I'm asking what's your judgment.

WITNESS VINIAR:

What do you

I guess I would say, I'm going

to maybe answer your question a little bit more in a

generality.

problems for various financial firms in the market--

When I look at some of the issues that I saw as

COMMISSIONER HENNESSEY:

No, I'm sorry.

interrupting you because my time is limited.

interested in--

I am

107
1
2

VICE CHAIRMAN THOMAS:

Mr. Chairman, I yield the

gentleman an additional--

COMMISSIONER HENNESSEY:

VICE CHAIRMAN THOMAS:

COMMISSIONER HENNESSEY:

Three minutes?
--three minutes.
I have to believe that

you were at some point involved in sitting around with a

bunch of people saying, we think AIGFP is going down, and

someone said why?

what did you think?

And of course you don't really know, but

WITNESS VINIAR:

So like I think--and you just

talked about some of them--I think first and foremost, you

start with any financial institution, liquidity, liquidity,

liquidity.

You know, the only thing that ever causes a

financial institution to truly go down is running of money.

So liquidity--the first ten issues are liquidity.

I think the second--

COMMISSIONER HENNESSEY:

19
20

And what I'm most

interested in is, what triggered the liquidity crisis.
WITNESS VINIAR:

I think the second thing is that

all financial institutions, including AIGFP, need to be very

cognizant of very large, concentrated positions.

the things we have learned, and we know, is that we are not

smart enough to know what is going to happen.

can be wrong.

And one of

All models

108
1

Tail risk can happen even farther out on the

spectrum than you ever thought it would.

that showed how unlikely it was that, not just AIGFP but

others would lose money on super senior CDOs, I think if

everybody had looked at those models before 2007, everyone

would have agreed with them and said really, really, really

unlikely.

8
9

COMMISSIONER HENNESSEY:

All of the models

So they concentrated too

much tail risk and bet the firm on that.

WITNESS VINIAR:

Too much.

And then the third

thing I would say is, as I said before, we think it is very

dangerous to ignore what the market says.

have to pay attention to marking to market.

says something's worth 90, then all you know is that today

it is worth 90.

won't.

17
18

And, that you
If the market

Maybe it will go back to 100, but maybe it

COMMISSIONER HENNESSEY:

Okay, but in this case

there really wasn't a market price for them to use?

WITNESS VINIAR:

There were enough indications of

similar things in the market that you could mark things to

market.

market and come up with a fair value.

thing you have, but markets will tell you what's going on

with similar securities, with securities with similar risks,

and you should pay attention to those and take actions based

We don't believe you ever can't mark things to
Maybe not the exact

109
1

on those.

COMMISSIONER HENNESSEY:

Okay, let me ask one

more.

So Mr. Cassano, as I heard him, was telling us that

he still believes in his model.

securities in the long run will be good.

they're still there, that the cash flows will still flow.

7
8

He still thinks that these
And to the extent

Did he or AIGFP, did they underestimate the need
for collateral?

WITNESS VINIAR:

It appears that way.

COMMISSIONER HENNESSEY:

And is that what

triggered--in terms of the proximate cause of the liquidity

run, they needed the cash to pay you and other

counterparties, right?

WITNESS VINIAR:

You get back to liquidity,

liquidity, liquidity.

don't know, maybe in the end they do pay off in 30 years, as

you said.

the market.

What causes it maybe in the end, I

But in the interim you have to pay attention to

COMMISSIONER HENNESSEY:

The image that I am

building in my mind of someone sitting there insisting my

model is right, and then someone on a staff saying, well,

the model may be right some day but we are never going to

know, because we have got to pay these guys right now.

then the response is, no we don't, I'm a better negotiator

than all of you.

Let me go negotiate with them.

And

110
1

How am I don't on my story?

WITNESS VINIAR:

COMMISSIONER HENNESSEY:

I think--(Shrugs his shoulders.)
Okay, I'm done.

Thank

you.

CHAIRMAN ANGELIDES:

Well, and I just actually

want to point out, I do think this is a very central issue

for our deliberations.

here in this panel is, there were the long-term economic

value, or losses of these securities, and of course you've

got to juxtapose that against the liquidity pressures that

are developing in the market starting in July of 2007, and

around other devices also--for example, the Bear Stearns

asset management funds where, because of the mark to market,

either redemption provisions in the Bear Stearns asset

management, or the collateral call provisions tied to mark

to market--it did begin, it seems to me, a set of liquidity

pressures that began to build over a period of time.

Because what we are dealing with

COMMISSIONER HENNESSEY:

Yeah.

I am just having a

difficult time drawing broader lessons from these two

outliers.

why I think AIGFP failed.

about how these two firms operated, and a little bit about

the transaction.

24
25

I think I've learned something about, I think,
I think I've learned something

It's very difficult for me to extract from this a
broader lesson about derivatives and their role in the

111
1

crisis, or even a broader reason why this particular

interaction contributed to AIGFP failing, or more

importantly, contributed to the crisis.

CHAIRMAN ANGELIDES:

Well we will have a lot of

time for deliberation.

because this was one of the major flashpoints, potentially--

these are all questions--this could have been one of the

major flashpoints, and there may have been others, where

liquidity pressures began to build in this market.

I think this is a central issue

And that is why I think it is of interest.

think your line of questions was very interesting in this

regard.

COMMISSIONER HENNESSEY:

Thank you.

If I could

just, ten seconds, and ya'll are disadvantaged because we

heard from Bear Stearns, I don't know, a couple of months

ago, and I heard a response which I found similarly

incredible, which was--not from you--but from what we heard

from your CEO yesterday, where he said we didn't do anything

wrong.

didn't make any mistakes.

dried up and we got caught up in that.

We didn't make any mistakes.

In hindsight, we

It was just the liquidity market

We heard that from Bear Stearns.

I didn't

believe it then, and frankly I didn't believe it from Mr.

Cassano yesterday.

Thank you.

CHAIRMAN ANGELIDES:

All right.

Mr. Wallison?

112
1

COMMISSIONER WALLISON:

Thank you, Mr. Chairman.

Actually I want to follow a very similar line of questions

that Mr. Hennessey, Commissioner Hennessey followed, but

from a slightly different point of view.

He mentioned the idea of outlier, and I see a lot

of the same things happening here.

about in the case of AIG a real outlier on which we are

trying to develop some major conclusions based on one

incident.

That is, we are talking

And it turns out now, as Commissioner Hennessey

was drawing his questions, it turns out now that that was

connected quite directly to a model.

operation of a particular model.

And the success and

So, Mr. Forster, if I can spend a little bit of

time talking to you about the Gorton Model, because that

does interest me quite a lot.

First of all I would like to clear up one thing.

That is, did anyone else in your knowledge use the Gorton

Model for what you used it for?

AIG?

WITNESS FORSTER:

Or was this proprietary to

I think the Gorton Model itself

is proprietary to AIG.

that the Gorton Model used was used by other people, as

well.

I think the general building blocks

COMMISSIONER WALLISON:

So the Gorton Model now

113
1

evaluated the risk of loss on super senior portions of these

CDOs.

of the assets in the CDOs?

Did the Model evaluate the assets or the composition

WITNESS FORSTER:

No.

COMMISSIONER WALLISON:

So it just--let me go on

a little bit further then and ask:

So in your testimony you

said that in the summer of 2005 you began thinking more

about the multi-sector CDOs, and you began to question

whether the modeling that was needed, the additional

analysis of deals, was sufficient.

Or were they

sufficiently taking account of interest-only loans.

that's how you phrased it in your testimony.

I think

Were you then beginning to ask whether the Model

was actually looking at the underlying loans and how it was

functioning at that point?

WITNESS FORSTER:

I think, just to take step back

if I may, through any business that we did it always made

sense to take a step back at different times and question

the assumptions that we were using in any of it, and I think

that is what we did in July of 2005.

Some of the questions that I have posed at that

time, we probably knew the answers to; others were just

reinforcing the assumptions that we were making.

24
25

At the time what we wanted to do was--the Model
is obviously only as good as the inputs that you put into

114
1

it--we wanted to make sure that the underlying loans,

underlying reference obligations, we were still comfortable

with those, and we still felt the ratings and things like

that reflected the risk that was inherent in them.

COMMISSIONER WALLISON:

Let me see if I

understand correctly.

The model did look at the underlying

loans, the kinds of loans that were being made?

you were talking about interest-only loans, for example,

those were taken account of in some way in the Model?

And when

that if the Model was made up of 95 percent interest-only

loans, the Model would have reflected the risk associated

with that?

13
14

Is that correct?
WITNESS FORSTER:

It's not quite correct, I

think.

COMMISSIONER WALLISON:

WITNESS FORSTER:

Sorry.

Good.

Please correct me.

The underlying ratings

of the obligations, if you had the subprime obligation, if

it was all interest-only, or heavily concentrated in certain

areas, then the rating of that obligation would reflect

back.

So if it was all interest-only, the rating

agencies would see that as more risky.

get a lower rating.

the instrument.

It would likely then

The Model would just take the rating of

COMMISSIONER WALLISON:

Oh, so the Model relied

115
1

on the rating agencies?

WITNESS FORSTER:

Yes.

The Model--I mean, to a

large extent.

stressed the rating agencies' assumptions, and we checked

that we were comfortable with the rating agencies' ratings.

But the Model basically uses the ratings of the underlying

data.

8
9
10

COMMISSIONER WALLISON:

what we learned from those questions?
WITNESS FORSTER:

I haven't followed them in too

much detail, but I understand the general issues, yes.

13
14

Have you by any chance

followed some of our questions to the rating agencies and

11
12

We made additional changes to it, and we

COMMISSIONER WALLISON:

Now I understand the

problem with the Model.

Okay, let me ask one more question that is

related to this.

the Model and what you have done in the past, what is your

conclusion about why this Model failed?

At this point, based on your analysis of

WITNESS FORSTER:

The Model has failed to the

extent that ultimately we take credit losses, which I

suspect will occur to some extent.

that sense only in that, you know, the underlying reference

obligations that we're putting in, the ratings that we're

assuming, turned out to be, you know, not as robust as we

expected.

The Model has failed in

We were putting them through a very stressed

116
1

scenario, and the world turned out to be--a combination of

the world turning out to be more stressed than we had

predicted, and that the ratings were less reliable than we

had expected.

COMMISSIONER WALLISON:

I guess the lesson here

is whether it makes any sense for a business to place all

its eggs in the basket of a model, rather than, as Goldman

is suggesting, looking at what the market is doing.

WITNESS FORSTER:

I don't think it's a question

of looking at what the market was doing, because we were

marking our positions to market.

personal view is that that wasn't the issue.

I don't think, actually my

I do totally agree with the view that, you know,

too much reliance and too much notional was placed in one

area due to reliance on a model.

COMMISSIONER WALLISON:

Okay.

Just based on your

knowledge, and obviously you might not have much broader

knowledge than simply what AIG was doing, are you aware of

any other major firm that did its trading and entered into

its obligations on the basis of a model?

WITNESS FORSTER:

I mean I know of other

institutions that entered into similar transactions.

they actually used to come up with their attachment points,

I couldn't tell you I'm afraid.

COMMISSIONER WALLISON:

Okay.

What

Thanks very much.

117
1
2

Mr. Viniar, I would like to ask a few questions

of you about how Goldman acted.

And again I am trying to

get away from what I think is a rather unproductive

discussion of how you guys thought about collateral, but I

am interested in how you dealt with the fair-value issue.

And you said that you tried to come to a value

based on what you saw in the market.

If you determine that

there is a thin market, you still rely on the consequences

of that.

in 2007, late 2007 early 2008, simply disappears?

the only sales that are being made in one kind of market,

and in this case this was the mortgage-backed securities

market, there were hardly any sales at all?

occurred, they were, as everyone would have said, distress

sales.

to protect themselves against default.

18
19
20

What if the market, as it did for a period of time
So that

And when they

People who were absolutely forced to sell in order

Can you tell me what you do in a situation like
that?

Do you mark down to a distress sale?
WITNESS VINIAR:

That's a very good question.

And, frankly, about the only time I can remember where there

really was virtually no market in a product since I've been

looking at it was late 2007--late 2008, really, early 2009,

in the real estate related areas.

It was very difficult.

And we don't mark everything to zero in that

118
1

case.

But what we do is, we take whatever market

comparables we see, and the other thing we do is we'll do

all different types of analysis.

look at what the cash flows coming off an asset were and

say, okay, what return would someone require in this market

to buy those cash flows?

So for example, we might

And so the return requirements would have gone up

dramatically, but we'll still take those into consideration.

So we'll look at other transactions people are doing, the

returns they're requiring to do those transactions, and say

even though there are no transactions in this market, if

they required those returns for the cash flows that they're

getting, what would the pricing be?

some cases a fairly dramatic markdown, but not to zero.

So that would cause in

So we will use methodologies such as that where

we will find market-observable data of some type and see how

we can use that data to price the securities that we have.

COMMISSIONER WALLISON:

Well you know what I'm

going to ask now.

cash flows were fine.

So what do you do in a case like that?

That is, that for the super seniors the
It was the market that was not fine.

WITNESS VINIAR:

Well in some cases the cash

flows were fine; in some cases there were questions about

whether the cash flows would be fine.

COMMISSIONER WALLISON:

It would be fine, in the

119
1

future?

WITNESS VINIAR:

Or whether they would be--yeah,

whether they would be fine, and therefore what return

requirements people would have in order to buy that

projected stream of cash flows, which could be a

significantly higher return because the cash flows were

significantly less certain, and therefore you would mark

things down on that basis.

9
10

COMMISSIONER WALLISON:

And so this was really a

gut kind of thing?

WITNESS VINIAR:

It was based on--again, we'd

look at market observable transactions to see what returns

people were requiring, but--and if there were no trades in

that specific security, you would have to use all kinds of different

15
16

methodologies that you sought in the market to
decide what the value was.

17
18
19

COMMISSIONER WALLISON:
this?
WITNESS VINIAR:

We used models, but we

see in the markets.

Did you use a model for

We--I actually--I'm not sure.

used models as informed by what we

WITNESS LEHMAN:

Yeah, I would say, you know,

throughout--and it depends on the specific time frame--there

were models that we had used.

one of many things that we used to help inform our decisions.

But they were helpful tools,

120
1

But really, it is very important that the model is

calibrated to what we are actually seeing in the market

because the big difference here is bifurcating between

fundamental value or ultimate losses versus market value.

Risk premium is what we are looking to observe

often, and the market was telling us that risk premium was

going up in this time period.

fundamental value was unchanged, risk premium clearly was

changing in what we saw in the market.

WITNESS VINIAR:

Even if one's opinion of

And one of the things from a

risk management point of view that we always are paying

attention to is, at times when markets tell you something

very different than what your models tell you, it is cause

for concern and cause for pause, and cause to say should we

be doing something differently?

the models were telling you, it was breaking down in the

market's view of what's going on.

Because clearly whatever

So it is a very important factor that we’ll look at.

COMMISSIONER WALLISON:

When you wrote down the

value of an asset because you looked at the market and you

saw how it was functioning, did you--what did you do with

the associated liability?--

WITNESS VINIAR:

I’m not sure--

COMMISSIONER WALLISON:

That is to say, if the asset

declined in value because the market was declining, wasn't

there an appreciable increase in the liability that was

121
1

associated with that?

122
1

WITNESS VINIAR:

If it was just funded for

example by debt, the answer is we wouldn't mark that to

market.

COMMISSIONER WALLISON:

WITNESS VINIAR:

COMMISSIONER WALLISON:

7
8
9
10

to get at.

You wouldn't mark that--

No.
That's what I was trying

You wouldn't mark that to market?
WITNESS VINIAR:

Not necessarily.

It depends on

what's on the other side of it.
COMMISSIONER WALLISON:

Okay.

In your testimony

you said that Goldman Sachs arranged credit default swap

coverage for clients.

this actually worked in practice.

I'm trying to just get a sense of how

Let's say that a client has come to you and wants

protection on a super senior CDO.

There's going to be a

price you're going to ask for that.

you're going--or in most cases, you're going to hedge that

somewhere else.

you're going to hedge with say an AIG or some other

counterparty in the market.

And you know that

So you're going to protect that client, but

Do you test the market first to find out what's

available, and what the prices would be to hedge the risk?

Or is there a way that you can establish what you're going

to charge without that?

WITNESS LEHMAN:

I think it's imperative as a

123
1

market maker to have continuous involvement in these

markets, talking to various different clients, understanding

what's happening.

4
5

So having a sense of the supply/demand dynamic is
very, very important in that specific situation.

COMMISSIONER WALLISON:

So in other words you

would know for almost every kind of security that is

presented to you for protection, you would have some view of

what you were going to have to pay to lay off that risk if

you took it?

prices at the same time?

So you don't actually have to be requesting

WITNESS LEHMAN:

That's correct.

You are market

makers.

markets day in/day out, and they are going to have a view on

what's happening in the market and the right price for that

product.

Our traders on the desk are involved in these

Certainly at times for less liquid products it's,

you know, it's more challenging than for more liquid

products, but that is what we expect of the traders on the

desk.

COMMISSIONER WALLISON:

One more question.

And

that is, much of what you have talked about is what you do

for clients when clients come in and ask for protection.

24
25

Do you have a portfolio of your own of CDOs, for
example, that are your own investments, Goldman's own

124
1

investments?

the super senior levels of those CDOs, to the extent that

you held them?

4
5

And what kind of protection did you seek for

VICE CHAIRMAN THOMAS:

I yield the gentleman an

additional three minutes.

COMMISSIONER WALLISON:

WITNESS LEHMAN:

Thank you.

Commissioner, I think it is

important--and I'll answer in one second--but the business

that AIG and other longer term investors or insurance

providers did was different than the business that I do at

Goldman Sachs.

So specifically, the trading desk is a function

of the over-the-counter nature of the fixed-income market.

We do act as principal for clients in our trading.

have positions and we manage our risk holistically, cash and

derivatives, by product.

have positions of varying sizes as we carry an inventory to

service clients.

So we

And that is, so we will at times

COMMISSIONER WALLISON:

So it's not--let me

understand this.

are for the purpose of simply investing?

"shows as an action" as we used to say in law school.

is to say, you are holding them temporarily in order to meet

the needs of clients?

Goldman does not actually have assets that

WITNESS LEHMAN:

They are always

Well I can speak for my

That

125
1

business, and perhaps Mr. Viniar can talk more about the

firm, but in my business that's correct.

business.

WITNESS VINIAR:

It's a trading

I think it would be an

overstatement to say "always."

be true.

buy and sell things for the account of Goldman Sachs.

it's a very small part.

9
10

Mr. Vice Chairman.

Thank you.
Thank you.

think I am the chairman right now.
COMMISSIONER WALLISON:

You are. You have the

gavel.

VICE CHAIRMAN THOMAS:

COMMISSIONER WALLISON:

But

I think I'm finished,

VICE CHAIRMAN THOMAS (presiding):

13
14

We do have some proprietary desks that would just

COMMISSIONER WALLISON:

11
12

I think predominantly would

I've taken the gavel away.
So I'm stepping out of

your way.

(Laughter.)

VICE CHAIRMAN THOMAS:

COMMISSIONER GRAHAM:

Senator?
I am going to have to start

by raising a little different perspective on what this

Commission's responsibilities are that my friend Keith did a

few moments ago.

I interpreted what Keith said that the financial

crisis had an ending point, and our responsibility is up to

126
1

that ending point but not subsequent to the ending point.

2
3

Our actual charter from the Congress reads that
our responsibility is, quote:

To examine the causes, domestic and global, of

the current financial and economic crisis in the

United States.

I interpret that as being an ongoing responsibility, because

I believe clearly the millions of people who are out of

work, and those who have lost their homes, and those who

have lost their hope, don’t think the financial and

economic crisis is over.

And in fact, I believe that, given the nature of

what Congress did, a rather unusual step, that that

underscores my reading of legislative intent.

We in many forums have been analogized to the

CORA Commission, which was a commission really of the Senate

Banking Committee, the committee that occupies this very

room, back in the early 1930s to look into the causes of the

Great Depression, and to prescribe solutions to those found

causes.

Our Commission was established by Congress with

the single purpose of diagnosing the causes.

It would be

like going to the doctor and having one doctor do the

diagnosis, and then go next door and have another doctor

decide what prescription you should receive against that

127
1

diagnosis.

We are only in the first office of diagnosis.
Why would the Congress have split the

jurisdiction in that manner?

logical reason is because the Congress felt that it, itself,

was part of the causes of the problem; that we are going to

find areas such as areas of Jennie Mae, and Fannie Mae, and

Freddie Mac, where the Congress played potentially a key,

critical role in this; and that Congress felt that it,

because of that, was not a credible diagnostician, but that

My answer is that the most

it could be a credible prescriber against the diagnosis.

If that is a correct analysis, then I think since

the Congress has been involved in this through today--in

fact, the consideration of important legislation is before

the Congress as we meet this morning--that our charter is a

continuing charter to deal with the continuing financial

crisis.

Therefore, issues such as how did the Federal

Government deal with this issue of the AIG indebtedness to

Goldman Sachs is a very relevant part of our diagnosis of

the current financial and economic crisis.

21
22
23

Now I say that so that the questions I'm going to
ask are not dismissed as being irrelevant to our inquiry.
And so going back to the role of the Federal

Government, AIG, and Goldman Sachs, let me understand.

the hypothetical number of 48 cents on the dollar was

128
1

accurate, that was what these securities were, that was

their market mark, if you had been paid for--if you, Goldman

Sachs, and I will direct this question to Mr. Lehman--if you

had been paid the 48 cents that the market said they were

worth, would you not have collected the other 52 cents from

these various counterparties from whom you had hedged your

AIG investment?

8
9

WITNESS LEHMAN: Sure and so I think, Commissioner--and
maybe Vice Chairman Thomas's question earlier--the trades

with AIG where they were long synthetically or in derivative

form at 100 cents on the dollar, using your 48 or 50 cents

on the dollar just to use round numbers, they had posted

very close to 50 cents on the dollar by the point in time of

November 2008.

So AIG or the Government, I'm not sure who

exactly made the decision to want the exposure in cash

format, but at that point in time they paid the balance,

what AIG had not collateralized to us to, which was the

market price to own the security outright.

By and large, you know, we were looking for the

cash that we had from AIG, as well as the incremental monies

to purchase those securities from our counterparties to

deliver them to AIG or the Government.

24
25

COMMISSIONER GRAHAM:
question more complicated.

You've made my simple

129
1

WITNESS LEHMAN:

I apologize.

COMMISSIONER GRAHAM:

It seems to me that you had

two ways to make yourself whole.

One was whatever money the

Federal Government was going to provide through AIG.

second, the hedged contracts that you had said you had

purchased.

And

If that is correct, it seems to me by the Federal

Government paying 100 cents on the dollar rather than the 48

cents that the market said they were really worth, the

beneficiary party was not Goldman Sachs but was whoever held

those contracts that would have paid you the difference

between the Federal Government and what your real loss was.

Is that a correct statement?

WITNESS VINIAR:

Those CDS contracts only paid

off if AIG defaulted.

had to pay 100, or zero.

defaulted, then we could collect under the contracts.

Otherwise--

19
20
21

So basically the Government either
If they paid zero and AIG

COMMISSIONER GRAHAM:

So your contracts didn't

cover for less than total default?
WITNESS VINIAR:

That was the purpose of the

collateral with AIG.

And the difference between the

collateral they paid and the collateral we felt we were owed

was covered by the CDS contracts, which only paid--the CDS

contracts in general only settle on the case of a default.

130
1

That's why they're credit default swaps.

COMMISSIONER GRAHAM:

You said that there was one

brief meeting at which there was some negotiation between

Goldman Sachs and a representative probably of the New York

Fed as to what this transaction would be.

York Fed individual left the meeting, and the next thing you

heard you were going to be paid 100 percent?

8
9

WITNESS VINIAR:

And then the New

Is that right?

It was a phone call.

It was one

phone call, and it was a brief phone call, and that was it.

COMMISSIONER GRAHAM:

Were there any--was that

the totality of your relationships with the Federal

Government vis-a-vis AIG?

transactions involving financial relationships that Goldman

Sachs had with AIG?

15
16

WITNESS VINIAR:

19
20

Other than Maiden Lane?

COMMISSIONER GRAHAM:

CHAIRMAN ANGELIDES (presiding):

CHAIRMAN ANGELIDES:

Would you like a

couple of more minutes?
COMMISSIONER GRAHAM:

Mr. Chairman, my time is

up.

I don't

believe there are any others, but I'm not positive.

17
18

Were there any other subsequent

right, thank you.

I'm satisfied.
You're satisfied?

Mr. Georgiou.

COMMISSIONER GEORGIOU:
Mr. Chairman.

All

Thank you very much,

I would like to ask the AIG gentlemen, if I

131
1

could, how old is AIG?

2
3

Do you know?

WITNESS BENSINGER:

Anybody?

I believe it is slightly

under 100 years old.

COMMISSIONER GEORGIOU:

Okay.

And at the end of

'07, the market capitalization was about $147 billion?

that right?

WITNESS BENSINGER:

COMMISSIONER GEORGIOU:

That sounds right.
And is it fair to say

that we all can agree now that the price which you charged

at AIGFP for the essentially insurance protection you were

providing in the credit default swaps against the failure of

the underlying securities was insufficient to protect

against the risk that you undertook?

that proposition on the AIG side?

WITNESS FORSTER:

Does anybody agree to

Mr. Forster?

Sure I think with hindsight clearly there

turned out to be more risk embedded in the transactions than

we thought.

So, yes, the price didn't reflect that-COMMISSIONER GEORGIOU:

Right.

So you should

have charged more money to Goldman Sachs and any other

counterparty who was buying credit default swaps protection

against these super senior tranches of these securities in

order to protect against their default--in order to insure

them that you could pay against--pay if they defaulted?

Correct?

WITNESS FORSTER:

I mean looking back from here

132
1

and seeing now what the likelihood was of ultimate defaults,

the answer to that is, yes.

COMMISSIONER GEORGIOU:

Because isn't it the case

that the company, AIG, basically failed as a result of

collateral calls and other obligations associated with these

products that caused the company to collapse and require an

infusion of some $80 billion to start with from the

Government?

Mr. Habayeb?
WITNESS HABAYEB:

You know, looking in hindsight

from a liquidity perspective within Financial Products and

other parts of the company, there were significant liquidity

exposures for AIG.

markets, not being a bank with access to the Fed Window, and

facing the perfect storm in the market, those were all

things that led up to AIG's failure.

Faced with being shut out of the capital

COMMISSIONER GEORGIOU:

Okay, but I don't really

buy this perfect storm argument, which has come before us a

number of times, in which witnesses in the private and

public sector have continually testified to this Commission

that all of these things occurred which caused the financial

crisis without anybody doing anything wrong in the private

or the public sector; that it was simply a confluence of

events, which the Chairman has called an immaculate

calamity, and I call sort of a pathetic mythology.

So I frankly don’t buy the perfect storm.

133
1

mean, I think these events were caused by human decisions

that were in many instances profoundly wrong.

explore this a little bit, if I can, with the Goldman Sachs

people.

And I want to

Now, Mr. Viniar, you testified, and your opening

statement says, that with respect to AIG our relationship

was governed by the same client service and risk management

focus described above.

context, our clients first came to us to help them manage

To put our relationship with AIG in

credit exposure to super senior CDO positions on their

books.

We entered into credit derivative swap contracts-

-that is, sold protection--to help them hedge against a fall

in the value of their super senior CDOs.

into offsetting contracts, bought protection with AIG to

manage the resulting exposure in our books.

You with me?

WITNESS VINIAR:

COMMISSIONER GEORGIOU:

We then entered

Yes.
Okay.

You can keep your

microphone on because we're going to talk for a little bit

here.

WITNESS VINIAR:

Okay.

COMMISSIONER GEORGIOU:

What I would like to know

is--and if I could take a look at that chart here, what we

call chart number four--what I would like to know is--and I

134
1

am going to give you some advice now, unsolicited and unpaid

for, on how it is then you can evaluate whether your derivative

contracts are profitable or loss making for Goldman Sachs.

Okay?

Now in the big chart, the big piles of,

you know, little silos on the left-hand side, it shows that

you paid 12 basis points annually for protection from AIG on

$1.76 billion worth of risk of default on a particular

tranche of CDO Abacus 2004-1.

So you paid $2.1 million annually to be protected

against 100 percent risk of loss of $1.76 billion.

follow me?

WITNESS VINIAR:

COMMISSIONER GEORGIOU:

Do you

Um-hmm.
Okay.

Now I would like

to know what you charged, since you only entered into this

transaction with AIG, as I understand your testimony, to

hedge yourself against the risk that was created when your

clients asked you to provide them protection against the

failure of this same tranche, so I would like to know what it

is that you charged as compared to the 12 basis points you

paid AIG for the protection, what you charged your clients

for the same protection on the same tranche?

WITNESS VINIAR:

COMMISSIONER GEORGIOU:

24
25

I don't know.
Well I would like to ask

you to provide that to the Commission in writing.
WITNESS VINIAR:

Sure.

135
1

COMMISSIONER GEORGIOU:

Okay.

Now if as I

believe is likely the case it was 10 times or more than you

were paying to AIG for the same protection, I would suggest

to you that that is a pretty good metric of how much money

you made on that particular transaction.

charged your clients X in terms of basis points of the risk

undertaken per year for the protection you sold to them so

that you would pay them in the event that that tranche

failed.

And you in turn laid off that risk to AIG and paid

them 12 basis points.

percent per year for that same protection.

That is, you

That is, a tenth of a, 12/100ths of a

So you no longer had a risk so long as AIG could

honor their obligation.

full $1.76 billion to your clients, but you were going to

get it from AIG.

on the charge that you made between what you charged your

clients annually and what you paid them.

If the thing failed, you owed the

So you were neutral except for the spread

WITNESS VINIAR:

Correct?

So far everything you said

sounds right, other than I have no idea if it was ten times

as much, but I certainly hope--

COMMISSIONER GEORGIOU:

Maybe it was 100 times as

much.

Maybe it was 5 times as much.

want to know.

Because when you tell us that you don't know how much you

make in your derivatives business, nobody here really

Okay?

We don't know.

But I

And our Commission wants to know.

136
1

believes it.

And I will tell you why.

It's crazy.

It doesn't make any sense.

Goldman

Sachs is, if not the most sophisticated investment bank,

certainly one of the most sophisticated investment banks in

the world.

much money you're making on your various aspects of your

business.

And nobody here believes that you don't know how

It doesn't make any sense.

And I will tell you another thing.

I am

continually flogged by the guys in your asset management

business to try to entrust--to get me to entrust my

family's--

12
13
14
15
16
17
18

CHAIRMAN ANGELIDES:

Mr. Georgiou, would you like

three minutes?
COMMISSIONER GEORGIOU:

If I could, please.

Actually, five, if I could.
CHAIRMAN ANGELIDES:

Well I'm sure you'd like 10,

but let's start with 3.
COMMISSIONER GEORGIOU:

--to entrust my family's

assets to Goldman Sachs to manage.

And I can tell you that

I will never--number one, I think it is inappropriate to

even consider it while we are in the midst of this

Commission proceeding and all these matters that are before

us, but I certainly would not do it if I thought that

Goldman didn't have a clue as to what aspects of its

business it was making money on, and what it was losing

137
1

money on.

So I don't really believe it.

So what I would

really like you to do is, as to all of the tranches that you

purchased credit default swap protection from AIG on, I

would like you to have a nice chart that shows us exactly

what you paid in terms of percentages of those tranches for

protection from AIG, and what you were charging to your

clients who were buying the protection.

reason, you say, since you're not in the proprietary trading

business primarily, you're just doing it to provide services

to your clients, I want to know exactly what the differences

were.

Because that's the

Then that will be one of the elements you can use

when you come back to us to respond to Ms. Born and

Commissioner Angelides' question about how you can evaluate

whether you made money or didn't make money on your

derivatives business.

Can you do that?

WITNESS VINIAR:

We will provide you that

information.

COMMISSIONER GEORGIOU:

Okay Thank you.

Now let me move to one other area.

You know,

everybody has been talking here about the fact that the

Taxpayers ended up paying you on the obligation which AIG

owed you to pay on the failure of these particular tranches

138
1

100 percent.

Now when you write down--when you write down your

position, that is when Mr. Lehman and others are trying to

identify as best they can the marks of what's happened to

the underlying securities when you're going back to AIG to

call for collateral, do you recognize that loss on your

books?

security on your books as a loss netted out against the gain

from some other activity that you're in?

Or the diminution in the value of the underlying

WITNESS VINIAR:

Yes.

COMMISSIONER GEORGIOU:

Okay.

So that means that

you were continually writing it down and taking those losses

against your profits for the purposes of reporting income

that the firm made, correct?

WITNESS VINIAR:

Correct.

COMMISSIONER GEORGIOU:

Okay.

That means that

when the Government paid you 100 percent of your position, I

take it you recognized that gain, the difference between the

48 cents that Commissioner Thomas was talking about that

you'd written down this to, and the 100 percent that you

received, you recognized that gain as profit and paid tax on

it?

23
24
25

Is that right?
WITNESS VINIAR:

But we have a position on the

other side, so it would go--they would equalize.
COMMISSIONER GEORGIOU:

You had a position on the

139
1

other side with your own clients?

WITNESS VINIAR:

COMMISSIONER GEORGIOU:

Um-hmm.
Okay.

On which you--

okay, on which you recognized, presumably--

WITNESS VINIAR:

So they would offset.

COMMISSIONER GEORGIOU:

I've got it.

Okay.

they would offset when you wrote it down, and they would

offset when you wrote it up?

WITNESS VINIAR:

Yes.

COMMISSIONER GEORGIOU:

CHAIRMAN ANGELIDES:

Mr. Georgiou, would you like

two minutes?

13
14

COMMISSIONER GEORGIOU:

CHAIRMAN ANGELIDES:

COMMISSIONER GEORGIOU:

VICE CHAIRMAN THOMAS:

21
22
23
24
25

Thank

You're indebted to me.
No, I mean-Excuse me?

No, those were

my two minutes, not his.

19
20

If I could, yeah.

you very much, Mr. Chairman.

Okay, I've got you.

COMMISSIONER GEORGIOU:

I've been indebted to

both-CHAIRMAN ANGELIDES:

--on the other side of the

minute trade.
COMMISSIONER GEORGIOU:

I've been indebted to

both of you in so many ways I can't even count.
Okay, have you gotten--has anybody gotten a

140
1

chance, Mr. Viniar, I guess, to read this story by Greg

Gordon of the McClatchy Newspapers that ran yesterday

morning titled "Goldman Admits It Had Bigger Role In AIG

Deals"?

5
6
7

WITNESS VINIAR:

I saw it and I skimmed it.

did not read it.
COMMISSIONER GEORGIOU:

Okay.

Well if you

skimmed it, then that's a good thing, because under this--

What it says here is that a senior Goldman executive

disclosed the bilateral wagers on subprime mortgages in an

interview with McClatchy, making the first time that the

Wall Street titan has conceded that its dealing with

troubled insurer AIG went far beyond acting as a, quote,

"intermediary" responding to its clients demands.

official who Goldman made available to McClatchy on the

condition he remain anonymous declined to reveal how much

money Goldman reaped from its trades with AIG.

proprietary trades with AIG.

protection that you were doing just to net out your position

with regard to client commitments that you had made.
Can you tell us who that person was?

WITNESS VINIAR:

24
25

That is, its

Independent of countervailing

The

I actually have no idea what the

reporter was talking about.
COMMISSIONER GEORGIOU:

Okay, but nobody--well

you are the most senior person here today.

Can you get back

141
1

to us with who that person is, because I think we would like

to talk to them.

WITNESS VINIAR:

Sure.

COMMISSIONER GEORGIOU:

And it says here:

Okay.

Thank you.

Goldman's proprietary trades

with AIG in 2005 and '06 are among those that many Members

of Congress sought unsuccessfully to ban during recent

negotiations for tougher regulation of the financial

industry.

But it says here that Goldman agreed recently to

settle these wagers which had a face value of $3 billion

with AIG for somewhere between $1.5 billion and $2 billion,

which AIG lost and that Goldman supposedly paid less than

$10 million for the credit default protection that you

settled for $1.5 billion to $2 billion.

that result?

17
18

WITNESS VINIAR:

Do you know about

I don't know what the author is

referring to, no.

COMMISSIONER GEORGIOU:

So you don't have any

transaction that you recently settled with AIG--you're the

Chief Financial Officer of Goldman--

22
23

WITNESS VINIAR:
lots of transactions.

24
25

No, I--I don't know.

We might of.

COMMISSIONER GEORGIOU:
billion.

We settle

Well it's $1.5 to $2

I know that even in Goldman Sachs' rarified world

142
1

I would think that that might be on your radar screen.

Mr. Lehman, could you tell us?

WITNESS LEHMAN:

Yes commissioner perhaps I can be

helpful here. That trade I believe was done in the summer

of 2009, and it was done consistent with our pricing

at the time.

time because it was done, again, in the context of our market.

So it was not a revenue event at that point in

8
9
10

CHAIRMAN ANGELIDES:

Time, Mr. Georgiou, can you

wrap up, please.

COMMISSIONER GEORGIOU:

it for $1.5 to $2 billion?

WITNESS LEHMAN:

Okay, but you did settle

Is that right?
No, I believe--well, I don't

know the specifics of the trade.

where you have 806 million for the 1.76 was part of it, but

I believe there to be other parts of that trade.

COMMISSIONER GEORGIOU:

I believe Abacus 041,

Okay, but is it fair to

say that you paid $10 million for the credit default

protection and recovered between $1.5 billion and $2 billion

on that particular trade?

21
22

WITNESS LEHMAN:
numbers right now.

23
24

Again I don't know the specific

We can come back to you on that.

COMMISSIONER GEORGIOU:

And that's from AIG,

correct?

WITNESS LEHMAN:

Correct.

COMMISSIONER GEORGIOU:

Okay.

And so that is

143
1

effectively from the Taxpayers.

CHAIRMAN ANGELIDES:

All right.

Let's do this.

Just to wrap up your questioning, can I offer something up,

Mr. Georgiou?

asked for today was you asked for the information on all the

transactions with AIG; the entity on the other side; and

essentially the payment provisions on the other side.

Correct?

9
10

It seems to me that one of the things you

COMMISSIONER GEORGIOU:

The cost to the other

party--

CHAIRMAN ANGELIDES:

Correct.

COMMISSIONER GEORGIOU:

--of precisely the same

protection which Goldman Sachs was selling--was purchasing

from AIG.

CHAIRMAN ANGELIDES:

And can I just suggest, and

maybe ask a quick question before we go to Mr. Holtz-Eakin,

were there transactions with AIG where there was not an

entity on the other side?

19
20

WITNESS VINIAR:

I actually don't know.

know?

COMMISSIONER GEORGIOU:

WITNESS LEHMAN:

23
24
25

Do you

No.

Mr. Lehman?
I think we should come back

to you with specifics.
CHAIRMAN ANGELIDES:

Yes.

And I was going to say

that, unless you can give me an answer now, part of this is

144
1

we would like to see very specifically all those

transactions with AIG, which would include people on the

other side with the information that Mr. Georgiou said, as

well as those transactions where there was not an entity on

the other side, where it was purely bilateral.

COMMISSIONER GEORGIOU:

Yes.

more minute before you go off?

CHAIRMAN ANGELIDES:

COMMISSIONER HOLTZ-EAKIN:

Correct?

And can I get one

Please-I will yield one

minute.

CHAIRMAN ANGELIDES:

Okay.

COMMISSIONER GEORGIOU:

Okay, one minute.

apologize, but I want to just get to one other point which I

think is important.

You know, Mr. Blankfein at his testimony, and you

today, Mr. Viniar in your testimony, continue to assert that

you were adequately hedged against AIG's failure with a

number of other counterparties.

to do collateral calls with AIG, and of course you knew that

they were, AIGFP was, you know, close to $80 billion by that

point on one side of a transaction, and they weren't capable

of paying all those debts, you started--

23
24
25

WITNESS VINIAR:

That is, when you started

We only knew their transactions

with us.
COMMISSIONER GEORGIOU:

Well, okay, you only knew

145
1

their transactions with you, but I'm sure anecdotally in the

marketplace you knew that other people were buying similar

protection from them.

In any event, you chose to protect yourself by

doing two things.

aggressive manner.

of AIG's default.

One, asking for collateral in a fairly
And two, purchasing default protection
Correct?

WITNESS VINIAR:

COMMISSIONER GEORGIOU:

WITNESS VINIAR:

Correct.
Okay, now--

That was predetermined that if

we were not getting the collateral that we were owed, that

we would hedge down to zero.

COMMISSIONER GEORGIOU:

Okay.

Now it's been

asserted here, and in other forums by Mr. Blankfein and

yourself, that you never really needed the Government to pay

you 100 percent of the obligations that AIG owed you on

those credit default swaps because you were adequately

hedged by other parties against the risk of an AIG default.

I would like you, if you know, to tell us today

who provided those hedges to you.

And whether they--whether

in your judgment they were in a position to honor those

hedges?

in writing to us who they were and what they cost and

whether in your judgment--or I guess we can make some

evaluation ourselves--whether they were capable of honoring

And if you don't know, then I'd like you to provide

146
1

it.

Because I find it incredulous that if AIG, the

largest insurer in the world, with $150 billion market cap,

wasn't in a position to honor its obligations to you, that

some other parties were in a better position to honor them

in the event AIG defaulted.

And of course AIG did default, and the Government

stepped in.

And you're trying to tell us that there were

other private parties who were prepared to honor that

obligation to AIG instead of the Government.

skeptical about the proposition.

CHAIRMAN ANGELIDES:

And I'm highly

Let’s go to the answer and then

let’s move on to Mr. Holtz-Eakin and I have an observation, I’m

sorry. Let's get the answer quickly, and then I will just

remind Commissioners what we have already asked for and

received to date on this, and what we are missing that I

imparted to Mr. Cohn yesterday.

WITNESS VINIAR:

Okay, just very quickly.

CHAIRMAN ANGELIDES:

Yes, but if you know the

names of the counterparties of the amount you had in CDS

against AIG particularly around September, mid-September,

that would be very helpful if you could tell us right now.

WITNESS VINIAR:

AIG did not default.

didn't.

Just very quickly, first of all

You mentioned AIG defaulted, but they

Second of all--

147
1

COMMISSIONER GEORGIOU:

That's not true.

They

148
1

didn't default because the Government gave them $80 billion

to honor their obligations.

WITNESS VINIAR:

Right.

COMMISSIONER GEORGIOU:

Correct. But they-So they did default--I

mean, they would have defaulted but for the infusion of

Taxpayer capital, correct?

WITNESS VINIAR:

They would have--I believe would

have defaulted, but they didn't default, therefore we

couldn't collect under the CDS contracts.

But I do not know

the specific names of the parties, but I know we're going to

get you those.

predominantly with other major financial institutions.

what you will find is that, given the volume of trading,

most of the financial--major financial institutions deal

with each other, Goldman Sachs, JPMorgan, Morgan Stanley,

Deutsche Bank, PIMCO, we basically collateralize all of our

trades with each other.

those counterparties were collateralized as well.

that's why I am confident that they would have paid off,

because we had the cash.

But I think it's important to know they were
And

And so the contracts we had with

COMMISSIONER GEORGIOU:

And so

Well, all right, but many

of them wouldn't have been able to pay off unless they too

were infused with exceptional Taxpayer assistance.

CHAIRMAN ANGELIDES:

WITNESS VINIAR:

Let's move on.

We had the cash.

149
1

CHAIRMAN ANGELIDES:

Okay--well, you didn't have

the full cash, but let me just do this.

this up.

You had collateral.

WITNESS VINIAR:

CHAIRMAN ANGELIDES:

Let me just wrap

Correct.
You also bought protection

essentially for the collateral you did not have--

WITNESS VINIAR:

Correct.

CHAIRMAN ANGELIDES:

and we have

the chronology of what you bought in CDS protection, and

from whom you bought it.

asked for, is if you look at what we have been given it

says, for example, in July of '07 you bought $100 million of

credit protection against AIG.

bought another $50 million.

What is missing, and what we have

And then subsequently

you

It ultimately gets to I think around $3 billion.

And I think around the time period of AIG's near collapse

and the loan by the Government, I think you have about $2.7

billion outstanding.

WITNESS VINIAR:

Um-hmm.

CHAIRMAN ANGELIDES:

What we have asked for, and

what we have not gotten, is we have asked very specifically

the counterparties with whom you had that $2.7 billion of

protection so we could take a look at it.

Now we do know, looking at the list today, that

for example when you look at the full list without knowing

150
1

who that $2.7 is, people you've bought along the way, there

151
1

are some names there like Lehman Brothers that clearly by

September 16th wouldn't have been in a heck of a good

position to pay.

has asked for is important.

So I think the information Mr. Georgiou

All right, so let's do this.

then we will go to Mr. Holtz-Eakin.

make a comment.

8
9

VICE CHAIRMAN THOMAS:

Mr. Thomas, and

Mr. Thomas wanted to

And based upon the

information that we got in part from the McClatchy Newspaper

story, I am going to ask the staff to chart whatever

information they are going to need.

to have to talk to you about the money that moved to AIG,

which then went overseas to Deutsche Bank, and other banks,

which then came back to Goldman in virtue of cash that was

paid back.

They're probably going

So you've got to follow that circular, as well,

and we will work that out.

that Commissioner Georgiou also requested the unnamed

Goldman source to the McClatchy Newspaper article, and I

want to assure you, I think you said we want to talk to him-

-I want to assure you, it's not for a panel.

public disclosure.

would like to take a look at.

24
25

The point I wanted to make was

It's not for

He has information that we now know we

And so in requesting up through whatever chain
you report to about getting that individual to talk to us,

152
1

we have our own ways if he isn't forthcoming, or your

company isn't forthcoming, but we are not interested in

outing the individual; we are interested in getting the

information that he apparently has and has supplied to

others.

CHAIRMAN ANGELIDES:

Well, and if the article is

accurate.

that's I think why it’s of particular interest.

9
10

It does say "whom Goldman made available."

VICE CHAIRMAN THOMAS:

Well understanding we're

dealing with the press, so to the degree it's accurate.

CHAIRMAN ANGELIDES:

of the Commission today, Mr. Holtz-Eakin.

13
14

Yes. And the most patient member

COMMISSIONER HOLTZ-EAKIN:

Thank you,

Mr. Chairman.

15
16

CHAIRMAN ANGELIDES:

And you can have as much

time as you want.

COMMISSIONER HOLTZ-EAKIN:

Right.

I want to

thank you for your time today, gentlemen, everyone.

really do appreciate you showing up and answering these

questions.

I just want to clean up some details, and I

apologize for repeating some things, but just to make sure I

understand them.

24
25

I want to pick up where Mr. Georgiou left off
with the Taxpayer money.

This is what I don't understand,

153
1

because I'm an economist and I'm trained to be stupid--

(Laughter.)

COMMISSIONER HOLTZ-EAKIN:

--but you've said

you're fully hedged against AIG in these transactions.

you just don't care what the price is that you get, because

you're going to get par no matter what.

a dollar, regardless.

8
9
10

You're going to get

So when the Fed calls Mr. Schwartz and says, will
you take a discount, why does he even have to think?

You're

going to get the same amount of money.

WITNESS VINIAR:

No, again, the CDS contracts

that we get, we only collect on those if AIG actually

defaults.

anything under the CDS contracts.

So if AIG does not default, we don't collect

COMMISSIONER HOLTZ-EAKIN:

And so you got a

benefit from them paying you at par that was above and

beyond what you would have gotten, even though you were

fully hedged.

This is, in the end, I think what the panel is

desperately trying to get you to acknowledge; that you

received an economic value from the intervention of the

Taxpayers and the U.S. Government.

WITNESS VINIAR:

Is that not true?

Vis-a-vis our direct

transactions to AIG, it is not true.

otherwise would have gotten.

We got what we

If AIG had defaulted, we would

154
1

have collected--we had the collateral, and we would have

collected under our hedges.

same thing that we got from the Government.

We would have collected the

COMMISSIONER HOLTZ-EAKIN:

Okay.

Yesterday Mr.

Cassano testified that in his view there would have been no

credit event with the CDSs; that the underlying CDOs--and

even to the end stipulated that in the end there will be no

credit event; that the modeling was correct and that if you

would watch the Maiden Lane assets play out over the course

of their lifetime, the contract will just expire and there

would never have been a payment.

Is that Goldman Sachs' view today of those

underlying CDOs that are in Maiden Lane?

there to be a credit event?

WITNESS LEHMAN:

Or do you expect

Commissioner, I don't have an

updated view on fundamental losses or, for that matter,

market prices of the Maiden Lane III assets.

something I can--I can address with your staff.

COMMISSIONER HOLTZ-EAKIN:

CHAIRMAN ANGELIDES:

Well here's an update.

Those are provided by Black

Stone, Mr. Holtz-Eakin--

VICE CHAIRMAN THOMAS:

COMMISSIONER HOLTZ-EAKIN:

CHAIRMAN ANGELIDES:

WITNESS LEHMAN:

But that is

BlackRock—
43 cents on the dollar?

BlackRock, Black Stone--

Just to be clear, those are

market prices, or the ultimate view of losses from BlackRock?

155
1
2
3

COMMISSIONER HOLTZ-EAKIN:

These are current market

prices? I don't know.

WITNESS LEHMAN:

Because I think what Mr. Cassano--

5
6

CHAIRMAN ANGELIDES:

COMMISSIONER HOLTZ-EAKIN:

No these are-My familiarity began

when this Post-It arrived.

(Laughter.)

CHAIRMAN ANGELIDES:

projections of economic losses?

ahead.

I'm sorry, are these
No.

You know what, go

Ask your question.
COMMISSIONER HOLTZ-EAKIN:

No, I'm just trying to

understand the nature of this transaction at the end, and

the significance of avoiding bankruptcy for AIG in terms of

what transacted both in terms of cash, but also in terms of

exposure to risk.

the risk of the underlying assets.

books entirely.

You no longer--there's no exposure now to
That's now off your

And there's a value to avoiding risk.

And I'm just trying to tease through what Goldman

got in this transaction.

You lost some risk exposure.

You

got some cash.

that.

find it improbable that you can sit there and say we got the

same thing no matter what if the Taxpayer had not

intervened, because you lost an enormous amount of risk

And I was just trying to do the math on

And I can come back to the specific question, but I

156
1

exposure up and down, and you got the same cash.

Usually when you get the same cash and have no

risk, you are better off.

figure out.

So that's what I'm trying to

I want to talk about the risk thing in my

remaining time, because I want to echo the comments that

Commissioner Hennessey made about the nature of this hearing

and what we have learned.

I think the one thing that we have drawn out of

the series of hearings--and this one in particular--is the

colossal failure of risk management in many of these

institutions.

would have such a deeply siloed risk management system, and

that the CFO who is in charge of liquidity risk management

would be unaware of contractual obligations to deliver

collateral, the most fundamental liquidity event I can

imagine.

And in AIG I find it just stunning that you

And so, Mr. Forster, I know you are familiar with

Mr. Cassano's testimony yesterday.

view that the modeling was right and that there would never

be a credit event?

securities should in fact have a market value which is equal

to their par value?

24
25

Did you concur with his

And that ultimately these underlying

WITNESS FORSTER:

I think obviously the portfolio

was transferred to Maiden Lane in 2008, so I don't have a

157
1

huge amount of insight or surveillance over that portfolio.

COMMISSIONER HOLTZ-EAKIN:

At the time did you

agree with the modeling?

have concurred with his statement that there will never be a

credit event, and that ultimately these securities will

trade in liquid markets when they come back at par value?

Did you agree with, and would you

WITNESS FORSTER:

I think if we were looking--and

perhaps this isn't your exact question--if we were looking

at the statement in sort of 2007, did I expect to see any

material loss?

No, I expected to see no material loss.

If I looked at it now--

COMMISSIONER HOLTZ-EAKIN:

WITNESS FORSTER:

Um-hmm.

--and decided what would I think?

I don't have a huge amount of insight into it anymore, but

having looked at what I’ve seen sort of BlackRock estimates and

things like that, they clearly project quite significant

losses.

with their thoughts.

And I would see no reason why not to concur

COMMISSIONER HOLTZ-EAKIN:

So you didn't expect

material losses.

are substantial discounts, offers to trade at those marks,

why don't you buy?

So Goldman comes to you with marks that

WITNESS FORSTER:

For, again this is a difference

between what you ultimately expect and what the market price

might be at that one time.

clearly, you know, no appetite to add additional risk to the

And at that time there was

158
1

book.

2
3

COMMISSIONER HOLTZ-EAKIN:

So there was risk.

And did you report that risk to the CFO?

WITNESS FORSTER:

We thought that the risks that

we were taking back at that time were extremely remote, but

clearly it was not zero risk.

7
8

COMMISSIONER HOLTZ-EAKIN:

substantially more risky than Mr. Cassano testified?

9
10

So these were

WITNESS FORSTER:

Well they have turned out to be

substantially more risky, yes.

COMMISSIONER HOLTZ-EAKIN:

What would have

happened if you'd bought them at the marks Goldman was

offering?

WITNESS FORSTER:

I guess we would've just had

even greater risk.

And as the market--we would have had a

greater risk position.

at risk.

through--for the remainder part of 2007 and 2008, we would now

have even larger losses.

We would have had a greater notional

And obviously as the market deteriorated still further

COMMISSIONER HOLTZ-EAKIN:

to mark your books to those transaction prices?

WITNESS FORSTER:

And would you have had

I don't know.

I'm not an

accountant, I'm afraid.

My role was to provide the

information and the accounting folks would decide what was

relevant information.

159
1
2

COMMISSIONER HOLTZ-EAKIN:

Okay. Why don’t we just

stop there. Thank you very much.

CHAIRMAN ANGELIDES:

Do you want to--Mr. Holtz-

Eakin, I have one quick question.

to fill in the--

The staff is there just

COMMISSIONER HOLTZ-EAKIN:

I think, given the

confusing nature of the discussion, we've got all these

notes, it is best to just go to this in writing and we will

get a clear story.

10
11

CHAIRMAN ANGELIDES:

Okay.

I have a quick

question.

COMMISSIONER HOLTZ-EAKIN:

CHAIRMAN ANGELIDES:

Go ahead.

Mr. Vice Chairman, do you

want to--well, this is just a technical question.

buying CDS protection on AIG in 2007.

that had increased.

you have marked to market the value of your AIG credit

protection that you had bought?

19
20

[Off microphone]

CHAIRMAN ANGELIDES:

VICE CHAIRMAN THOMAS:

WITNESS VINIAR:

25
26

So would

I assume the

answer is yes.

By 2008 the price for

Just a technical question.

WITNESS VINIAR:

You began

The answer what?
Use your mike.

Sorry.

I assume the answer is

yes.
CHAIRMAN ANGELIDES:
follow up on that.

All right, if we could

160
1

All right, Mr. Vice Chair?

VICE CHAIRMAN THOMAS:

It gives me great pleasure

to, not withstanding his opening remarks about the panel, to

yield three minutes to Commissioner Hennessey for questions.

5
6

COMMISSIONER HENNESSEY:

Thank you, Mr. Vice

Chairman.

Just some additional questions I guess for Mr.

Forster.

AIGFP's risk manager at the time was Mr. Mikatis?

Is that right?

WITNESS FORSTER:

That's correct.

COMMISSIONER HENNESSEY:

And what role did he

have in overseeing the risk involved in the CDO business at

AIGFP?

WITNESS FORSTER:

I believe he took over the risk

management function for the credit part of the book in 2007,

I believe.

COMMISSIONER HENNESSEY:

And as a practical

matter, was he the primary decision maker?

suggested to me that he was a very strong risk manager, but

that Mr. Cassano took a lot of the decision making for the

CDO portfolio specifically and made those decisions himself.

WITNESS FORSTER:

It's been

I think it's fair to say that

Mr. Mikatis is a very strong risk manager.

I think at the

time our issues were that the--whilst there was some risk

embedded in these contracts, that we viewed the risk to be

161
1

extremely remote.

COMMISSIONER HENNESSEY:

I understand the view,

which is--that's consistent with everything I have heard.

My question is, as sort of a practical matter, who was the

real decision maker on the risks that were being taken in

that CDO portfolio?

WITNESS FORSTER:

Well ultimately I guess Mr.

Cassano was in charge of FP, so he would have a big say.

And then also obviously, as I know you heard yesterday, all

the transactions were approved at the AIG, Inc., level, and

that would also be another level of decisions.

COMMISSIONER HENNESSEY:

I guess what I'm trying

to get at is, did Mr. Cassano play a larger role in

decisions about the CDO risk than he did in other kinds of

risk at AIGFP?

WITNESS FORSTER:

I honestly couldn't answer

that.

I mean, my role was only very much in credit, and

there are obviously lots of other businesses that the

company is involved in.

question, sorry.

I really couldn't answer the

COMMISSIONER HENNESSEY:

Okay.

AIGFP has been

described by some as the world's largest credit hedge fund.

Is that a fair characterization of where they were in 2007

and 2008?

matter?

Not as a legal matter, but as a real economic

162
1

WITNESS FORSTER:

We clearly didn't think that

was the case.

notional bets.

money and very risk remote.

the multi-sector CDO business, to not be that case.

6
7

We thought they were very much out of the
They turned out in some cases,

We do have much larger notionals in other
businesses that have turned out to be perfectly good bets.

8
9

Clearly what we'd taken were extremely large

COMMISSIONER HENNESSEY:

But you're telling me

that within AIGFP your experience was that your colleagues

did not think of your employer as the world's largest credit

hedge fund?

12
13

WITNESS FORSTER:

I mean obviously I can't speak

for what my other colleagues thought.

COMMISSIONER HENNESSEY:

WITNESS FORSTER:

In terms of--

I never heard that phraseology

at the time.

COMMISSIONER HENNESSEY:

And a couple more

questions.

collateral calls--and maybe this is for you and Mr.

Bensinger--these collateral calls are increasing the demands

for liquidity.

These collateral calls.

Okay.

Obviously the

At what point in time did you or people senior to

you in AIGFP realize that those collateral calls might put

FP out of business?

WITNESS BENSINGER:

I don't really think that

163
1

there was a determination that that would occur until very

close to the middle of September when the markets began

really falling off the cliff even more precipitously than

they had after the Lehman bankruptcy.

potential prospect of downgrades by the rating agencies of

AIG, I mean that was really--

COMMISSIONER HENNESSEY:

That weekend, the

So up until September of

'08, there really wasn't discussion of, you know what, these

collateral calls might--not "would" but might put us under?

WITNESS BENSINGER:

As I had said, when we raised

the additional $20 billion of capital in May, all of the

assumptions that we were using were predicated upon the fact

that that additional capital buffer and liquidity buffer

would be able to carry through, you know, intensive market conditions.

But the market conditions deteriorated to the extent that

they exceeded those assumptions.

COMMISSIONER HENNESSEY:

questions about counterparty risk.

or one of your other counterparties--

CHAIRMAN ANGELIDES:

COMMISSIONER HENNESSEY:

Okay.

A couple more

Presumably when Goldman,

Oh, go ahead. Yes, Finish.
--wants to do business

with you, they are looking at the credit rating of AIGFP,

which for a long time was, as I understand it, AAA, right?

WITNESS BENSINGER:

Yes.

COMMISSIONER HENNESSEY:

Ya'll had to presumably

164
1

deal with the scenario where there was a possibility that

maybe AIGFP's own credit rating would be downgraded.

you know that the firm's survival was contingent upon having

say a AAA, or I don't know, a AA credit rating?

falling below that would mean that the whole house of cards

would collapse?

WITNESS BENSINGER:

was necessarily the case.

stable.

Did

And that

No, I don't think that that

The company's ratings were

It was AAA until the spring or summer of 2005

during the events that I described in my opening remarks.

The company was downgraded to a AA level, where

it really remained all the way through mid-September of

2008.

COMMISSIONER HENNESSEY:

I'm asking a slightly

different question.

there was a serious probability that it might be downgraded

further.

some strange reason downgraded further, that that event

would cause the whole firm to collapse?

the firm's continued survival was contingent upon

maintaining such a high credit rating?

I'm not asking if you thought that

I'm asking, did you know that if the firm were for

WITNESS BENSINGER:

Did you know that

I think the credit rating was

only one element of many elements.

I think the decline in

the market prices that caused the significant portion of the

collateral calls was really the most principal determinant.

165
1

I think the ratings downgrade was--

COMMISSIONER HENNESSEY:

I get that.

I'm trying

to get at a different thing.

time to 2007, or 2008, and I ask you:

downgraded today to single A or lower, can AIGFP survive?

What do you believe your answer would have been at that

point in time?

8
9

WITNESS BENSINGER:

If we imagine going back in
Suppose your firm is

It's impossible for me to

answer that question as an isolated question.

It was really

in the context of everything else that was happening that

was causing the liquidity strain.

COMMISSIONER HENNESSEY:

CHAIRMAN ANGELIDES:

14
15

Thank you.

All right.

Let's wrap up

here.
Ms. Born, and then Ms--oh, boy, it's been a long,

long Commission journey.

each have a question.

Ms. Born, and then Mr. Wallison

COMMISSIONER BORN:

Yes, thank you.

I just wanted to follow up on the way the

Government bailout of AIG benefitted Goldman in that you got

paid 100 cents on the dollar for the CDOs that you

transferred to Maiden Lane III in order to get cancellation

of the CDSs.

24
25

We have recently learned that there was another
benefit that Goldman got from the Government at the same

166
1

time.

That is, that the Government forced AIG to waive all

legal claims against Goldman relating to those CDOs.

you aware of that?

4
5
6

WITNESS VINIAR:

Are

Only because I read it in the

newspaper.
COMMISSIONER BORN:

Well do you know whether or

not anybody at Goldman Sachs discussed with a Government

official, or a staff person at the Federal Reserve Bank of

New York that waiver?

Or whether or not it could receive

that waiver?

WITNESS VINIAR:

I'm not aware of that.

COMMISSIONER BORN:

So if now, thanks to that

waiver that the Government had AIG give to Goldman Sachs, if

AIG--even if AIG believed that Goldman Sachs had defrauded

it in negotiations to receive those credit default swaps

from AIG, AIG would not be able to sue or make any claim

against you?

Is that correct?

WITNESS VINIAR:

I believe, first of all, that

whatever that waiver is, it was consistent to all of AIG's

counterparties.

But I don't know anything about it.

COMMISSIONER BORN:

We would very much like to

have a full answer on this.

I understand your General

Counsel is here.

able to provide full information about any contacts that

Goldman had with Government or Federal Reserve Bank

I hope that your General Counsel will be

167
1

officials about this waiver, and that we can see the waiver,

the extent of it, and understand what possible economic

benefits Goldman Sachs received from being relieved of any

legal liability to AIG.

WITNESS VINIAR:

CHAIRMAN ANGELIDES:

Okay.

counsel, we would be happy to--

WITNESS VINIAR:

CHAIRMAN ANGELIDES:

little time.

11
12

If you want to confer with

I think we'll provide you---if you'd like to take a

Okay, thank you.

Mr. Wallison.

I wanted to give you the

opportunity.

WITNESS VINIAR:

Thank you.

CHAIRMAN ANGELIDES:

COMMISSIONER WALLISON:

Mr. Wallison?
I just have a technical,

what I think is a technical question for Mr. Forster because

I didn't get to it during my earlier questioning.

And that is, again I'm interested in this model.

the CDOs were supposed to be what were called "multi-sector

CDOs."

residential, CMBS, commercial mortgages, and home equity.

In your example of what was in them, you said RMBS,

All of those are in the real estate area, and I'm

just wondering whether when you were referring to multi-

sector you were thinking only multi-sector within the real

estate area, or were you thinking that this would include

And

168
1

credit cards and other kinds of collateral in these CDOs.

I'm just trying to get at what this model was supposed to be

covering, and when it was--whether it was in fact addressing

the kind of assets that it was originally conceived to

address.

WITNESS FORSTER:

Um, I mean I'm not sure of the

exact breakdown of all the different asset classes that were

in the different CDOs, but obviously predominantly it was

residential mortgages in the U.S.

COMMISSIONER WALLISON:

I think we had some

testimony yesterday that almost all of the assets in these

CDOs were residential real estate.

incorrect, but I would like to get a fix on that.

all could provide us with the information about what was in

the CDOs in terms of percentages between 2003 and 2007, that

would be quite helpful to us in understanding how this model

applied to what you were doing.

CHAIRMAN ANGELIDES:

And perhaps that's
So if you

Mr. Wallison, I just wanted

to let you know, we actually--I believe the information has

already been provided.

have seen, but I just want to say we do have--they have

already provided the information on all those transactions,

all those CDOs, just to let you know.

We have provided a sample, which you

COMMISSIONER WALLISON:

CHAIRMAN ANGELIDES:

We do have it.

Good.

Thank you.

We are going to break for

169
1

lunch here.

is really of Goldman, because I've been--this whole

discussion about people being on the other side of the

trade.

I am going to ask one quick question.

And it

You do take proprietary positions, though,

without regard to folks being on the other side of trades,

from time to time?

Correct?

WITNESS VINIAR:

Yes, we do.

CHAIRMAN ANGELIDES:

Okay.

And we'll get that

specific information.

So I remember when I was a kid, I

still grew up in the era where I would be spanked

occasionally, not a lot but sometimes, my father having

grown up in an immigrant household probably didn't say this

is going to hurt me more than it's going to hurt you, but

I'm fascinated about how do you balance these matters with

clients?

I mean, there's the--I think the e-mails back in

the '07 period when it's clear you're going to start making

down assets.

say:

do you balance your proprietary positions with your client's

positions?

this is an enormous challenge, given that you're taking

positions, and your clients are taking position.

And you're informing clients.

I mean, do you

This is going to hurt you as much as it hurts us?

How

I know it's a big question, but it seems to me

How do you do that?

170
1
2

WITNESS VINIAR:

I'm not sure I understand the

question.

CHAIRMAN ANGELIDES:

Well your interests may

diverge from your clients' interest.

You may be, for

example, net short on something where they're long on

things.

certain way that's not in their interest, how do you balance

that?

our clients first?

And so if you're beginning to push the market in a

I mean, how do you do that?

WITNESS VINIAR:

that we move the market.

market.

Do you say we always put

I think there's a misconception
We are a participant in the

We're, you know-CHAIRMAN ANGELIDES:

But don't participants move

markets?

I mean, aren't the nature of these fluctuations in

our markets--I mean, obviously there are macro forces, but

there are also the activities of participants both on the

way up and the way down.

WITNESS VINIAR:

Sure, but we're,

CHAIRMAN ANGELIDES:

we're--

And let me just finish this.

You can't say that mortgage originators, borrowers don't

move markets on the way up, for example, in housing, and

then, you know, shorting of the market, ABX Index, CDS, I

mean certainly a phenomenon here where both you have macro

forces plus the activities of participants both moving

markets up and down.

And you're not exactly a tiny player

171
1

here.

WITNESS VINIAR:

In the mortgage market we

actually were a pretty small player.

or 5 percent of the underwriting of RMBS and CDOs. So there

are many--

CHAIRMAN ANGELIDES:

We were, you know, 4

Well, but you take four or

five people who are 20 to 25 percent of the market, that's

not insignificant.

9
10

WITNESS VINIAR:

I think it would be very hard

for us to move--

CHAIRMAN ANGELIDES:

just in the market?

therefore conflicts don't arise?

14
15

You don't move the market, and

WITNESS VINIAR:

I think we largely are in the

market; we largely do not move the market.

16
17

So your position is, you're

CHAIRMAN ANGELIDES:

Yes, we want to eat today.

I know it's a small matter--

COMMISSIONER GEORGIOU:

But I just want to follow

up.

Yesterday I mentioned this to your other colleagues who

were here.

your firm before he became Treasury Secretary and the

architect ultimately of the bailout, when he testified in

front of this Commission, he said that one of the biggest

difficulties for management of investment banks and

ultimately their regulators is to manage the conflicts of

interest that are naturally created by the various roles

When we questioned Hank Paulson, who used to run

172
1

that an investment bank like Goldman Sachs performs, to

follow up on the Chairman's views.

CHAIRMAN ANGELIDES:

COMMISSIONER GEORGIOU:

Question-One, you are acting on your own behalf.

And two,

you are acting on behalf of clients' behalf.

these e-mails talks about how 30th floor focus, which I

assume means your top management, was on the fact that when

you marked down your position to AIG in order to collect

more collateral from them on the risk that you had, were

exposed to them for, the consequence of those marks to other

clients of yours like Bear Stearns Asset Management for whom

you raised money, would have been disastrous.

happens is their marks would have to be written down, and

then that would trigger the right of their investors to call

back capital, and so forth.

And one of

Because what

So I guess my point is, and just a question to

you, is for you to acknowledge that Goldman Sachs simply

doesn't act in one way.

interests.

acts on its own account.

It sometimes acts as an underwriter in which it owes

fiduciary duties to investors and to the parties for whom it

is raising money.

25
26

It doesn't just act for client

It sometimes acts for clients.

It sometimes

It sometimes acts as an advisor.

And all of these roles have potential conflicts
of interest, which you have to manage.

They are not

173
1

nonexistent, but hopefully they are managed.

Could you

174
1

speak to that, please?

2
3

WITNESS VINIAR:

I agree with that.

That is very

different from what the Chairman was--

CHAIRMAN ANGELIDES:

Well not it's not, really.

It's the same.

And maybe there wasn't clarity.

But, you

know, just to be specific, on May 11th when Craig Broderick

sent the e-mail in which he wrote that Dan Sparks and the

Mortgage Group, quote, "were in the process of considering

making significant downward adjustments to the marks on

their mortgage portfolio, especially CDOs and CDO-squareds"

and that, quote, "This would have potentially big P&L impact

on us, but also to our clients due to the marks and

associated margin calls on repo derivatives of other

products.

determining the most vulnerable clients."

You need to survey the clients to take shot at

I mean, by this time I think you guys were net

short.

hurt you more than it's going to hurt us?

conflict there.

So aren't you telling your clients, this is going to

WITNESS VINIAR:

You have a

But there's a big misconception

that we just decide to mark things and move the market.

mark based on where the market is.

market is, and that is what our marks reflect.

24
25

So we look at where the

It could have a positive or negative effect on
us.

It could have a positive or negative effect on our

175
1

clients.

But it's where the market is.

CHAIRMAN ANGELIDES:

WITNESS VINIAR:

CHAIRMAN ANGELIDES:

Right.

That’s where were trying to mark to-So here's what you

would stipulate to.

manage.

because that's where the market is.

earlier today there's a lot of latitude or judgments on

where that market is when it's illiquid.

There are conflicts of significance to

You would say that's not applicable to marking
But we have established

Will you stipulate

to that?

WITNESS VINIAR:

Yes.

CHAIRMAN ANGELIDES:

Okay.

With that, a short

succinct answer, I want to thank all the panel members for

coming here today.

instance both entities and their counsel, AIG and certainly

post-subpoena Goldman, for the information they have

provided.

I want to thank, actually in this

And I want to thank you all.

We are going to take--I know you're going to be

thrilled by this, members, but we're going to come back at

12:35 to begin our second session, which will allow us a

luxurious lunch.

We will be back here at 12:35.

(Whereupon, at 12:18 p.m., the hearing was

recessed, to reconvene at 12:35 p.m., this same day.)

24
25
26

176

177
1

AFTERNOON SESSION

(12:45 p.m.)

CHAIRMAN ANGELIDES:

The Financial Crisis Inquiry

Commission public hearing on derivatives and their role in

the financial crisis will come back into order.

We are now at our final session of a two-day

hearing, and this final session is entitled "Derivatives,

Regulators, and Supervisor."

I want to thank our witnesses for being with us

today.

all our sessions, and that is by asking all of you to please

stand and be sworn.

your right hand, I will say the oath and you will affirm.

We are going to start this panel off, as we start

If you would please stand and raise

Do you solemnly swear or affirm, under penalty of

perjury, that the testimony you are about to provide the

Commission will be the truth, the whole truth, and nothing

but the truth, to the best of your knowledge?

MR. DINALLO:

I do

MR. GENSLER:

I do.

MR. LEE:

I do.

(Witnesses duly sworn.)

CHAIRMAN ANGELIDES:

Gentlemen, thank you.

Thank you very much.
We have received your

written testimony.

And knowing this Commission, it has been

read and reviewed.

We will ask each of you to make a five-

178
1

minute opening statement, no more than five minutes.

of you, or all of you, may have testified before, so you may

be familiar with the devices in front of you.

minute, a yellow light will go on.

go on when your time is up.

Some

At one

And the red light will

So what I would like to do is, Mr. Dinallo, start

with you and we will go my left to my right and ask each of

you to make your opening statements, and then we will go to

questions from Commissioners.

10
11

And also, I should have said, please turn on your
microphone.

WITNESS DINALLO:

Thank you.

CHAIRMAN ANGELIDES:

WITNESS DINALLO:

Thank you.

Thank you, Chairman

Angelides, Vice Chairman Thomas, and the Members of the

Financial Crisis Commission for inviting me to testify.

I was the Insurance Superintendent for New York

State from January 2007 through July 2009.

professional experiences include leading numerous

investigations of Wall Street firms as a senior member of

the New York State Attorney General's office, heading

regulatory affairs at Morgan Stanley, and being a general

counsel of Willis Group.

My other

Previously I've submitted extensive written

testimony.

This testimony was prepared with the assistance

of the Insurance Department of New York State.

However, the

179
1

opinions expressed are my own.

180
1

I would like to use my oral testimony to make a

few broad points about what I believe this crisis has taught

us.

As you already know, the primary source of AIG's

problems was AIG's Financial Products Division which had

written credit default swaps, derivatives, and futures with

a notional amount of about $2.7 trillion.

8
9

The counterparties to those swaps apparently
thought that the AIG Holding Company's top credit rating

meant that they were safe, but in fact that credit rating

was based on the strength of AIG's insurance companies,

which were largely unavailable due to regulatory

requirements and protections.

Perhaps most important, AIG's Financial Products

was able to make such huge bets with its credit default

swaps with little backing up its promise to pay, thanks to

deregulation in general, and three specific points:

First was allowing financial institutions to

select their own regulator.

and loan in 1999, AIG was able to select as its primary

regulator the OTS, which at that point would have been about

1/1000th of its balance sheet.

By purchasing a small savings

Second, Gramm-Leach-Bliley abrogated Glass-

Steagall and permitted AIG to operate an effectively

unregulated hedge fund or monoline with insufficient

181
1

reserves to back up its promises.

because AIG had a top credit rating based on the strength of

its insurance companies.

company, I don't think anyone would have done the business

with it.

This was only possible

But had AIGFP been a stand-alone

Finally, there was the CFMA which specifically

exempted credit default swaps from regulation.

there were no requirements to hold capital reserves behind

the promise to pay as there are with insurance policies,

10
11

This meant

bank deposits, futures, and even regulated gambling.
This changed, in my view, 100 years of known

capital requirements and led to our Century's version of

shadow banking.

My essential thesis is that these changes

permitted AIG and FP and other institutions to sell wildly

under-capitalized pseudo-insurance and other core "financial

products" that previously had well-known capital

requirements, reserving, and net capital requirements.

I would note that at a time when financial

services' firms were in trouble because of insufficient

capital, and at a time when commercial banks and investment

banks had very serious problems, insurance operating

companies remained relatively strong.

24
25

Clearly a lesson from this crisis is that all
financial institutions should be required to hold sufficient

182
1

capital and reserves to meet their promises.

derivatives should be for hedging, largely, not

substitutions of core financial commitments.

And, that

Thus, while I am strongly in favor of innovation,

I believe it is time to recognize that not all change is

good.

excessive risks, pick their regulators, and avoid century-

old tested rules about net capital and reserves is in fact

bad.

Innovation that allows financial institutions to take

I would strongly examine the changes from the

CFMA and its synergies with the changes around Glass-

Steagall to understand what went wrong with our regulatory

system and the impact that had on the financial crisis.

Because I believe that, dating back to 1907, there is

strong learnings to be had on this.

We had learned a lot from the first two financial

crisis, '07 and the Depression, put in place I think

very good, sound capital and other regulatory requirements;

and then made serious, serious changes in 1999 and 2000 and,

within eight years, I think you can see a direct, almost

cause and effect on the impact of capital requirements, the

regulatory regime, and the eventual financial crisis.

I am here to answer any of your questions.

I am

very excited and honored to be here, and I hope I can help

you in any way possible.

Thank you very much.

183
1
2

CHAIRMAN ANGELIDES:

Thank you, Mr. Dinallo.

Mr.

Gensler?

WITNESS GENSLER:

Good afternoon, Chairman

Angelides, Vice Chairman--or should I say "Chairman Thomas"-

-and Members of this Commission:

I thank you for inviting me here to speak today.

I would also like to thank former CFTC Chair Brooksley Born

for her leadership of our Commission when she was there, but

also her leadership on derivatives and advice she has given

to the agency, and most recently that she has joined yet

another advisory panel helping the CFTC and SEC sort through

issues.

In response to your invitation, my written

testimony includes reasons why the over-the-counter

derivatives marketplace were not regulated not only here in

the United States but also in Europe and in Asia.

had this international situation where it's not regulated in

either of these markets.

We have

To quickly summarize, I think there were five

reasons articulated around the globe in the past to exempt

derivatives from regulation.

First--and I expand on this in the written

testimony--but first, there was an institutional

marketplace.

Second, the dealers were presumed to be regulated

184
1

as if they were banks, or maybe they were banks themselves.

2
3

Third, it was presumed these markets, and
articulated, that they would discipline themselves.

Fourth, the contracts were customized and

generally not susceptible, at least early in these markets,

to centralized clearing or trading.

7
8

And fifth, the old saw was:

Well, if we regulated

it here, it would go somewhere else.

I think significant growth and development in

these markets and the financial crisis starkly calls into

question each of these reasons.

In terms of our financial system and the crisis,

I do think both our financial system and the financial

regulatory system failed the American public.

are many reasons for these twin failures, and this

Commission is delving into all of those, I will just focus

on the role derivatives played in the crisis, starting with

the most specific role it played, and going to the more

general.

And I will list six.
First of course the collapse of AIG, an

ineffectively regulated derivatives dealer.

more?

Though there

Need I say

Second, the role that credit default swaps more

broadly played, particularly credit default swaps written on

asset and mortgage-backed securities.

Whether it was multi-

185
1

sector credit default swaps written by AIG or other similar

CDS written by other providers, sometimes monoline insurance

like by MBIA and Amback and so forth, these products--

basically insurance--along with weak underwriting practices

in the mortgage markets, and weak rating agency practices, I

think all worked together in terms of promoting and

facilitating, one might say amplifying, a housing bubble.

8
9

Furthermore, when the value of housing went the
other way, these credit default swaps had a calamitous

effect on the financial institutions that had written them.

The AIGs, but not just AIGs, who had written them when

housing went down.

and ultimately the Taxpayer stood behind it.

And of course they had to pay the piper

Third, the credit default swaps were also used to

lower bank regulatory capital.

Europe.

default swap book was used to help lower capital charges

elsewhere.

problems.

This was done mostly in

As you know, over 70 percent of AIG's credit

When one system failed, then others had

Fourth, I think the financial system was far to

interconnected, and it was interconnected in part because of

derivatives.

compliment you on that you put up on your website that

showed this interconnectedness.

large financial firm you had testifying here yesterday and

You had a wonderful chart that I want to

I think it was for one

186
1

today.

But that web of interconnectedness, that web really

puts everything at risk when in the future a Federal Reserve

Chair or a Treasury Secretary can't let something fail.

I think in the middle of '08 we saw that for sure.

And

Fifth, the entities themselves, the dealers

themselves in this market were not really well regulated.

Sometimes they were banks, but they were not effectively

regulated for dealers; but often they weren't banks, they

were affiliates of banks.

They were affiliates of Lehman,

and Bear, and AIG.

said, they weren't really effectively regulated.

And as the former insurance commissioner

And then sixth, the over-the-counter derivatives

market placed lax market transparency.

people will debate whether this was really anything to do

with the crisis, this lack of transparency.

lack of transparency did make the financial system more

vulnerable.

wouldn't toxic assets have been more easier to price if the

derivatives that related to them were actually transparent?

Also, clearinghouses fundamentally need reliable pricing to

price them.

Now I've heard, some

I believe the

Leave us not think of toxic assets, and

Where are we today?

The legislation reported by

the Conference Committee and voted out of the House of

Representatives yesterday this week is strong,

comprehensive, and historic, and I support that legislation

187
1

and hope it gets to the President's desk.

2
3

First, it will include strong regulation of the
dealers themselves for the first time--

4
5

CHAIRMAN ANGELIDES:

Can you wrap up pretty

quickly, Mr. Gensler?

WITNESS GENSLER:

It will have mandatory clearing and mandatory

trading, and with that I am glad to take questions.

9
10

CHAIRMAN ANGELIDES:

WITNESS LEE:

Thank you, Mr. Chairman, Mr. Vice

Chairman--

CHAIRMAN ANGELIDES:

WITNESS LEE:

15
16

You did it in less than ten.

All right, Mr. Lee?

11
12

Ten seconds.

Microphone, please.

Thank you, Mr. Chairman, Mr. Vice

Chairman, good afternoon:
I appreciate the invitation to appear here today.

I respect the important work the Commission is doing to

understand the causes of the financial and economic crisis

facing our country.

During my 17 years in public service, which ended

in May of this year, I served on Capitol Hill, including

quite a few hours in this very room.

Federal Deposit Insurance Corporation, and at the Office of

Thrift Supervision.

I served at the

I am appearing here today at your invitation and

188
1

in my capacity as a private citizen.

OTS's official view on any matters of law, policy, or

procedure.

any insights I can offer to further your inquiry and report.

My testimony is not

But I do appreciate the opportunity to provide

From early 2006 until March of 2008, I was

Managing Director at OTS for complex and international

organizations.

supervisory responsibility for AIG and other conglomerate

holding companies supervised by OTS.

During that time, my division had direct

While I was serving as Managing Director, in

early 2006 my group was asked to design a program

specifically tailored to the supervision of large complex

savings and loan holding companies.

In addition to developing the program, my group

performed examinations and targeted reviews of the

conglomerates under our purview.

examinations were performed by career examiners and

specialists who were onsite at the firms themselves.

OTS's conglomerate

While OTS's authority existed because these

entities owned federal savings banks, its examination

reports were assessments of the overall enterprises and they

were directed to the top-tier companies' board of directors.

OTS examined the firms according to the framework

provided by the OTS Holding Company Program's core

components, those being capital, organizational structure,

189
1

relationship with the thrift institution, later changed to

risk management, and earnings.

3
4

With respect to OTS's supervision of AIG, I would
like to emphasize the following points:

The risk management policies and procedures the

company put in place following the reshaping of management

in 2005--policies, to be fair, that OTS occasionally praised

in its reports--did not perform well under the stresses

brought on by the deteriorating housing market in late 2007

and through 2008.

The subprime residential real estate stresses at

AIGFP resulted from credit default swap products originated

largely in the 2003 to 2005 time period.

a key focus of our examination work from 2006 to 2008.

This portfolio was

The derivatives at AIGFP were not regulated.

point has been made here earlier.

any standardized regulatory reporting framework.

The

Nor were they subject to

This lack of transparency, as has been observed

by my colleagues here this afternoon, was an obstacle to the

effective oversight of this business by AIG.

In the 2006 to 2008 time frame, OTS reports show

increasing supervisory criticism of AIG's risk management

financial reporting and corporate governance, including

specific criticisms of the parent's oversight of the

subsidiary AIGFP, among others.

190
1

These criticisms culminated in a downgrade of the

holding company ratings, and enforcement action in the form

of a Supervisory Letter which I signed in March of 2008.

AIG failed, as has been noted earlier in these

hearings, because it could not meet obligations to

counterparties.

faulty assumptions about available liquidity from the

markets and from the firm's insurance operations.

For its liquidity planning, AIG relied on

This liquidity was either nonexistent or not

available when it was needed, and this miscalculation had

catastrophic consequences for the firm in September of 2008.

Shortly following the issuance of the Supervisory

Letter I referenced earlier, I sought and accepted a

position as a regional director with the OTS outside of

Washington, D.C., and my involvement with this case ended at

that time.

Clearly there are many lessons policymakers,

regulators, and market participants can learn from the

collapse of this company, and many of those have been

addressed in my written testimony to the Commission here

this morning.

Commission a couple of recommendations.

But I would like to underscore for the

First, regulators, when given responsibility for

supervising large firms, must have the procedures and

resources in place to fully meet these responsibilities.

191
1

sounds simple, but it is rarely that way in reality.

Finally, I would like to underscore that the

regulation of derivatives' products ought to be a key

national goal, and many of the concerns I had about this

program have been addressed in many of the provisions

contained in the Dodd-Frank legislation that is currently

pending before Congress.

8
9
10

So I will close there and welcome your questions.
Thank you.
CHAIRMAN ANGELIDES:

Thank you, Mr. Lee.

We will

now begin the questioning.

one observation before we start.

thank you for coming here at our request.

of information, we had requested that Mr. Rich, who is the

former Director of OTS, Office of Thrift Supervision, be

with us today.

issue, but were unable to serve, a subpoena because we were

informed that Mr. Rich is overseas.

least to be on the record.

But I would like to just make
And that is:

Mr. Lee,

Just as a point

We were unable to get a response.

We did

But I wanted that at

We had previously interviewed Mr. Rich, and we

will follow up with him.

But I want to thank you for

voluntarily accepting the invitation when it was issued.

WITNESS LEE:

CHAIRMAN ANGELIDES:

organization.

You're welcome, sir.

Thank you.

To be here on behalf of that

192
1

So we will now begin.

And I normally begin the

questioning, today but I am going to defer my questioning

and turn this over right now to the Vice Chairman.

VICE CHAIRMAN THOMAS:

Thank you, Mr. Chairman,

and I will take just a minute so that the Commissioners can

have most of the initial questioning.

Mr. Dinallo, thank you.

You are obviously the

center of whatever storm it was.

We have not had the

ability to quiz the State of New York and its legal

structure in dealing with it.

picture from a Washington perspective, and this is going to

be valuable.

We keep looking at the larger

Chairman Gensler, I was going to ask you if you

felt comfortable giving us some idea of what you thought

some of the causes were.

very tentative to see if you would be willing to comment on

the legislation.

And then I was going to be very,

But having spoken with you before, I really

appreciate your willingness to just come out front.

it is a very difficult job, especially sometimes when we are

talking to some of the private entities, to get an answer

that you can do anything with.

to deal with this.

24
25

Because

So we are going to be able

And, Mr. Lee, I also want to thank you.

initial question, if I were going to ask you one, which I

193
1

won't, would be what did you know and when did you know it?

But I would of rather have asked that of someone else who

was running the show and was here during that time, but we

don't have the ability to do so.

My only question to you, Chairman Gensler, would

be what were we thinking?

I mean, for someone who wasn't

involved in it, and you run down your list, and we look at

some of the changes, how come they, as is almost always the

case, seem so obvious?

But people who were in the center of

it, and you yourself again one of the practitioners,

happened to think it's a positive thing to move from the

private sector to the Government.

when you go back into the private sector, especially if it's

in the same area that you were governing within a

governmental position.

I'm a little concerned

But everyone we’ve talked to has said, we

didn't see it.

Nobody was expecting it.

your perspective, both private sector and now as Chairman of

the Commodities Futures Trading Corpora--, how come we

didn't see it?

We didn't realize it.

We didn't know.

Prices were going to go up.

WITNESS GENSLER:

Mr. Vice Chair, I think there's

two things that could be in that question about what we

didn't see.

From

One was the regulatory side, and one was this

194
1

whole the excesses building up.

VICE CHAIRMAN THOMAS:

Regulatory is always after

the fact, and you never get it as good, and you're fighting

the last war.

So to a certain extent I understand that.

Although clearly I have always argued that

transparency goes a long way in allowing everybody, market

participants and the Government, to see what's going on.

And I'm concerned about that.

the private sector folk who, 30 times the multiples?

But I'm more interested in

10
11

COMMISSIONER GEORGIOU:

Okay, so let me address

the second one, but I would be glad to address the

regulatory side, too.

On the private sector side, I think that we had

tremendous imbalances in our economic sphere.

researching many of those:

bubble that was facilitated I think in part by these credit

default swaps but not alone by that.

very weak rating agency practices.

practices.

And you are

low savings rates, this housing

I think we also had
Very weak underwriting

That housing bubble, where it seemed like

everything's just going up, when it started to turn and come

the other way, then the excess leverage in the system,

terribly high leverage in the system, both at AIG and at

numerous other financial institutions--it was not isolated

195
1

to investment banks or commercial banks, even though the 30

to 1 numbers you're talking about were investment banks--all

of a sudden everybody got cut very hard.

There was very little room for mistake.

little capital in the system.

contributed to that, for sure.

credit default swaps.

greater leverage in the system.

I think derivatives
Not just because of the

I think overall derivatives allow

VICE CHAIRMAN THOMAS:

Let me then retain my time

at this time, Mr. Chairman, and allow the other

Commissioners to comment.

CHAIRMAN ANGELIDES:

COMMISSIONER BORN:

thank you all for being here.

15
16
17

Very

We will start with Ms. Born.
Thank you very much, and

I particularly welcome one of my successors in
office, Commissioner, Chairman Gensler of the CFTC.
Regulation of the over-the-counter derivatives

market was virtually eliminated in 2000 with the enactment

of the Commodity Futures Modernization Act.

time, no federal regulator, including Mr. Gensler currently,

has regulatory authority over that market, or oversight of

that market.

And since that

Moreover, states, as Mr. Dinallo points out in

his testimony, have been prohibited from enforcing their

anti-gaming and anti-bucket shop laws with respect to

196
1
2

derivatives.
By June 2008, less than eight years after

deregulation, this market grew to more than $680 trillion in

notional amount and played, I think, a major role in

derailing our financial system and harming the economy.

The financial regulators, both state and federal,

had their hands tied in trying to control the market because

of the erroneous decision that no regulation was needed to

protect the public.

I have hope today for meaningful regulation of

this market to provide significant protection to us all if

the financial reform bill that is currently pending before

Congress becomes law.

And let me, with that, turn to Mr. Gensler.

You

said that in 2008 the financial system failed, and the

financial regulatory system failed.

said also that there have been failures with respect to the

over-the-counter derivatives market.

How did that market fail?

WITNESS GENSLER:

In your view, you have

Well I think that derivatives

which were initially meant to lower and mitigate risk, and a

really very important hedging tool for thousands of

companies and municipalities, also concentrated and

heightened risk.

AIG for sure.

They concentrated and heightened risk at

But elsewhere as well.

197
1

Secondly, beyond concentrating and heightening

that risk, there is that interconnectedness, that wonderful

graphic that this Commission has on just one entity, limits the

flexibility of the Government to let something fail.

things not only became too big to fail, but too

interconnected to fail, or to be allowed to fail.

7
8
9

And thirdly, I think specifically to the crisis-oh, there's this wonderful graphic-COMMISSIONER BORN:

And that, I might add, is

only 49 of the counterparties of Goldman Sachs, and they

have testified they have more than 10,000.

WITNESS GENSLER:

Right, so imagine if a Treasury

Secretary, or a head of the Federal Reserve, was

contemplating letting that institution fail.

have to think of those 49 others.

the first $90 billion that went into AIG, $60 billion of it

went straight through AIG to another party.

question of did they paid 100 cents on the dollar.

And then they

And as we know in AIG, of

This whole

The same thing would happen probably here,

without reform and new laws, that pressure.

heightened and concentrated risk on these financial

institutions.

Secondly, the interconnectedness.

So it

We can't

escape that without real reform, these clearinghouse reforms

that we so desperately need.

But then thirdly, the credit

198
1

default swap narrative is a very--it was an insurance

product.

institutions, not just AIG, then were going to come down

asunder.

And when the housing bubble burst, many

COMMISSIONER BORN:

Well let's look at AIG first,

because it was a colossal failure.

AIG's failure as related to its over-the-counter derivatives

trading, and most particularly the credit default swaps?

WITNESS GENSLER:

Do you see that as--

Oh, absolutely.

Though they

had many other lines of business, the concentrated risk was

in AIG Financial Products, a lightly regulated London and

Connecticut business; $2.7 trillion derivatives book; but

it was concentrated in the credit default swap business.

COMMISSIONER BORN:

You’ve said I think that we

learned in the financial crisis that the failure of one

large institution can bring others down as well, or at least

has that potential.

Do you think that AIG, if it had been allowed by

the Government to fail, would have had systemic risk

implications?

WITNESS GENSLER:

Commissioner Born, absolutely.

I think that if AIG would have failed, we would have seen a

series of other failures.

itself was as close to the brink in those critical weeks in

September of 2008, I don't think any financial institution,

I think that the financial system

199
1

even the strongest, if they were large and interconnected

like this, was really--they were all vulnerable.

COMMISSIONER BORN:

You might explain for the

Commission how these counterparty credit risks that build up

in the derivatives markets with millions of contracts would

be handled differently if there were central clearing.

you might explain how that risk is diminished.

8
9

WITNESS GENSLER:

And

Central clearing was an

innovation of the 1890s and actually came in the wheat and

corn markets.

future delivery of corn or wheat, somebody would stand in

the middle that that farmer didn't have to rely on some

jobber or money person from Chicago or New York to really

stand there on the other end.

It was so that a contract that was for the

So a clearinghouse stands as a middle man, and on

every day values the contract.

or down.

Every days he says is it up

So how it would work in this circumstance, all

those lines, all those intricate spider's web [indicating

the chart], the clearinghouse would be in the middle legally

novating the contract, taking money on a daily basis so that

if one party failed they would stand to complete the

contract.

24
25

AIG had to get tens of billions of dollars
immediately because they didn't have a clearinghouse

200
1

mechanism in between.

2
3

COMMISSIONER BORN:
posting margin--

WITNESS GENSLER:

COMMISSIONER BORN:

WITNESS GENSLER:

COMMISSIONER BORN:

Well wouldn't they have been

Yes---on a daily basis---the clearinghouse---so that there would not

have been this enormous exposure built up?

WITNESS GENSLER:

That's right.

A clearinghouse

mandates that there's daily valuation and daily posting of

margin, which is a performance bond in case one party fails.

And fortunately the new legislation includes that, and I

know the CFTC we would vigorously enforce it if it becomes

law.

COMMISSIONER BORN:

Do you feel that the

interconnectedness of derivatives' counterparties poses a

systemic risk to the financial system on an ongoing basis?

WITNESS GENSLER:

It absolutely does.

I think

that the new legislation significantly addresses that,

because--as the testimony in front of this Commission in

January a CEO from Wall Street said, 75 to 80 percent

of derivatives could be standard enough to be brought into

clearinghouses.

enhancement, and lowering of risk.

And that, would really be a significant

COMMISSIONER BORN:

Let's look a little bit now

201
1

at credit default swaps and synthetic CDOs, which are

essentially a package of credit default swaps, apart from

the impact on AIG.

You said you thought that that played a role in

the housing bubble and mortgage securitization bubble?

that right?

WITNESS GENSLER:

That's correct.

I think it

lowered some of the underwriting standards of Wall Street,

but it also amplified the risks in the system.

I mean, one

homeowner’s mortgage could actually be in numerous different

contracts and numerous credit default swaps, and it is I

think very much a part of the ride up the roller coaster and

the unfortunate calamity down the roller coaster.

COMMISSIONER BORN:

What role do you think lack

of transparency played in the financial crisis with respect

to derivatives?

WITNESS GENSLER:

I think it played a real role.

This is legitimately quite a debate, and through this

legislative process many people have taken the other side of

this debate.

system more vulnerable, lack of transparency.

But I personally think that it makes the

In the securities and futures markets, President

Roosevelt came to Congress in the '30s and asked for

regulation of those markets in part to promote transparency.

Then everybody gets to price off of that

202
1

transparency.

Derivatives is really a dealer-controlled

club, in a sense, where one party doing a transaction, a

corporation, doesn't know what another party is hedging at.

In the crisis itself, we had things called toxic

assets.

derivatives, I think those assets would have had better

pricing if they had reference in, particularly, the CDS

marketplace.

Though those weren't technically over-the-counter

COMMISSIONER BORN:

Let me just ask you a

question about the panic that occurred in September of '08

when Lehman Brothers failed, AIG then had to be rescued,

other things were happening in the markets.

and essentially there was a run on the shadow banking

system, a run on investment banks, actually a run on banks,

not through their deposits but through their shadow banking.

Do you think--

Do you think that derivatives were part of that

run?

That is, did uncertainties about counterparties'

credit worthiness cause, in derivatives, cause anxiety?

Were people trying to close out derivatives' positions, or

get collateral, or take other actions?

WITNESS GENSLER:

I think there were, though I

was a private citizen and not on Wall Street or a regulator

at the time.

I do think that you're right, there was a run

on the bank.

The old bank in the movie, George Bailey and

his bank, in that wonderful movie, the run was in money

203
1

markets, the run was in prime brokerage, the run was in

investment banking elsewhere.

The risk premium widened.

Lehman failed.

There

was still some question as to how their derivatives book would be

transferred.

rate book was in central clearing, and with 27 trades, a

group out of London, LCH Swap Clear, actually did move that

book successfully.

As it turned out, much of Lehman's interest

But there were days that people didn't know how

it would be moved.

business that didn't move as successfully.

And there was the customer side of the

COMMISSIONER BORN:

Just to wrap up on this

concentration of risk in the hands of some large

institutions--let's take the over-the-counter derivatives

dealers as really big concentrations of derivatives' risk--

do you think that makes those institutions too big to fail?

WITNESS GENSLER:

COMMISSIONER BORN:

WITNESS GENSLER:

Well-Or plays a role at least?
There are six institutions in

the U.S. that have well over 95 percent.

to 10 overseas.

22
23
24
25

There's another 6

So these 15 or 20 institutions--

COMMISSIONER BORN:

By the way, would you agree

that Goldman Sachs has a derivatives' business?
WITNESS GENSLER:

Well I left there 13 years ago,

which if I might say was a Bar Mitzvah ago, but I believe

204
1

that it does have--it's a swap dealer.

dealing desk.

COMMISSIONER BORN:

WITNESS GENSLER:

Thank you.

Just an aside.

But to your question, your

earlier question was just remind--I'm sorry?

6
7

It has a swap

COMMISSIONER BORN:

My earlier question was

whether or not interconnections--

WITNESS GENSLER:

COMMISSIONER BORN:

Yes.
--through the derivatives on

the part of the, for example the big six derivatives'

dealers, make them in effect too interconnected to fail.

WITNESS GENSLER:

I think unless we have strong

regulation to the President, and I am hopeful as you are

that we will, we will have left these institutions too

interconnected for a Government to realistically let them

fail.

be able to get into clearinghouses, move them off the books

of the banks into clearinghouses, force the daily valuation,

the daily posting of margin, and all the risk mitigation, I

think that we have a shot at this thing.

21
22

But if we can take that 75 to 80 percent that might

There's still going to be a risk.

These things

are highly concentrated financial institutions.

COMMISSIONER BORN:

Mr. Dinallo, some people have suggested that the

Thank you.

real problem at AIG related to its securities lending

205
1

program, and that its exposure to AIG Financial Products

through that company's credit default swap business was a

mere secondary problem that it had.

CHAIRMAN ANGELIDES:

COMMISSIONER BORN:

WITNESS DINALLO:

I'm sorry?

I'm given five to

answer the question?
COMMISSIONER BORN:

CHAIRMAN ANGELIDES:

No, no-That was five minutes for

the Commissioner.

COMMISSIONER BORN:

CHAIRMAN ANGELIDES:

By the way, five minutes?
Please.

Do you agree with that?

I have five minutes.
You should make your answers

as succinct and pithy as possible.

(Laughter.)

WITNESS DINALLO:

CHAIRMAN ANGELIDES:

WITNESS DINALLO:

Thank you.

I will try.

A New York minute.

I don't--no, I don't believe

that's true.

the reason that we all ended up at the Fed and working at

AIG throughout that week was the problems with the Financial

Products Division, whose issues I think dwarfed the

securities lending issues.

I mean, at least the calls that I received and

The securities lending issue was an issue, and it

certainly exacerbated the situation.

Although I will point

out that no other insurance companies had a securities

206
1

lending issue.

State law, and the New York State Insurance Department was

fairly ahead of the curve on this in helping to wind down,

or directing AIG to wind down its securities lending

business away from asset-backed securities.

And we examined them all under New York

So for a year leading up, we had wound it down by

25 percent, even though we were only about 7 percent of the

exposure as a regulator.

What I think did happen--and there was a toxic

synergy here which goes to whether you should ever permit

sort of a bolted-on derivatives business, is the

counterparties certainly seeing that there were collateral

issues at AIG then went and started to demand their

securities back.

So there was in a sense--I don't mean this in a

legal sense--but there was in a sense inside information

about the demand for the cash back on the securities lending

business, which was not seen anywhere else to anything of

the same extent.

I do think that a pooled securities lending

business is not a wise idea, on reflection, because I think

it leads to sort of regulatory assignment questions.

was pooled at the holding company level, and that meant that

several states were all somewhat responsible for it.

So it

I think that when you have operating companies,

207
1

insurance operating companies, there really ought to be just

one regulator over that operating company.

created some kind of a regulatory gap--although people

disagree about this.

was there, although there was a long lead up that I think

permitted them to go to a concentration in RMBS that I don't

think was particular wise.

and you know all the positions about that.

And this I think

Certainly we were on top of it when I

Although it was all AAA rated,

So I don't think in any way, shape, or form it

was the driver.

time, the life insurers were fully solvent and they were

certainly not the reason that there was any bailout or any

reason that we were called to help with the issues on

Financial Products Division.

In fact, when I testified in this room last

COMMISSIONER BORN:

So in a way, what may have

happened was concern that came from what was happening at

AIGFP with its credit default swaps' portfolio may have

caused a type of run on the securities lending, on the part

of the securities lending counterparties?

WITNESS DINALLO:

I think it was that, and the

general financial crisis where everyone was reaching for

cash.

COMMISSIONER BORN:

WITNESS DINALLO:

Right and wanted money-And by the way, just

parenthetically, as my written testimony says, this is the

208
1

one area where all of a sudden in some way that's a little

bit attenuated but true, that all of a sudden the holding

company could be reached into for cash into the operating

companies, because they had lifted this business into

essentially a holding company structure and you would not

otherwise permit that.

COMMISSIONER BORN:

WITNESS GENSLER:

Right.
And can I just add, it was also

the nature of the securities that AIG decided to take,

residential-backed mortgage securities.

of doubling down more on the housing market.

COMMISSIONER BORN:

WITNESS DINALLO:

So they were sort

Yes, indeed.

Let me--

Oh, there's just--another

thing?

COMMISSIONER BORN:

WITNESS DINALLO:

Sure.
I think it's very interesting

to think about statutory accounting versus mark-to-market

accounting.

and we can debate the wisdom, but it does permit you to take

a long dated risk and match it to an asset, and basically

manage yourself out of some poor decisions because you

really only have to make sure that when the person, God

forbid, passes away so to speak, dies, you have the asset to

match against that liability.

Insurance companies do statutory accounting,

There's a big debate I believe whether securities

209
1

lending should be permitted for insurance companies because

in a sense it exposes their statutory accounting to the mark

to market accounting of investment banks, which is clearly

what started to happen.

do think that there's an argument that there's a regulatory

moat around the insurance company that should not permit for

any drawbridges whatsoever, or you get exposures like with

FP and exposures like the pooled securities lending

business.

That's like for another day, but I

COMMISSIONER BORN:

Well when AIGFP did have

these tremendous collateral calls on its credit default

swaps and got to the point where it wasn't able to meet its

obligations, the Federal Reserve Bank of New York stepped in

and the Federal Government then stepped in more generally,

and has made commitments of over $180 billion to it, do you

think that that was necessary in order to save--in order to

prevent systemic harm?

WITNESS DINALLO:

Well I agree with the

Chairman's views that I thought it was necessary.

there, and people seemed genuinely concerned, and shocked,

and believing that, you know, there was some chance that

commercial paper at major institutions was not going to roll

over.

ATMs might kind of grind to a halt that week.

I was

These were sophisticated thinkers and speakers.

I think that it was necessary, because also I

That

210
1

thought that the possibility that the American public, or the

world would somehow start to have doubt in insurance

products, which of course was not the reason for the crisis

and didn't have anything really to do with AIG's issues,

would be one step too far and you would end up having

potentially runs on insurance companies, which you could

argue doesn't actually happen, but people stop buying it and

you essentially have a long-term run.

So I thought it was very, very important.

What I

always wished could have happened was--and I don't now

whether this could have been done in an emergency way, and

maybe this is the kind of thing that should be put in a

statute--is I would have liked to have seen the U.S.

Government just substitute its guarantee in rating for FP's

obligations, instead of actually just pouring in the cash.

Because essentially that would have taken off a lot of the

issues, and I think that it wouldn't have looked quite like

a bailout, and there would have been essentially the same

outcome to a large extent.

Now I don't think TARP, or whatever it was called

then, permitted that but maybe they could have gotten some

kind of emergency measure.

lot because that essentially was the issue, this belief

whether they were going to be able to pay.

I'm sure you've heard before from yesterday, et cetera, that

I think that would have helped a

Because, right,

211
1

really it was a liquidity problem not a risk problem in that

the actual vintages of the CDOs weren't, you know, the most

modern ones.

So with the right long-term guarantees, you might

have--and you will see it worked down to a number that's not

nearly $200 billion.

7
8

COMMISSIONER BORN:

CHAIRMAN ANGELIDES:
on my Chairman duties.

11
12

Thank you.

My time is

up.

9
10

Yes.

I apologize for falling down

Mr. Vice Chairman?

VICE CHAIRMAN THOMAS:

That's okay, because you

recognized me.

(Laughter.)

VICE CHAIRMAN THOMAS:

Mr. Wallison, I want you

to join in on this for just a minute.

multiple chart up again.

We've got this

Chairman Gensler, I want you to expand on your

comment.

Because we've heard opposing views, that

derivatives helped to inflate the housing bubble.

is where you have an example where, through synthetic and

partially synthetic CDOs, you can multiply the number

without having to multiply the actual mortgage packages.

And I believe Commissioner Wallison says that

And this

that's not necessarily a bad thing because they would have

just gotten worse if they had to go out and multiply them.

212
1

Is that accurate?

COMMISSIONER WALLISON:

Yes.

The argument is

that there was demand for exposure to subprime mortgages in

the United States, demand around the world.

satisfied by making more subprime mortgages in the United

States, or it could be satisfied through synthetic CDOs

which replicated the potential risks and rewards such as

they might have been in subprime mortgages.

Now it could be

So the argument is that, by allowing synthetic

CDOs it made it possible for this demand for that exposure

to be satisfied without actually having to make the

mortgages.

that?

That's the argument.

VICE CHAIRMAN THOMAS:

Do you want to respond to

Well I want to add an

option, or an elaboration and get your reaction to it,

because arguably CDOs were dependent on CDS to exist.

so as more CDOs over time had a synthetic component, maybe

you needed the synthetics to keep the cash market going.

WITNESS GENSLER:

And

I think that the--you're

calling them synthetic, or derivatives in this marketplace,

and the cash had an interplay.

future and the actual oil can have an interplay.

was saying earlier, and would firmly believe, is that credit

default swaps allowed for the mortgage underwriting practice

to be lowered, the actual due diligence and everything.

Just as in the oil market, a
But what I

213
1

Somebody else was the gate keeper.

Somebody else

was bearing the risk.

a lot of investors were investing in collateralized debt

obligations because there was what we used to call when I

was earlier in the financial industry, called "bond wraps."

They were done by insurance companies, not by derivatives

people.

8
9

AIG, or MBIA, or somebody else.

And

Those bond wraps and CDS usually meant that
investors would invest more.

So it's in that way that I

think it in 2004 to 2007 contributed.

of the housing bubble at all, but I think it helped

contribute during those critical years.

COMMISSIONER WALLISON:

It was not the only cause

Well we're talking I

think about two different things here, Mr. Vice Chairman, if

I can continue--

VICE CHAIRMAN THOMAS:

COMMISSIONER WALLISON:

about two different things.

WITNESS GENSLER:

COMMISSIONER WALLISON:

Go ahead.
I think we're talking

We may be.
A synthetic CDO doesn't

have anything to do with an actual loan.

the risks associated with a CDO that includes the actual

loans.

24
25

It just replicates

So I mean it doesn't add--it doesn't make those
original CDOs that include actual loans any more or less

214
1
2

risky.
Now you could buy a CDS on an actual CDO with

real mortgages in it, and that might respond to the point

you are making.

had insurance of all kinds of risks over time, and to say

that insurance makes people more willing to take risk is

well know, but the insurer, as Mr. Dinallo will tell you,

has to understand the risks that the insurer is taking on.

I would add, though, that of course we've

But let's just go back to the issue of the

synthetic CDO.

synthetic CDO and it allows you to take the same exposure,

then the subprime mortgages don't actually have to be made.

My point was simply that when you have a

VICE CHAIRMAN THOMAS:

And the purpose of my

intervention--and then we'll get back to the regular round--

was that I wanted you to amplify on the statement that you

said that derivatives helped to inflate the housing bubble.

And then at some point, if it seems appropriate,

if you could mention the rating agencies and their

involvement in direction and substance of how it inflated,

in your opinion.

21
22
23

WITNESS GENSLER:
was helpful.

I think Commissioner Wallison

It is two, though related, separate points.

My overall point was not about synthetic CDOs,

even though I know that's a much debated topic.

just around the credit derivatives.

Mine was

And somewhat because of

215
1

their newness.

11, 12 years ago.

other forms of insurance, are a very new product, very

ineffectively regulated insurer, so to speak, AIG Financial

Products, and others.

otherwise, you know, good judgment on underwriting factors

of this.

They didn't really exist to any extent 10,
But in this period of time, contrasted to

So I think that they did replace

And synthetic collateralized debt obligations,

and just general collateralized debt obligations have very

similar features in many regards, and to that I share your

view.

12
13

VICE CHAIRMAN THOMAS:

And then just on rating

agencies, AAA, AA--

14
15

Those are separate points, though related.

WITNESS GENSLER:

Oh, Rating Agencies I think that, although

it's

outside the lane I swim in, I'm supposed to swim in the

derivatives lane. I Think--

18
19
20

VICE CHAIRMAN THOMAS:

I understand you've been in the

pool a long time.
WITNESS GENSLER:

Yes, but I think that the

rating agencies contributed, and the weaknesses in the

rating agencies particularly related to asset securitization

product, whether that was because of conflicts of interest,

whether that was other reasons, I'm sure you'll investigate,

but I think they definitely contributed.

credit default swaps, poor underwriting standards, the

Rating agencies,

216
1

housing bubble, you know, it was a little bit of a cycle,

then it became a bigger cycle, it peaked, and those Case-

Shiller numbers, and then collapsed.

4
5

VICE CHAIRMAN THOMAS:

sometimes comes close to being in the same lane.

6
7

Insurance and assurance

CHAIRMAN ANGELIDES:

Right.

Thank you, Mr.

Chairman--

VICE CHAIRMAN THOMAS:

CHAIRMAN ANGELIDES:

Vice Chairman.
Mr. Vice Chairman.

Boy, it

has been a long journey.

I am going to take a few minutes

now before we move on to Mr. Wallison and Mr. Hennessey--

VICE CHAIRMAN THOMAS:

CHAIRMAN ANGELIDES:

Hennessey is first.
Oh, Hennessey is first.

keep looking right.

for a minute right now.

Dinallo, I want to ask you a couple of questions.

And actually just take some of my time
And I want to actually ask--Mr.

You made an interesting observation that AIG's

ability to sell credit default swaps was based on the AAA

rating of the holding company, which was based on the

insurance subsidiaries whose assets were not available to

backstop the activities of AIGFP.

So how on earth did that rating essentially get

ascribed to instruments being written by an entity not

backed by the assets that gave rise to the AAA?

failure of the rating agency to make the distinction?

Is that a
Or is

217
1

that a complete failure of the people buying the product to

understand what assets were available?

WITNESS DINALLO:

I think that it is both.

It is

I think the most profound miss I have seen out of this, that

I would have some--

6
7

CHAIRMAN ANGELIDES:
one.

8
9

That's a pretty darn big

WITNESS DINALLO:

It's pretty profound.

And I

think it is extremely important--and I don't mean to

disagree with Chairman Gensler, but there is one incore

distinction you have to make.

The difference between MBA and Amback, say, and

the difference between FP is a really important distinction.

I just want to take a minute and explain this, because I

think it explains so much of what went on.

In the early '80s, the assurance--

VICE CHAIRMAN THOMAS:

Excuse me.

Mr. Dinallo,

if you're going to explain it, there are actually people

watching who have no idea what those letters—

WITNESS DINALLO:

VICE CHAIRMAN THOMAS:

Okay.
you just rattled off

represent.

WITNESS DINALLO:

So these are--okay, thank you.

VICE CHAIRMAN THOMAS:

WITNESS DINALLO:

What we're talking about are financial guarantee

Thank you.

Thank you, Vice Chair.

218
1

companies, companies that take their capital, their rating,

and they guarantee the obligations of others, whether it's

219
1

an issuer of bonds, or eventually structured CDOs.

And when we started to see this happen in the

Department of Law--I mean, in the Department of Insurance,

it was early on that AIG back in the early '80s, and

Citigroup, and others, started to do this.

quote, "monetize" their rating.

They started to,

And the Department demanded that these be set

alone and called monolines.

business.

And they could only do this one

They had to be standing alone.

They had no

access to the guarantee funds, to Government bailout.

they were highly regulated with very high capital

requirements and a low return on equity.

to be leverage businesses.

And

They weren't going

And the belief was that if they went, you didn't

want them to take down the Government through the guarantee

funds, or an otherwise stable insurer.

sound familiar?

Is this starting to

Okay.

There's a good argument that I told your staff

that what AIG did, and the CEOs there and the executives,

was they figured out after the CFMA that they could

basically bolt on a severely under-capitalized monoline, get

the AAA rating of the holding company, and sell guarantee

insurance without the capital set-aside that it would have

otherwise required under New York State insurance law.

That is why I believe it was so profitable for so

220
1

many years, because it was doing a business that otherwise

you would call on Wall Street "dumb money."

they could get huge returns because they could sell

insurance, as Chairman Gensler said, without the same

capital set-aside.

6
7

That's like a miracle.
you make tons of money.

8
9
10

When you get to do that,

You pay, eventually.

So I do think that essentially the rating
agencies and the counterparties missed this.

And they

believed that in the trillion dollar balance sheet of AIG--

11
12

But instead,

CHAIRMAN ANGELIDES:

Somewhere, somehow, there

would be money.

WITNESS DINALLO:

Like it would in a monoline.

There's tons of money in a monoline, and it comes up to meet

the obligations.

CHAIRMAN ANGELIDES:

So the AAA rating was

accorded to the holding company?

specifically with respect to backing these instruments?

WITNESS DINALLO:

Or was it also accorded

I think it's a little

confusing.

I'm not perfectly knowledgeable.

Each operating

company does have its own rating for insurance purposes, and

I don't know.

was guaranteed by the holding company, which is essentially

them saying we have a double, or a triple A rating and we're

basically monetizing that through FP.

I presume that FP--my understanding was FP

221
1

CHAIRMAN ANGELIDES:

pure portability of the funds.

those cases of if it's too good to be true, it's probably

too good to be true.

WITNESS DINALLO:

But you really didn't have
All right, this is one of

And the other--well, also add

onto it that normally when you have a monoline, you don't do

collateral in events of default and margins to the

counterparty.

9
10

CHAIRMAN ANGELIDES:
real default.

WITNESS DINALLO:

CHAIRMAN ANGELIDES:

It's only in the event of

Correct.
Correct.

All right, now,

Mr. Thomas, you wanted to ask something?

VICE CHAIRMAN THOMAS:

Yeah, I want to try to jump

from, Mr. Dinallo, what you were saying to the fact that OTS

is at the table as a regulator and dealt with AIG as a

regulator, only because of an acquisition, and that their

ability to regulate would be nowhere near what you would

think the degree of regulation would be, given what they

were doing in AIGFP.

Can you just flesh that out a little bit?

And

obviously, Mr. Lee, we will want to bring you in on this,

because I think that's the other thing that you need to talk

about.

Your explanation was terrific.
WITNESS DINALLO:

I think--I just want to add that.

So,

222
1

so after Bearings--my understanding is, after Bearings went

down, there was a series of regulatory requirements that

each company doing business in London would have to show who

its supervisor was and roll up all of risk.

of the Basel II requirements.

This was part

And so then in order to do business in London,

you had to demonstrate this.

Now the FSA would accept other

regulators than itself.

others had to go out and get a group supervisor.

So all of the investment banks and
And AIG's,

I would have thought, would have been one of the insurance

supervisors, or maybe someone else, but they did acquire

this very small thrift, 1/1000ths of its balance sheet, in I

think '99 or 2000, and thereby, by a trick of regulatory

arbitrage, arguably, was able to designate the OTS as its

holding company supervisor.

That was permitted.

In fact, when I was at

Morgan Stanley, I came after the fact.

argument that Morgan Stanley could have done the same

because it owned Discover and some small banks in Utah.

They chose the SEC.

There was an

So that is I think one of the other lessons, is

there ought to be some common sensical nondiscretionary

choices about who you're regulator is.

dating.

sort of stuck with.

It should not be

It should be a married relationship that you're

223
1

And I think that that has led to lots of switches

in charters in federal and state banking situations where,

if one regulator is too tough, they just flip over to the

other regulator.

unbelievable that we permit it.

That should just be prohibited.

CHAIRMAN ANGELIDES:

It's

All right, just picking up

very quickly, and then I actually want to pick up on what

the Vice Chair was querying about OTS, but I want to finish

with you quickly, and then I want to swing to you, Mr. Lee.

And that is, that in 2007-08, based on interviews

with our staff, it appears that the State Insurance

regulators did begin to address security lending challenges

they saw at AIG.

you mentioned in the interviews, and it is in the materials

given to us, that you essentially had control over 7 percent

of the assets, and the investments were being run out of a

holding company which you really said was a matter of

regulatory arbitrage in another respect, correct?

But one of the things that struck me was,

WITNESS DINALLO:

Well, there's a--

CHAIRMAN ANGELIDES:

Could you have stopped that?

Could you have said, pull these back to the insurance

subsidiaries?

WITNESS DINALLO:

Yes.

I don't know--I don't

know if New York standing alone could have, but I guess

each--

224
1

CHAIRMAN ANGELIDES:

WITNESS DINALLO:

CHAIRMAN ANGELIDES:

You could have said--

--I guess historically-You could have said to the

insurance subsidiary--

WITNESS DINALLO:

Yes.

CHAIRMAN ANGELIDES:

--we're not going to allow

AIG investments to invest your assets.

WITNESS DINALLO:

CHAIRMAN ANGELIDES:

Yes.
So in a sense the state

insurance regulators, looking back on this, should have done

that?

WITNESS DINALLO:

Let me make--I think it's a

Full text of Financial Crisis Inquiry Commission : Documents Relating to the Financial Crisis of 2007-2009 : Official Transcript : Hearing on "The Role of Derivatives in the Financial Crisis.", Thursday, July 1, 2010, Dirksen Senate Office Building, Washington, D.C.

FRASER