Holman Jenkins' Rare Mistake

I finally got around to reading Holman Jenkins' interview with Goldman Sachs CEO Lloyd Blankfein in the weekend edition of the Wall Street Journal. The colleague who urged me to read it was correct- it's primarly a public relations piece by Blankfein to try to smooth over the bank's image prior to news that it will be again paying stratospheric bonuses after being rescued by the Fed and Treasury last fall.

Of course, now, Blankfein will have none of that, as conveyed in the interview. Note, for example, these passages,

"Then there's the matter of AIG, source of snarling recriminations even among Goldman's Wall Street brethren. If AIG, a huge player in all kinds of markets, had gone down, the impact on the economy would have been incalculable. Mr. Paulson and Fed Chief Ben Bernanke wouldn't risk it. They reversed course after Lehman and bailed out the insurance giant to a tune that now has reached $180 billion. To this day, charges fly that the AIG bailout was a backdoor bailout of Goldman.

AIG had been a big issuer of guarantees on subprime-backed paper; Goldman had been a big buyer of those guarantees. Nonetheless, when government officials rang up to ask what would be the potential impact of an AIG bankruptcy on Goldman, Mr. Blankfein says his answer was: "negligible." He did not, he says, ask Washington to save AIG: "It never occurred to me, having lived through Lehman Brothers weekend, that there was government money for anything. People wanted to know how we were going to do when AIG went down. I was telling them we were fine."

Mr. Blankfein points to what he calls a fundamental aspect of Goldman culture—its risk-management discipline. AIG had been regarded on Wall Street as a gold-plated client, not just a "Street" counterparty. But Goldman had nonetheless taken the usual step of requiring AIG to post collateral nightly against any deterioration in the market value of the guaranteed assets.

Mr. Blankfein placed some of the phone calls himself. "AIG was being beastly, difficult to deal with, not responding well to our calls for collateral. And I called them up and fought with them, and it was always because they were disagreeing with our 'marks.' They never said, and I never had reason to suspect, 'We're illiquid. We don't have the money.' It never occurred to me."

Goldman, in its rigor, reinsured any shortfall with other counterparties, who were also required to post collateral nightly. "We had one day of exposure with them. It doesn't mean I can't lose $300 million if they don't pay because that's how much a market can move in a day, but basically I'm not worried about it."

These estimates, of course, have a theoretical element. The underlying assets would certainly have collapsed even further in value if Wall Street firms and AIG began dropping like nine-pins. We'll never know. In the event, AIG was rescued—though that now meant that taxpayer money, in a sense, was being shipped to Goldman to meet AIG's collateral obligations.

Some say today the government should have spurned Goldman's collateral demands. Some say it should even have forced Goldman to settle the outstanding positions at a discount.

Realistically, though, AIG faced hundreds of counterparties; and short of bankruptcy, which Washington had ruled out for AIG, no obvious formula presented itself for rewriting thousands of AIG contracts without risking the market panic Washington was trying to forestall. For its part, Goldman would have been on thin ice with its own shareholders if it had voluntarily relinquished valuable contract rights to make nice with Washington."

There's just one problem with that last paragraph. Mr. Jenkins is wrong.

In an article that appeared in the Wall Street Journal within a few months of the financial sector meltdown of last fall, one astute observer noted that there was, in fact, an existing process by which AIG's numerous counterparties could have been fairly and equally treated.

That option, of course, was bankruptcy. And it's rather curious to me that Jenkins glosses over this with a simple "Washington had ruled (that) out for AIG."

As that editorial writer noted several months ago in the Journal, putting AIG's swaps through bankruptcy, quickly, would have resulted in all counterparties taking a known, equal percentage haircut on the value of their positions. This is no different than learning that the value of your swap declined for some market reason. Swaps gain, and lose value all the time.

The source really is somewhat immaterial.

I'm surprised Jenkins gave Blankfein, Goldman and Washington all passes on this rather monumental corruption of capitalism.

AIG's takeover by the federal government is precisely the sort of unnecessary appropriation of private property, followed by draconian, confusing Congressional and administration rules impositions, that begs for more use of bankruptcy and less entanglement of Washington with private enterprise.