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Commentary

Readings: Goldman/AIG, Obama’s Sellout, Dubai and China

WSJ: Goldman Fuelled AIG Gambles

Goldman Sachs Group Inc. played a bigger role than has been publicly disclosed in fueling the mortgage bets that nearly felled American Insurance Group Inc.

Goldman was one of 16 banks paid off when the U.S. government last year spent billions closing out soured trades that AIG made with the financial firms.

Goldman originated or bought protection from AIG on about $33 billion of the $80 billion of U.S. mortgage assets that AIG insured during the housing boom. That is roughly twice as much as Société Générale and Merrill Lynch, the banks with the biggest exposure to AIG after Goldman, according an analysis of ratings-firm reports and an internal AIG document that details several financial firms’ roles in the transactions.

In Goldman’s biggest deal, it acted as a middleman between AIG and banks, taking on the risk of as much as $14 billion of mortgage-related investments. Then Goldman insured that risk with one trading partner—AIG, according to the Journal’s analysis and people familiar with the trades.

The trades yielded Goldman less than $50 million in profits, which were mostly booked from 2004 to 2006, according to a person familiar with the matter. But they piled risks onto AIG’s books, which later came to haunt the insurer and Goldman. The trades also gave Goldman a unique window into AIG’s exposure to losses on securities linked to mortgages.

When the federal government bailed out the insurer, Goldman avoided losses on its trades with AIG covering a total of $22 billion in assets.

Interestingly, the problem here isn’t what Goldman did, but that it got the bailout inspite of what it did (they got paid in full for their “insurance” when AIG was bailed out, effectively bailing out Goldman). The outrage is just not there yet, but it feels like it should be if you read Matt Taibbi on Obama’s Big Sellout:

What’s taken place in the year since Obama won the presidency has turned out to be one of the most dramatic political about-faces in our history. Elected in the midst of a crushing economic crisis brought on by a decade of orgiastic deregulation and unchecked greed, Obama had a clear mandate to rein in Wall Street and remake the entire structure of the American economy. What he did instead was ship even his most marginally progressive campaign advisers off to various bureaucratic Siberias, while packing the key economic positions in his White House with the very people who caused the crisis in the first place. This new team of bubble-fattened ex-bankers and laissez-faire intellectuals then proceeded to sell us all out, instituting a massive, trickle-up bailout and systematically gutting regulatory reform from the inside.

How could Obama let this happen? Is he just a rookie in the political big leagues, hoodwinked by Beltway old-timers? Or is the vacillating, ineffectual servant of banking interests we’ve been seeing on TV this fall who Obama really is?

Whatever the president’s real motives are, the extensive series of loophole-rich financial “reforms” that the Democrats are currently pushing may ultimately do more harm than good. In fact, some parts of the new reforms border on insanity, threatening to vastly amplify Wall Street’s political power by institutionalizing the taxpayer’s role as a welfare provider for the financial-services industry. At one point in the debate, Obama’s top economic advisers demanded the power to award future bailouts without even going to Congress for approval — and without providing taxpayers a single dime in equity on the deals.

The piece is outrageously blunt, and Taibbi is seriously outraged. Most of this might sound ordinary to us in India, where politics and business are designed to go hand in hand; we would hardly be surprised to know that a Satyam’s Raju had political connections and used them well, or that the Government has always bailed out anything that it wants with no respect for the taxpayer. Still, a phenomenal read to see how rotten systems all over the world are.

FT: Why Dubai’s debacle does matter:

Dubai’s ambitions weren’t merely domestic. Dubai World and its subsidiaries, with their assumed government backing, went on a debt-fuelled global buying binge. Dubai’s economy expanded rapidly in the boom. But much of this growth came from construction projects of dubious economic merit. When the music stopped, property prices crashed. Knight Frank estimates the vacancy rate for Dubai office buildings is 40 per cent. Yet planned new construction is set to double the city’s office space over the next couple of years.

There is a country on the other side of Asia, whose currency is also pegged to the dollar. Although its economy is expanding rapidly, short-term interest rates are below 2 per cent and the money supply has grown by 30 per cent over the past year.

This country is experiencing a real estate boom. Reports tell of a newly constructed ghost city with dwellings for a million people. Speculators are reportedly snapping up luxury developments, which remain unoccupied long after completion. Despite a 20 per cent vacancy rate in the capital city, new skyscrapers are being planned.

This country’s economy is also state-directed. Its rulers are looking for 8 per cent annual GDP growth as they seek to diversify their economy away from exports. State-owned enterprises are borrowing and investing to meet this target. Construction and infrastructure are taking an ever greater share of GDP, even though many projects are likely to prove unremunerative. A mentality of “build and they will come” prevails.

In short, economic conditions in China have much in common with those that prevailed until recently in Dubai. The population of China is roughly a thousand times greater than the tiny emirate’s. For this reason alone, the lessons from Dubai should be heeded.

China will probably take some time to blow up, especially in real estate. India has had it’s smallest real estate downturn ever, making builders go nuts about building tiny little apartments costing upwards of a crore. A 4000 sq. ft. house in San Diego lists for 800K (4 cr.) with no takers, and they’re trying to sell a 4750 villa in the outer edge of gurgaon for 3.2 crore (Vipul Tatvam Villas – bad road leading up, delayed two years from the Feb 08 completion, and all stuff like parking etc. will be extra. I know only because this place is right behind where I live). The amount of overbuilding in commercial real estate is mind-boggling (in the metro cities); but it seems the markets can remain irrational longer than I can survive! So till then, what problem? Music playing, must dance.

  • DK says:

    >Well.. I guess it is a tough time for rational people these days. They (we?) seem like those people who keep crying about the second coming and the End of the world

    But I think the great real estate bull run is about to begin. Quite a bit of r2i (return to india activity) happening. With a strengthening dollar, expect nice asset bubbles.

  • Anonymous says:

    >Here in UK, I read everywhere that all that growth is happening in emerging market. All the investment advisers are advising to invest in China or East (HK,Singapore) or India and companied having business in this region like HSBC, Standard Charter as next big thing.

    Seems bubble is building up.

    Milind

  • Deepak Shenoy says:

    >Very interesting – yes bubble is surely building up.

    But I'd question the asset bubble when the dollar is strengthening – if that is so,money's moving to the US, no?

  • Px says:

    >Deepak ,
    people are not that suave to move to the us. Politics is deeply entwined with the builder lobby, and will do anything for the music to play on!
    Plus when interest rates are so low and inflation is brisk, and the banks are pushing loans this is bound to happen