From Rolling Stone magazine:
. . . Goldman used two methods to hide the mess they were selling. First, they bundled hundreds of different mortgages into instruments called Collateralized Debt Obligations. Then they sold investors on the idea that, because a bunch of those mortgages would turn out to be OK, there was no reason to worry so much about the lovely ones: The CDO, as a whole, was sound. Thus, junk-rated mortgages were turned into AAA-rated investments. Second, to hedge its own bets, Goldman got companies like AIG to provide insurance – known as credit-default swaps – on the CDOs. The swaps were essentially a racetrack bet between AIG and Goldman: Goldman is betting the ex-cons will default, AIG is betting they won’t. . . .
Which brings us to this November 2007 internal memo from AIG. It was obtained by CBS News in the States, and details collateral calls on AIG’s CDS portfolio.
As finance blog Economics of Contempt handily points out, a striking feature of the document is just how aggressively certain banks were pricing the reference CDOs. That was a problem for protection-seller AIG, which would have had to start posting more collateral the lower the reference prices were quoted.
The most aggressive quoter of them all?
One Goldman Sachs.
Related links:
Point counter point: AIG, Goldman and the NYT – FT Alphaville
The AIG fiasco or how not to manage your CDO exposure – A Credit Trader