Financial Institution Management (global Crisis 2008)

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- Gaining profiting on downturn in U.S. Market

$700 billion on purpose of fund rescuing financial and $20 billion in fresh aid provided by US government to investment. This funding reduced the trouble of investment bank from those losses when investment bank purchased Merill Lynch. Goldman Sachs enlarged it's exposure in the subprime market till the end of 2006 while selling their mortgage position, sometimes even at a loss and then using a large amount of their company's own money to get the advantage from a crash. (Gillian.T, 2009). Goldman Sachs recorded a profit when they bet against the housing market in just one day while other banks are recording losses. (Stephanie.K, 2010). By doing this, Goldman earned $50 million a day.

CDO named Timberwolf (valued $1 billion) sold by Goldman was then incurring 80% lost which led to the collapsing of investment bank. Not only this, Goldman sachs has sold products packaged by their own with themselves as the only party betting them, which was under the case of “Hudson Mezzanine 2006-1” with the $2 billon CDO.

“Goldman Sachs turned initially was the US housing crisis into a lush financial crisis” explained by Joe Nocera. (Joe.N, 2010). Publics started to become risky borrowers to make bad loans with the investment banks which lead to the housing bubble deflation 2007. Investors were allowed by Goldman Sachs to bet on loans that already been made. With this, government bailouts of banks and near-collapse of global financial system were contributed. )

Total compensation by Goldman is $53.2 Billion. Special inspector, Neil Barofsky has investigated on whether the securities that are sold by Goldman where the cause that led to the losses at AIG and if Victim of fraud were the American taxpayers. In 2008, $85 billion (conclusively 180 billion) paid by government from rescuing AIG from bankruptcy. (Reuters, 2010).

- Exposing foreign institutions to subprime risk

Offshore tax havens were used by Goldman Sachs to sell RMSB in all over the world mainly in European and Asian banks. In 2006, student loan, commercial and residential were backed by high-grade bonds. This ratings and Goldman’s descriptions were overblown by their real quality. During September 2006 when this bonds offered, one of billions of dollars were “valued” of such deals. A bond analyst which was analysing the 2006 Cayman deal dismissed the fact that clients is a form of not so intelligently disguised way for Goldman and Sachs & co to get rid of its useless exposures to the subprime real estate market onto external investors. (Greg.G, 2009)

As the conclusion, structured finance products were driven by investment banks which provides a steady current of financing for lenders with high chances of risk, loans with poor quality and that enlarged risk throughout the US financial system. the primary cause of financial crisis are the investment banks that engineered, traded, sold and gaining profit from mortgage related structured finance product.

3.0 SECURITY INSURANCE COMPANY

AIG sold financial derivative namely credit default swap (CDS), it offered buyers insurance protection against a possible default by a company.

- An effect of the rapid growth in mortgage bubble

Under regulatory capital requirement, CDS was highly demand from banks as kind of regulatory arbitrage. By purchasing CDS, banks have the ability to free up money, leading them to sell more mortgage-related securities for profit maximization (HoumanShadab, 2009). Banks with highly risky projects and low levels of capital caused them become highly vulnerable to increases in mortgage defaults because CDS only provides a false illusion of safety (TanjuYorulmazer, 2012).

The rapid growth in CDS, together with the securitization of subprime mortgages caused systemic risk to be spread throughout the economy in a complex and non-transparent transaction. This created financial exposure of different institutions associated with the risk of contagion. Not only that, AIG was rated at AAA at that time, which means the ratings agencies believed the probability of defaulting was nearly zero. This further made the securities much easier to market.As a result, CDS stimulated the sales of CDO significantly, making it even more popular with global investors and strengthening the illusion that their investments is exceedingly secure and they will be covered by the insurance policies if they fail (Gilani, 2008).

- Speculation on the failure of company

Moreover, AIG permitted other investor to buy CDS on CDOs that they don’t have an insurable interest on. In others word, if the CDO investment default, the investors who paid the insurance (may not be an actual owner of CDO) would collect the full value of that CDO. It helped exhange bond trading into a highly leveraged, high-speed business (Davidson, 2008). In effect, as CDS are tradable instruments, some investors bought CDS as a bet against the failure of the CDOs. Such self-validating speculation makes CDS become toxic (Soros, 2009). For example, John Paulson, as one of the investors, he made $12B betting against mortgage securities (Wall Street Economists, n.d).

- Failure of risk management & lack of capital reserve

AIG failed to assess the risks of MBS, CDOs and other mortgage market exposures caused it bailout. AIG’s internal credit-risk models predicted that the possibility of defaulting in CDO is extremely low. Even if the default of CDO occurs, they will only require to payout an insignificant amount (Gethard, 2008). Therefore, AIG reinvested the collateral cash in subprime mortgage backedsecurities with long maturity dates. In fact, the credit risk model which AIG relied on did not take the downgrade of AIG’s credit rating and the sharp decline in the mortgage market into account. When housing bubble burst, AIG found that it was unable to sell the subprime mortgage it invested in, creating maturity mismatches. It then caused a bailout up to $85 billion to AIG as it’s unable to payout a huge amount of demanding repayment of CDO (ISDA, 2009). At the end, the failure of AIG has threaded the entire global economy (Npr, 2008).

- Relationship with Goldman Sachs

Goldman Sachs was speculated on it’s own promoting subprime mortgages, betting on housing bubble’s collapsing. Goldman Sachs helped to structure credit default contracts with AIG on MBS which enabled them to generate profit from the decline in these