This past week Goldman Sachs ended up paying a big “fine” while admitting no guilt for being involved in the sub-prime meltdown. My read is that basically it is a rebate to the government for bailing out AIG and thus allowing AIG to pay Goldman for the terrible underpricing of insurance contracts (subprime mortage puts) AIG wrote and Goldman sold at a big markup to smart investors who figured out a way to profit from the meltdown in the housing industry.
An analogy: Someone comes to Goldman and asks them to make a new sneaker for the market. Goldman says they can make it, but what they really do is design it and outsource the manufacturing. AIG, not realizing what they are doing, is the lowest price bidder by far and sells manufacturing to Goldman for way below cost, thereby losing money on each sneaker. So Goldman makes lots of money reselling the sneakers and other brokers go to AIG to make similar sneakers and AIG makes sneakers for them, too. However, AIG has outstanding contracts and the losses on the uncompleted sneaker orders are so bad they can’t sell off other good assets fast enough to cover the losses. The Federal Reserve, realizing the crisis and trying to do their job of protecting the banking system, is left with two bad choices. They can either lend AIG money to finish the outstanding orders and hopefully have AIG pay them off as they liquidate the company or have many people end up barefoot. So they lend them the money. The smart investors win, Goldman and the other brokers win, AIG loses, and we still don’t know if the Fed has a loss. The government says to Goldman (and they may also say the same thing to some of the other brokers and banks), we helped you out by helping AIG so now we think it is only fair for you to rebate some of your profit. Goldman, realizing they may have earned $2 billion from this business and may want to have a good relationship with the Feds in the future, gives $550 million to the feds.
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