What Did They Know and When Did They Know It?

It has always seemed unlikely to me that the financial sector and government regulators had no idea that credit default swaps being sold by AIG on mortgage debt were inadequately backed. Now comes news from Floyd Norris of the New York Times that not only was this known, but that Goldman Sachs and Merril Lynch among others was insuring themselves against an AIG default. As Norris describes it,

At least two banks — Goldman Sachs and Merrill Lynch — had purchased protection against an A.I.G. default. It is possible that others had as well, but the inspector general did not ask.

Goldman, the report states, had spent more than $100 million to buy $1.2 billion in protection against an A.I.G. default. That enabled Goldman to argue that it really did not stand to lose if A.I.G. went under.

Merrill said it had spent $40 million in such fees, but the report does not say how much protection Merrill had purchased.

AIG of course was also insuring Canadian mortgages in competition with CMHC, and it was no doubt many of these mortgages that the Harper government purchased on such generous terms over the past year. Surely if the banking sector on Wall Street knew of AIG's shortcomings, so to did Bay Street and hence given their close relationship, the Harper government.