Fool’s Gold – Gillian Tett – 2009.

Gillian Tett: assistant editor of the Financial Times. Book subtitled: “How unrestrained greed corrupted a dream, shattered global markets, and unleashed a catastrophe”. Respectable reviewers have called it:

• “A blistering narrative expose” (IoS)
• “An absorbing 15-year gallop across the Wild West of the financial markets” (Indy)
• “Her blow-by-blow story is an impressive piece of detective work. She pulls back the curtain on a closed, unaccountable world of finance” (Will Hutton, Guardian)

Her book starts in 1994, and gives a chronological account of what happened in America in the different banks which were key players in the creation of the obscure ‘derivatives’ at the bottom of the sub-prime mortgage scandal. It reads like a history book, and is meticulously referenced. Although she says there were many factors behind the financial crisis, including poor regulation and lax credit ratings, she considers the key was the proliferation of credit derivative contracts.

She asks: “Why did the bankers, regulators, and ratings agencies collaborate to build and run a system that was doomed to self-destruct?” And explores the answer by starting with the story of a small group of bankers working for JP Morgan in the 1990’s. They developed innovative products, all called ‘derivatives’ – eg ‘credit default swaps’, ‘synthetic collateralised debt obligations’. In her opinion:

“The story of the great credit boom and bust is not a saga that can be neatly blamed on a few greedy or evil individuals. It tells how an entire financial system went wrong, as a result of flawed incentives within banks and investment funds, as well as the ratings agencies; warped regulatory structures; and a lack of oversight.”

She does name a few key players, who also appear in other books (Peter Hancock, Bill Withers, Bill Demchack, Jamie Dimon, Greg Lippman, etc), and describes their relationships. However, her book is more event than personality driven.

The original idea of derivatives was that they were designed to control & disperse loan risk at the bank; this was why they were attractive. Unfortunately, they could also be used to magnify risk (p.249) – to concentrate & conceal it. This latter quality came to dominate, and eventually contributed to worldwide financial catastrophe.

• Derivatives are complex – properly understood only by a few – slicing & dicing

• Banks could only use them, to their own ends, if they were loosely regulated

• Banks therefore lobbied to ensure weak regulation & supportive ratings agencies

• Ratings agencies (paid by banks) didn’t understand them either …. So banks got away with it

• Remaining anxiety of regulators satisfied when banks laid off remaining risk with the important insurance company AIG (too cheaply, as it turned out) - a decision which ultimately lead to AIG’s downfall

• Banks started to use derivatives with mortgages ….. then (into the new century) subprime mortgages …. but miscalculated the inherent risk.

• Popularity spread to Europe – esp German banks; Northern Rock

• Underlying all - an intellectual belief in efficiency & superiority of free markets

Highlights:

1. p.147 – (2005) - “The big dirty secret of the securitisation world was that there was such a frenetic appetite for more and more subprime loans to repackage into CDOs that the supply of loans had started to lag behind demand. Mortgage derivatives were an easy substitute, since there was no constraint on how many of those that could be created.”
2. p.158 – (late 2005) – AIG refused insurance – so banks kept the risk on their books
3. p.218 – (2007) – Mervyn King (BoE Governor) warned bankers that it was foolish to assume all triple-A assets were safe; mortgage companies in trouble
4. p.228 – (2007) – Companies start to fail ….. Northern Rock in trouble
5. p.297 – Alan Greenspan (former Fed chairman) admits (2008) that he’d been wrong. Had historically “vehemently championed unfettered free-market competition, and the argument that markets were not merely efficient, but self-correcting. Now says that he had made a ‘mistake’ in believing that banks would do what was necessary to protect their shareholders and institutions.”
6. p.306/7 – Afterword to Paperback Edition (Dec 2009) – How do policy-makers deal with a system so heavily dominated by banks deemed ‘too big, and too interconnected to fail’? ‘During the second half of the twentieth century, American and British policy makers and financiers had taken it for granted that their economy was based on capitalist principles ….. core tenet of free market competition. ….Though Wall Street and the City had repeatedly preached the gospel of creative destruction to other parts of the economy …. policy makers and bankers were unwilling, or unable, to apply this principle to the banks.

I like this book, because it’s meticulously researched, and has an Index, Glossary & Notes. But I didn’t find it an easy read.