To understand the calamity on Wall Street, we need erudite financial analysis and good old-fashioned stories about human fallibility. Gillian Tett, who oversees global market coverage for The Financial Times, offers some of each. In “Fool’s Gold,” she describes how a small group of bankers at storied J. P. Morgan built a monster that got out of control and helped destroy much of their industry. Tett’s tale doesn’t explain all of the recent mayhem, but it is one place to start.
FOOL’S GOLD
How the Bold Dream of a Small Tribe at J. P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe
By Gillian Tett
293 pp. Free Press. $26
Paul M. Barrett on the Book Review Podcast (mp3) She shows us the financial world through the eyes of her talented but short-sighted subjects: geniuses at math and marketing, they thought they had discovered how to defy the laws of nature. The old rules didn’t apply.
Beginning in the mid-1990s, the wizards at Morgan decided they could defeat the banker’s oldest foe — the danger that borrowers will not repay their loans. If that sounds as audacious as bringing the dead to life, it’s not far off. The Morgan team thought they could combine esoteric financial instruments so cleverly that repayment risk would simply disappear, or at least become so diluted as no longer to matter. Relieved of risk, banks would lend more money, corporations would grow more quickly and capitalism would blossom.
Accomplishing this “bold dream,” as Tett puts it, required arduous toil in the financial laboratory — accompanied, at times, by after-hours antics of “Animal House” proportions. The author excels at recreating this fevered environment. She also deciphers Wall Street mumbo-jumbo in terms that a lay reader, or at least a determined lay reader, can understand.
The Morgan bankers assembled innovative amalgams of what are known as credit derivatives. In its simplest form, a credit derivative is a contract between two parties in which the seller agrees to compensate the buyer if a loan goes into default. Used conservatively, a derivative can provide a hedge against risk. Bank A, worried about a loan it has made, strikes a derivative deal to pay a fee to Bank B in exchange for Bank B’s promise to compensate Bank A if the loan sours. Bank A sheds some of the uncertainty related to its loan and feels emboldened to make fresh loans. Bank B assumes some of the risk but immediately enjoys the fee income. It’s “win-win,” as the Morgan bankers told themselves and anyone else who would listen.
They went on to combine the derivatives with a process called securitization, which traditionally involved lenders selling their loans to an investment bank. The investment bank “bundled” the loans together and sold pieces of the bundle to pension funds and other investors. The original lenders, having offloaded their loans, could make new ones. The investors acquired a slice of the loan bundle and its interest income without having to go to the trouble of meeting and assessing the borrowers. Win-win, again.
The Morgan group broke new ground by securitizing not just loans but credit derivatives. They industrialized the procedure, selling securitized debt and derivatives on an extraordinary scale. It got very, very complicated.
The intricacy itself appealed to the Morgan bankers, as did the magical idea of dispersing risk to investors far and wide so that lenders could lend without hesitation. The author introduces characters like the evocatively named Blythe Masters, a pretty blond British woman with a “BBC accent,” an economics degree from Cambridge and fervor for credit derivatives. “I think these products appealed to me because I had a quantitative background,” Masters told Tett, “but they are also so creative.”
Masters became the alluring public face for Morgan’s derivative “products,” marketing them to clients impressed by the concept that risk could vanish. Channeling Masters, Tett writes: “For the first time in history, banks would be able to make loans without carrying all, or perhaps even any, of the risk involved themselves. That would, in turn, free up banks to make more loans, as they wouldn’t need to take losses if those loans defaulted.” By now, you must be seeing the too-good-to-be-true aspect to all this.
Morgan exercised some restraint in imbibing the derivatives potion it peddled to others. That’s one reason that, years later, it is one of the survivors on Wall Street, although as part of J. P. Morgan Chase. Less prudent were Bear Stearns, Lehman Brothers, Merrill Lynch and American International Group.
Tett explains that Morgan’s rivals took the reckless, and in some cases fatal, step of adding subprime mortgage loans to the derivatives-and-securitization mix. That’s an important distinction. When the real estate bubble burst in 2006 and 2007, derivatives and securities tied to subprime mortgages suddenly lost value. It turned out that Wall Street’s computer models simply hadn’t anticipated a national housing crash. The supposedly benign dispersal of risk was revealed for what it really was: a global plague that spread dangerous risk to nearly all major financial institutions. Lenders that had spewed loans with abandon abruptly froze up, refusing to do business even with trusted corporate customers. Investors panicked; stock markets crashed.
Tett’s close focus on Morgan illustrates how the hubris of a relative handful of little-known financiers contributed to the worldwide crisis. But the author’s contention that the “bold dream” conjured up at Morgan was “corrupted” by others may absolve Masters and her comrades too neatly. First, Tett strangely plays down how lavishly Morgan paid its derivatives clique to pursue their bold dream. Surely fat bonuses helped obscure the dangers.
The Morganites sold the notion that financial gravity had been overcome—that risk had been vanquished and that lending could proliferate endlessly. That some would take this to absurd extremes seems entirely foreseeable. The retrospective shock that Tett’s subjects express in interviews rings hollow, especially when we learn that some of them, although not Blythe Masters, left Morgan and personally imported derivatives know-how to institutions that behaved more rashly.
Morgan’s culpability doesn’t end there, either. Tett notes that Morgan provided key manpower and initiative in a ferocious Wall Street lobbying campaign that persuaded Congress, the Securities and Exchange Commission, and the Clinton and Bush administrations to back off from regulating derivatives trading in any meaningful way. Industry advocates received vital backing from the high priest of free market ideology, Alan Greenspan, then the chairman of the Federal Reserve.
The argument that persuaded Washington to allow manic derivatives trading to go unchecked boiled down to the myth that financiers had a powerful self-interest in keeping one another honest. Wrong. As Tett reports, Greenspan went before Congress last October to admit that “he had made a ‘mistake’ in believing that banks would do what was necessary to protect their shareholders and institutions. ‘[That was] a flaw in the model . . . that defines how the world works,’ ” Greenspan confessed belatedly.
Based on Tett’s account, most former members of the Morgan derivatives squad haven’t acknowledged similar regret. That’s ominous, because while many on Wall Street have lost their jobs, a lot of the Morgan alumni are still out there, as are many of their competitors who displayed even greater irresponsibility during the derivatives madness. This book leaves one wondering whether we’ll be smart enough to rein them in with tougher regulations before they open their next bag of tricks.
Paul M. Barrett is an assistant managing editor of BusinessWeek.
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LONG BEACH - The principal of Tincher Preparatory had never seen a student achieve perfect attendance throughout an academic career.
Now he has.
And to hardworking eighth-grader Bradley Matheus, the feat is no big deal.
"My dad hates people who are always late to things," the 13-year-old said. "That mentality kind of rubbed off on me. I'm pretty punctual."
According to Matheus, that means he's on time for his many extracurricular activities such as Boy Scouts, fencing and helping to set up the school's carnival.
He's even known to voluntarily feed the Long Beach school's pet fish and clean the aquarium tanks.
"He's just been a delightful student to have," said William Vogel, the school's principal. "His parents have done a wonderful job with him."
When asked if he was ever close to missing a day, Matheus recalled just two instances: once when he was in first grade and another this past spring break.
"I just don't get sick that often," he said. "I got lucky, I guess."
When he's not studying, Matheus watches programs on the Discovery and Sci-Fi channels. He also builds robots that draw and go through mazes, and air cannons that shoot tennis balls, water balloons and potatoes.
"He's one of those kids that doesn't let anything get in his way," said Vogel, a 19-year education veteran, describing Matheus. "He has a very scientific and mathematical mind."
Eventually the straight-A
"He's very interested in (robotics), and that's why he's so excited to be going to CAMS (California Academy of Math and Science) next year and joining their robotics team," said Jamie Matheus, his mother and a kindergarten teacher for Tincher Preparatory.
CAMS, located on the campus of Cal State Dominguez Hills, is a highly competitive high school that admits just 167 freshmen per year. It also has a major robotics program.
"Ever since he was in third grade he read an article about CAMS and decided that was the school for him," said Jamie Matheus about her son. "So he's really worked hard to get in."
Vogel said he believes Matheus' academic success can partly be attributed to never missing a day of school.
"I think if kids came to school all the time a lot of the kids who do have difficulty at school would be doing so much better," he said.
brian.cuaron@presstelegram.com, 562-499-1288
Brisbane has welcomed more than 500 new Australian citizens who helped launch Queensland Week celebrations on Saturday morning.
Friends and family packed out South Bank's Suncorp Piazza as the state's newest citizens made a pledge of commitment to their newly-adopted state and nation.
Brisbane Lord Mayor Campbell Newman told ABC Radio it was cause for a double celebration.
"I think it's particularly special for people that they're not only becoming Australian citizens but they're doing it on Queensland's special day.
"(They are) joining a great state and a fantastic city and I think that's something to be particularly excited about."
Saturday is Queensland Day, which commemorates Queen Victoria's signing of Letters Patent separating Queensland from the colony of New South Wales 150 years ago in 1859.
This year's Queensland Week celebrations over the Queen's Birthday weekend include the state's biggest variety show and a free barbecue.
The variety show, featuring 2,500 state school students, will be held on Saturday night at the Brisbane Entertainment Centre while on Sunday, thousands are expected to pack out the Queensland Week Big BBQ at Roma Street Parklands.
Sunday's celebrations will also feature performances from Dora the Explorer, inflatable mazes, face painting, balloon artists, displays and workshops from 10.30am (AEST) to 3.30pm (AEST).
Also part of the Q150 program will be a free night of comedy at the Suncorp Piazza on Sunday night from 7.30pm (AEST).
Comedy Fix will bring together comedians, including lyrical trio Tripod, Charlie Pickering and Queensland's own The Kransky Sisters, for a night of stand-up and satire.
The 2009 Suncorp Queenslanders of the Year will be announced on June 9 followed by the 2009 Queensland Greats Awards two days later.
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