For four years, Gillian Tett has been warning of the dangers of credit default swaps (CDSs) in the Financial Times, where she works as a journalist and assistant editor. For most of those years, she was accused of scaremongering. As recently as the 2007 World Economic Forum, economists denounced her article on the risks being taken by Northern Rock (NRK) and underwritten by Lehman Brothers (LEHMQ). In March 2009, she was awarded the British Press Award for Journalist of the Year. In her new book, “Fools Gold: How Unrestrained Greed Corrupted A Dream, Shattered Global Markets And Unleashed A Catastrophe,” she shows her readers, step by step, the research which allowed her markets team to accurately predict the banking crisis.
By taking a social anthropologist’s view of the foreign exchange markets, Tett went first to the 1990s collapse of Japan’s banking system, which she covered in her first book, “Saving the Sun.” From there, she stepped fully into the “vast, murky debt world,” beginning with a mid 1990s meeting on a private Florida beach, where a young, innovative group of JP Morgan (JPM) bankers pioneered credit derivatives.
The purpose for creating credit derivatives was to better manage loan portfolio risks with a lower capital-debt ratio. This would have the effect of magnifying the bank’s profits through increased leverage. What the “Morgan Mafia” did not anticipate was that if enough debt was not repaid, it would also magnify the bank’s losses to the same extent.
In the meantime, other banks caught the fever. Interested in reducing their own reserve requirements, they quickly followed the JP Morgan lead. Regulators and bankers alike were enthralled by this new innovation. When the 1933 Glass-Steagall Act which separated commercial from investment banking was repealed in 1999, new doors opened. By the time the JP Morgan team dispersed, their original concept of credit derivatives had shifted from reduction of risk into outright speculation, morphing into hedge funds and other highly leveraged investments which increased risk rather than better managing it.
Through the next decade, the market for collateralised debt obligations and other credit derivatives grew until it reached an estimated $12 quadrillion (British $12,000bn), a staggering amount of which had been shifted from relatively safe corporate loans to extremely risky areas such as subprime mortgages. Although all the risk had been repackaged into CDSs and other similar vehicles, none of it had left the financial system. Instead, it just kept growing, waiting for the inevitable moment when the risky debts upon which all this had been built would start to default.
By 2004, the ratio of required debt to capital in American banks had been reduced from 12:1 to 40:1. At the same time, the number of financial regulators on Wall Street had also been reduced, to seven.
Today, JP Morgan is the recipient of $25 billion worth of TARP funds, the fifth largest amount relating to residential mortgages. Tett’s book faithfully tracks every step of that path, bringing across challenging financial terminology in a page-turner that reads like a cross between investigative reporting and thriller. So familiar is Gillian Tett with her intricate subject matter that she is able to describe it in a simple, accessible manner which most readers will appreciate.