Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed...
Transcript of Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed...
FoolsGold
GILLIANTETT
HachetteDigital
wwwlittlebrowncouk
TableofContents
TitlePageCopyrightPageDedicationPrefacePARTONE-Innovation
CHAPTERONE-TheDerivativesDreamCHAPTERTWO-DancingAroundtheRegulatorsCHAPTERTHREE-TheDreamTeamCHAPTERFOUR-TheCuffsComeOffCHAPTERFIVE-MergerManiaPARTTWO-Perversion
CHAPTERSIX-InnovationUnleashedCHAPTERSEVEN-MrDimonTakesChargeCHAPTEREIGHT-RiskyBusinessCHAPTERNINE-LeveragingLunacyCHAPTERTEN-TremorsPARTTHREE-Disaster
CHAPTERELEVEN-FirstFailures
CHAPTERTWELVE-PanicTakesHoldCHAPTERTHIRTEEN-BankRunCHAPTERFOURTEEN-BearBlowsUpCHAPTERFIFTEEN-FreefallEpilogueNotesGlossaryAcknowledgementsIndex
FoolsGold
GILLIANTETT
HachetteDigital
wwwlittlebrowncouk
PublishedbyHachetteDigital2009
CopyrightcopyGillianTett2009
Allrightsreserved
Nopartofthispublicationmaybereproducedstoredinaretrievalsystemortransmittedinanyformorbyanymeanswithoutthepriorpermissioninwritingofthepublishernorbeotherwisecirculatedinanyformofbindingorcoverotherthanthatinwhichitispublishedandwithoutasimilarconditionincludingthis
conditionbeingimposedonthesubsequentpurchaser
ACIPcataloguerecordforthisbookisavailablefromtheBritishLibrary
eISBN9780748112210
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HachetteDigitalAnimprintof
LittleBrownBookGroup100VictoriaEmbankment
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ForAnalieseandHelenMarie
PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely
greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare
Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness
Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment
fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives
OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion
First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters
Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
TableofContents
TitlePageCopyrightPageDedicationPrefacePARTONE-Innovation
CHAPTERONE-TheDerivativesDreamCHAPTERTWO-DancingAroundtheRegulatorsCHAPTERTHREE-TheDreamTeamCHAPTERFOUR-TheCuffsComeOffCHAPTERFIVE-MergerManiaPARTTWO-Perversion
CHAPTERSIX-InnovationUnleashedCHAPTERSEVEN-MrDimonTakesChargeCHAPTEREIGHT-RiskyBusinessCHAPTERNINE-LeveragingLunacyCHAPTERTEN-TremorsPARTTHREE-Disaster
CHAPTERELEVEN-FirstFailures
CHAPTERTWELVE-PanicTakesHoldCHAPTERTHIRTEEN-BankRunCHAPTERFOURTEEN-BearBlowsUpCHAPTERFIFTEEN-FreefallEpilogueNotesGlossaryAcknowledgementsIndex
FoolsGold
GILLIANTETT
HachetteDigital
wwwlittlebrowncouk
PublishedbyHachetteDigital2009
CopyrightcopyGillianTett2009
Allrightsreserved
Nopartofthispublicationmaybereproducedstoredinaretrievalsystemortransmittedinanyformorbyanymeanswithoutthepriorpermissioninwritingofthepublishernorbeotherwisecirculatedinanyformofbindingorcoverotherthanthatinwhichitispublishedandwithoutasimilarconditionincludingthis
conditionbeingimposedonthesubsequentpurchaser
ACIPcataloguerecordforthisbookisavailablefromtheBritishLibrary
eISBN9780748112210
ThisebookproducedbyJOUVEFRANCE
HachetteDigitalAnimprintof
LittleBrownBookGroup100VictoriaEmbankment
LondonEC4Y0DY
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ForAnalieseandHelenMarie
PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely
greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare
Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness
Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment
fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives
OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion
First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters
Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
CHAPTERTWELVE-PanicTakesHoldCHAPTERTHIRTEEN-BankRunCHAPTERFOURTEEN-BearBlowsUpCHAPTERFIFTEEN-FreefallEpilogueNotesGlossaryAcknowledgementsIndex
FoolsGold
GILLIANTETT
HachetteDigital
wwwlittlebrowncouk
PublishedbyHachetteDigital2009
CopyrightcopyGillianTett2009
Allrightsreserved
Nopartofthispublicationmaybereproducedstoredinaretrievalsystemortransmittedinanyformorbyanymeanswithoutthepriorpermissioninwritingofthepublishernorbeotherwisecirculatedinanyformofbindingorcoverotherthanthatinwhichitispublishedandwithoutasimilarconditionincludingthis
conditionbeingimposedonthesubsequentpurchaser
ACIPcataloguerecordforthisbookisavailablefromtheBritishLibrary
eISBN9780748112210
ThisebookproducedbyJOUVEFRANCE
HachetteDigitalAnimprintof
LittleBrownBookGroup100VictoriaEmbankment
LondonEC4Y0DY
AnHachetteLivreUKCompany
ForAnalieseandHelenMarie
PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely
greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare
Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness
Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment
fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives
OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion
First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters
Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
FoolsGold
GILLIANTETT
HachetteDigital
wwwlittlebrowncouk
PublishedbyHachetteDigital2009
CopyrightcopyGillianTett2009
Allrightsreserved
Nopartofthispublicationmaybereproducedstoredinaretrievalsystemortransmittedinanyformorbyanymeanswithoutthepriorpermissioninwritingofthepublishernorbeotherwisecirculatedinanyformofbindingorcoverotherthanthatinwhichitispublishedandwithoutasimilarconditionincludingthis
conditionbeingimposedonthesubsequentpurchaser
ACIPcataloguerecordforthisbookisavailablefromtheBritishLibrary
eISBN9780748112210
ThisebookproducedbyJOUVEFRANCE
HachetteDigitalAnimprintof
LittleBrownBookGroup100VictoriaEmbankment
LondonEC4Y0DY
AnHachetteLivreUKCompany
ForAnalieseandHelenMarie
PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely
greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare
Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness
Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment
fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives
OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion
First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters
Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
PublishedbyHachetteDigital2009
CopyrightcopyGillianTett2009
Allrightsreserved
Nopartofthispublicationmaybereproducedstoredinaretrievalsystemortransmittedinanyformorbyanymeanswithoutthepriorpermissioninwritingofthepublishernorbeotherwisecirculatedinanyformofbindingorcoverotherthanthatinwhichitispublishedandwithoutasimilarconditionincludingthis
conditionbeingimposedonthesubsequentpurchaser
ACIPcataloguerecordforthisbookisavailablefromtheBritishLibrary
eISBN9780748112210
ThisebookproducedbyJOUVEFRANCE
HachetteDigitalAnimprintof
LittleBrownBookGroup100VictoriaEmbankment
LondonEC4Y0DY
AnHachetteLivreUKCompany
ForAnalieseandHelenMarie
PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely
greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare
Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness
Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment
fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives
OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion
First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters
Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
ForAnalieseandHelenMarie
PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely
greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare
Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness
Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment
fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives
OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion
First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters
Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
PrefaceWere the bankers mad Blind Evil Or were they simply grotesquely
greedy To be sure there have been plenty of booms and busts in historyMarketcrashesarealmostasoldastheinventionofmoneyitselfButthelatestandongoingcrisisstandsoutduetoitssheersizeeconomistsestimatethattotallosses could end up being $2000 billion to $4000 billion a sum that is notdissimilartothevalueofBritishgrossdomesticproductMorestartlingstillthisdisaster was self-inflicted Unlike many banking crises this one was nottriggeredbyawarawidespreadrecessionoranyexternaleconomicshockThefinancialsystemcollapsedinonitselfseeminglyoutoftheblueasfarasmanyobserverswereconcernedAsconsumerspoliticianspunditsandnottheleastfinanciers contemplate thewreckage the questionwemust drill into isWhyWhydidthebankersregulatorsandratingsagenciescollaboratetobuildandrunasystemthatwasdoomedtoself-destructDidtheyfailtoseetheflawsordidtheyfailtocare
Thisbookexplorestheanswertothecentralquestionofhowthecatastrophehappenedbybeginningwiththetaleofasmallgroupofbankersformerlylinkedto JP Morgan the iconic century-old pillar of banking In the 1990s theydeveloped an innovative set of products with names such as lsquocredit defaultswapsrsquo and lsquosynthetic collateralized debt obligationsrsquo (of which more later)which fall under the rubric of credit derivativesTheMorgan teamrsquos conceptswere diffused and mutated all around the global economy and collided withseparateinnovationsinmortgagefinanceThatplayedacriticalroleinboththegreat credit bubble and its subsequent terrible burstingThe JPMorgan teamwere not the true inventors of credit derivatives But the story of how theparticular breed they perfected was taken into far riskier terrain by the widerbankingworldoffersasharpperspectiveon thecrisisEquallyrevealing is thelittle-known taleofwhat the JPMorganbankers (and later JPMorganChase)didnotdowhentheirideaswerecorruptedintoawidermarketmadness
Thestoryof thegreat creditboomandbust isnota saga that canbeneatlyblamed on a few greedy or evil individuals It tells how an entire financialsystemwentwrongasaresultofflawedincentiveswithinbanksandinvestment
fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives
OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion
First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters
Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
fundsaswellastheratingsagencieswarpedregulatorystructuresandalackofoversightItisatalebestunderstoodthroughtheobservationofhumanfoiblesasmuchasthrougheconomicorfinancialanalysisAndwhileplentyofgreedybankersplaycrucialpartsinthedrama-andperhapsafewmadorevilonestoo- the real tragedyof thisstory is thatsomanyof thosesweptup in the lunacywerenotactingoutofdeliberatelybadmotives
OnthecontraryinthecaseoftheJPMorganteamwhoformthebackboneofthistalethebitterironyisthattheyfirstdevelopedtheirderivativesideasinthehopesthattheywouldbegoodforthefinancialsystem(aswellofcourseasfortheirbankandtheirbonuses)Eventodayafterallthedevastationsomeofthe tools and innovations developedduring the credit boom shouldbe seen aspotentiallyvaluablefortwenty-first-centuryfinanceInordertounderstandhowthatcouldbethoughadeepunderstandingofhowandpreciselywhytheycametobesoabusedisvitalIofferthisjourneythroughthestoryasoneattempttobegintocometogripswiththeanswerstothatcrucialquestion
First a brief note of explanation ofwhy I chose to focus on the JPMorganteam My own path into this story started in the spring of 2005 in a plushdarkenedconferenceroominNiceAcoupleofweeksearlierIhadtakenupthepostofcapitalmarketseditoroftheFinancialTimesandsoIhadflowndowntotheFrenchRivieratotakepart inaconferencetodiscussthecreditderivativesworldBacktheninthegloriouslynaivedaysofthefinancialboomtheissueofcredit derivatives was something that most journalists (and their readers)considered rather obscure and dull Indeed I had often viewed it that waymyselfUnlikemostothernewspapers theFThadalways strived tocover theworkings of the vast debt and derivatives market however these topics hadtraditionally commanded less attention and status than the high-profileglamorousissuessuchascorporatefinancemainstreameconomics-orthestockmarket Sectors such as equities or corporate activity have traditionally beeneasier for journalists to cover since they are less opaque and include visiblecharacters
Howeverinlate2004whenIwasworkingontheLexanalysiscolumnoftheFT I realized that something highly significant was under way in the vastmurkydebtworldInitiallyIwasunsurequitewhat thestorywasbutIcouldsensethatsomethingwasbubblingSowhenachancearrivedtorunthecapitalmarkets team I grabbed it and headed to Nice to get an introduction to thisnewfangledworld(AsIwouldlaterdiscoverbankingconferencestendtooccur
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
in places such as Boca Raton Barcelona the French Riviera or other smartholiday resorts rather than cities like Hull or Detroit) Walking into thatgatheringforthefirsttimewasadisconcertingexperienceThehallwasfullofyoungmenandwomendeckedoutinthesmart-casualwearthatistheunofficialconferenceuniformfor theCityorWallStreetchinosshirts loafersmatchedwith chunky expensive watches (for men) or equally expensive but discreetearrings(forwomen)Referencestobillions-oreventrillions-ofdollarswerecasually tossed into conversation Yet much of the time the bankers avoideddirectreferencestoanymentionofwhatcompaniesorconsumersmightdowiththe money such as building factories or buying food instead finance waspresentedasanabstractmathematicalgame that tookplace incyberspaceandwhichcouldonlybegraspedbyatinyeliteFinancewasnotaboutgrubbycashbut a string of mathematical equations Greek letters or phrases such aslsquoGaussian copularsquo lsquostandard deviationrsquo lsquoattachment pointrsquo lsquodelta hedgingrsquo orlsquofirst-to-defaultbasketrsquo
Iwasutterlybaffled Ihaddoneplentyofmathsat schoolbutnothinghadequippedmeforthisButasIsatinthedarkenedconferenceroomIalsohadasense of deacutejagrave vu Over a decade earlier before I had started working as afinancialjournalistIhaddoneaPhDinsocialanthropologythebranchofthesocial sciences devoted to studyinghuman culture fromamicro-level holisticperspective based on on-the-ground fieldwork Back then I had used mytraining to make sense of wedding rituals and ethnic conflict in Tajikistan amountainouscentralAsianregionHoweverasIlookedaroundmeinthatNiceconference hall in the spring of 2005 the same approach I had once used todecodeTajikweddings seemed useful in the credit derivatives tribe tooAs arank outsider I understood little of what was being discussed howeverconferencesseemedtofillasimilarstructuralfunctionasweddingceremoniesBotheventsallowedanotherwisedisparatetribeofplayerstounitemingleandforge all manner of fresh alliances on the margins of the main event Theyrestated and thus reinforced the dominant ideology - or cognitivemap - thatunitedthegrouptransferringitfromgenerationtogenerationThePowerPointsthe bankers presented on topics such as the CDO waterfall did not merelyconvey complex technical data they also reinforced unspoken sharedassumptionsabouthowfinanceworkedincludingtheideathatitwasperfectlyvalid todiscussmoney inabstractmathematicalultra-complex termswithoutanyreferencetotangiblehumanbeings
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
The participants in theNice banking conferencewere barely aware of suchlsquofunctionsrsquoandtheyhadlittleincentivetoreflectontheiractivityorexplainittooutsidersBusinesswasboomingThatvalidatedtheircognitivemapInanycasealmostnobodyoutside theirworldhadevershownmuchinterest inwhattheydidIwasthefirstreporterfromamainstreamnewspaperthathadbotheredtoattendthatparticularconferencetoothermainstreamreporterseventhoseinthebusinesssphereCDOsseemedfartoogeekyatopictoarouseinterest
Uneasily I looked around the hall trying to get a compass to help menavigate who were they key players How could I interpret this strangelanguage lsquoWho are those people up on the stagersquo I whispered to a chino-wearingmansittingnexttomeinthedarkhallOnthestageapanelofyoungfinanciers were earnestly debating the prescribed topic lsquoDo investors trulyunderstandCDOdefaultriskrsquo(Theansweritappearedwaslsquonotalwaysrsquo)Myneighbour lookednervoushewhispered thathisbankbannedemployees fromtalkingtojournalistslsquosinceyouguyskeepwritingallthatshitaboutderivativesblowing up the worldrsquo But then he relented lsquoThey used to all work at JPMorganrsquo
lsquoJPMorganrsquoIaskedsurprisedIntheearlypartofthetwenty-firstcenturyit was Goldman Sachs and its powerful alumni network that seemed todominate the world of finance inspiring envy from rivals JP Morgan bycontrastseemedratherdullbycomparisonsowhywasitsopresentnow
lsquoItrsquoslikethisMorganmafiathingTheysortofcreatedthecreditderivativesmarketrsquomy neighbourwhispered and then he shut up abruptly as if he hadgivenawaysomekindofstatesecret
I never saw that particular financier again thus never discovered if he had apersonallinktothatMorganmafiaYetmycuriositywaspiquedInthemonthsthat followed I set out on an intensive mission to try to make sense of thisstrangeunfamiliarcreditworldAlongthewayIalsotriedtountanglewhyJPMorganhadplayedsuchakeyrole in thisnewfangledsphereWhenIfirstsetout on this journey I had absolutely no idea of themomentous eventswhichwould eventually shatter this credit world By chance I had seen a banking
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
system implode once before inmy career since Iworked in Japan in the late1990s However when I wrote about that disaster I never imagined for amomentImightseethatpatternunfoldagaininWesternfinancefarlessintheCDOsphereWhatdrewmetothecreditworldwasjustajournalistrsquoshunchthatabigstorywasbubblingwhichseemedwidelyignored
Lateraround2006IbecameseriouslyalarmedbywhatIsawandstartedtowarnthatareckoningloomedThenlaterstillwhenthefinancialsystemstartedto collapse I realized that the tale of the creditworld in general and the JPMorgan group in particular offers some good insights intowhatwentwrongThatisnotletmestressbecausetheJPMorgangrouppersonallyengagedinthe abuses that eventually destroyed some banks They did notNorwere theMorgan mafia the only players that created the market for complex financialproductsNumerousotherbankerswereinvolvedinthisprocesstooTowriteabookwhich iscomprehensible Ihavebeen forced to streamline thestoryYetthe strange journey that the Morgan group have travelled over the last twodecadesdoesprovideinsightsintowhythefinancialsystemspunoutofcontrolandwhyasetofideaswhichonceseemedlsquogoodrsquoturnedsoterriblylsquobadrsquoItisatragicsalutarytalenotjustforbankersbutforallofus
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
PARTONE
Innovation
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
PARTTWO
Perversion
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
PARTTHREE
Disaster
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
Epilogue
On29January2009JPMorganChasehostedacocktailpartyfortwohundred
ofitskeyclientsandcontactsintheelegantsurroundingsofthePianoBarinthesmart Swiss ski resort of Davos The occasion was the much buzzed-aboutannualgatheringoftheWorldEconomicForumwhichforthefirstsevenyearsof the decade had been dominated by the investment banking elite GoldmanSachsBarclaysLehmanBrothersandothersthrewlavishdinnersforfavouredguestsandbankexecutivesstruttedontheconferenceroomstagesextollingthevirtues of free markets globalization and financial innovation Sleek blacklimousineswhisked them betweenmeetings at hotels in close proximity theyweretoograndtotrudgethroughtheslushThisyearafunerealmoodhunginthecrispmountainairAlmostnobanking
CEOs attended John Thain the former CEO of Merrill Lynch had beenscheduled tohostabreakfastbuthad justbeensackedBobDiamondheadofBarclays Capital cancelled his dinner appearance at short notice LloydBlankfein head of Goldman Sachs stayed away as a demonstration of cost-cuttingAs theAmericanandEuropeanpublic realized the scaleof thebanksrsquowoesoverthewinterandthelevelofgovernment-readtaxpayer-moneybeingusedtopropthemupoutragehadescalatedThenumberswerestaggeringBythewinterof2009economistsestimatedthatmark-to-marketlosseshadalmostreached $3 trillionBanks and insurance companies had alreadywritten downmorethat$1trillionandreceivedmorethan$300billionofgovernmentfundsThebalancesheetoftheBankofEnglandwasexplodinginsize-likethatoftheFederalReserve-asitscrambledtoshoreupthemoneymarketsNationaldebtswere spiralling too In theUKalone economists atGoldmanSachscalculatedthat Britain would end up spending around pound120 billion or 8 per cent of itsGDPrescuingitsbanksTheIMFreckonedthebillwouldbenearer13percentThe Financial Times calculated that would push national debt up to pound1200
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
billion or around 80 per cent of GDP A similar pattern was developing inAmericatooPoliticiansonbothsidesoftheAtlanticwerefuriousVoterswereevenmorelividAmidthatbacklashfewbankerswantedtobeseenpartyinginaSwissskiresortDiamond of Barclays Capital had additional reasons for staying away from
Davos By late January his bankrsquos share price was collapsing in particularlyspectacular style as a new sense of crisis erupted among British banksIrrespectiveofallthemoneythattheBritishgovernmenthadalreadyearmarkedforthebanksinvestorswerebecomingincreasinglyworriedthatitmightnotbeenough tostop thecrisis fromspirallingfurther lsquoWearesliding intocompletenationalizationbutalmostinaback-doorwayrsquofrettedVinceCabletheLiberalDemocrat politician who argued that it would be lsquomore honestrsquo simply toembarkon full-scalegovernmentcontrol so that the state sectorcouldat leastsorttheproblemsoutTheUKTreasuryvehementlydeniedanydesiretodothatInsteaditstartedworkonasetofplanstoinsurethemosttoxicassetsheldbybanks suchasRBSandHBOSBut as theproblemsgrewworse the senseofinvestor concernwas rising too - notmerely about the state of the banks butaboutwhethertheBritishgovernmentreallyhadthefinancialstrengthtomountafullyfledgedrescuemissionlsquoThebalancesheetofRBSisbiggerthantheUKeconomyrsquofrettedCampbellBarclaysforitspartvehementlydenieditneededanyhelpsinceithadalreadyraisedfinancefromMiddleEasterninvestorsButinthatfebrileclimateDiamond-andtherestoftheBarclaysteam-knewtheyneeded to stay on their home patch to keep fighting Even the short trip toDavosseemedajourneytoofarJamieDimonwasoneoftherareexceptionswhowaswillingtoappearatthe
Swissmountain resort (The otherwas StephenGreen head ofHSBCwhichhadalsoemergedinbettershapethanmanyrivals)DimonhadneverbeenonetostayintheshadowsoutspokenspeechwaspartofhisbrandByearly2009DimonwastryingtospeakwithmoregravitasthanhehadinhisyouthHewaskeenly aware of the increasingly heavyweight of responsibility falling on hisshoulders Yet he reckoned that somebody onWall Street needed to have thecouragetospeakupandstandoutifnothingelsebecausehewasgettingfedupwithall theprocrastinationamong theWesterngovernmentsonhowto fix themesslsquoThisstuffisgettingoldIjustwishtheywouldgetonwithitPoliticiansare playing catch as catch canrsquo Dimon said at one of the events triggeringspontaneousapplauselsquoIhavenrsquotyetseenpeoplegetalltherightpeopleintotheroomandclose thedoor andput a solutionupon thewallGodknows some
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
really stupid things were done by American banks and American investmentbankers Some stupid thingsweredone but itwasnrsquot just thebankersWhereweretheregulatorsinallthisrsquoDimonhadtheluxuryofbeingabletospeakasasurvivorJustbeforeflying
toSwitzerlandhehadunveiledJPMorganChasersquosfourth-quarterresultswhichshowed the bankrsquos profits were just $702 million 76 per cent down on thepreviousyearduetoa$18billionwrite-downonitsleveragedloansand$11billion losses on mortgage assets lsquoItrsquos very disappointingrsquo Dimon curtlydeclared warning that the bank could suffer further significant losses on itsmortgagebook ifhousepriceskept fallingThebankrsquos shareprice tumbledassomeanalystswarnedthatcreditcardandstudentloanlossescouldemergetoolsquoJamieDimonissetforafallrsquoclaimedCharlieGasparinoaprominentfinancialcommentator suggesting that it lsquowill put in question his current status as theking of Wall Streetrsquo Compared with its rivals though the bankrsquos positionlooked dazzling By January 2009 the US government had dramaticallyincreased itsstake inCitigroupafternewcredit losses threatened to trigger itscollapseBankofAmericahad alsobeenbailedout againwhen it discoverednew rotten assets on the books of Merrill Lynch As its rivalsrsquo share pricescollapsed JPMorgan had become the biggest bank in the world in terms ofmarketcapitalizationWhenanindustrydinnerwasheldinLondoninJanuarytohandoutbankingprizesJPMorganwonmorecategoriesthananybankhadeverdonebeforeThebankrsquospartyinthePianoBaronthenightofThursday29Januaryspoke
volumesabouthowthebankrsquosstatushadchangedTheinvitationstotheeventhad been designed to carry the ghostly signature of J Pierpont Morgan thebankrsquos founder and former Wall Street guru In the autumn of 2008 theJPMorgan investmentbankhadrebranded itselfaslsquoJPMorganrsquo inhonourofthetraditionallinkwiththeirfounderInaworldwhereinvestorshadlostfaithincyberfinanceJPMorganrealizedthatitwasahugeadvantagetohavesuchan illustrious history and an actual legend to promote The bank had alsorevived the motto of J Pierpontrsquos son - JP lsquoJackrsquo Morgan - that called forlsquoFirst-Class Business in a First-ClassWayrsquo It was now being stamped on tointernalmemosThelsquoheritagersquoMorganbankerswereutterlythrilledJPMorganhadbigplansDuringtheearlyyearsofthetwenty-firstcenturyit
hadwatchedwith aweand envy asGoldmanSachs extended its tentacles intopoliticsandgovernmentoftenviaitspowerfulnetworkofalumniJPMorgannow planned to emulate that strategy It started an lsquoalumnirsquo society on the
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
suggestionofAndrewFeldsteinandotherformerJPMorganbankersandhadbeguncultivatingpoliticalalliesAsJPMorganrsquosguestsnibbledoncanapeacutesinthePianoBarAlGore anadviser to thebank couldbe seenmingling in thecrowdsSocouldTonyBlairanotherwell-paidnewadviserAsBillWinters surveyed the crowds in the PianoBar he seemed to harbourmixed emotions about the strange journey he had travelled with the bankAlmostfifteenyearshadpassedsincehehadfirstgonedowntoBocaRatonforthatwildweekendofdrinkingandbrainstormingInsomerespectsheseemedlittlechanged from theyoungderivatives traderwhohadbeen thrown into theswimmingpoolHishairwasnowfleckedwithgreyanddarkcirclesringedhiseyes - a testament tomonths of financial crisis Yet he still had a fun-lovingstreakGivenachancehelaughedhewouldbehappytoslipoutoftheformalreceptiongrabatobogganandhurtledowntheslopesofDavos
Winters also remained convinced that financial innovation could be athoroughly good thing He had seen at first hand the utterly disastrousconsequences of innovation used in an unwise manner but not all theinnovationshadturnedsosourheinsistedInspiteofall thefearsof theNewYork Federal Reserve the credit derivatives world had continued to functionduringthecrisisevenwhentradinghadstoppedinalmosteveryotherpartofthemarketCreditderivativescontractslinkedtoLehmanhadsettledsmoothlytooJPMorganrsquosownhistoryshowedthatinnovationneednotleadtocriseslsquoImeanwehavemadeplentyofmistakesrsquoWintershastilyaddedAseverhewaswaryofsoundingupbeatlsquoButwemadedeliberatechoicesnottodothingslikeCDOofABS people are sitting around now and saying innovation is bad thatderivativesare this terrible thing thatcreditderivativesshouldbebannedButreallythiscrisisisnottodowithderivativesItisaboutbadmortgagelendingbadrisk-managementpracticeshowtheinnovationwasusedrsquoItwasamessagethoughthatwashardtogetacrossAsWinterscirculatedat
Davos he had repeatedly tried to explain to people that he still believed thatinnovation - used correctly -could be a good thingHardly anyonewanted tolistenWhat bankers said no longer carried much respect Time and again inDavosdelegateshad lashedout against lsquoderivativesrsquo andcredit derivatives inparticular Wen Jiabao the Chinese premier pointedly berated the Westernfinancial world for its lack of self-discipline Vladimir Putin his Russiancounterpartscoffedatbankersrsquouseoflsquovirtualmoneyrsquonotingthatlsquotheprideof
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
Wall Street banks have now ceased to existrsquo The optimistic side ofWinterslikedtohopethatthebacklashwouldprovetemporaryTherealistthoughwasdismayedItlookedasifitcouldtakeyearsbeforetheangersubsidedPerhapslonger than anyof the original team inBocaRaton remained in their bankingcareersAnd what of the other members of the old JP Morgan group In late 2008Wintersrsquos former bossPeterHancockmoved toOhio to take a job as a vice-chairmanofKeyCorp awell-respected regional bank inClevelandWhenhetold his former colleagues about the move some were astounded that such acerebralinternationalmanwouldheadtoOhioAfterHancockleftJPMorganin2000 though his career never resumed its formerbrilliant trajectoryFor afew years he ran a consultancy with Roberto Mendoza another former JPMorgan banker and Robert Merton the Nobel Prize-winning economistofferingadviceon financial innovationBut theventurenever truly flourishedHancock sometimes struggled to convince clients to adopt his wildly creativeandinnovativeideasoreventounderstandhowvaluablederivativescouldbeifthey were used wisely He found that lack of comprehension painfullyfrustratingHehopedthatClevelandwouldofferanewchancetoimplementhisvisionlsquoWatchingthefinancialcrisisunfoldIfeltthatIcouldbeofgreateruseasabankexecutiveaccountableforideasandexecutionasopposedtobeingonthesidelinesasanadviserrsquoheexplained
Over inPittsburghDemchakwas thriving in theworldof regionalbankingPNCwas one of thewinners in the crisis its losses dramatically smaller thanthose of its competitors partly due to Demchakrsquos canny management of thecreditportfolioFromtimetotimerumourscirculatedthatDemchakwasabouttobehiredbacktoWallStreettohelpfillinforthedireshortageofexperiencedexecutiveswhobothunderstoodhowcomplexfinanceandderivativesworkandhademergedfromthecrisiswithcleanhandsDemchakthoughwasinnohurrytojumpInNewYorkDemchakrsquosgoodfriendAndrewFeldsteincontinuedtorunhis
fundand tochasehisdreamofbuildingabettercreditderivativesworldTheclimate though was proving extremely challenging By the end of 2008BlueMountainhad$48billionundermanagementandhadoutperformedmostof its peersButwhen the crisis erupted atLehmanBrothers the entire hedgefundsectorwitnessedadramaticoutflowoffundsBlueMountainwashitbythat
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
trendironicallybecauseithadproducedsuchgoodrelativereturnsin2008thatinvestorswantedtorealizetheirgainsEventuallythedrainagewassobadthatBlueMountainwas forced to impose apartial lsquolock-uprsquowhereby investors areprohibitedfromwithdrawingtheirfundsFeldstein remained determined to fight back lsquoWhat we think of as the
traditional hedge fund will shrink - that is hedge funds operating with highdegreesofleverageandwithexpectationsofquarterlyredemptionrsquoheobservedin early 2009 lsquo[But] I think it is too soon to say whether the alternativeinvestmentindustrywillshrinkOvertimeitwouldbeuntenableforinvestorstokeeptheirmoneyinzero-yieldinggovernmentbondsrsquoButFeldsteinwasnrsquotexpectingarecoveryanytimesoonBackinthe1990s
hewasatcollegewithBarackObamalsquoIwasnotaclosefriendofObamainlawschoolrsquo he reflected lsquobut I did interactwithhim frequently especially on thebasketballcourtYoucan tella lotaboutpeopleby theway theyplaypick-upbasketball -whatwas very easily recognized aboutObamawas that hewas aleaderrsquoHe feared thatObama faced amonumental challenge in repairing thefinancialsectorFeldstein was facing his own daunting challenge to create a more rational
creditderivativesworldByearly2009thebankingindustryhadfinallystartedlsquotearinguprsquo-oroffsetting-derivativescontractsonalargescalereducingthevolume of outstanding deals in the market by more than half Bankers werestarting to adopt amore standardized system for structuring credit derivativesProgresshoweverwaspatchyandslowTheeffortstobuildaclearingplatformfor the credit derivatives world were also lagging due to internal industrybickering Jerry Corrigan and Feldstein blamed the problem on a dire lack oflsquofinancialstatesmanshiprsquooraninabilityofbankstothinkaboutthepublicgoodAblockawayfromBlueMountainrsquosofficesatJPMorganrsquosheadquarterson
270 ParkAvenue BlytheMasters remained embroiled in her own fights ShewasnolongerdirectlyinvolvedintheworldofstructuredcreditorderivativesbutinsteadwasrunningthecommoditiesdivisionofJPMorganAlongsidethatjob she held the post of chairman of the Securities Industry and FinancialMarketsAssociation(SIFMA)themainindustrybodyrepresentingthearenaofcomplexfinanceTechnicallythatmadeherthemostseniorWesternbankertoholdthethanklesstaskofchampioningtheareaoffinancethatwasthecentreofaviolentbacklashItwasatoughroleInlate2008aftertheLehmandisasterMasters started receiving hate mail One British newspaper dubbed her thewomanwhocreatedthelsquoweaponsoffinancialmassdestructionrsquoAngrypostings
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
ontheinternetblamedherforwreakingdisasteronthesystemlsquoIfthefinancialworld crashes yoursquoll know who to blamersquo shrieked one hysterical blogAnothersuggestedthattheHollywoodactressTildaSwintoncouldplayMastersinafilmaboutthecrashsincetheylookedsimilarWhenshemovedhouseinearly 2009 the gossip column of the New York Post gleefully reported thatMasters had lsquoslashed the price of theReadeStreet residence to $119milliondownfrom$14millionrsquoThevitriolappalledherformercolleagueslsquoThisisobsceneIsuspecttheyare
pickingonherbecausesheisawomanbecauseshestandsoutrsquooneobservedlsquoIt is a travesty of ldquojusticerdquo Not a single one of us was involved in thetransactions that latercausedsomuchdamage allof thisgrouparedecenthumanbeingsrsquoMastersherselftriedtobephilosophicalAsshehadgrownoldershe had developed a growing sense of humour about the absurdities - andunpredictability-oflifeWhen she addressed a meeting of SIFMA in New York in late 2008 she
pointedlyreferredtoherselfaslsquosomeonewhohasbeencalledaweaponofmassdestructionrsquo She knew the publicwas angry andwanted something to blameand she could understand that She was livid herself at how bankers hadpervertedherderivativesdreamYetshe-likeWinters-continuedtohopethatsomethingsomehowofthevalueofcreditderivativeswouldbesalvagedlsquoItrsquosprobablysafetosaythatourindustryimageisatanall-timelowrsquosheadmittedwith masterful British understatement when she addressed the SIFMAconferenceAsevershecutastrikingfigureIndeferencetothedarkmoodofthetimessheworeasombrechocolate-brownsuitinsteadofherusualjewel-tonedhueslsquoSome in the industry bristle at the suggestion that Wall Street or anyone
couldhavepredictedorshouldhaveavoidedthismeltdownrsquoshecontinuedlsquomanyplayershadaroleincreatingthiscrisisincludinglendersborrowersandregulatorsButevenifnotalloftheblamethatwillcomeshouldbedirectedtoourindustrythereisunfortunatelyplentyofblametogoaroundrsquolsquoOurindustryneedstorebuild[its]reputationrsquosheaddedlsquoandthefirststepis
to acknowledge accountability and to own the responsibility of rebuilding amoresystemicallysustainablebusinessmodelFinancialengineeringwastakento a level of complexity which was unsustainable But it is important todistinguishbetweentoolsandtheirusersWeneedtorememberthatinnovationhascreatedtoolsformanagingriskrsquoShewas keenly aware of the ultimate irony of thewhole saga lsquoThe events
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
thathavebroughtushereareatragedyofunfoldingproportionsitwouldbeagreatertragedyifwefailtolearnthelessonsthattheyofferrsquoInLondonTimFrostkeptrepositioningCairnCapitalDuringthecourseof
2008 Cairn suffered more blows as a clutch of CDOs linked to mortgagesecuritiesweredeclaredtobeinanlsquoeventofdefaultrsquoYetmanyotherpartsoftheCairnCDOempire thatwere connectedwith corporate credit continued toperformAndFrostwasfindingwaystodrawbenefitsfromallthebitterlessonshehadlearnedInthelasttwoyearsCairnhaddevelopedanimpressivesidelineas an adviser to bankers or investors trying to restructure collapsed shadowbankslsquoWearestilltheonlyfundwhichhassuccessfullymanagedtorestructure[anSIV]rsquoheoftensaidlsquoWehavealotofexpertisetoofferrsquoCairnhadsnappeduptheportfoliosofmanyruinedCDOsatknockdownprices In late2008 theBank of England quietly appointed Cairn as an adviser The fees on suchadvisory and restructuringworkwerepaltry compared towhatFrost hadoncehopedtoearnfromthehedgefundbuttheBankmandatewasastunningsignofjusthowsuccessfullyheandhiscolleagueshadmanagedtofindopportunityinadversityTerriDuhonrsquosconsultancybusinesswasenjoyingaflurryofdemandaswere
advisoryservicesrunbyRobertReochandCharlesPardueAsthefullscaleofthetoxicshockbecameclearpolicymakersandassetmanagersrealizedjusthowlittle they really knew about CDOs and other complex instruments and theywerefrantictofindadviserswhoknewbetterandhadcleanhandsSuchpeopleseemedinshortsupplyManyofthelsquoMorganmafiarsquoremainedinclosetouchbyemailtryingtomake
senseof theunfoldingdramaSome felt lividaboutwhathadhappened in themortgage world lsquoThe essential question is what in tarnation led marketparticipantstoover-originatesubprimemortgagesatincreasinglysillytermsandthen warp credit derivative technology into synthetic CDO of ABS when the[over]supply of real mortgages was insufficient to satisfy demandrsquo ragedFeldsteinSomealsorecognizedthoughthatideologywasalsotoblamelsquoTheeconomicmodels thatHancock andMerton and others upheldwere right in asense but the problem is that they did not give enough emphasis to all thehumanissues theregulatorystructuresandthings like thatrsquoobservedMasterslsquoTheideawasthatthoseissueswerejustldquonoiserdquointhemodels-butthatisjustdead-arsedwrongWedonrsquotliveinthatworldofperfecteconomicmodelsrsquoFor some the Congressional testimony of Alan Greenspan the former
chairmanoftheFederalReserveintheautumnof2008markedanintellectual
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-
turningpointDuring the previous two decades Greenspan had vehemently championed
unfettered free-market competition and the argument that markets were notmerely efficient but self-correcting When Greenspan appeared in front ofWashington lawmakerson24October2008headmittedhewas lsquoina stateofshocked disbeliefrsquo and that he had made a lsquomistakersquo in believing that bankswould do what was necessary to protect their shareholders and institutionslsquo[That was] a flaw in the model that defines how the world worksrsquo hedeclaredlsquoI think Greenspan is quite rightrsquo one of the former JP Morgan team
observedshortlyafterlsquoNowitisclearweneedanewparadigmButwehavenrsquotfoundityetandfranklyIdonrsquotknowwherewewillrsquoLikemanyoftheJPMorganteam-andalmosteverybodyelseintheWesternworld - I too am still trying to make sense of the last decade of grotesquefinancial mistakes I have found myself drawing on my training as a socialanthropologistbeforeIbecameajournalistsomefifteenyearsagoBackinthe1990swhenIfirststartedworkingasafinancialreporterIusedtokeepratherquietaboutmylsquostrangersquoacademicbackgroundAtthattimeitseemedthattheonly qualifications that commanded respect were degrees in orthodoxeconomicsoranMBAthecraftofsocialanthropologyseemedfartoolsquohippyrsquo(as one banker caustically observed) to have any bearing on the high-rollingquantitativeworldoffinance
ThesedaysthoughIrealizethatthefinanceworldrsquoslackofinterestinwidersocial matters cuts to the very heart of what has gone wrong What socialanthropology teaches is that nothing in society ever exists in a vacuum or inisolationHolisticanalysisthattriestolinkdifferentpartsofasocialstructureiscrucialbethatinrespecttoweddingritualsortradingfloorsAnthropologyalsoinstilsasenseofscepticismaboutofficialrhetoricInmostsocietieselitestrytomaintain their power not simply by garnering wealth but by dominating themainstream ideologies both in terms of what is said and also what is notdiscussed Social lsquosilencesrsquo serve to maintain power structures in ways thatparticipantsoftenbarelyunderstandletaloneplanThatsetof ideasmaysoundexcessivelyabstract (orhippy)But theywould
seemtobesorelyneedednowInrecentyears regulatorsbankerspoliticiansinvestorsandjournalistshaveallfailedtoemploytrulyholisticthought-toour
collectivecostBankershavetreatedtheirmathematicalmodelsasiftheywereaninfallibleguidetothefuturefailingtoseethatthosemodelswerebasedonaridiculouslylimitedsetofdataAlsquosilorsquomentalityhascometoruleinsidebanksleaving different departments competing for resources with shockingly littlewider vision or oversight The regulators who were supposed to oversee thebanks have mirrored that silo pattern too in their own fragmented practicesMost perniciousof all financiers have come to regardbanking as a silo in itsown right detached from the rest of society They have become like theinhabitantsofPlatorsquoscavewhocouldseeshadowsofoutsiderealityflickeringon the walls but rarely encountered that reality themselves The chain thatlinkedasyntheticCDOofABSsaywithalsquorealrsquopersonwassoconvoluteditwasalmost impossible foranybody to fit that intoa singlecognitivemap -betheyanthropologisteconomistorcreditwhizzYettheonlythingthatismoreremarkablethanthisdeadlystateofaffairswas
that it went so unnoticed for so long For my part I first crashed into thecomplexfinancialworldbackin2005whenIvolunteeredtostartwritingaboutcreditfortheFinancialTimesBy2006myteamhadbecomeseriouslyalarmedbythetrendsandtriedtopointoutthedangersItwasalonelyendeavourMostmainstream newspapers all but ignored the credit world until the summer of2007Sodidpoliticiansandnon-bankersCreditwasconsideredtoolsquoboringrsquoorlsquotechnicalrsquo tobeof interest toamateurs Itwasaclassicareaofsocial silenceInsofarasanybankerseverreflectedonthatsilence(whichveryfeweverdid)most assumed that it suited their purposeswell Freed from external scrutinyfinancierscoulddoalmostanythingtheywishedLockedintheirlittlesilosfewcouldseehowthepiecesfittedtogetherorhowbloatedfinancewasNowhoweveritisclearthatthislackofholisticthoughtanddebatehashad
devastating consequences Regulators have realized too late that they werewrong to place so much blind faith in the creed of risk dispersion Bankexecutives have been confronted with vast losses created by dysfunctionalinternalsilosPoliticiansarefacingadebtcrisisasaneconomicboomcrumblestodustMost tragicofallmillionsofordinaryfamilieswhoneverevenknewthatCDOs existed far less dealtwith them have suffered shattering financialblows They are understandably angry So am I It is a terrible damningindictmentofhowtwenty-first-centuryWesternsocietyworksIn pointing out the cultural issues I do not mean to suggest that tangible
macroeconomic issues were not also crucial too Excessively loose monetarypolicystokedthecreditbubbleSodidsavingsimbalancesandpoorregulatory
structuresThosetangibledeficienciesmustbeaddressedCentralbankersneedtopaymoreattentiontothestructureoffinancewhentheysetmonetarypolicyRegulatorsmustmonitorbanksinamoreholisticmannerBanksrequirebiggercapitalcushionsFinancialproductsmustbecomesimplerandtransparentManyrecent innovations such as mezzanine CDO of ABS need to die OthersthoughcouldstillbevaluableNobodywouldtrytobanallprescriptiondrugsorstop all nuclear processing if some innovationsmalfunctioned The basic ideathatbanksshoulddispersesomeoftheircreditriskorinsureagainstabondorloandefaultstillseemsvaluableYetwhat isalsoneeded isawider rethinkof thecultureof financeFor too
manyyearsbankershavetreatedlsquocreditrsquoasmerelyanisolatedgameofnumbersThe roots of the word though come from the Latin credere meaning lsquotobelieversquo That is a concept centred onwider social relationswhich financiersforget at their peril After all if there is one element above all that is nowneeded to restore sanity to banking it is that policymakers bankers andpoliticians must adopt a more holistic vision of finance In essence what isneededisareturntotheseeminglydullvirtuesofprudencemoderationbalanceandcommonsenseOddly enough the symbol that JP Morgan inadvertently inherited from
ChaseManhattanwouldseemanappropriatemetaphor-theoctagonallogothatharkedbacktothewoodenplanksoncehammeredtogethertomakewaterpipesThe rebranded JPMorgan has dropped the logowhich is perhaps a pity Inmanyways the craft of finance is not so verydifferent from that of thewaterindustrybothexist inorder topushacommodityaroundtheeconomyfor thebenefitofallIfthosepipesarewildlyinefficientleakyorcostlytheneveryonesuffersInthelasttwodecadesasfinancespunsofaroutofcontrolitstoppedbeingaservantoftheeconomyratherthanitsmasterThatneedstobereversedPerhaps it is time to stamp an octagonalwater symbol over the door of everymodernbankasareminderoftheperilsofforgettingthatmoneyisanothervitalfluid that must flow freely and safely throughout our fragile interconnectedworld
Notes
NOTESONSOURCES
Theprimarysourcesforthisbookhavebeenextensiveinterviewswiththemaincharactersmentionedinthebookaswellasnumerousotherpeopleoverseveralyears Except where it is specifically mentioned the quotes are drawn fromauthor interviews or from author articles already published in the FinancialTimes Ihavealsodrawnheavilyfromfinancial reportspublishedby theBankfor International Settlements International Monetary Fund European CentralBankandBankofEnglandaswellas theCapitalMarketsMonitorspublishedbytheInstituteforInternationalFinanceStudiesconductedbytheCounterpartyRiskManagement Group the IIF the Group of Thirty and Basel Committeehavealsobeenused aswell as a large rangeofmedia sourcesand reportsbyfinancial industry analysts The research also benefited from a large array oftextbooks and popular literature on finance and the recent credit crunchincluding (but not exclusively) Tavakoli J Structured Finance ampCollateralizedDebtObligationsJohnWileyampSons20032008DasSatyajitTraders Guns amp Money paperback Pearson 2006 Morris Charles TheTrillionDollarMeltdownPublicAffairs2008BookstaberRichardADemonof Our DesignWiley 2007 Bernstein PeterCapital Ideas EvolvingWiley2007andAgainsttheGodsWiley1998RebonatoRiccardoThePlightoftheFortuneTellersPrincetonUniversityPress2007ChernowRonTheHouseofMorgan Grove Press 2001 Lowenstein Roger When Genius FailedHarperCollins2001SorosGeorgeTheNewParadigmforFinancialMarketsPublicAffairs2008ShillerRobertJTheSubprimeSolutionPrinceton2008DaviesHowardandGreenDavidGlobalFinancialRegulationPolity2008
CHAPTERONE
4By1994thetotalnotionalvalueofderivativescontractsLoomisJCarollsquoTheriskthatwonrsquotgoawayrsquoFortune7March1994
11VersionsofderivativestradinghaveexistedforcenturiesDoddRandalllsquoBackgrounder Derivativesrsquo Initiative for Policy Dialoguelthttpwww2gsbcolumbiaeduipdj_derivativeshtmlgt
12 Salomon Brothers was one of the first author interviews see alsoLowensteinRogerWhenGeniusFailedHarperCollins2001pp103-4
15ButJPMorganhadalwayshada transcultural identity seeChernowRonTheHouseofMorganGrove2001
22AfewmonthsbeforetheBocaoff-siteLoomisJCarolopcit
24 Irsquove known people who worked on the Manhattan project PhilipsMatthewlsquoThemonsterthatateWallStreetrsquoNewsweek6October2008
CHAPTERTWO
30Out of that they decided to create an industry body to represent theswapsworldISDAandRiskISDA20thAnniversaryReportMarch2005
31Given the sheer size of the [derivatives] market Corrigan E GeraldSpeechtoNewYorkStateBankersAssociationdinnerJanuary1992
33SoWeatherstoneagreedtochairtheG30reportISDAandRiskopcitp30
36 Felix Rohatyn a legendary Wall Street figure Hansell Saul andMuehringKevinlsquoWhyderivativesrattletheregulatorsrsquoInstitutionalInvestorSeptember1992
39 I want to produce a guide by practitioners that has so much usefulpracticaladvicethatitwillbereferredtoforyearstocomeISDAandRiskopcitp30
41BrianQuinnanexecutivedirectoroftheBankofEnglandsaidGapperJohn lsquoInternational capitalmarkets - bank supervisor calls for tougher futuresregulationrsquoFinancialTimes29September1993
41IfthemarketplayerscontinueforwardinthespiritoftheG30SpeechbyJCarterBeeseatISDAconferenceinWashington3November1993
42ThecompanyhadmadeadealwithBankersTrustEssentiallyinthefirstsixmonths PampGwas to pay Bankers Trust a rate of CP (commercial paper)minus75basispointsAfterthattheratewouldsetatahigherlevelclosetothefloating rate In return for this initial below-market rate PampG faced graveuncertainties as towhere ratesmight be sixmonths out Still PampGhad someinsuranceagainsta run-up in the formofasix-monthoption toset the rateatanytimeThegoalofPampGtreasurywastogetthefourandahalfyearsrsquomoneyatCP-40And if the interest rateskept falling thenPampGwouldhaveenjoyedlarge costs savings For full details seelthttpwwwderivativesstrategycommagazinearchive20001100fea3aspgt
42 in 1993 Citronrsquos investment pool delivered returns of 85 per centLynchDavidJ lsquoOrangeCountyHowithappenedHowgolden touch turned
intocrisisrsquoUSAToday23December1994
43Thequestionnowisnolongerwhetherregulatoryorlegislativechangeswill be made Fillion Roger lsquoGAO portrays derivatives as fraught withdangersrsquoReutersNewsService19May1994
45 lsquoDerivatives are perfectly legitimate tools to manage riskrsquo TaylorAndrew lsquoCritical report fuels drive to regulate derivativesrsquo CongressionalQuarterlyWeeklyReport21May1994
46TheheadofClintonrsquos newNationalEconomicCouncilRobertRubinPhillipsKevinArrogantCapitalLittleBrown1994
46WhenIsayIdonrsquotthinklegislationisneededLipinSteveandRaghavanAnita lsquoGAO to join hot debate on derivativesrsquoWall Street Journal 18May1994andPeltzMichaellsquoCongressrsquoslameassaultonderivativesrsquoInstitutionalInvestor1December1994
CHAPTERTHREE
50lsquoFunnilyenoughrsquoshetoldareporterFredricksonTomlsquoBlytheMasters34rsquoCrainrsquosNewYorkBusiness26January2004
53 Moreover the credit derivatives concept did not seem sufficientlyprofitableFordetailsofwhyFreundandCrystalexperimentedwith the ideathen dropped it seeGuillGeneBankersTrust and theBirth ofModernRiskManagementWhartonFinancialInstitutionsCentre2007p30
57SureenoughinAugust1996theFedissuedastatementseeSupervisoryGuidanceforCreditDerivativesWashingtonFederalReserve12August1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
63 Demchakrsquos team worked stealthily for details of how this structureworked seeThe JPMorganGuide to Credit Derivatives Risk Publications1999 See also Das Satyajit CDOs and Structured Credit Products Wiley2005pp322-44foraveryextensivediscussionofthesignificanceofBistroinrelation to the structures thatproceeded from it and the subsequent impactontheindustry
65FiveyearshencecommentatorswilllookbacklsquoCreditDerivatives-FiveYears Outrsquo Derivativessrategycom JulyAugust 1997lthttpwwwderivativesstrategycommagazinearchive19970797rtblaspgt
CHAPTERFOUR
66Bistro-styleCDStrades tookoff fastForgeneraldiscussionsof that seeDasSatyajitopcitpp322-44
68ThepaceofchangeinthewaybanksmanagecreditriskAsarnowElliotTheJournalofLendingandCreditRiskManagementSeptember1998p13
68BlytheMastersstilllooksmorelikeaJPMorganinternIbidp8
70 But they were also uneasy For a debate about the problems of fittingexisting regulations to securitizations and the Fed and OCC response seeCapital Interpretations Synthetic Collateralized Loan Obligations 15November 1999 lthttpwwwocctreasgovftpbulletin99-43apdfgt andSupervisoryGuidance forCreditDerivativesWashingtonFederalReserve 12August 1996lthttpwwwfederalreservegovBOARDDOCSSRLetters1996sr9617htmgt
72 Cassano happily agreed See details about this and comments fromCassano in Conference Call Transcript AIG Financial Services Grouppresentation83031May2007ThomsonStreetEventsp23
73Capital reservescouldonlybecutSeeCapital InterpretationsSyntheticCollateralized Loan Obligations 15 November 1999lthttpwwwocctreasgovftpbulletin99-43apdfgt
80AstheaudiencefiledintotheCiprianiTheJPMorganGuidetoCreditDerivativesRiskPublications1999
CHAPTERFIVE
85Thefateof thehedgefundmaverickLongTermCapitalManagementFor an excellent accountof this seeLowensteinRogerWhenGeniusFailedHarperCollins2002
86 In 1999 the year after LTCM imploded The study in question wasImprovingCounterpartyRiskManagementPractices by theCounterpartyRiskManagementPolicyGroupJuly1999
86The fact that the OTCmarkets function Remarks by Alan GreenspanbeforetheFuturesIndustryAssociationBocaRatonFlorida19March1999
87CongressnailedthedoorshutBrickellMarklsquoZeroto$200trillionrsquoISDAandRiskopcitp25
89BeyondthattheadvantagesarelesscompellingSantoliMichaellsquoLandof the Giants Next in line How would Chase meld with Merrill Time toreunitetheHouseofMorganrsquoBarronrsquos13April1998
89 The so-called lsquonon-interest incomersquo Michael Nancy lsquoBankingrsquos topperformersrsquoABABankingJournal1June2000DatafromSECfilingsandthemagazinersquoscalculations
89 From a standing start in 1980 Frank Stephen E lsquoAfter EmbracingChange JP Morgan is Struggling to Boost its Bottom Linersquo Wall StreetJournal27May1998
89In1999themedianROEforthetop100bankswas18percentFrankStephen E lsquoAfter embracing change JP Morgan is struggling to boost itsbottomlinersquoWallStreetJournal27May1998
93AsClaytonRoseoneoftheseniorJPMorganbankersobservedIbid
94ButsuchhasbeenthepaceofchangeinglobalfinanceanonymouslsquoWallStreetrsquos old order changes (Chase Manhattan acquires JP Morgan)rsquo TheEconomist16September2000
97 I believe we handled everything with integrity Chaffin JoshualsquoCompanies and finance The Enron collapse - JP Morgan had too much
exposuresayschairmanrsquoFinancialTimes7February2005
97 We did it according to accounting conventions Interview WilliamHarrison chairman and CEO of JPMorgan Chase discusses his firmrsquosinvolvementintheEnronscandalCNBCMarketWeekwithMariaBartiromo5August2002
98 Itrsquos unnerving how the bad news keeps piling up at JP MorganTimmons Heather and Palmeri Christopher lsquoThe perils of JP MorganrsquoBusinessWeek21January2002
98 Or as the Evening Standard of London tartly declared ChamblissLauren lsquoHow a banking giant was laid lowrsquo Evening Standard 16 October2002
99 Credit derivatives are a mechanism for transferring risk WestlakeMelvyn lsquoInvestment banking - surviving the credit crisisrsquoTheBanker 1May2002
CHAPTERSIX
107TherewasagreaterneedforthederivativesmarketMouldsJosephinelsquoTim Frost says credit derivatives can solve the crisis in pensionsrsquo DailyTelegraph5June2006
107ThelegalandshareholderframeworkIbid
108We can promote outstanding people quickly Chambers Alex lsquoHowJPMorgansurvivedthelossofagenerationrsquoEuromoney1May2006
108ItisunlikelythatthesectorwouldhavegrownIbid
109 In 2003 Risk magazine designated Deutsche Bank Risk magazineawardsJanuary2003lthttpwwwrisknetpublicshowPagehtmlpage=9109gt
109PensionfundswerenowtargetingHughesJenniferBealesRichardandTett Gillian lsquoInvestment - even governments are putting money into higher-yieldinginstrumentsrsquoFinancialTimes17June2005
110TheproductdevelopmentnowisincrediblyfastvanAcoleyenKatriencommentstoESFandIMNconferenceNiceApril2005
112Remarkablythatmeantthatalmosthalfofallmortgage-linkedbondsBISAnnualReportJune2007p146
117Each player had its own twist onmodelling Commentmade by TerriDuhontoESFandIMNconferenceNiceApril2005
118Peoplewho are focused on ratings alone are prime fodder CommentmadebyCharlesParduetoESFandIMNconferenceNiceApril2005
118We are very transparent in everything we do Unpublished interviewwiththeFinancialTimesMay2005
120Thepurestinformationtouseisdataon[historic]defaultsUnpublishedinterviewwiththeFinancialTimesinMay2005
120 InMarch 2000 David Li a researcher at JPMorgan The paper inquestionwasDavidLilsquoOnDefaultCorrelationACopulaFunctionApproachrsquoJournalofFixedIncomevol9no4March2000
121AsAlexVeroudethemanagerofaCDOforGulfInternationalBankCommenttoESFandIMNconferenceNiceApril2005
122AsDavidLihimselfsaidaboutthemodelhehadfashionedWhitehouseMark lsquoSlices of risk How a formula ignited market that burned some biginvestorsrsquoWallStreetJournal12September2005
122Therevenuesofthelargestinvestmentbanksgrew14percentbetween2003and2004DatatakenfromInvestmentbankingandcapitalmarketsreportQ42005BostonGlobalConsulting
CHAPTERSEVEN
124ThetwoleaderswerenearoppositesTullyShawnlsquoThedealmakerandthedynamorsquoFortune9February2004
125Does itbotheryouCNBC interviewWilliamHarrison andCoachDeanSmithdiscussbusinessandbasketballSpecialReportwithMariaBartiromo23February2004
134 Instead of heading first to the headquarters in the City of LondonFarrellGreglsquoDimonaddssparkletoJPMorganChaseOustedCitigroupbankerfightshiswaybacktotoprsquoUSAToday29November2005
136YondCassiushasaleanandhungrylookStiresDavidlsquoAtJPMorganlookoutforNo2rsquoFortune18October2004
CHAPTEREIGHT
139HishugebankingmergerisnotyetdeliveringlsquoWaitinggame-TheLexColumnrsquoFinancialTimes22August2005
140Heknowswhereall thebodiesareburied in thatmonsterderivativesportfolio Kerr Ian lsquoJamie Dimon and his ldquoterriblerdquo resultsrsquo Euroweek 29October2004
142GiventheprofileofJPMorganasaninstitutionChambersAlexlsquoHowJPMorgansurvivedthelossofagenerationrsquoEuroweek1May2006
144 Onlookers lsquoshould [not] be concerned that home prices are risingHousingBubbleProspectsQampANationalAssociationofRealtorsAugust2005lthttpwwwrealtororgresearchnsffilesbubbleqampapdf$filebubbleqampapdfgt
144Housepriceshaverisennearly25percentoverthepasttwoyearsTheEconomic Outlook Ben S Bernanke 20 October 2005 as cited in SchillerRobertJTheSubprimeSolutionPrincetonUniversityPress2008
145 In 2005 American households extracted no less than $750 billionlsquoSources and Uses of Equity Extracted from Homesrsquo US Federal ReserveMarch2007
146Inmid-2005thoughSchillerRobertJopcitp35
146Fromearly2002toearly2005BISAnnualReportJune2007p126
147TheninJanuary2006anindexfortrackingtheseofferingsandtheirvalues was launched For details of how the ABX works seelthttpwwwmarkitcominformationproductscategoryindicesabxabout_abxhtml
CHAPTERNINE
152Bymid-2005therewere$12trillionCDScontractsEstimatesonthesizeof theCDSmarket are usually reached by surveying the biggest deals Theseestimateshavevariedconsiderablyovertimedependingonwhatprocessisusedto collect the surveys The British Bankers Association for example hasdifferent figures from ISDA It should also be noted that there is a starkdifferencebetweenthelevelofgrossoutstandingCDScontractsandthelevelofnetmarketrisksincemanyoutstandingcontractsshouldcancel(orlsquonetrsquo)eachotheroutNet riskor the replacementcostofcontracts isoftena tenthof thesizeofgrossoutstandingriskFiguresonthegrossoutstandingsizeoftheCDSmarket here and subsequently unless otherwise stated are drawn from ISDAdata See lthttpwwwisdaorgstatisticspdfISDA-Market-Survey-annual-datapdfgt
152 There is a type of euphoria Comments by Terri Duhon and CynthiaMcNultytotheESFandIMNconferenceNiceApril2005
155Thosewhoare successful know thisBrownMark andCurrieAntonylsquoYieldhungerdrivesstructuredcreditrsquoEuromoneySeptember2004
157 Banks now face the challenging task Boston Global ConsultinglsquoSucceedingwithGrowthrsquoReportonthe2004globalbankingindustry
158 He decided to bring Merrill into the securitization business with avengeanceSeePulliamSusanNgSerenaSmithRandalllsquoMerrilluppedanteas boom inmortgage bond fizzled - fresh $6 billion hit is expected as toll ofCDO push risesrsquoWall Street Journal 16April 2008AlsoGregoryMichaeland OrsquoConnor Collen lsquoMerrill Lynch reinvesting in SanFranrsquo PrivatePlacement Letter 7 July 2003 This account has also drawn on the authorrsquosinterviewswithMerrillLynchemployees
158By2006MerrilltoppedtheleaguetableDatasuppliedbyDealogic
158One corner of the AIG empire See transcript of AIG Investor Groupmeeting 830 5 December 2007 Thomson StreetEvents p 5 GuerreraFrancescoandFelstedAndrealsquoInadequatecoverrsquoFinancialTimes6October2008 PullmanNg and Smith lsquoMerrill upped antersquo op cit This account has
alsodrawnontheauthorrsquosinterviewswithAIGemployees
160CitirsquosCDOmachinebeganrunningwithsuchafreneticspeedSeethe10-Q filing by Citigroup to the SEC for the third quarter of 2007 p 9 fordetailsof thesuper-seniorholdings thatcamebackon to itsbalancesheetasaresultoftheliquidityputsTheserelatedtoCDOofABSSeealsothecommentsthatBarneyFrankmadeabouthismeetingwithChuckPrinceCEOofCiti inSyre Steven lsquoFrank talk about rulesrsquo Boston Globe 20 March 2008 ThisaccounthasalsodrawnontheauthorrsquosinterviewswithCitiemployees
161ArguablythemostaggressiveplayerofallinEuropewasUBSDetailson this excluding extensive numbers can be found in Shareholder Report onUBSrsquos Writedowns UBS 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt This account hasalsodrawnontheauthorrsquosinterviewswithUBSemployees
163 Frankly most of us had not even heard the word lsquosuper-seniorrsquoInterview with the Financial Times in April 2008 See also Hughes ChrisSimonian Haig and Thal-Larsen Peter lsquoCorroded to the core How a staidSwissbankletambitionsleaditintofollyrsquoFinancialTimes21April2008
CHAPTERTEN
168InOctober2006BillKingthemanTullyShawnlsquoJamieDimonrsquosSwatTeamrsquoFortune15September2008Supplementedwithauthorinterviews
168Ahouse crisis approachesWitter Lon lsquoThe no-money-down disasterrsquoBarronrsquos21August2006
169BuildersthatbuiltspeculativehomeseditorialcommentlsquoldquoPoprdquogoestheUSrealestatebubblersquoTorontoStar6September2006
169 When even Toll Brothers the high-end builder Shilling A GarylsquoImplosionWhenevenTollBrothersthehigh-endbuildersufferscancelationsyouknowtherealestateboomisoverrsquoForbes19June2006
169ThedelinquencyrateonsubprimemortgagesroseBISAnnualReport2007p126
169BetweenOctoberandDecember2006aloneIbidp110
169 One particularly fast area of growth was so-called lsquomezzaninestructuredfinancersquoCDOsDatefrominternalcalculationsbyJPMorgan
170OveratDeutscheBankagroupoftradersBasedonauthor interviewsSee also PittmanMark lsquoHow stage was set for meltdown SubprimemarketbeganwithtalkoverChinesetakeoutrsquoBloomberg23December2007
170GoldmanSachswasalsorollingthediceBasedonauthorinterviewswithGoldmanemployeesSeealsoKellyKatelsquoHowGoldmanwonbigonmortgagemeltdownrsquoWallStreetJournal14December2007
171ThemarkethasoverreactedKellyKatelsquoBehindasubprimecall-BearStearnsanalystdismissedthefearsandnowfeelsheatrsquoWallStreetJournal12July2007
172WearerespondingtothenewbusinessenvironmentLambeGeraldinelsquoDowKimtheco-presidentofglobalmarketsandinvestmentbankingatMerrillLynchassuresGeraldineLambethataspateofdiversifiedacquisitionsisallpartofadisciplinedstrategytoreshapethecompanyrsquoTheBanker1February2007
172When the Boston Consulting Group Investment Banking and Capital
MarketsMarketsReport -FourthQuarter2006BostonConsultingGroup20March2007
174SointensewasthemaniaBISAnnualReport2007p106
174As long as themusic is still playingNakamotoMichiyo andWightonDavid lsquoBullish Citigroup is ldquostill dancingrdquo to the beat of the buy-out boomrsquoFinancialTimes10July2007
178HoweverasBaselrsquosBISnoted lsquoTherecentbehavioroffinancialmarketvolatilityrsquoBISPaperno292006
179SuchdispersionitaddedwouldhelptolsquomitigateandabsorbshockstothefinancialsystemrsquoIMFrsquosGlobalFinancialStabilityReportApril2006
180InparticularthecurrentenvironmentmaybemorevulnerableBorioCandWhiteWlsquoWhithermonetaryandfinancialstabilityrsquoPaperpresentedtoReserveBankofKansasCityEconomicSymposiumJacksonHole30August2003andlaterpublishedinvariouseconomicjournals
180 Alan Greenspan commanded such formidable respect and powerAuthor interview See also similar comments express in Cassidy JohnlsquoAnatomyofameltdownrsquoNewYorker1December2008
181Whatworriesmeiswhatmighthappenif-orwhen-thesystemstarttode-leverageUnpublishedFinancialTimesinterviewspring2007
181These developments have clear benefits but they may also have sideeffectsBISAnnualReport2007p151
181We are currently seeing elements in global financial markets TettGillianlsquoPrepareforassetrepricingwarnsTrichetrsquoFinancialTimes29January2007
183 InApril 2007 theBankpointedout in itsFinancialStabilityReportBank of England Financial StabilityReportApril 2007 p 9 See chart 10 inparticular
184IntenyearsrsquotimewemaythereforebebetterinformedSpeechbyPaulTuckerexecutivedirectorandmemberoftheMonetaryPolicyCommitteeoftheBankofEnglandatMerrillLynchConferencelsquoAperspectiveonrecentmonetaryandfinancialsystemdevelopmentsrsquoLondon26April2007
185AnumberoffundamentalchangesintheUSfinancialsystemRemarks
at the New York Bankers Association Financial Services Forum ChairmanrsquosReceptionNewYork5April2006
187Iwanttocallyourparticularattentionto[ourrecommendations]whichcall for urgent industry-wide efforts lsquoToward greater financial stability Aprivate-sectorperspectiversquoTheReportoftheCRMPGII27July2005
188OftenittakesacrisistogeneratethewillandenergyGeithnerTimothyMcCarthy Callum and Nazareth Annette lsquoA safer strategy for the creditproductsexplosionrsquoFinancialTimes28September2006
189Ifnothingelse thatwouldshowthatglobal leadersForasummaryoftheviewsthatPeerSteinbrueck theGermanfinanceministerexpressed to themeetingseetheBBCreportontheinterviewbetweenDieWeltandSteinbrueckreported as lsquoGermanyrsquos Steinbrueck interviewed on hedge funds industrypolicyrsquo BBCMonitoring European 9 May 2007 In this he said lsquoI fear theeffects on the stability of the international financial system if hedge funds getinto heavy water and their creditors take excessive risks because of lack oftransparencyIn thisrespect Iaminagreementwithanumberof internationalinstitutions all are worried about these dangers that could result frominsufficienttransparencyrsquo
197HardhitbyturmoilKellyKateandNgSerenalsquoBearStearnsfundhurtbysuprimeloansrsquoWallStreetJournal12June2007
198 Irsquom fearful of thesemarkets Quotation taken from indictment filed byprosecutorsinNewYorkStatelawcourtsagainstCioffiandTanninFordetailsseelthttpfl1findlawcomnewsfindlawcomnytimesdocscrimuscioffitannin61808indpdfSeealsoLandonThomaslsquoProsecutorsbuildBearStearnscaseonemailsrsquoNewYorkTimes20June2008orHurtadoPatriciaandScheerDavidlsquoFormerBearStearnsfundmanagersarrestedbyFBIrsquoBloomberg19June2008
200AnotherillustrationofthedangerfacingfundsthatborrowGoldsteinMatthewlsquoBearStearnssubprimebathrsquoBusinessWeek12June2007
202Moodyrsquos announced it was cutting its ratings on 131 bonds See NgSerena and Kelly Kate lsquoIlls deepen in subprime-bond arena Wall StreetJournal18June2008
203In lateJuneBearStearnspubliclyannouncedSeeCreswell JulieandBajaj Vikas lsquo$32 billion move by Bear Stearns to rescue fundrsquo New York
Times 23 June 2007 Mackintosh James Scholtes Saskia and White BenlsquoBear hits other banks by raising exposure to subprimemortgagesrsquoFinancialTimes23June2007
206Anotherwasthedowngades that theratingsagencieswerethemselveswere starting tomake For a good timeline of those events seeBISAnnualReport2008pp95-9
207 The problem is that people just donrsquot know quite what to trustUnpublishedinterviewwithDonaldAikenbytheFinancialTimesAugust2007
207Thus while the IKB funds held more than $20 billion in assets Foraccounts of this see Gumbel Peter lsquoSubprime on the Rhinersquo Fortune 2September 2007 Mollenkamp Carrick Taylor Edward and McDonald IanlsquoImpact of mortgage crisis spreads - how subprime mess ensnared GermanbankrsquoWallStreetJournal10August2007
CHAPTERTWELVE
211 I see striking similarities with the early stages of our own financialcrisisAuthorinterviewSeealsoTettGillianlsquoFinancialfaithfoundwanting-JapanoffersasalutarytaleinbankingcrisesrsquoFinancialTimes2January2008Tett Gillian lsquoThe big freeze A year that shook faith in financersquo FinancialTimes3August2008
211BernankeobservedinaspeechbeforetheFederalReserveofChicagoChairman Ben S Bernanke at the Federal Reserve Bank of Chicagorsquos 43rdAnnualConferenceonBankStructureandCompetitionChicago17May2007
212Intheorderof$50billionto$100billionSeeDelBrunoJoelsquoSubprimefallout overblownrsquo Associated Press 21 July 2007 Aversa Jeannine lsquoFedbossreactstosubprimesituationrsquoAssociatedPress20July2007
212Or asBillDudley a senior figure at theNewYorkFederalReserveSpeechbyDudleytoaSIFMALegalandComplianceconferenceNewYork13June2007
212 In truthonlya thirdof those structureswere thought tobe linked tomortgages SeeBankofEnglandFinancialStabilityReportOctober2007 p19
214Quite honestly the funding never ordinarily kept us awake at nightlsquoDealoftheYearCairnHighGradeSIV-liteRestructuringrsquoRiskJanuary2007
219We are certainly not going to protect people from unwise lendingdecisionsDuncanGary lsquoGovernorwarnscareless lendersldquotheBankwillnotbailyououtrdquorsquoTheTimes9August2007
221TherearealotofinvestorswhoinvestedonaleveragedbasisCommenttaken from proceedings of Jackson Hole conference session on GeneralDiscussionHousingandMonetaryPolicyp480
221WhatweareseeingrightnowisatotaloverreactionIbidp483
222TherealissuerightnowisarunIbidp485
222 It is stunning how littlemany policymakers know TannenbaumCarl
blog on real-time economics Wall Street Journal 4 September 2007lthttpblogswsjcomeconomics20070904economists-react-views-from-jackson-holegt
225At the start of 2007 the rate of default on subprimemortgages SeeBankofEnglandFinancialStabilityReportOctober2007p17drawingfromdatafromMortgageBankersAssociationandThomsonFinancial
226Theaveragerateonanadjustablemortgagerosefrom35percent inlate 2005 Calculation by Citigroup based on Bloomberg data fromOpportunitiesinDislocationCitigroupOctober2007
226Therersquosnomodelforwhatrsquoshappeningnow IvryBoblsquoBernankewaswrong-subprimecontagionisspreadingrsquoBloomberg10August2007
226OwningahomehasalwaysbeenatthecenteroftheAmericandreamPresidentBushdiscusses homeownership in financingDepartment of theUSWhiteHouseFDCHRegulatoryIntelligenceDatabase31August2007
228Although the firmremainsprofitableRobertPestononBBCNews24830pm13September2007
229AttheturnofthecenturythebankhadembracedsecuritizationwithavengeanceFordataonthisseelsquoThefundingcrisisatNorthernRockrsquoBankofEnglandFinancialStabilityReportOctober2007pp10-11
229At the start of the year its website Tett Gillian lsquoElaborate debt dealsspreadriskbutdistortthedatarsquoFinancialTimes15January2007
233 I donrsquot know how anyone could characterize it as a bailout HolzerJessica lsquoSteel downplays governmentrsquos role in ldquosuperfundrdquo aimed at calmingmarketsrsquoTheHill16November2007
234 The performance particularly in the US housing [and] mortgagesector Freeland Chrystia and Scholtes Saskia lsquoView from the top RayMcDanielchiefexecutiveofMoodyrsquos InvestorsServicersquoFinancialTimes12October2007
234BySeptember2007more than30percentof thesubprimemortgageloansissuedinlate2005byFremontSeeBankofEnglandFinancialStabilityReportOctober2007p17sourcedtoBloomberg
237 Whereas in a CLO it is unlikely that all the loans default
simultaneouslyKingMattand team lsquoEstimatingCDOofABSwritedownsrsquoCitigroupFixedIncomeQuantitativeResearch6November2007
239Onecluetowhathadgonewrongcouldbefoundinthedrytechnicaldetails See the 10-Q filing by Citigroup to the SEC for the third quarter of2007p9fordetails
241ThelossesatUBSwerearguablyevenmoreshockingSeeShareholderReport on UBSrsquos Writedowns 18 April 2008lthttpwwwubscom1einvestorsshareholderreporthtmlgt
243We had seen what had happened after Enron Author interview withseniorauditorsandbankers
243Inthefirsthalfof2007 largeWesternbankshadpostedSeeBankofEngland Financial Stability Report October 2008 p 14 for data on capitalNotesthatglobalbanksbeforethecrisishadtier-onecapitalof$34trillion
246HugequantitiesofmoneyfromtheemergingworldHSBCreportcitedinElliotLarrylsquoGlobaleconomyOilmoneyiscoming-andthereislittletheWestcandoaboutitrsquoGuardian1March2008
250This isa relatively small transaction representingaround2percentOfficial release and statement lsquoNorthern Rock sells mortgage assets toJPMorganforpound225billionrsquoCitywire11January2008
252 In early2008SteveBlack repeatedly toldanalysts that thebankwasnotactivelypursuingmergers In factat thebankrsquos investorday inFebruary2008whenhewasasked ifhewoulddoa largeoverlapping investmentbanktransactionhesaidlsquoTheonlywaywewoulddoitwouldbeifyoucouldfindsomething that filled some strategic gaps where you got the overlappingbusinessesforfreersquo
254Asthefinancialwoesintensifiedinearly2008ThissectionisdrawnfrominterviewswithkeyparticipantsSeealsoKellyKatelsquoThefallofBearStearns(part1)LostopportunitieshauntfinaldaysofBearStearnsrsquolsquoThefallofBearStearns(part2)FearrumorstouchedofffatalrunonBearStearnsrsquolsquoThefallofBearStearns(part3)BearStearnsnearedcollapsetwiceinfrenziedlastdaysrsquoWall Street Journal 27 28 29May 2008 Burrough Bryan lsquoBringing downBearStearnsrsquoVanityFair1August2008BamberBillandAndrewSpencerBearTrapTheFallofBearStearnsandthePanicof2008BrickTowerPress2009
255On5MarchBearrsquoscashholdingsonpapertopped$20billionDataonliquidity levels from SEC as cited in Bank of England Financial StabilityReportApril2008p11
260We had been on the brink of the biggest financialmeltdown Quotestaken fromGruenAbby lsquoWallSt dances at newsofFedrsquos interest rate cut -somefearreliefwonrsquotbelong-termrsquoStarLedger19March2008
261Withthatonejaw-droppingdealDimonDashEriclsquoChieflivesuptotheMorgantraditionInpurchasingBearStearnsDimonemergesasamajorwinnerrsquoNewYorkTimes19March2008
263By2007theNewYorkFedcalculatedthatthecombinedassetsofallofthe SIVs See lsquoReducing Systemic Risk in a Dynamic Financial SystemrsquoTimothyFGeithnerPresidentandChiefExecutiveOfficerNewYorkFederalReserveremarksattheEconomicClubofNewYorkNewYork9June2008
CHAPTER15
266Alsointhespringof2008theInstituteofInternationalFinanceFinalReport of the IIF Committee onMarket Practices Principles of Conduct andBestPracticesRecommendationsIIFWashington17July2008
266AsBrickellstoodonthepodiumintheballroomoftheViennaHiltonSpeechtoISDAannualconferenceVienna16April2008
267CostlyasthosereformswillbethosecostswillbeminusculeCoveringletter from E Gerald Corrigan and Douglas Flint to Secretary Paulson andGovernor Draghi 6 August 2008lthttpwwwcrmpolicygrouporgdocsCRMPG-III-Transmittal-Letterpdfgt
268We face a race Tucker Paul lsquoTheNew Financial Frontiersrsquo speech toChatham House London 13 June 2008 atlthttpwwwbankofenglandcoukpublicationsspeedres2008speech348pdfgt
268ThoughsomearguedthatthoseABXpricefallshadgonetoofarSeeBankofEnglandFinancialStabilityReportMay2008p18
276 On 16 September the $62 billion Reserve Primary FundlthttpwwwreservefundscompdfsPress20Release202008_0916pdfgt
276By the summer of 2007AIGwas holding around $540 billion super-senior risk The account aboutAIG is drawn from interviewswith financierspreviously at the group supplemented by material drawn from transcripts ofAIGrsquos conference callswith investors on 31May and 5December 2007 Seealso Guerrera Francesco and Felsted Andrea lsquoInadequate coverrsquo FinancialTimes 6October2008MorgensonGretchen lsquoBehindcrisis atAIGa fragileweb of risksrsquo New York Times 29 September 2008 OrsquoHarrow Robert andDennis Brady lsquoDowngrades and downfall How could a single unit of AIGcause the giant companyrsquos near-ruin and become a fulcrum of the globalfinancialcrisisStrayingfromitsownrulesformanagingriskandthenfailingtoanticipatetheconsequencesrsquoWashingtonPost31December2008
284OnSunday13October2008JamieDimonreceivedanurgentphonecall This is drawn from author interviews supplementedwith LandlerMark
andDashEric lsquoDrama behind a banking dealrsquoNewYork Times 15October2008Undertheschemethegovernmentinitiallyagreedtoinvest$250billioninseniorpreferredbankstockhalfofwhichwasearmarkedforninelargebankshalf would be available to thousands of small and regional banks Theinvestmentscountedtowardseachbankrsquosbaseor tier-onecapital ratioUndertheoriginalplantheminimuminvestmentwassupposedtobe1percentofrisk-weightedassets themaximumupto$25billionor3percentofrisk-weightedassetswhicheverwasless
288Mark-to-market losses had almost reached $3 trillion See Bank ofEnglandFinancialStabilityReportOctober2008p14Theestimatecoversallthree main currency areas and refers to mark-to-market losses on financialassetsThesetotalled$285trillioninOctoberbutwerebelievedtohaverisenfurtherinthesubsequenttwomonths
288Banksand insurancecompanieshadalreadywrittendownmore than$1 trillion See Capital Markets Monitor February 2009 Institute ofInternationalFinanceWashingtonBanksaccountedformorethan$800billionofwrite-downsinsurancecompaniesfortherest
288TheFinancialTimescalculatedGilesChrislsquoPublicdebtsurgestowardspound1200billionmarkrsquoFinancialTimes20February2009
290When an industry dinner was held in London to hand out bankingprizes IFRawards for2008presented in January2009 JPMorganwonsixoutoftheninemaincategoriesconsiderablymorethananyotherbankhadeverdone
293Whatwe think of as the traditional hedge fundwill shrink FreelandChrystia MacIntosh Julie lsquoView from the top Andrew Feldstein chiefexecutiveofBlueMountainCapitalrsquoFinancialTimes19December2008
295OneBritishnewspaperdubbedherTeatherDavidlsquoBlytheMastersThewoman who built financial ldquoweapons of mass destructionrdquorsquo Guardian 20September2008
295AngrypostingsonthetheinternetSeelthttpwwwbloghercomblame-game-global-financial-collapse-fingers-are-pointing - one - woman - blythe -masters commentsgtlthttpzionistgoldreportwordpresscom20081110scam-artist-blythe-masters-speaksgt
295 When she addressed a meeting of SIFMA in late 2008 Openingcomments lsquoThrough the turmoilrsquo address to SIFMA Annual Meeting NewYork28October2008lthttpeventssifmaorg2008292eventaspxid=8566gt
Glossary
Asset-Backed Commercial Paper (ABCP) A short-term security thatcommonlylastsbetweenovernightand180daysItistypicallyissuedbyabankorotherfinancialinstitutionbackedbyphysicalassetssuchastradereceivablescommercialloansorholdingsofbondsUntil2007itprovidedcheapfunding
Asset-BackedSecurity(ABS)AsecuritythatisbackedbyportfolioofassetsorcashflowsfromassetsthatarenormallyplacedinaspeciallydesignatedvehicleThe assets areoften (but not always) loansThe assets areusuallydiversifiedideallytohelpreducerisk
BankCapitalThemarginbywhichcreditorsarecoveredifthebankrsquosassetsareliquidatedAmeasure of a bankrsquos financial health is its capitalasset ratio which bankregulationsrequiretobeaboveaprescribedminimum
BaselAccordA set of regulations that established levels of bank capital drawn up by theBaselCommitteeonBankingSupervision(BCBS)acommitteeofinternationalcentralbankersandsupervisorsThefirstaccordknownasBasel Iwasdrawnupin1988In2004aBaselIIaccordwaspublishedthatwasdesignedtoalignbankcapitalwithriskinaclosermannerThesecretariatforthecommitteeisintheBankofInternationalSettlementsintheSwisstownofBasel
Bistro(BroadIndexSecuredTrustOffering)JPMorganrsquosproprietarynamefortheideaofcreatingCDOsoutofcreditderivativesItwasfirst launchedin1997andwas theforerunnerfor thesyntheticCDOstructure that laterbecamewidespread
Collateralized Debt Obligations (CDOs) A form of asset-backed securityTheyaretypicallycreatedbybundlingtogetheraportfoliooffixed-incomedebt(suchasbonds)andusingthoseassetstobacktheissuanceofnotesSuchnotesusuallycarryvaryinglevelsofriskCashCDOsarecreatedfromtangiblebondsbondsorotherdebtsyntheticCDOsarecreatedfromcreditderivatives
CollateralizedDebtObligations ofAssetBackedSecurities (CDOofABS)CDOs built out of asset-backed securitieswhich are usually (but not always)typesofmortgage-backedbonds
CollateralizedLoanObligationsCDOsbuiltoutofloanswhichareusuallylsquoleveragedloansrsquo(thoseextendedtocompanieswhosedebtisratednon-investmentgrade)
ConduitAnentitythatfundsitselfbyissuingshort-termdebtandinvestsinassetssuchastrade receivables commercial loans or bonds It is backed up by credit linesfromabankandcloselyaffiliatedwithabankbutitdoesnotalwaysappearonabankbalancesheetStructuredinvestmentvehicles(SIVs)arecloselyrelatedto
conduits
CorrelationThedegreetowhichassetpriceseventsorrisksmoveinthesamemanner
CreditDefaultSwap(CDS)Acontractbetween twopartieswhere thebuyerpays a regular fee to the seller in exchange for a guarantee that they will becompensated in the case of any default on a stipulated piece of debt CDScontractsaresimilar to insurance insomesensesbut theyarenot regulated inthesamemannercanbefreelytradedandcanbestruckevenifthebuyerdoesnotownthedebttheywishtolsquoinsurersquo
CreditDerivativesA bilateral contract between a buyer and seller whose value derives from thecredit risk attached to an underlying bond loan or other financial assetTypically they are designed to compensate one party if that underlying assetgoesintodefaultCDSs(creditdefaultswaps)areoneformofcreditderivativesbutnottheonlyone
DerivativeA financial instrument whose value derives from an underlying asset mostnormallycommoditiesbondsequitiesorcurrencies
GaussianCopulaAstatisticaltechniquedevelopedbyDavidLiaformerJPMorgananalystformeasuringthelevelofcorrelationanddefaultprobabilitiesinCDOs
LeverageTechniquesthatcanmagnifyreturns(orlosses)Thephraseismostcommonlyused to refer to debt since the application of debt to a financial structure orstrategy canmagnify returns and lossesHowever less commonly the phrasecan also be used to describe themanner inwhich the structure of a CDO orotherderivativemagnifiesinvestorexposuretopriceswings
LeverageRatioMostcommonlyusedtodescribetheratiobetweenequityanddebtorearningsanddebt
LeveragedFinanceFundingforcompaniesthatcarryaratingbelowinvestmentgradeThisincludeshigh-yield bonds (bonds to companies rated below investment grade) and
leveragedloans(loanstothesamecategoryofcompanies)Inthisdecadeithasbeenwidelyusedtofundprivateequitybidsalsoknownasleveragedbuyouts
LiquidityThedegreetowhichassetscanbetradedfreelyornot
Mortgage-BackedBondSecurityBondsthatareissuedfromaspecial-purposevehicle that holds a portfolio of mortgages These bonds are often issued inseveraltranchesofriskiness
RepurchaseorlsquoReporsquoMarketAmarketwheretwoparticipantsagreethatonewillsellsecuritiestoanotherandmakeacommitmenttorepurchaseequivalentsecuritiesonafuturespecifieddateoroncallataspecifiedpriceIneffectitisa way of borrowing or lending stock for cash with the stock serving ascollateral
SpecialPurposeVehicleAshellcompany that iscreated toholdaportfolioofassets suchasbondsorderivativescontractsandthenissuesecuritiesbackedbythoseassetsItmaybecreatedbyabankbutisaseparatelegalentity
Structured Investment Vehicle (SIV) An entity that operates in a mannersimilar to a conduit butwhichdoes not enjoy complete credit support fromabankandisoftenruninamannerthatismoreindependent
Super-Senior Risk The most senior part of the capital structure of a CDOwhichistheleastexposedtotheriskofdefaultSuchriskalwaysusedtocarrytriple-Adesignationsfromthecredit-ratingsagencies
TrancheAclassofsecuritiesthatareissuedbyacollateralizeddebtobligationorasset-backedsecuritythatcarriesacertainlevelofriskNormallyCDOsissueseveraldifferent tranches of securities including a senior tranche (least risky) juniortrancheorequitytranche(mostrisky)andmezzaninetranche(inbetween)
AcknowledgementsThisbookcouldnothavebeenwrittenwithout thehelpofavastnumberof
peopleonbothsidesoftheAtlanticwhohavegenerouslygiventheirtimeovermany years to helpme understand how the financialworldworks (andmorerecently how it ceased to function) These thoughts and conversations haveentwinedtocreatethetapestryofthisbookManyofthebankersregulatorsandinvestorswhohaveprovidedinspirationforithaveaskedtoremainanonymousThatisnosurprisegiventhecurrentpoliticalclimateButwhileIhavenotcitedtheirnamestheyknowwhotheyareandIwishtostressthatIamtrulygratefulfortheirtimeThanksshouldalsobegiventothenumerousformerandcurrentstaffofJPMorganwhohavetalkedtomeonmanyoccasionssinceearly2005ThebankdidnotinitiatethisprojectandithasnotapprovedthisbookOnthecontrarysomeJPMorganemployeeswereextremelyuneasywhentheyfoundoutthatIplannedtowriteabookandafewactivelytriedtodissuademeIntheendthoughalmostallgraciouslyrespondedtomyquestionsandsomedevotedmanyhourstotryingtoexplaintheirstoryIfIhavemisunderstoodtheirtalethemistakesareentirelymineMyemployertheFinancialTimesgenerouslyallowedmetotaketimeoffto
pursue thisproject even in themiddleofacredit crisis I ammostgrateful toLionelBarberandMartinDicksonrespectivelyeditoranddeputyeditorIfirststarted trying to wade through the alphabet soup of the credit world back in2005 in tandemwithmyFT colleagues and along the way I have benefitedenormously from their insights and help Particular thanks are due toRichardBealesChrisBrown-Humes JoannaChungPaul JDaviesAlineVanDuynFrancesco Guerrera Jennifer Hughes Michael Mackenzie Sam Jones DavidOakleyAnoushaSakouiSaskiaScholtesHennySenderGarySilvermanandPeterThal-LarsenJanetTavakoliSatyajitDasandArturoCifuentesweresomeof the fewmavericks who were willing to speak openly to theFT about thelooming credit dangers at an early stage In various stages of writing AdamRidleyCharlesMorrisHenry FajemirokunKeithHart and SatyajitDas readvarious drafts and offered extremely helpful comments Henny Sender alsoofferedverykindlogisticalsupportPascalSpreenShannonGitlinandMadhaviPulapaka conducted research Merryn Somerset Webb has been a wonderful
source of support over the years Sophia Arnold andMarthaMehta providedintellectual inspiration andwelcome laughter I am also very grateful toKeithHart and other senior anthropologists for advice The postgraduatework I didfifteen years ago in the social anthropology department of CambridgeUniversityunderErnestGellnerandCarolineHumphreyinstilledananalyticalframework that deeply influencesme even todayMore recently I have alsogreatly benefited from debates at the London School of Economics and theUniversityofWestminsterMy agent Amanda Urban (Binky) at ICM in New York was endlessly
supportiveaboutthebookprojectevenbackinearly2007whenitwaswildlyunfashionabletotalkaboutCDOsandCDSKarolinaSuttonatCurtisBrowninLondonwasveryhelpfultooEmilyLooseatFreePressinNewYorkworkedextremely hard under brutally tight deadlines to turnmy text into a book thatwould be readable by a wide audience She did a truly remarkable job I amthankfultothemallManythanksalsotoTimWhitingandZoeumlGullenofLittleBrowninLondonforturningthecopyintoabookthatwouldmakesenseforaBritishaudiencewithgreataplombAt critical junctures Cynthia Fajemirokun Esmond Naylor Peter and
RomaineTettallofferedvalueddomesticsupportPriyaPatelandJuliePhilipsprovided help with childcare The biggest thanks though must go to HenryFajemirokun whose profound insight and determination to challenge theacceptedwisdom have been a central source of intellectual inspiration formeovertheyearsinrelationtothisbookandmuchelseIamalsoverygratefulforhissupportduringthefrenziedwritingprocessSayinglsquothankyoursquosoundsglibbutImeanit
Index
ABNAMROAbuDhabiInvestmentFundABXindexCDOsandAllianceBootsAmaranthcollapse(2006)AmericanInternationalGroup(AIG)ArthurAndersenAsianmarketslsquoasset-backedcommercialpaperrsquo(ABCP)sectorauditorsAustralia
BankofAmericaBankofEnglandbankingcrisisandlsquoself-regulationrsquoandBankofInternationalSettlements(BIS)BankOnebankerscognitivemapsofBankersTrustbankingsectorBritishgovernmentrescuepackage(October2008)capitalreservesseecapitalreserves requirements European banks hoarding of cash and (2007) interbankmarketlosseslosses(subprimesector)profitspublic outrage at US government rescue deals see also commercial banksinvestmentbankingshadowbankingsystemBarclaysBankBarclays Capital Basel Accord (1988) Basel II (2004) Basel Committee ofBanking Supervision (BCBS) Batchvarov Alexander Bayerische LandesbankBearStearnscredit derivatives and Federal Reserve and hedge funds and JP Morganpurchase of (March 2008) lsquoreporsquo (lsquorepurchasersquo) market and Beese J CarterBentsenLloydBernankeBenBestTonyBistro(lsquobroadindexsecuredtrustofferingrsquo)mortgagefinanceandlsquosuperseniorriskrsquoandBlackSteveBearStearnspurchaseandBlack-ScholesformulaBlairTony
Blair administration (1997-2007) Blankfein Lloyd BlueMountain Capital(Feldsteinhedgefund)BNPParibasBocaRatonhotelFloridaBorioClaudioBostonConsultingGroupBowsherCharlesBradfordandBingleyBrazilBrettonWoodssystemBrickellMarkISDAandBritishgovernmentbankrescuepackage(October2008)NorthernRockandseealsoBankofEnglandbrokeragesseealsoBearStearnsGoldmanSachsLehmanBrothersMorganStanley(USbrokerage)BrownGordonBundesbank German Bush administration (2001-9) Business Week magazinebuyoutgroups
CableVinceCairnCapitalCalelloPaulCanadaBankofcapitalreserverequirementscreditderivativesandJPMorganandlsquocarrytradersquoCase-Schiller indexCassano JosephCazenove (UKcorporate advisorygroup)CDXindexChanosJimChase Home Finance Chase Manhattan JP Morgan merger (2000) ChicagoUniversityofChicagoBoardofTradeChicagoMercantileExchangeChinaCioffiRalphCiprianiballroomconference(1999)CiscoCitibankCitigroupCDOsandJamieDimonandlosses(2007)shadowsystembailoutplan(2007)SIVsandsizeoflsquosuperseniorriskrsquoandCityofLondonderivatives market regulatory systems see also Bank of England regulatoryauthoritiesinUKClintonadministration(1993-2001)CMBXindex
CollateralizedDebtObligations(CDOs)ABCPsectorandABXindexonbanksrsquobooksBearStearnsandbundlesandlsquotranchesrsquoCDOofABSCDOofABSmezzaninelsquoCDOsquaredrsquoCitigroupandfromcorporateloansderivative-basedEuropeandgrowth ofmarket JPMorgan and lack of knowledge ofMerrill Lynch andlsquomonolinersquoinsurancecompaniesandpriceinformationandratingsagenciesandrisk-assessmentmodelsandlsquosubprimersquomortgagesandlsquosuperseniorriskrsquoandseelsquosuperseniorriskrsquoswaps team and lsquosynthetic CDOsrsquo see also Collateralized Debt Obligations(CDOs) mortgage-based Collateralized Debt Obligations (CDOs) mortgage-basedBearStearnsandCDOofABS(asset-backedsecurities)CitigroupandEuropeandIKBandJPMorganandMerrillLynchandUBSandcommercialbankscommercialpapermarketsABCPsectorcommodities derivatives Commodities Futures Modernization Act (2000)CommoditiesFuturesTradingCommission(CFTC)conduitsbankCongressbillsonderivatives(1994)consultancyfirmsContinentalIllinoisBankcollapseCookePetercorporate and commercial loans capital reserves and CDO business andderivatives and JP Morgan and repackaging and corporate bonds businesscorrelation of default risks Gaussian copula model and Corrigan E Gerald(Jerry)LTCMreport(1999)report(2005)report(2008)CostasJohnCountrywide(mortgagelender)creditboomcreditcarddebtlsquocreditdefaultswapsrsquo(CDS)assigningofindicesofseealsoABXindexJPMorganandmortgagebusinessandvalueofseealsoBistro (lsquobroad indexsecured trustofferingrsquo)creditderivativescreditderivativesbacklogsinprocessingofBankersTrustandBearStearnsandBocaRatonoff-sitemeeting(June1994)bundlesandlsquotranchesrsquocapitalreservesrequirementsandCDOsandCFTCandCitibankdeal
Corrigan report (2008) and Bill Demchak and dot-com bubble burst andEuropean markets Exxon Oil deal Federal Reserve and Alan Greenspan andgrowth of market Peter Hancock and hedge funds and industrialization ofinternalcreditlimitsandJPMorganandLehmanBrothersandLondonmarketBlytheMasters and misuseperversion of mortgage finance and offsetting of(2009)originsofconceptSIVsandSPVsandswapsteamandUSregulatoryauthoritiesandvalueofBillWintersandseealsoBistro(lsquobroadindexsecuredtrustofferingrsquo)lsquocreditdefaultswapsrsquo(CDS)derivativesswapsCreditSuisseCrystalJohncurrencyderivatives
Davosannualmeetingdefaultriskcorrelation and insuring against see lsquocredit default swapsrsquo (CDS) creditderivativeslackofdataonmortgagefinanceandseealsolsquocreditdefaultswapsrsquo(CDS)DemchakBillcreditderivativesandJPMorganandPNCBankandlsquosuperseniorriskrsquoandswapsteamanddenBraberRonderegulationderivativescorporate and commercial loans business E Gerald Corrigan and currencyderivativesG30reportandhighleverageproductsindicesofinterestratederivativesISDAandJPMorganandseealsocreditderivativesderivativesteamatJPMorganseeswapsteamJPMorganDeutscheBankDeutscheIndustriebank(IKB)DexiaDiamondBobDillonReadCapitalManagementDimonJamieBearStearnspurchaseandCitigroupandcreditcycleandDavosannualmeeting(2009)LehmanBrothersandmortgagefinanceandshadowsystembailoutplanand(September2007)USgovernmentbankrescuedealandSandyWeillandDonaldsonAndrewdot-combubbleburstingofDraghiMarioDrexelBurnhamLambertfailureDrexelMorganampCompanyDudleyBill
DuhonTerri
TheEconomistEnronEquityOfficePropertieseurotheEuropeanBankforReconstructionandDevelopment(EBRD)EuropeanbanksEuropean Central Bank (ECB) European governments European marketsEuropean Securitisation Forum (ESF) Euroweek magazine Evening Standard(London)ExxonOil
FamaEugeneFFannieMaeFederalReservesystemBearStearnsandbrokeragesandcommercialbanksandcreditderivativesandinterestratesandLehmanBrothersandaslsquolenderof lastresortrsquoNew York Federal Reserve Feldstein Andrew hedge fund (BlueMountainCapital) macroeconomic hedges (2007) Ferguson Roger Financial ServicesAuthority UK (FSA) Financial Times Fitch credit-rating agency Forbesmagazine foreign exchange sector currency derivatives Fortune magazineFreddieMacfree-market ideology Alan Greenspan and Peter Hancock and politicians andFreundPeterFroelichPaulaFrostTimCairnCapitalandFTSEindexFuldRichardfutures
G8meeting(WashingtonDC2007)GasparinoCharlieGaussiancopulamodelGeithnerTimothyGeneralAccountingOfficeUS(GAO)GeneralMotorsGermanyGileBetsyGlass-SteagallAct(1933)GlobalCrossingglobalizationGoldmanSachs
BearStearnsandEGeraldCorriganandderivativesandhighprofitsJPMorgan merger discussions (2000) Gonzalez Henry Goodwin Sir FredGoreAlgovernmentbondsUSGreenStephenGreenspanAlanfree-marketideologyandinterestratesandGroupofSevenGroupofThirty(G30)
HammersmithandFulhamBoroughCouncilHancockPetercredit derivatives and free-market ideology and The JP Morgan Guide toCreditDerivativespromotionsswapsteamandHarrisonWilliamHayekFriedrichvonHBOShedgefundsBear Stearns and credit derivatives and Andrew Feldstein and G8 meeting(April2007)andLehmanBrothersandleverageandlossesatlsquomark-to-marketrsquoprinciplesandUBSandhedgesmacroeconomicHerstattBankcrisis(1974)HornbyAndyhousingmarketUKhousingmarketUSdownturn(2006-8)housepricesinterestratesandlackofdefaultdataonHSBC
IBMIcelandinflationinnovationJamieDimonandPeterHancockandlsquoinnovationcyclersquonegativeresultsandSwapsteamandtechnologyandseealsocreditderivativesderivatives Institute for International Finance (IIF) report (2008) insurancecompanieslsquomonolinesrsquointerestratederivativesinterestratesFederalReserve and InternationalMonetary Fund (IMF) International Swaps
and Derivatives Association (ISDA) internet the see also dot-com bubblelsquoinversersquo floater products investment banking commercial banking and JPMorganandinvestmentfundsIslamicfinanceItalyBankofiTraxxindex
JacksonHoleconferencesJainAnshuJapanbankingcrisis(late1990s)JCFlowersJonesDavidJPMorgan(alsoJPMorganChase)lsquoAAArsquocreditratingAIGandBear Stearns and capital reserves requirements and CDO business and CDSbusinessandChaseManhattanmerger (2000) lsquoCommercialBankManagementProgramrsquocorporate and commercial loans credit derivatives and culture and ethos ofderivativesandJamieDimonanddot-combubbleandEnronandG30reportandGlass-SteagallAct(1933)andlsquoheritagebankersrsquoandhistoryofinternalcreditlimitsinvestmentbankingLehmanBrothersandleveragedloansandLondonoperationsseealsoWintersBillmergersandacquisitionsandM-lec (superfund) and mortgage finance and New York Federal Reserve andNorthernRockandrebranding(2008)resultsrisk management and shadow system bail out plan and (September 2007)strategy (late 1990s-2000) lsquosupersenior riskrsquo and see also swaps team JPMorganTheJPMorganGuidetoCreditDerivativesjunkbonds
KaraHomesKerrIanKimDowKingBillKingMattKingMervynKnightMalcolmKodweisJohnKoreanDevelopmentBankKovacevichRichardKuipersAndyKurerPeter
LagardeChristineLatinAmericandebtcrisisLCDXindexLehmanBrothers bankruptcy (September 2008) credit derivatives and LereahDavidleverageCDOsanddefinitionsofderivativesproductsandhedgefundsandlsquoleverageratiorsquoleveragedloansLevingtonGarethLewisKennethLiDavidLiborrateLimTJLippmanGreglsquoliquidityputsrsquoLittlewoodDavidLloydsTSBLongTermCapitalManagement(LTCM)LongTermCreditBank(LTCB)
MahoniastructureChaseManhattanMarkeyEdwardlsquomark-to-marketrsquo principles Master Liquidity Enhancement Conduit (M-lec)(superfund)MastersBlythecapitalreservesrequirementsandcreditderivativesandmarketingandpromotionslsquosuperseniorriskrsquoandmathematicsMazataudPaulMcCulleyPaulMcDaniel Raymond McKinsey consultants McNulty Cynthia MendozaRobertomergersandacquisitionsJPMorgan-BearStearnsJPMorgan-ChaseManhattanmerger(2000)MerrillLynchBankofAmericamergerBearStearnsandCDOsandderivativesandlosses(2007)mortgage business and Orange County scandal (1994) revenues and profitslsquosuperseniorriskrsquoandConnieVolstadtandMertonRobertMiddleEasternfundsMilkenMichaelMillerMertonHmoney-market fund sector lsquomonolinersquo insurance companiesMontanaBoard ofInvestmentsMoodyrsquoscredit-ratingagencyMorganGrenfell (Britishbrokerage)MorganGuarantyTrustCompany (lsquoTheMorganBankrsquo) see also JPMorganMorgan Stanley (US brokerage) Dean Witter acquisition mortgage business
Bistro-styletradesandlsquocreditdefaultswapsrsquo(CDS)anddefaultriskdefaultslossesinsee also mortgage-backed securities lsquosubprimersquo mortgage sector mortgage-backedsecuritiesbundlesandlsquotranchesrsquoCDS trades and credit derivatives and JP Morgan mortgage lsquopipelinersquo andMerrillLynchandpackagingrepackagingpricesofSIVsandSPVsandBillWintersandseealsoCollateralizedDebtObligations (CDOs)mortgage-basedMussaMichael
NakasoHiroshiNASDAQNatWestBankNew York Federal Reserve New York State Bankers Association New YorkTimesNice(France)NorthernRock
ObamaBarackoff-balance-sheet activitiesOffice for Thrift Supervision (OFT)Officer of theComptrolleroftheCurrency(OCC)OliverWymanconsultantsOrsquoNealStanoptionsOrangeCountyscandal(1994)OspelMarcuslsquoover-the-counterrsquodeals(OTCtrades)
PaineWebberPanditVikramPardueCharlesPartridge-HicksStephenPaulsonHenrypensionfundsPestonRobertPimcoPNCBank
PrestonLewisPricewaterhouseCoopersPrinceChuckprivateequitycompaniesProcterampGamblePutinVladimir
QuinnBrian
Rajendra Ganesh RAROC (riskmeasurement system) ratings agencies CDOsandratingscaleratingscutsandreviewsregulatoryauthoritiesEuropeanfailuresofinternationalseeBaselAccord(1988)regulatoryauthoritiesinUKbanking crisis and City of London Financial Services Authority UK (FSA)lsquolight touchrsquo of Labour government see also Bank of England BritishgovernmentregulatoryauthoritiesinUSAbankingcrisisandCFTCcommercialbanksandcreditderivativesandGlass-SteagallAct(1933)OfficeroftheComptrolleroftheCurrency(OCC)SecuritiesandExchangeCommission(SEC)seealsoFederalReservesystemNewYorkFederalReserveTreasuryUSUnitedStatesgovernmentReochRobertlsquoreporsquo (lsquorepurchasersquo) market Reserve Primary Fund Risk magazine riskmanagement Jamie Dimon and see also default risk risk-assessment modelslsquosuperseniorriskrsquorisk-assessmentmodelsCDOsandGaussiancopulamodellimitationsofVaRRobbinsdaleAreaSchoolsdistrictRockefellerFoundationRohatynFelixRohatynNickRoseClaytonRosnerJoshRoyalBankofScotland(RBS)RubinRobertRussia
SampP500indexSallieMae(USstudentloanprovider)SalomonBrothersIBM-
WorldBankdeal(1981)SanfordCharlesSavingsandLoanscrisis(late1980s-early1990s)SchwartzAlanSecurities and ExchangeCommission (SEC) Securities Industry and FinancialMarkets Association (SIFMA) securitization concept see also Bistro (lsquobroadindex secured trust offeringrsquo) Collateralized Debt Obligations (CDOs)mortgage-backedsecuritiesshadowbankingsystembailoutplan(2007)collapseof(2007-8)seealsoCollateralizedDebtObligations(CDOs)creditderivativeshedge funds structured investment vehicles (SIVs) shell companies SheratonHotel(NewYork)meeting(2000)ShettyRomitaSiderisIanSingaporesocialanthropologySossidisNicholasSpainspecial purpose vehicles (SPVs) Spector Warren Standard amp Poorrsquos credit-ratingagencyStandardCharteredSteelRobertSteinbruumlckPeerstockmarketsStottJakobStrauss-Kahn Dominique structured investment vehicles (SIVs) Cairn CapitalandCitigroupandcommercialpapermarketsandIKBandproliferationofregulatoryauthoritiesandstudentloanslsquosubprimersquomortgagesectorABXindexseeABXindexdefaultslossesinUSregulatoryauthoritiesandlsquosuperseniorriskrsquoAmericanInternationalGroup(AIG)andBistroandCitigroupandJPMorganandMerrillLynchandUBSandswapsSalomonBrothersandseealsolsquocreditdefaultswapsrsquo(CDS)creditderivativesswapsteamJPMorganbankingcrisisandBistroandCiprianiballroomconference(1999)creditderivativesanddispersaloffemalemembersG30reportandInvestorDerivativesMarketing(IDM)groupJPMorgan Chase and Nice conference (1995) personal and social liveslsquosuperseniorriskrsquoandswapsdealssee also Demchak Bill Duhon Terri Feldstein Andrew Frost TimHancockPeterMastersBlytheWintersBillSwensenDavidSwissBankCorporationSwissNationalBankSwissRe
lsquosyntheticcollateralizeddebtobligationsrsquo
TABXindexTannenbaumCarlTanninMatthewtaxationTaylorAllantechnologycreditderivativebacklogsandrisk-assessmentmodelsThainJohnThiekeStevenTollBrothersTravelersGroupTreasuryUKTreasuryUSbank rescue deals and Trichet Jean-Claude Troubled Asset Relief Program(TARP)TuckerPaulTXU
UBSUnited Kingdom (UK) see Bank of England British government City ofLondon United States government bank rescue deals federal agencies Glass-SteagallAct (1933)M-lec (superfund)andregulatorypoliciesseealsoFederalReservesystemregulatoryauthoritiesinUSATreasuryUSTroubledAssetReliefProgram(TARP)
Value at Risk (risk measurement system VaR) van Acoleyen KatrienVarikootyKrishnaVeroudeAlexVoickePeterVolckerPaulVolstadtConnie
WachoviagroupWallStreetCrash(1929)
WallStreetJournalWarnerDouglaslsquoSandyrsquoWashingtonMutualcollapseWatsonRickWeatherstoneDennisG30reportandrisk-assessmentandWeaverKarenWeberAxelWeillSandyJamieDimonandWellsFargo(mortgagelender)WenJiabaoWhalenChristopherWhiteBillWintersBillBearStearnspurchaseandcreditderivativesandIKBandmortgage finance and shadow system bail out plan and (September 2007)swapsteamandWinters-BlackpartnershipwomenworkingcomWorldBankWorldTradeCenterattack(11September2001)WorldCom
ZandiMarkZeitlinBrian
- Title Page
- Copyright Page
- Dedication
- PART ONE - Innovation
- PART TWO - Perversion
- PART THREE - Disaster
- Epilogue
- Notes
- Glossary
- Acknowledgements
- Index
-