Tuesday, May 12, 2009 at 12:24 pm
Gillian Tett tells how JP Morgan made credit derivatives big, then backed off before they blew up
The FT hosted a breakfast this morning where Gillian Tett promoted her new book about derivatives and the financial crisis, Fool's Gold. There was a great moment during the Q&A when NYT columnist Joe Nocera started off, "There's this character in your book, Mark Brickell ..."
"He's sitting behind you," Tett interrupted. At which point Joe and the rest of us turned around to look at the nattily attired man sitting on the windowsill.
Brickell is really the closest thing to a villain in Tett's book—a former J.P. Morgan derivatives guy who in the 1990s became the point man in the banking industry's effort to keep Congress from subjecting over-the-counter derivatives to regulation. Yet he showed up at Tett's book event, which tells you something about her style. She's a reporter (and a social anthropologist with expertise in Tajik wedding rituals) on a hunt not for villains but for explanations.
To me this is the great strength of her book, which tells the story of the team at J.P. Morgan that popularized credit derivatives in the 1990s (they didn't invent them; some people at Bankers Trust did that) and then pulled back during the great credit-derivatives-enabled housing insanity of the 2000s. I read it cover-to-cover on a flight out to L.A. a couple weeks ago, and while the J.P. Morgan focus keeps it from being anything like a definitive account of the credit crisis, this peculiar perspective delivers all sorts of insights that a more conventional account might not. Mainly it shows how hard it is to resist the demands and temptations of a financial market gone mad—JP Morgan Chase succeeded in doing so, Tett argues, only because of the lucky marriage of a time-honored-if-beleaguered culture of responsibility, risk-assessment, and long-term thinking inherited from the old J.P. Morgan with the similarly risk-aware approach of new CEO Jamie Dimon. But that turned out to be a rare combo: Citi, Merrill and UBS sure didn't have it.
The book also comes closer than anything I've read to nailing down the connection between the rise of credit default swaps and all the craziness in housing finance. It doesn't entirely nail it—when Tett gave Brickell a few minutes to speak this morning, he confidently denied that there was any connection at all. But Tett's account of the enabling role that CDSes played certainly makes me suspect that there was something there.
Finally, there's this point in my book (now less than a month from publication) where I'm discussing Robert Merton, Steve Ross and their 1970s options-pricing theories and I write:
The rise of these derivatives, as Ross called them, became one of the great financial stories of the next quarter century. Chronicling it adequately would require a book of its own.
Again, Tett's book doesn't entirely do that—it's not what she set out to do. But reading it I kept getting the sense that it was filling in big holes in my narrative (which I'd left because I didn't want to spend two more years expanding my book to 700 pages). So it's nice to see that on my book's Amazon page there's a recommendation to buy the two books together—for a mere $34.07."
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Tuesday, May 12, 2009 at 5:51 pm
"he confidently denied that there was any connection at all"
I tend to agree with him, in the sense that I don't see these products as the cause of anything. I think that they enabled some poor and/or criminal investments, but that's simply because they fit the requirements that these leverage happy investors craved.
Here's his basic view:
http://www.forbes.com/2008/09/22/solutions-finance-regulation-oped-regsolutions08-cx_mb_0922brickell.html
"Regulators should, in particular, consider the impact of government policies on housing finance, since no sector of U.S. financial markets has more state involvement. Investments in housing may have been stimulated by a series of policies--the "implicit guarantee" of Government-Sponsored Enterprises' liabilities, mandated investments in "affordable housing," lower bank capital requirements for mortgages than for corporate loans--that could reduce market discipline."
I agree, except for the focus on GSEs. The entire system was under an implicit guarantee, of which GSEs are a small part. I like this better:
http://blogs.wsj.com/economics/2009/05/11/feds-lacker-safety-net-could-be-more-limited/
U.S. Federal Reserve Bank of Richmond President Jeffrey Lacker said late Sunday that a more limited financial safety net would help stabilize the financial system.
lacker_A_20081016134646.jpg
Lacker
“I believe that a strong case can be made that the financial safety net, especially those parts that were more implicit and perceived than explicit and written into laws, played a significant role in the accumulation of risks that ultimately led to the turmoil we are still experiencing,” he said in prepared remarks to a banking conference in China.
Lacker argued that the presence of a government safety net limits the incentive for too-big-to-fail institutions to prepare for liquidity disruptions, “thus increasing the likelihood of crises.”
That was the underlying assumption that the big time investors and bankers were working under. Without these implicit guarantees, nothing on earth would have led them to try such risky investments. From my point of view, this system has been in place since the 1980s. What has happened has just confirmed my point of view, as did the S and L Crisis, way back when.