Fool’s Gold: How unrestrained greed corrupted a dream, shattered global markets and unleashed a catastrophe - Gillian Tett
They say Hollywood blockbusters should start with an explosion and work their way up to a climax and so it is with the title and sub title here. In fact, it slightly misrepresents the book, since what’s inside the covers is not sensationalist in tone, even while the subject matter certainly is.
The author is a well-respected journalist at the Financial Times, and this book, first published in 2009 is not only one of the earliest contributions to the narrative of the credit bubble, but has become almost part of that history since it was published so soon after it occurred, with the author one of the few journalists who realised the crash was coming.
The opening sentence of the preface to the paperback edition, written in December 2009 sees Gillian Tett set out her stall,
“Back in early 2007, before the credit bubble burst, I hit upon the idea of writing a book about credit derivatives and other forms of complex finance because I thought the public should understand more about the dangers they posed.”
Tett admits that the crash was caused by “Poor mortgage regulation, global savings imbalances, a failure of bank oversight, lax credit ratings, a crazy consumer debt binge, as well as excessively loose US monetary policy all played critical roles too....”
but she sees a key issue:
“... one that exacerbated the credit bubble during the boom – and then vastly complicated the disaster when the bubble burst – was the presence of all those credit derivative contracts.”
In telling the story of a financial crash that affected every one of us, and which has so many participants, every author has to make a choice of the hook or angle on which to hang the tale. There are various narrative devices that can be employed to make the debacle personable and understandable. We are amazed by the figures, of course, those billions gambled, the trillions lost, but we also need characterisation if we are to care, and so books such as this search out individuals who played a part, often small, but instructive nevertheless, and invite us to sympathise with them, perhaps even view them as emblematic.
In the case of Michael Lewis’ The Big Short (click here for a review), the characters are those financiers who saw the crash coming and bet big time against it. Tett’s book, published earlier than most, focuses on origins and the particular specialism Tett had been reporting for the Financial Times – credit derivative contracts, then uses that as a way of exposing general failings within the firms and the financial system as a whole.
Tett takes us back to a summer weekend in 1994 at the Boca Raton resort in Florida where a group of JP Morgan bankers had a get-together to think of new financial products. Various bankers are introduced to us, characters deftly if perfunctorily drawn, and the challenge identified.
“They were there for an off-site meeting, called to discuss how the bank could grow its derivatives business in the next year. In the humid summer heat, amid the palm trees and gracious arches, the group embraced the idea of a new type of derivative that would transform the wider world of twenty-first finance, and play a decisive role in the worst economic crisis since the Great Depression.”
What they come up with is a way of “... using derivatives to manage the risk attached to the loan book of banks.” In the words of one of the participants. “It was not until many years later that the team grasped the full implication of their ideas known as credit derivatives. As with all derivatives, these tools were to offer a way of controlling risk, but they could also amplify it. It all depended on how they were used.”
Put simply, Tett’s tale is the classic disaster movie narrative. We know the skyscraper will burn down, the dinosaurs will run wild and the ship will hit an iceberg, but the people involved can’t hear us shouting “It’s behind you” in best pantomime fashion. The JP Morgan bankers find a new way of minimising risk while creating a way of other bankers to help contribute to a “...worldwide financial catastrophe”.
The way Tett describes it, difficult concepts become easy to understand. Previously the problem of default risk (i.e.: a borrower not repaying a loan or bond) had seen banks take obvious steps such as lending only to those it thought would pay it back or diversifying the risk by lending to many customers, rather than just a few. Banks might also club together to make joint loans, and also impose a limit on how much they loaned to specific sectors such as housing.
But the JP Morgan banker, synthesising ideas already about in the market asks the question, “What if the default risk could be sold on?” Wouldn’t that remove risk from the bank, allowing it to make more loans, it would also shift the credit risk from the balance book, and so avoid the Basel I accord, which stipulated capital requirements for loans.
The story that follows is how a basically sound idea is misused to do the opposite of minimise risk, earning huge bonuses for the banks, and eventually tipping the world economy into financial meltdown. Since anyone reading the book knows what’s going to happen (and if they didn’t, the title would give it away), the book relies for its interest on pointing out the short-sightedness of many involved, but also the wilful ignorance of the few. Tett has a background as an anthropologist, and her observations are interesting:
“... the finance world’s lack of interest in wider social matters cuts to the very heart of what has gone wrong.... Bankers have treated their mathematical models as if they re an infallible guide to the future, failing to see those models were based on a ridiculously limited set of data. A “silo” mentality has come to rule inside banks, leaving different departments competing for resources, with shockingly little wider vision or oversight”
I think she’s a little soft on banks here, since even those with basic accounting skills are aware of the pitfalls of projections and mathematical models. I think the real reason the bankers looked away was they were making so much money from it all. When it all fell apart, the defence of most of them was that they had never known, and for the few who did know, it was that the regulators should have stepped in to impose rules to stop his sort of thing occurring. Both explanations are self serving, something Tett hints at:
“Anthropology also instils a sense of scepticism about official rhetoric... elites try and maintain their power... by dominating the mainstream ideologies, both in terms of what is said, and also what is not discussed. Social “silences” serve to maintain power structures in ways that participants often barely understand, let alone plan.”
I’d agree with all of that apart from the let off at the end. I think bankers do understand, which is why they spend so much time lobbying regulators and governments to leave them free to be. Except, of course, when they need bailing out.
Tett argues that “...what is needed is a wider rethink of the culture of finance. For too many years brokers have treated “credit” as merely an isolated game of numbers”.
This may be true, but since the rest of us know exactly what happens when we personally or through work - are extended too much credit (i.e.: take on too much debt), it beggars belief that bankers, supposed experts of numbers, can’t understand it. The fact is, if their remuneration is based on making money from transactions – bets – of this sort – and no one is cautioning them, and they don’t have to worry about long term consequences, but only next year’s bonus, they will act recklessly. I’m not sure you need to be an anthropologist to realise that.
The result is that “...by the autumn of 2009 the IMPF estimated that some $11,000 trillion of funds had been pledged to Western governments to support banks...” and yet the banking sector was more concentrated than ever before, “... with the top 10 banks holding a 90 percent market share in 2009 versus 74 percent in 2004.”
It’s a depressing tale, and one which the intervening two years have yet to produce an upbeat ending. Bankers continued to earn bonuses because of profits at banks where the risks had been shouldered by the taxpayer, while governments struggle to control their own debts, and economic recovery falters then fails.
Tett argues for the need for “Generalists who can act as cultural watchdogs and translators”, in other words, keep an eye on all these experts in their technical silos.” I think it may take more than that. If the governments and taxpayers have to bail out the banks, they should have more of a say in what goes on in them. Whether that will happen, only time will tell.
Tom Otley
They say Hollywood blockbusters should start with an explosion and work their way up to a climax and so it is with the title and sub title here. In fact, it slightly misrepresents the book, since what’s inside the covers is not sensationalist in tone, even while the subject matter certainly is.
The author is a well-respected journalist at the Financial Times, and this book, first published in 2009 is not only one of the earliest contributions to the narrative of the credit bubble, but has become almost part of that history since it was published so soon after it occurred, with the author one of the few journalists who realised the crash was coming.
The opening sentence of the preface to the paperback edition, written in December 2009 sees Gillian Tett set out her stall,
“Back in early 2007, before the credit bubble burst, I hit upon the idea of writing a book about credit derivatives and other forms of complex finance because I thought the public should understand more about the dangers they posed.”
Tett admits that the crash was caused by “Poor mortgage regulation, global savings imbalances, a failure of bank oversight, lax credit ratings, a crazy consumer debt binge, as well as excessively loose US monetary policy all played critical roles too....”
but she sees a key issue:
“... one that exacerbated the credit bubble during the boom – and then vastly complicated the disaster when the bubble burst – was the presence of all those credit derivative contracts.”
In telling the story of a financial crash that affected every one of us, and which has so many participants, every author has to make a choice of the hook or angle on which to hang the tale. There are various narrative devices that can be employed to make the debacle personable and understandable. We are amazed by the figures, of course, those billions gambled, the trillions lost, but we also need characterisation if we are to care, and so books such as this search out individuals who played a part, often small, but instructive nevertheless, and invite us to sympathise with them, perhaps even view them as emblematic.
In the case of Michael Lewis’ The Big Short (click here for a review), the characters are those financiers who saw the crash coming and bet big time against it. Tett’s book, published earlier than most, focuses on origins and the particular specialism Tett had been reporting for the Financial Times – credit derivative contracts, then uses that as a way of exposing general failings within the firms and the financial system as a whole.
Tett takes us back to a summer weekend in 1994 at the Boca Raton resort in Florida where a group of JP Morgan bankers had a get-together to think of new financial products. Various bankers are introduced to us, characters deftly if perfunctorily drawn, and the challenge identified.
“They were there for an off-site meeting, called to discuss how the bank could grow its derivatives business in the next year. In the humid summer heat, amid the palm trees and gracious arches, the group embraced the idea of a new type of derivative that would transform the wider world of twenty-first finance, and play a decisive role in the worst economic crisis since the Great Depression.”
What they come up with is a way of “... using derivatives to manage the risk attached to the loan book of banks.” In the words of one of the participants. “It was not until many years later that the team grasped the full implication of their ideas known as credit derivatives. As with all derivatives, these tools were to offer a way of controlling risk, but they could also amplify it. It all depended on how they were used.”
Put simply, Tett’s tale is the classic disaster movie narrative. We know the skyscraper will burn down, the dinosaurs will run wild and the ship will hit an iceberg, but the people involved can’t hear us shouting “It’s behind you” in best pantomime fashion. The JP Morgan bankers find a new way of minimising risk while creating a way of other bankers to help contribute to a “...worldwide financial catastrophe”.
The way Tett describes it, difficult concepts become easy to understand. Previously the problem of default risk (i.e.: a borrower not repaying a loan or bond) had seen banks take obvious steps such as lending only to those it thought would pay it back or diversifying the risk by lending to many customers, rather than just a few. Banks might also club together to make joint loans, and also impose a limit on how much they loaned to specific sectors such as housing.
But the JP Morgan banker, synthesising ideas already about in the market asks the question, “What if the default risk could be sold on?” Wouldn’t that remove risk from the bank, allowing it to make more loans, it would also shift the credit risk from the balance book, and so avoid the Basel I accord, which stipulated capital requirements for loans.
The story that follows is how a basically sound idea is misused to do the opposite of minimise risk, earning huge bonuses for the banks, and eventually tipping the world economy into financial meltdown. Since anyone reading the book knows what’s going to happen (and if they didn’t, the title would give it away), the book relies for its interest on pointing out the short-sightedness of many involved, but also the wilful ignorance of the few. Tett has a background as an anthropologist, and her observations are interesting:
“... the finance world’s lack of interest in wider social matters cuts to the very heart of what has gone wrong.... Bankers have treated their mathematical models as if they re an infallible guide to the future, failing to see those models were based on a ridiculously limited set of data. A “silo” mentality has come to rule inside banks, leaving different departments competing for resources, with shockingly little wider vision or oversight”
I think she’s a little soft on banks here, since even those with basic accounting skills are aware of the pitfalls of projections and mathematical models. I think the real reason the bankers looked away was they were making so much money from it all. When it all fell apart, the defence of most of them was that they had never known, and for the few who did know, it was that the regulators should have stepped in to impose rules to stop his sort of thing occurring. Both explanations are self serving, something Tett hints at:
“Anthropology also instils a sense of scepticism about official rhetoric... elites try and maintain their power... by dominating the mainstream ideologies, both in terms of what is said, and also what is not discussed. Social “silences” serve to maintain power structures in ways that participants often barely understand, let alone plan.”
I’d agree with all of that apart from the let off at the end. I think bankers do understand, which is why they spend so much time lobbying regulators and governments to leave them free to be. Except, of course, when they need bailing out.
Tett argues that “...what is needed is a wider rethink of the culture of finance. For too many years brokers have treated “credit” as merely an isolated game of numbers”.
This may be true, but since the rest of us know exactly what happens when we personally or through work - are extended too much credit (i.e.: take on too much debt), it beggars belief that bankers, supposed experts of numbers, can’t understand it. The fact is, if their remuneration is based on making money from transactions – bets – of this sort – and no one is cautioning them, and they don’t have to worry about long term consequences, but only next year’s bonus, they will act recklessly. I’m not sure you need to be an anthropologist to realise that.
The result is that “...by the autumn of 2009 the IMPF estimated that some $11,000 trillion of funds had been pledged to Western governments to support banks...” and yet the banking sector was more concentrated than ever before, “... with the top 10 banks holding a 90 percent market share in 2009 versus 74 percent in 2004.”
It’s a depressing tale, and one which the intervening two years have yet to produce an upbeat ending. Bankers continued to earn bonuses because of profits at banks where the risks had been shouldered by the taxpayer, while governments struggle to control their own debts, and economic recovery falters then fails.
Tett argues for the need for “Generalists who can act as cultural watchdogs and translators”, in other words, keep an eye on all these experts in their technical silos.” I think it may take more than that. If the governments and taxpayers have to bail out the banks, they should have more of a say in what goes on in them. Whether that will happen, only time will tell.
Tom Otley 
