Customer Reviews

Fool's Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe

5 star:		(35)
4 star:		(22)
3 star:		(5)
2 star:		(5)
1 star:		(0)

 

 

The book starts with a fly-on-the-wall description of big, offsite meeting in Boca Raton for J.P. Morgan employees. There they made plans to ensure that J.P. Morgan led the industry in credit derivatives. This story of the bravado of young party animals becomes the backdrop for how we got into this mess. These recently minted and overconfident traders and analysts risk takers, lead a headlong charge into a poorly understood market innovation. After that, Tett describes in detail the array of models, players and events that lead to the financial crisis and weaves them all together to explain the events like no other author yet has done.

Although the description of events are detailed, Tett leaves out explanations of how basic psychology and particular modeling errors contributed to the problem - such as the researched described in Hubbard's The Failure of Risk Management: Why It's Broken and How to Fix It (although Hubbard is talking about risk management in a broader sense than financial risks alone, I still recommend both books for this topic). But Tett is also more pragmatic and specific than Taleb's The Black Swan: The Impact of the Highly Improbable and makes more logically supported conclusions than Posner's A Failure of Capitalism: The Crisis of '08 and the Descent into Depression.

Tett seems to cover just about every aspect of the recent crisis that an author can cover without getting into specific mathematical modeling errors (Hubbard argues this is a critical contributor but it would be hard to elaborate without alienating much of the audience). She covers AIG, Bear Sterns, Fannie Mae, the credit rating agencies and the Basel II accords. She mentions Gaussian copula model, Goldman Sachs and the actions of Alan Greenspan. The details of Structured Investment Vehicles (SIV) and Value at Risk are included along with recent events like the Troubled Asset Relief Program (TARP).

I do not believe there is another single book that has this breadth of coverage combined with a logical picture of how they formed an avalanche of connected events. As of now, this is the single most important book on the topic, period.

Having read this book over 3 days (interrupted only by work, playtime with my two toddlers, and sleep), I highly recommend it to anyone who cares about our financial system (be it that you work in finance, or hate financiers that brought us the ruins - just bear in mind they were not the only ones to blame, throw in the regulators, lenders, and borrowers who enjoyed the party, and politicians who took credit for the housing boom). The book is well-written, focused, and surprisingly a page-turner that you don't want to put down once you start reading it.

Having fought the battles in the trenches over the past two years during the ongoing financial crisis, I have a deep appreciation for what Gillian Tett has accomplished in this book. It provides a comprehensive view of one corner of the financial markets - the one that caused so much of the wreckage over the past two years. While it will be a daunting task for any single writer to document the crisis we are still going through (given the multiple contributing factors/actors to this crisis), the author has done a great job producing a contemporary record on the credit derivatives market and its role in fueling the housing bubble leading up to the crisis.

Obviously, the author deliberately chose to exclude some critical episodes of the credit crisis (such as the SocGen trading scandal, the resulting ill-timed massive cut in Fed funds rate leading to the oil shock of 2008 that partially contributed to the inflation scare and added shock to the economy). She also chose to withhold judgment on policy responses during the early stage of the crisis and exclude the various "local" factors contributing to the subprime housing boom (think Hank Paulson and Ben Bernanke claiming the subprime crisis "being contained", think Barney Frank and his role in shielding Fannie and Freddie from proper oversight, think Clinton and Bush administrations' claim that homeownership was at "historical highs"). She may be right to do so as inclusion of these topics will obfuscate the focus on credit derivatives. An educated reader will want to keep in mind such background information as part of the mosaic of the financial crisis.

Without a full understanding of all the factors contributing to the crisis we find ourselves in, it would be tempting to find solutions that seem to eliminate the excesses of the past years only to sow the seeds for future problems. So-called "always fighting the last war". A simplistic solution to the credit derivatives abuse would be to ban it. A simplistic solution to the failed U.S. auto industry would be to subsidize it with taxpayer funds. A simplistic solution to the housing problem would be to mitigate mortgage foreclosures through taxpayer subsidies (as if everybody who bought a home deserves to live in that home or be a homeowners in the first place).

Gillian Tett was nominated as British Business Journalist of the Year not for this book, but her regular writings in the Financial Times. Her writings in the FT are insightful and timely. This book only reinforces her reputation as one of the best journalists in the field.

On a separate note not related to the book but the book reviews found on Amazon, I find it hard to believe that any review by people who haven't actually read the book is entertained on this site. Simply saying that "I heard this was a good book and I heard the author interviewed" is no qualification for one to write a book review. There is no prize to win from writing the first review, especially when it's only based on hear-say. Anyone who does that is doing the author and intended readers a great disservice, no matter how flattering the review is. Amazon should impose some minimal standard on such postings.

I loved the documented history this book provides. It's a treasure trove of dates, quotes and important juxtapositions on the development and unwinding of structured finance. I turned the pages and you will too. But in the end, I was disappointed by the author's superficial understanding of the underlying issues. She wants to argue that the banks used clever innovation to exploit big loopholes in Fed and Basel regulations and to arbitrage ratings but she doesn't have a deep enough understanding to truly explain how this was done. As a result, she ends up contributing to the general populations' great misunderstanding of these markets.

Pages 61 to 64 provide one of many examples. She concludes at the top of page 64, "Banks had typically been forced to hold $800 million in reserves for every $10 billion in corporate loans on their books. Now that could be just $160 million. The CDS concept had pulled off a dance around the Basel rules." Regulators and rating agencies aren't that naive! Three pages earlier she notes that the issuer of credit default insurance had to post $700mm of collateral, held as Treasuries, and that the Fed demanded that the issuer either had to have a triple AAA rating, i.e. the capacity to absorb losses greater than the $700mm it posted as collateral, or else the bank had to post an addition $160mm of reserves with the Fed, over and above the $700mm. The logic of this requirement is obvious, either way, someone, the bank or the insurer, had to post at least $800 of reserves. There is a popular belief that AIG posted no collateral but the truth is that while, it in part did not post liquid collateral, it in fact posted the value of its other businesses as collateral. The Fed, of course, took those businesses as collateral in exchange for posting liquid collateral.

Her descriptions of leveraged super senior on pages 96-98 are similarly muddled, incomplete and misleading, greatly overstating the extent to which sophisticated regulators, rating agencies and commercial paper investors failed to understand the issues surrounding these structures. It's akin to a beginning chess player interpreting the games of grandmasters by mistakenly assuming they are boldly trying to win pieces rather than much subtler truly winable advantages. Instead, capital markets are highly efficient. And regulators and rating agencies are far more knowledgeable than the popular press wants to admit. I would suggest going to: http://www2.standardandpoors.com/spf/pdf/fixedincome/082205_levsuperseniorcdosSNAP.pdf and reading paragraph 1.3, "Incentives for the Protection-Buyer in a Leveraged Super Senior Transaction".

In the end, if the value of loans fall far enough, no matter how much you slice and dice the risk tranches someone must eat those loses. The slicing and dicing isn't necessarily the problem but rather the magnitude of the losses. And so, the story is woefully incomplete without also understanding the buying spree of Freddie and Fannie who, when they were not allowed to guarantee sub-prime and alt-a mortgages, instead bought 15-20% of the market with cheap quasi-government guaranteed financing, which drove up pricing. Brokers and banks couldn't have offered homeowners the ridiculous terms they did unless investors stood eagerly ready to buy on those terms. In large part, that buyer was Freddie and Fannie.

For its rendition of history, I would give the book 4; for the more important underlying argument, a 2; and so generously in total, a 3.

An excellent book, engagingly written, tracing the excesses of the credit derivatives and credit structured products that were a major part of the cause of the current crisis.

This book is NOT a overview of the whole crisis. It is specifically intended to concentrate on the aspect above. It is written for those who are generally financially literate (e.g., typical readers of the Financial Times and Wall Street Journal), not for those who are already knowledgeable in credit derivatives and credit structured products (a more expert reader would want explanations at the level of the books by Janet Tavakoli). However, for the primary audience, more basic explanations of CDSs, Synthetic CDOs, Super Senior tranches, ABX indices, Conduits and SIVs etc -- all the specialised vocabulary that has been in the financial news in the last two years -- are quite sufficient and are more than adequate.

What I particularly liked, in addition to the very readable style, was the clarity of the overriding theme of corruption of the products with undiversified sub-prime mortgage assets, exaccerbated by excesses of leverage and shadow-banking vehicles to hold them; how an intelligent set of ideas was perverted in an environment encouraging greed at the expense of prudent risk-taking.

A highly informative book, well researched and written by Gillian Tett. Strongly recommended.

If you want to understand the current economic crisis, this book is a fascinating and well written narrative which personalizes the crisis from the JPM point of view. It also suggests and invites serious dialogue about the way by which the banking, regulatory and investment world conduct themselves. If one can extrapolate lessons to broader concerns about human folly related to global social areas, all the better.

Gillian Tett's book Fools Gold covers the current financial crisis from its purported beginning in 1994 to the point at which most of us became aware of the systemic flaws in the global financial systems, with an inside look at the crisis from J.P. Morgan's version of the story.

The book begins by engagingly and sympathetically introducing us to the players on the banking and investment side of the equation; the team of collegiate, young, impassioned and idealistic folks at J.P. Morgan responsible for creating and marketing credit derivatives back in the early 1990's. It loosely follows the team, and more interestingly, follows the firm's evolution through the 1990's (with an admiring nod to Jerry Corrigan's concern regarding risk) and subsequent leaders (with a resounding `hurrah!' to Jamie Dimon and his `hands on' management style) and the industry excesses outside of JPM that, combined with a crisis in confidence in the financial markets, have created the worst financial crisis known since The Great Depression.

The book provides the reader with a relatively balanced look at the conditions, culture and tools that allowed a cadre of `quants' (quantitative analysts) to trump historically `sound' banking practices across the banking industry and which further allowed the subsequent derivative / analysts culture combined with unregulated banking and investment banking practices to prevail and flourish during the mid-1990's up to the current period (2009). To be fair, Tett's narrative indicates that at least at J.P. Morgan, the risk sensitive side of the equation held sway within policies of the firm. She provides the reader with a compelling understanding of how the desire to bolster shareholder profits in an unrealistic market led to decisions to embrace greater risk across the banking, investment and finance industry in spite of the ever more looming and unaccounted for 5% side of the 95% correlation, the so-called 'fat tail'(simplistically, what happens if more than anticipated % of US mortgage holders default?).

In summary, Ms. Tett provides an insiders view of JPM's creation of and internal struggles with the increasingly complex derivatives which the firm initially lobbied for, then marketed and finally shied away from due to the unknown risk the instruments presented. As such, the book is an insider's view and a noteworthy `first look' of the financial industry's corporate culture out of which the crisis came but by no means was the sole player in.

The author's background as a social anthropologist (she holds a PhD from Cambridge) provides a solid basis for her narrative, and the ending Epilogue holds alone enough material for a burgeoning Masters student who wishes to potentially dissect the financial excesses of society and the psychological bases which fuel them ...

I've now read no fewer than seven excellent books detailing the financial atrocities of 2007-9. Each takes a different spin.

British broker Philip Augar covers the historical perspective; hedge fund manager and amateur philosopher George Soros looks to epistemology; former Federal Reserve Chairman Alan Greenspan provides a wide-ranging survey aimed more or less at self-exculpation; former Goldman Sachs chief and US Treasury secretary Hank Paulson breathlessly covers the regulator's perspective; New York Times journalist Andrew Ross Sorkin impressively covers the CEO's perspective and Michael Lewis writes from the perspective of those motley few who not only saw the crash coming (as we all did!) with hindsight, but bet on it happening ahead of time.

Now Gillian Tett, an excellent writer for the Financial Times, provides the credit structurer's perspective. Surveying the economic and intellectual environment which lent the tools and opportunity for these sub-prime backed products to get off the ground, Tett tells the story through the prism of the J. P. Morgan structuring desk from whose "BISTRO" transactions ("bank of international settlements total rip-off" indeed!) all of this started, but who still never fell for the mortgage-backed kool-aid which overwhelmed the rest of the market. The house of Morgan (Jean Strouse's reverent tome is well recommended) has a venerable tradition that even Goldman Sachs would envy; its performance over the last three years has burnished that reputation in a way that Goldman certainly ought to.

Tett's curiously titled book is, for the most part excellent, entertaining and novel. She does a better (and certainly more balanced) job of explaining the engineering of a CDO than Lewis (though in fairness, his is the only other entry to even have a go), and the J. P. Morgan angle is a clever narrative to lay over the goings on.

So much so that when Tett loses her focus on Morgan in the closing stages - her attention switches to the much larger field of conflict as the financial world blew up - the book suffers: Tett's treatment Bear, Lehman, AIG, and others is (of necessity) cursory, and those who are interested should seek out Sorkin's extraordinary survey, which is far more thorough.

Tett does pull it all back together again in her epilogue by re-focussing on the Morgan diaspora in a where-are-they-now summary, and she provides a stark and assertive personal perspective. Her background is social anthropology which she says (and I fully agree) provides a valuable perspective on how this could all have happened, and how it might happen again, that you won't find in Hayek or Friedman. But this is added as an afterthought rather than a spoke of the central thesis, which is a pity. For me that's the real story: the herd mentality, the group-think, the social and anthropological hierarchies that persist (and on which our financial and political institutions, frankly, are built) which tend to neuter the checks and balances which classical market theory says ought to be provided by the market. Curiously, George Soros gets closest to this, in his otherwise rather idiosyncratic (and a bit premature) book.

Tett's missed opportunity here is compounded when she misinterprets the metaphor of Plato's cave: The participants who look at only the shadows projected on the wall aren't at fault for failing to look at the "perfect forms" whose outlines create the shadows: Plato's point is they *can't* ever see them: it is the human condition to be stuck with the shadows. That ought to lead, therefore to a different conclusion: not that we should turn around to look at the projector - for that will surely blind us - but that we need at all times to maintain a healthy scepticism for what we are seeing. The fatal mistake is to suppose it is the truth.

If we can devise a way of building that impulse - a will to contingency, if you like - into our institutions, we'll be on the way to fixing this.

Fat chance, I suspect.

Olly Buxton

Of the recent chronicles of our ongoing financial collapse, this is one of the finest. I'll leave the theoretical hairsplitting to our financial clergy, but for us laity, it's a fast-paced page-turner. It's the type of book you can't put down, but by that I mean that it's a book that you mustn't lay down, because if you stop reading on a Friday and resume the following Monday, will you retain the meaning of all the financial jargon? For us mere mortals, there's a lot of detail here to remember, mostly initials (which Ms. Tett wrongly calls "acronyms"): IIF, ISDA, CDO of ABS, CDOs of CDOs, BISTRO, SIV, &c., &c.

But wait! The good news is that this book has a glossary! -- which most of the other financial-meltdown accounts lack. [Hurrah! Wild cheering!] The bad news is that there are only 25 terms listed in it [cheering dies down], and you're left on your own with such esoteric terms as "ABX derivatives," and the definitions themselves are far from obvious: "SIV: An entity that operates in a manner similar to a conduit but does not enjoy complete credit support from a bank, and has external equity investors who bear the first risk of losses." [cheering turns into a dull murmur]

That's unfortunate, because the general public sorely needs to know what happened, and the news media are apparently unable to provide a coherent and unbiased account. Without a basic understanding of the situation, the average person naturally reverts to his prejudices: that the meltdown was caused by minorities (you know who) purchasing homes that they knew they couldn't afford; that it was nothing more than another case of shysters trying to do an end run around the wise regulators; or, as is commonly believed in Europe, that it's the rotten Americans to blame again (when, actually, half of the CDOs were traded in the UK).

We, reverting to our peasant stock, also want to know who to blame for the mess, so that we can tar-and-feather them, but after reading this book, it's not so clear that any one person or group was to blame. Nor is it clear that the crisis could have been averted if only . . . if only . . . (more regulation, better regulators, Democratic administration -- supply your own pet panacea here). In fact, most people mentioned in this book seem to have conducted themselves admirably, or if not admirably, no worse than you or I would've behaved had we been among the financial elite.

My only complaint about "Fool's Gold" is that there is an occasional wrong word ("fallacious" --pg.113-- is not synonymous with merely "mistaken") or lapse of punctuation. Everyone hits the occasional wrong note, but this is the second book with such defects that I've recently read that was published by Simon and Schuster. Apparently they are too cheap to hire proofreaders. High marks to Ms. Tett; low marks to them.

This book review is my fourth, in a series of reviews on the financial crisis. The three previous books I reviewed focused almost entirely on the events leading to the collapse of a specific investment bank. Two books focused on the collapse of Lehman Brothers, and the other book focused on the collapse of Bear Sterns.
Fool's Gold by Gillian Tett is written from a different perspective. While the book is written with an emphasis on JP Morgan, the book is not focused entirely on the firm. The book is an in depth explanation of how a small group of bankers at JP Morgan invented the tools that are now blamed for exacerbating the financial crisis. They invented credit derivatives which were supposed to be beneficial for the economy and the banking system in particular. The author notes the irony, how instruments that were supposed to make banking more efficient, were manipulated by other firms to take undo risks and cause a near collapse of the financial system.
An interesting fact I learned from the book was how the first CDS was created. In 1993, after the Valdez oil spill, Exxon wished to borrow $4.8 billion from JP Morgan. JP Morgan knew Exxon was credit worthy, but did not want to extend them a loan because it would require a large capital reserve and produce little profit. JP Morgan persuaded the European Bank for Reconstruction and Development to insure the loan, while JP Morgan would keep the loan on its books. JP Morgan would pay a small fee to the bank, collect interest and be protected from a default by Exxon. JP Morgan was able to persuade regulators that since JP Morgan had no risk of default from this loan, they should be allowed to reduce capital reserves.
I have two main criticisms of the book. The author does an excellent job explaining the roots of the financial crisis, and the risks undertaken by the various financial institutions. However, the author is scant on detail when the crisis reached its height. I wish she had focused more on the collapse of Lehman Brothers, near collapse of AIG and other firms in late 2008. While the author devoted over 200 pages to explaining the various instruments the banks were using, she only devotes a few pages to the crucial year of the crisis: 2008.
My second criticism is that, although the author focuses almost entirely on the role of credit derivatives. I would have preferred that she also explain the other factors that caused the financial crisis i.e. Government actions, subprime lending etc. However, I do not think her goal in writing the book was to focus exclusively on these instruments and therefore I am not sure my criticism is valid.
Overall, the book is excellent and the author does a superb job in explaining the origination of structured investment vehicles, CDOs, and CDSs and their role in causing the financial crisis. I was surprised to learn the author had no formal education or job in finance, since she seemed to have such an excellent grasp on it, I would not recommend this book for someone who does not have a background in finance/economics. The book explains complex financial instruments which I think most people will have a hard time understanding. However, I think this is a great book for anyone who has an understanding of finance. This is the best publication I have read so far that explains the various instruments the banks created that ultimately lead the world to near financial Armageddon.

Tett has written an excellent book. However,she appears to have no understanding that the major conclusion of her analysis-that unregulated commercial and investment bankers deliberately collaborated in the creation of a massive speculative bubble ,based on the creation of collateralized debt obligations(CDO's), credit default swaps (CDS's),and other kinds of derivatives that were structured in such a way so that there was no transparency,in order to make a profit without production ,that collapsed and resulted in the most serious economic downturn for the USA and the world since the 1930's-had already been provided in greater detail by Adam Smith,John Maynard Keynes,Benoit Mandelbrot,and Nassim Nicholas Taleb long before her book was publisbed.No mention of these individuals occurs anywhere in her book.The reader is not provided with any historical background or perspective on the 400 plus year problem of banker financed bubbles that has been occurring regularly in all countries having a private profit maximizing banking system.The reader is not shown that this latest crash is just the most recent result of many,many past crashes resulting from banker financed speculative behavior.Only the names of the banks and bankers has changed over the centuries.This problem repeats with a regularity that is ergodic.The latest crash was completely predictable and preventable.

Tett does an excellent job of demonstrating the speculator views of modern bankers.Her best example is Mark Brickell. Mark Brickell's views are ,and were, very representative of the J P Morgan bankers involved in the creation of the types of speculative financial assets that led up to the crash. He was a firm believer in the Efficient Market Hypothesis (EMH)created at the University of Chicago's economics and business departments by economists such as Merton Miller,Eugene Fama,and Milton Friedman.The claim here was that the time series data of all financial markets were normally distributed .There is not a shred of historical,empirical, or statistical evidence to support the EMH claim,which is the equivalent of claims made by Ptolomaic astronomers from the first through the 17th century,that the earth was stationary and the center of the universe.All goodness of fit tests show that the time series data is best represented by the Cauchy distribution.The time series data is not even remotely normally distributed.Tett fails to note that Keynes,in his 1921 A Treatise on Probability,had pointed out the special case nature of the Normal distribution.Benoit Mandelbrot has,since the late 1950's ,shown time and again that the data sets are not normally distributed.The same can be said of Nassim Taleb since the mid 1990's.It is interesting that E Fama did his dissertation under Benoit Mandelbrot in the mid 1960's.He concluded that the probability distributions of the Dow 30,were, in the mid-1960's,all Cauchy.He then turned around and started claiming,directly contradicting the empirical and statistical analysis contained in his own dissertation ,that the time series data was normally (log normal) distributed.Tett's discussion of the use of the normal distribution as the basic foundation of banker models of risk takes place on pp.99-103.There is no mention of Keynes,Mandelbrot,or Taleb.However,her biggest omission is of Adam Smith,who was well aware of the dangers of banker induced bubbles.

The first extensive discussion of the problem of banker induced speculative bubbles was contained in Adam Smith's The Wealth of Nations(1776).Smith's conclusion was that loans given by bankers to speculators would end up being "wasted and destroyed ". That is what has happened every time in the past , what is happening in the present,and what will happen again in the future unless the private banking industry is prevented from making loans to speculators and/or prevented from creating speculative ,debt based ,financial instruments in the future.

Much has been made of how Tett is an anthropologist in reviews of this book which held promise of a fresh insight into the world of finance. But while it is a reasonable record of how financial madness gripped the world, there is little in the way of fresh thinking (the anthropologist angle is tacked on at the end in the final two pages). It is just a bunch of guys doing things. The main interview subjects don't seem to have been challenged to provide anything more than routine newspaper quotes and like most business books, the writing is superficial ("as the sun set in the cerulean Spanish sky" etc). Tett is a very good journalist but what might be good in a newspaper column, doesnt cut it in a full-length book.