Sunday, June 14, 2009

Fools Gold by Gilliam Tett

From the dust cover "How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe". It's a 2009 copyright which brings it right up to date. Gilliam Tett must have read Tracy Kidder somewhere along the line and her book has Kidder's closeups of the people involved. Those are fun to read. The "Small Tribe" at Morgan invented the credit default swap in the early '90s. This bit of financial magic amounts to default insurance. A credit default swap issuer gets paid a modest amount of money. In return the issuer guarantees the deal. If the borrower doesn't pay up, the issuer will make good the buyer's losses.
The first credit default swaps were issued on ultra safe packages of blue chip bonds. The banks persuaded the federal regulators to lower their reserve requirements if their loans were protected with credit default swaps. The credit default swap market took off like a rocket and the issuer's made a lot of money selling them. Late comers, stuck on stupid, began issuing credit default swap protection on shaky mortgage backed securities. The whole thing crashed in the fall of 2008 when Bear Stearns and Lehman imploded and everyone started collecting on their swaps. The issuers of the swaps didn't have the cash to pay off, and the Bush administration picked up the tab, fearing that letting AIG and the rest of them fail would touch off Great Depression II.

The author reviews some of the famous Wall St catastrophes of the past, Drexel Burnham Lambert , Long Term Capital Management, Enron and WorldCom. She gives J.P.Morgan a sympathetic treatment, they were smart enough not to get sucked into the mortgage backed security black hole.

She skims over the housing crash and the role of Fannie and Freddie in that crash. Fannie and Freddie fueled the sub prime disaster when they bought sub prime backed securities. This prompted the dumber Wall St houses to buy shakey mortgages, "securitize" them, and sell them. The resulting demand for mortgages led the mortgage companies to write mortgages on worthless property and to borrowers unable to make the payments. But not to worry, we will sell this sub prime mortgage to a bigger sucker on Wall St. When the suckers wised up and stopped buying the roof fell in.

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