JPMorgan's Dangerous Derivatives
The Good: Tett has pieced together the colorful backstory of JPMorgan's pioneering role in CDOs
The Bad: At times, the technical particulars of credit derivatives sidetrack the book's main thrust
The Bottom Line: "Fool's Gold" offers real—though occasionally textbookish—insights into the mechanics of the crisis
Fool's Gold:How the Bold Dream of a Small Tribe at J.P. Morgan WasCorrupted by Wall Street Greed and Unleashed a CatastropheBy Gillian TettFree Press; 293 pp.; $26The setting was Florida's fabled Boca Raton Hotel on a summer weekend in 1994. The characters at the JPMorgan (JPM) off-site were mostly twentysomething bankers from New York, London, and Tokyo. The upshot: "the banking equivalent of space travel." Despite many hangovers—and one broken nose—this brash group hatched a revolution in high finance, even though the purpose of their corporate retreat was merely to bolster the bank's burgeoning derivatives business.
That's the catchy riff with which Gillian Tett kicks off 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. Tett is a respected business journalist at the Financial Times with years of credit-market reporting under her belt. She was also schooled in social anthropology at Cambridge University, although regrettably she avoids a cultural analysis of the risk managers and risk seekers who were central to the events leading up to the mess we're in now.
The bright idea that came out of Boca was derivative investment vehicles based on commercial loans, which offered two benefits to banks: They could off-load the risk of the loans on their balance sheets to investors. That, in turn, freed up capital to make more loans. JPMorgan also was an innovator in negotiating AAA ratings with credit agencies and eliciting the blessings of regulators—both turning points in modern financial history. And Tett successfully pieces together the colorful backstory of the bank's work to win acceptance in the market for its brainchild, turning credit derivatives "from a cottage industry into a mass-production business." With the benefit of hindsight, we know that while these inventions were intended to control risk, they amplified it instead. This novel idea turned noxious when applied broadly to residential mortgages, a game that the rest of Wall Street later entered into with gusto.
Its chockablock title aside, Tett's book is mostly about what JPMorgan's crack derivatives team did not do, namely abuse their own invention. At times it veers down alleys that have little to do with the construction, dissemination, or explosion of the financial weapons of mass destruction (as Warren Buffett refers to derivatives) that the bank brought to the world. Readers get a rehash of Chief Executive Jamie Dimon's well-documented spat with mentor Sandy Weill at Citigroup (C), as well as digressions into Enron, the Internet bubble, and a series of other woes at JPMorgan as it struggled under two of Dimon's predecessors.
When the book returns to its main thrust—the mechanics of the crisis—the promise of an insider's take in the early chapters is replaced by technical particulars. We learn in deep detail about not only how collateralized debt obligations are assembled but also their many iterations. For those seeking a primer, Tett delivers.
She gives Dimon and his team ample credit for deft risk management. And recent events appear to back Tett up: JPMorgan beat earnings forecasts in April and showed market share gains in investment banking, in part because of Dimon's strategic acquisition of Bear Stearns last year. But her praise is often breathless, making her subjects come off as oddly naive or highly excitable. Nearly every sentence attributed to Dimon is punctuated with exclamation points. ("Love it!" "Get to the point!" "The business cycle will turn!") As the crisis unfolded, JPMorgan folks were alternately "shocked," "stunned," and "astounded" to find that rivals' derivatives traders "might simply ignore all the risk controls JPMorgan had adhered to."
Perhaps it's noteworthy that Tett's book begins when JPMorgan had the face-value equivalent of $1.7 trillion in derivatives on its books. Today that number has jumped to a mind-boggling $87 trillion. Part of that portfolio includes almost $8.4 trillion in credit derivatives, more than Bank of America's (BAC), Citi's, and Goldman Sachs' (GS) holdings combined. Clearly, the final chapter on Dimon and his team has yet to be written.