Chasing Alpha: How Reckless Growth and Unchecked Ambition Ruined the City's Golden Decade [Hardcover]

The bulk of this book is an exceptionally lucid and readable analysis of the developments in the international financial system in the ten years preceding the summer of 2007, when the economic "train wreck" we have since experienced first became apparent. The subsequent chapters on the credit crunch itself are inevitably less illuminating. By then, the media, which (other than the FT) had taken virtually no interest in the changing financial system when times were good, were all over the story, so the events - though ably described - are all too familiar. Augar explains the complex relationships between the various forms of investment exotica created during the boom years and identifies the inherent weaknesses that led to the the collapse of the "shiny new system" that the City and Wall Street had evolved.

I really enjoyed Philip Augar's The Death of Gentlemanly Capitalism: The Rise and Fall of London's Investment Banks, about the aftermath of the UK financial services "big bang" in 1986: In that book Augar is a credible witness, having held a senior post at J. Henry Schroder, and he writes in a lively and measured way.

But in the last eight years Augar has been "writing and consulting" and his absence from the industry in that time is a little telling. I was looking forward to Chasing Alpha, and was surprised to see him fluff his lines in the very first sentence of the preface, in giving an erroneous definition of "alpha" - significant as it is ostensibly (but as it transpires, not actually) the subject of the book.

Alpha, in the sense understood in the city, is not simply "supercharged profits" as Augar claims, though certainly positive alpha can create them, but a technical term gauging the variance of an instrument's (or more usually, a hedge fund's) performance over the market average, or "beta". An investment manager's alpha, therefore, is the added value it brings you that you would miss out on if you just invested in the benchmark. Hence the supercharged profits. Strictly speaking, the measure of alpha excludes the amplifying effects of leverage (borrowing to invest in the strategy, magnifying profits and losses of a dollar invested). Leverage increases the volatility of portfolio returns. Volatility is measured by vega, not alpha.

You may think I'm splitting hairs, but for two reasons I'm not: firstly, "alpha" is therefore only relevant to investment advisers (such as hedge fund managers) and is not a meaningful gauge for corporate chief executives nor, really, investment bankers (though granted, as with all buzzwords, it was - and still is - heavily overused in selling structured products).

Secondly, by definition, not everyone in the market can generate positive alpha - it is a measure of outperformance of the mean. Therefore, in the fund context, it was a far more credible label when hedge funds were a small segment of the market comprising the crème de la crème of the city's trading talent - the Soroses and GLGs of the world, who really could outperform the rest of the market. Nowadays, as Augar clearly recounts, the unregulated fund industry amounts to a massive shadow banking system which dwarfs the rest of the market, and all too often the supercharged profits were not generated by "alpha" but by leveraging something looking a lot more like beta. As long as the cost of funding the leverage was cheaper than the return of the benchmark, the strategy worked very well. But it amounted to a massive asymmetrical bet that this benign state of affairs wouldn't reverse. And, as we know know, it did, with a vengeance. The conflation of leverage (common) with alpha (extremely rare), leading the city to believe it had eradicated risk was a large part of the complacency which led to the rout.

Enough of portfolio theory. Having mis-described alpha, Augar then barely mentions it, making you wonder why he chose that title. For the credit crunch, as he patiently recounts, was not caused by chasing alpha. Even for the hedgies, chasing alpha wasn't the problem, deluding oneself that you were catching it was (what the 2 and 20 model called "alpha" was more like the premium on a deep out-of-the-money-put).

Augar seems to have in this way tabloidised his delivery - he's looser than he ought to be with the technical details (he misdescribes investments in SIV vehicles as "shares" - actually they're short-term debt investments, and that makes a world of difference) and his estimation both of the size of the alternative fund space and the extent to which it relied on leverage seemed pretty rudimentary. My own anecdotal experience suggests it was way bigger and way more highly geared than Augar suspects.

Away from the hedge funds the rest of his analysis settles down somewhat, and Augar's history is comprehensive enough, and it does read rather like a sequel to the Death of Gentlemanly Capitalism. However, in content, it doesn't cover colossally more than could have been extracted from careful reading the FT over the last couple of years. If you haven't done that, this book comes well recommended. If you have, you're not going to learn much here.

While it was an enjoyable enough read, I don't think Augar really gets to the nub of what caused the meltdown - he drops many names and spends too much time telling individual corporate stories with which he seems very familiar, but which don't really bear on the crisis. By contrast, his treatment of the phenomena that did (the originate and distribute model, for example) is cursory and his effort to tie it to the explosion in CDOs and the consequent effect on the mortgage market is salutary. That's the real story here and we are all implicated; not just the chasers of alpha.

Gillian Tett, who has been one of the best writers in the FT over the last couple of years, has recently published a book (Fool's Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and Unleashed a Catastrophe) which looks like it might get nearer to the real story; if you were going to read one book about the credit crunch you might be advised to look to that.

Olly Buxton

Philip Augar, a former group managing director of the pension fund managers Schroders, shows how Britain has become a hedge fund/tax haven. After Thatcher tore up all the rules, free market forces ran riot and the City offered endless credit to buy imported goods with borrowed money. Under Blair and Brown, it went from bad to worse. Predatory lending tripled under Brown.

The `value' of the world's stock markets quadrupled between 1997 and 2007. The derivatives market grew from $41 trillion to $677 trillion. But `credit default swaps', supposed to reduce risk, in fact spread it.

The City seemed to make money out of money, avoiding investment in real, value-creating, industries. As Augar notes, "Unlike France and Germany, where governments used national interest considerations to protect strategic industries from takeover by foreign companies, foreign buyers were welcomed in Britain."

When the US Federal Reserve cut interest rates, City traders could borrow cheap in the USA, lend dear and hedge the risk. As Augar writes, this was `money for old rope': "leverage and the bull market, not fund management genius, was behind many hedge funds' success." The hedge fund scam "turned out to be an ordinary investment business that for a while fooled the punters into paying very high fees for very average performance."

After the 2003 crisis, the government tinkered with the rules but left the system intact. The Financial Services Authority's remit was still to promote the City, not regulate it. In 2006, Treasury Minister Ed Balls said, "the government's interest in this area is specific and clear - to safeguard the light-touch and proportionate regulatory regime that has made London a magnet for international business."

In June 2007, Gordon Brown told the City that growth was "expected to be stronger this year than last and stronger next year than this. We will succeed if like London we think globally ... advance with light-touch regulation, a competitive tax environment and flexibility."

In September 2008, former Treasury Minister Ed Balls said, "Those who think the global market economy can be run without regulation or with self-regulation or light-touch regulation have been entirely routed."

Augar concludes, "It was modern market capitalism that did for us all." As he proves in this book, lawless greed drives the City as it strips Britain's industries. So what are we going to do about the City's criminality and treachery?