Gillian Tett has been writing on the subject of financial markets innovation for some time. I remember especially an early article in in the Financial Times magazine on how J. P. Morgan first developed credit derivatives to be a much wider used instrument by financial institutions, which is the basis for the opening part of this book. Her insights as to how this market developed from someone who was there at the start and in addition is written largely from the viewpoint of J.P. Morgan (JPM) gives a unique perspective as to what happened.
JPM was a highly innovative organisation at the outset in the early 1990s but also as time passed was held back from remaining the credit derivatives market leader as its own risk management processes controlled unrestrained writing of such instruments. This was especially the case as the sub prime sector exploded in the USA in the late 1990s onwards with lending to previously off limit poor credit risk low earners. Such debts where little historic data as to defaults existed were the subject of immediately repackaging for seemingly insatiable investors in search of higher yield securities at a time of consistent low interest returns.
The inevitable conflict as banks sought to increase profits under regulatory rules that permitted much lower levels of capital being required against such transactions versus normal bank loan lending stoked a situation where the stratospheric growth of this market proved largely unmeasurable and unregulated. Many banks used risk models that had little proven track records and while JPM struggled that it could not understand how its competitors could undertake such levels of high risk business, their competitors wrote increasing levels of such business.
The inevitable outcome of writing such business came full circle when the levels of defaults started to increase with interest rate rises for such low income earners meaning they could not service their debts. The level of bad debts then hit the yields and in turn the protections that had been built in when packaging such products started to be called on as the structures unwound. This took two fatal forms - the first being investors wanting to cash in investments where there was an unregulated market and thus very volatile downward pricing resulted. The second was that the underwriting by issuing banks or default insurance by AIG especially which has largely gone unprovided by such organisations led to the start of the credit crunch meltdown in 2007 and subsequent bank failures as they learnt how much business was reversing toxic assets back onto their books.
Tett keeps the level right throughout the whole story especially with the interactions of many different parties and jurisdictions, but always around the axis of JPM who because of their quality controls ended up being a winner as their competitors disappeared. You do not need most importantly to be a banker or financial markets expert to understand what is happening in this book. While some reviewers have criticised her for not going into greater depth on some regulatory issues, I fear this misses what is Tett's great achievement of having a truly panoramic story telling approach to a very complicated market and one which has struggled to accept its accountability for what happened subsequently.
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