Fool’s Gold | Gillian Tett

Summary of: 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
By: Gillian Tett


Dive into the world of financial derivatives with Gillian Tett’s Fool’s Gold, a book that explores the birth, development, and eventual corruption of the credit derivatives market. Through the lens of a small, innovative group at J.P. Morgan, readers will discover how this financial innovation spiraled out of control, ultimately unleashing a catastrophic economic crisis. The book offers insight into the key players, the daring ideas, and the way banks and financial institutions exploited innovations to their advantage. With a focus on real-world examples and comprehensive explanations of complex concepts, this summary aims to demystify the world of credit derivatives and their role in the global financial meltdown.

The Birth of Credit Derivatives

In 1994, a group of J.P. Morgan bankers gathered in Boca Raton to come up with new ways to profit from derivatives. They discussed a new type of derivative that would allow banks to insure themselves against the risk of a borrower defaulting – essentially, credit derivatives were born. The value and risk of derivatives depend on changes in another asset price, such as an interest rate or credit rating. Bankers realized that derivatives were producing a substantial proportion of their total profits and looked to create innovative products to differentiate themselves from their competitors. While derivatives could help reduce risk, they could also create more risk. The derivative business was highly competitive, leading to shrinking margins, but credit derivatives offered a way for banks to create a unique and profitable niche for themselves.

The Masterminds Behind J.P. Morgan’s Derivatives

J.P. Morgan’s derivatives and derivative credit swaps were developed by a team of exceptional individuals. Peter Hancock, a cerebral and innovative thinker, led the derivatives team, while Bill Demchak implemented his ideas. Bill Winters, a hardworking and flexible graduate of Colgate University, ran the derivatives team in Europe. Krishna Varikooty recognized the risks of mortgages and kept Morgan away from such unknowns, and Blythe Masters, a British executive who studied economics at Cambridge and became its CFO by age 34, put together Morgan’s first credit derivative. This chapter profiles the primary players who made it possible for J.P. Morgan to excel in the derivatives and derivative credit swaps markets.

Banking Without Boundaries

How JP Morgan Pioneered Derivative Trading and Fended Off Federal Regulation

J.P. Morgan’s pioneering efforts in the development of credit derivatives and their powerful lobbying tactics are highlighted in this book. The president of the New York Fed, E. Gerald Corrigan, became concerned over the sharp growth in derivative trading post-1980s and asked Morgan’s CEO Dennis Weatherstone to explain it. Peter Hancock was then brought in to help demonstrate the potentials of credit derivatives. Corrigan expressed his reservations in January 1992 about the reasons behind this rapid development which led to the influential “Group of 30” (G30) commissioning a study on the issue. Weatherstone agreed to lead the study knowing that its outcomes could impact the future derivatives regulation. Meanwhile, Mark Brickell, Morgan’s “swaps” banker and a known regulator antagonist, was fervently fighting against derivatives regulation in Washington. His intense lobbying led to the regulators backing off. The G30 report prescribed how banks should manage derivative risk, but recommended that government intervention was unnecessary. This book exposes how J.P. Morgan not only pioneered derivative trading but managed to defend it from potential federal regulation.

The Birth of Credit Derivatives

In the mid-90s, J.P. Morgan’s Blythe Masters devised credit swaps to enable banks to offload debt without selling the loan. Banks using credit derivatives to offload credit risk could carry lower capital reserves, a result of successful lobbying and regulatory oversight. J.P. Morgan applied securitization technology to sell bundles of loans to special-purpose vehicles (SPVs) that were paid to insure against the risk of default. These loan-backed securities were then sold to other investors, putting the proceeds into very credit-worthy securities to guarantee funds for payment in case of default. Regulators raised questions about the potential for a chain reaction in case of default, but they eventually persuaded regulators that the super-senior risk was not risky enough to require capital reserves. By 1999, other banks began seeking J.P. Morgan’s credit-default-swap advice, but the risks remained impossible to determine accurately.

J.P. Morgan’s Fall from Grace

J.P. Morgan’s conservative culture was upended by the 1999 Glass-Steagall Act’s repeal. While its peers embraced nontraditional businesses, J.P. Morgan’s bankers clung to their proud tradition. Bill Demchak, now co-head of credit in the newly merged institution, realized the dangers in Chase Manhattan’s highly risky loans to the Internet sector and scandalous borrowers. Chase’s involvement in the Enron, Global Crossing, and WorldCom scandals was in sharp contrast to the Morgan tradition of conducting a “first-class business…in a first-class way”. In 2000, J.P. Morgan’s derivatives chief resigned, signaling the end of an era as Chase Manhattan acquired the once-proud institution.

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