Gillian Tett’s new book, “Fool’s Gold”, is a refreshing and innovative approach to the failings of financial institutions, in that she convincingly ties such failings to the personalities and tribal behavioral patterns of the bankers and economists who putatively cause them. As a trained anthropologist, Tett is well qualified to examine tribal behavior, and her research demonstrates quite clearly that it is alive and well at the corporate level. In her view, the current global credit crisis was unleashed by a relatively small tribe of bankers at J.P.Morgan, a wholesaler of financial services and a significant part of JPMorgan Chase & Co (JPM) which is a leading global financial services firm with assets of $2.1 trillion.
Tett initiates her hypothesis with an account of how a group of young J.P.Morgan traders conduct themselves at an offsite meeting in Florida in 1994. The reader can imagine that her observations of tribal behavioral patterns in developing countries have a bearing on her description of the immature behavior of this group. After a suitable period of horseplay and heavy drinking, the band of bright young bankers applied themselves to the task at hand. The objective was to find ways of unleashing ‘a new wave of innovation in derivatives’.
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According to Tett’s account, it was the dubious creativity of that meeting that eventually led to the current financial meltdown and worldwide recession. Risk management was at the centre of the group’s discussion. Banks needed a way to control the risk on their balance sheets, and the challenge was to create a product that could effectively do that by being suitably packaged and then sold to others. The new product deriving from the group’s collective input was called a ‘credit derivative’.
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Essentially, credit derivatives allowed banks to place bets on whether or not a loan or bond would fail in the future, and it was indeed an innovative idea. One of the group’s outspoken members, Cambridge alumnus Blythe Masters, enthusiastically opined that credit derivatives would ‘fundamentally change the way banks price, manage, transact, originate and distribute risk’. She assumed that this would be good news for the financial world but, as we are now painfully aware, although her claim proved to be correct, the end results were disastrous.
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Tett claims with some authority that credit derivatives themselves could have worked well as a financial instrument, but unprecedented levels of greed and complacency, and a chronic lack of regulation inevitably led to a financial meltdown. Billions of dollars-worth of default risk was constantly changing hands and financial institutions began to operate as if they were immune to default loans. What appeared at first to be minor blips on the balance sheet became huge, destructive holes over time, until it became clear that J.P.Morgan had indeed unleashed a catastrophe.
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Gillian Tett’s book is one of the most enlightening accounts of the current world credit crisis and its fundamental causes, but not only that. Her claim that ‘nothing in society exists in a vacuum or in isolation’ is well illustrated by her comparison of primitive tribal behaviors with the antics of more modern tribes in today’s corporate and financial world. That in itself makes her book an interesting read.
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[tags] Gillian Tett, Fool’s Gold, financial, J.P.Morgan, credit derivatives, Cambridge, Blythe Masters, regulation, credit crisis, JPM, J.P. Morgan Chase [/tags]