All agree that the global financial crisis precipitated the recession of 2007-09. Few agree on what caused that crisis. Some revile villains: regulators and bank managers too lazy to do their jobs, greedy traders, mortgage salesmen, and investment bankers. They either re-tell gossip or rail about the villains' perfidy. Others take a more analytical approach, identifying impersonal forces behind the collapse. The Federal Reserve's overexpansion of credit after 2001, the resulting bubble, Wall Street's and mortgage banking's skewed incentives, and the global imbalances play central roles in the drama. Is there no middle ground? Is the financial folly not a story of both forces and the faces behind them?
Gillian Tett is an award winning financial journalist with the Financial Times and a Ph.D. in anthropology. She is the odd duck whose deconstruction of the financial crisis is both analytical and personal.
One imagines anthropologists studying primitive peoples on civilization's fringe. They live among them, getting to know them by studying their customs and artifacts. Anthropologists work to understand exotic cultures. In Fool's Gold, Gillian Tett studies the small tribe of geeks who pioneered the exotic credit derivatives that fueled the great credit boom of 2003-07. She got to understand the culture of these hard working, very smart, mathematically sophisticated, young analysts who began as a close-knit team at J.P. Morgan in the late 1980s. Anthropologist Tett discovered that a powerful set of values animated their culture. These geeks were inventive and prized innovation. They saw new financially engineered products as a great boon to banking. They left as artifacts designer securities and the models used to create them.
Overlaid on the geeks' culture were the values and world-view of J.P. Morgan's corporate culture. The founder of the Morgan geeks' tribe was Bill Winters, who became the international bank's co-Chairman. He imbued them with the bank's values and developed extremely capable and loyal followers, such as Blythe Masters, Head of Global Commodities Trading and head of the derivatives dealers' trade group. Their loyalty grew out of the blue chip bank's values, including a commercial bank's innate focus on credit risk and its commitment to do, "first-class business ... in a first-class way," as J.P. "Jack" Morgan, Jr. put it. Doing the right thing in banking is managing credit risk.
At financial engineering's core is modeling the cash flows that result from a deal or a synthetic security and thereby predict its return and its risk. As economists know, models can be sensitive to their assumptions. Knowing when to rely on those assumptions and when not to requires discipline, knowledge, and integrity. Cultural values affect how analysts and traders use models when real money is on the line. In the book's most poignant part, the author describes how members of her J.P. Morgan tribe could not understand the folly that was going on in their rivals' derivatives shops. Writing about Blythe Masters, Tett tells us, "Like Winters, she was so steeped in the ways of J.P. Morgan that it never occurred to her that the other banks might simply ignore all the risk controls J.P. Morgan adhered to. That they might do so was simply outside her cognitive map, as was also true for Winters" (p. 142). On October 29, 2008, JPMorgan Chase, as a result of the merger, reshuffled its management team. (1) Bill Winters, in many ways the hero of Fool's Gold, lost out and left JPMorgan Chase. By the time you read this review, he may be the CEO of another financial institution.
In high finance, bad credit management seems to drive out good. J.P. Morgan's conservatism made it vulnerable as a takeover candidate. At the height of the Internet bubble, Chase Manhattan Bank's profits and equity value were inflated by deals with such "sterling" credits as Enron, WorldCom, and Global Crossing. It …