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TIMOTHY FADEK



Reviewed here: Fool's Gold, by Gillian Tett House of Cards, by William D. Cohan Street Fighters, by Kate Kelly

It seems easy in hindsight to write books about how the global financial crisis began, how it grew and almost ate the world - and still might. Yet to tell the tale well, which each of these books does, is not so easy. The amounts of data to be assembled and mastered, the complexities of the story and the shifting sands of blame make it a daunting task.

The broadest of the three books is Gillian Tett's Fool's Gold. Head of global markets coverage for the Financial Times in London, Tett focuses on J.P. Morgan, the repackaged House of Morgan, once the pillar of U.S. finance and still one of the most patrician investment banks on Wall Street. From the perspective of Morgan's derivatives business, and of chief executive officer Jamie Dimon, she explains how investment bankers, who had usually made tidy fortunes by peddling stocks and bonds for the biggest corporations in the United States, got down and dirty with the likes of Bear Stearns and Lehman Brothers, which, by comparison, were street fighters not averse to cooking up any sort of deal that would make money.

  • 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, Free Press, 294 pages, $34


In their books, financial journalist and former investment banker William D. Cohan and Wall Street Journal reporter Kate Kelly tell the story from Bear Stearns's point of view. Morgan absorbed Bear, so the stories are really those of the victor and the vanquished.

The unlikely marriage of upper-crust Morgan and scrappy Bear Stearns had its origin in competition to make new classes of assets and to increase profits as fast as possible. What Morgan and Bear Stearns, Merrill Lynch, Lehman, Bank of America and, before them, Bankers Trust and Citigroup and, most of all, insurance giant AIG created to make money was a new universe of assets whose value was derived from underlying securities. The new styles of derivatives were like the invention of money itself. The quantities manufactured were staggering. Tett counts $6-trillion (U.S.) held in various hedge funds and vehicles designed to get risks out of sight. That was more than half the total U.S. public debt before the bailout program began.

The new classes of debt had been put together with the aid of Russian physicists and mathematicians, among other financial engineers working on Wall Street. It was said that, unable to get research grants in the new Russia, they went to Wall Street and switched their jobs from making weapons that would wreck cities to weapons that would destroy fortunes.



  • House of Cards: A Tale of Hubris and Wretched Excess on Wall Street, by William D. Cohan, Doubleday, 468 pages, $33




What the back-office math wonks had really invented was a kind of financial Ebola that could spread and kill everybody. Tett shows how the concept of getting around the international banking agreements called Basel I required getting risk off banks' books.

Rather than keep those risks and tie up capital, Morgan and other investment banks sold them to investors. But the new, securitized deals, especially packaged subprime mortgages, became monsters of poorly understood risk.

In Tett's view, J.P. Morgan's contribution to the tower of risk was an asset called a BISTRO ("broad index secured trust offering"). The idea was that the new gimmick, based offshore in a tax-friendly haven, would insure parent Morgan against default on its mortgages. Defaults were expected to be low, the BISTRO or some other special-purpose vehicle could easily raise sufficient funds to cover the potential defaults, and Morgan could then sell packaged mortgages backed by its own insurance and make pots of money on each transaction.

Bear Stearns and other New York financial houses were doing the same thing.

Most of these players relied on statistical models that said risks were not covariant: that is, a collapse in one market, say Las Vegas condos mortgaged in 2006, would not affect the prices or risks of Arkansas bungalows mortgaged in 2005. Covariance was recognized as the great enemy and the financial engineers sweated to isolate it.



  • Street Fighters: The Last 72 Hours of Bear Stearns, the Toughest Firm on Wall Street, by Kate Kelly, Portfolio, 247 pages, $32.50

The solution was to take a heap of debt instruments like mortgages or credit-card receivables and to turn the cash flows into layers of what were called Collateralized Debt Obligations, CDOs for short. Typically, they had 36 layers, or tranches. If cash coming in were insufficient to pay all obligations, the bottom layer, usually called "toxic waste," would take the hit and holders of that tranche would suffer a cut or even lose all their cash flow. Then layer 35 would take a hit, then layer 34. By the time you got to the top of the heap, the self-insuring pile of rights to cash flow appeared impregnable. So the big credit-rating agencies like Moody's gave the top layers AAA ratings, assuming, as the math guys did, that the whole tower would not, indeed could not, collapse.



It did not turn out that way. As Cohan makes clear in House of Cards, risks retained or imputed to Bear Stearns wrecked the company. Bear, once one of the biggest investment banks on Wall Street, went from a company whose share price had been $131 (U.S.) in October, 2007, to a wreck that J.P. Morgan proposed to rescue via a buyout at $2 a share. Ironically, at the moment Bear's management realized that the company was about to go bankrupt, Jimmy Cayne, its CEO, was playing bridge.

What caused the collapse of Bear is the subject of Cohan's massive chronicle of the disaster and Kelly's shorter, more narrative account.

Bear Stearns, as Cohan relates, had been founded in 1923. It survived the crash of 1929 and by 1933 had 75 employees and $800,000 in capital. Management eventually flowed to chairman Ace Greenberg, a former stock salesman from Wichita, Kan., whose hobbies included doing magic tricks in a local deli, and to CEO Alan Schwartz, a wannabe Major League Baseball player once sought by the Cincinnati Reds. The company grew rich and huge not just by taking orders to buy and sell stocks, but by investing its own money in what were often fresh ideas. Repackaging risk in derivatives was just the latest new idea.









Bear and other Wall Street investment banks realized that the real money was no longer in trading stocks - fixed commissions had long ago been abolished - but by creating and selling new forms of assets, risk control was compromised. For example, if layer 36 of a bunch of mortgages were seen as pure financial crud, the investment bankers could package a whole bunch of 36s into a new CDO made up of other CDO layer 36s. These were called CDOs squared because they were CDOs of CDOs. And when the bottom layers of these new obligations got to be too smelly to sell, the engineers made up CDOs of CDOs of CDOs - CDO cubed. The idea was that even if one hunk of CDOs, say Nebraska mortgages, went bad, Vermont credit-card receivables would be fine. That was okay in normal times, but when the global economy went into a massive contraction in 2008, every kind of consumer debt flopped. Covariance came back with a vengeance.

The math guys did not realize it, but the world is much more interconnected than a series of bell curves. The investment bankers, as Tett explains, had worked out theories that would show how their CDOs and other synthetic debt securities would work under conditions of the risks that they knew. They did not try to measure what she calls the "unknown unknowns," nor did they work out the consequences of what statisticians call the "long tails" of risk when the critters of the night crawl home. Those critters caused runs on banks with imploding mortgage portfolios such as Northern Rock in Britain and Washington Mutual in the United States, and ultimately led high rollers to ask for their money back from hedge funds that had blown it away on bad speculations. As one bank fell, others that had lent it money also fell. The house of cards was crumbling.

Asset linkage came home to wreck Bear in the summer of 2008 as the housing crisis matured into a full-blown panic. As Cohan and Kelly show, Bear Stearns's ability to finance its operations was coming to an end as it lost the confidence of the world financial community. Unlike a big commercial bank, which takes in money through its customers' savings and chequing accounts, Bear had to go to the money market every day of its life. The heart of the financing operation was a department where, every day, traders would call up other banks and ask if they could keep the billions they had borrowed the day before against assets pledged of similar value.

Bear's standing began to slip in March as hedge funds began to withdraw their money. Bear was being bled dry by withdrawals. It had $20-billion on March 5, $18-billion on March 10, $10-billion on March 11, and as that happened, the cost of getting insurance on Bear's own bonds exceeded the yields on junk bonds. The end was in sight.

Cohan's minute-by-minute retelling of how Bear turned into a stock worth no more than a few bucks a share, wrecking the personal fortunes of its investors, including senior managers who could not believe what the markets were saying, is probably more information than most readers want. But his summation, quoting Alan Schwartz, is succinct: "In truth, it was a team effort. We all fucked up. Government. Rating agencies. Wall Street. Commercial banks. Regulators. Investors. Everybody."

As a postscript, Kate Kelly tells where the big players went: Jimmy Cayne is in retirement. Ace Greenberg became chairman emeritus. Schwartz went to work for Rothschild's, the fabled but smallish British investment bank. Their multibillion-dollar personal fortunes, mostly held in Bear Stearns common stock, turned into just a few million. Thousands of Bear employees whose pensions had held Bear stock to the bitter end joined others from Lehman Brothers seeking jobs where their skills in making imaginary money might be useful.

Andrew Allentuck's latest book, When Can I Retire? Planning Your Financial Life After Work, was published this year.

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