Tuesday, September 15, 2009

Fools and Their Money

Fool's Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and Unleashed a Catastrophe: How an Ingenious Tribe of Bankers Rewrote ... Made a Fortune and Survived a Catastrophe Fool's Gold: How Unrestrained Greed Corrupted a Dream, Shattered Global Markets and Unleashed a Catastrophe: How an Ingenious Tribe of Bankers Rewrote ... Made a Fortune and Survived a Catastrophe by Gillian Tett

My rating: 5 of 5 stars
I've done a fair amount of reading about the Panic of 2008, and Gillian Tett's "Fools Gold" explains the exotic investment instruments at the heart of the panic better than any other work I've read. A group of derivatives traders at J.P. Morgan created commoditized credit default swaps in the early 1990s as a way to move risk off the company's books, freeing up capital for lending and investment that otherwise would need to be held in reserve. Morgan made payments to AIG, which assumed the risk that Morgan's assets would go into default. Derivatives traders at other firms began assembling securities backed by subprime mortgages, trying to put together instruments that would be just risky enough to obtain returns but safe enough to obtain AAA ratings. They then paid AIG to assume the risk of the mortgages underlying those securities going bad. However, many institutions kept what they thought were the least risky of these mortgages on their own books, as they could not obtain much in the way of returns on the securities that they would back. The whole thing was unregulated by government, and the ratings agencies were easily bamboozled into turning poo into gold (as it turned out). As the cruddy mortgages went bad, AIG began to take on water. When the less risky mortgages went bad, the financial institutions themselves sank.

Interestingly, J.P. Morgan did not get into the business of mortgage backed securities. Morgan's mathematicians could not put together a risk model with the kind of integrity to which they were accustomed. First, they had no data on what could happen if real estate values ever declined. Second, they had no long-term data on default rates for the kinds of subprime mortgages that proliferated in the early and mid 2000s. Moreover, Morgan/Chase chairman Jamie Dimon pushed the concept of a "fortress balance sheet" containing rock-solid assets on which the bank could rely if things went to hell. Dimon pushed Morgan's derivatives traders to investigate getting into the business of mortgage backed securities a couple of times, but, consistent with the notion of a "fortress balance sheet," he accepted the traders' reasons for staying away from that business.

The book contains a brief account of the events leading to the Lehman Brothers bankruptcy that turned a situation into a panic, and concludes with Tett's cultural analysis of U.S. and U.K. investment houses.

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Monday, September 07, 2009

How did Kazakhstan get me to Logan, Utah?

Your humble correspondent spent a few days last week at a knda, sorta family reunion (my favorite kind of reunion) in Logan, Utah, and the better part of one day in Rexburg, Idaho. This was an entirely people-centric trip, meaning that I did not go hiking in the Bear River Range or any other local adventures in which one cannot participate 'round these parts. Also, one of DW's old friends left open the possibility of getting together for dinner. With such a short turnaround (Friday-Tuesday), I thought it best not to make any meeting arrangements with my own Utah friends. DW's friend crapped out on us, but that may have been for the best, as it gave us a free day.

Present at said reunion were gentle readers Bill and Karen, along with Superbaby Sammy, guests of honor gentle reader KA and her family, DW's other siblings, and DW's parents. KA's DH recently took a position at the Agency for International Development, and he will be posted in Kazakhstan. As we know from one recent motion picture, Kazakhstan is friendly to Americans:

KA's DH is an agricultural economist by profession, so I am looking forward to photos of the Kazakhstan branch of the family, decked out in native costumes, standing amidst amber waves of grain. Anyhow, their imminent move to Kazakstan for a couple of years led us to have a gathering.

The most fun person to observe at this mini-reunion was gentle reader Bill, who came to town and bought two cars in one day. And he and gentle reader Karen signed on a house in Idaho that morning. It was fun to follow Bill's odyssey as he went to the dealership and back a few times until he and Karen obtained the right two cars. Talk about taking a plunge.

On Monday, DW and I drove up to Rexburg, Idaho, where one of DW's sisters had a baby as the rest of us were reunioning in Utah. Rexburg's welcoming sign is just a bit aggressive as to every other town in the United States--"America's Family Community." I'm sure most of the people there are very nice, but I kind of formed the impression that the town itself looks as if it's 1955 and built to stay that way. DW attended college there for one year, and she confirmed that it looked exactly the same as it did 20+ years ago. It might be interesting to set a cultural anthropologist loose there. But not in my SIL's neighborhood, which is jarringly new when compared to the town we drove through to get there. We had a great visit up there and hated to leave.

Anyhow, that's my Utah trip in a nutshell.