Could an anthropologist—someone who can draw links between the balkanized world of competitive banking and the tribalized world of competing societies—have prevented the economic crash?
“I look at financial systems from a holistic perspective,” says British author Gillian Tett, speaking from her office in London. “Meaning I look at how all the different parts add up together. Most people in the financial world are so specialized that they only see their own little silos.”
“The stories that people tell about themselves are crucial,” says Tett. “But you also have to look at the parts of society that people don’t want to talk about—the areas of social silence.”
If you’re looking for someone well-equipped to provide both an analysis and a narrative of the ongoing mayhem in the financial world, Tett seems a natural choice. A senior editor at the Financial Times, she covered Japan’s financial crisis in the ‘90s and was one of the very first to predict the current credit crisis, back in 2005. But it’s not just her background in finance that helps her. Tett also has a doctorate in anthropology, and can compare the structures of large bank holdings to, say, Afghanistan’s tribal system. “Bank departments often compete furiously for power and influence, while there is hardly any horizontal supervision or interaction. The tribe within the bank who makes the most money has the most power. That is dangerous, because without the necessary checks and balances, good ideas can be taken to extremes—with terrible consequences.”
Tett’s background in anthropology also helps her to take a cynical view of the rhetoric that elites use to justify their positions. “The stories that people tell about themselves are crucial,” she says. “But you also have to look at the parts of society that people don’t want to talk about—the areas of social silence, if you like.”
Clearly, for a long time the exploding activity in the credit derivatives market has been one such silent area. “Bankers presented derivatives as something very complicated, technical, and boring—which served them well. Because people thought it was that way, they didn’t spend too long looking into it.”
A drunken plan
As Tett writes in Fool’s Gold the fatal progress of credit derivatives began in June 1994, in Boca Raton, Florida, where a group of young J.P. Morgan bankers gathered for a long weekend of brainstorming about how to grow the derivatives business. The bankers, mostly in their 20s, set out to do what can be expected of any group of young people that’s given an unlimited bar bill—they got really drunk.
But the team also took on the audacious task of finding a solution to banking’s traditional Achilles' heel: the danger that borrowers will not repay their loans. They figured they could combine financial instruments so that repayment risk would disappear, or at least be so spread out through the market that it would become harmless. Relieved of risk, the bank could lend out more money, and thus grow its profit.
In the course of the following years, Morgan would enrich the world with complex financial products such as collateralized debt obligations and credit default swaps. Soon the other investment banks started offering similar products.
The most striking thing about the financial world Tett shows us is the tremendous entitlement of the young bankers of this Morgan team, often geniuses at math and marketing. “They were convinced they had the right to remake finance,” Tett says. “They were also completely naïve in their belief in the power of innovation.”
That doesn’t mean they were evil or malicious, she emphasizes. “They were just young and ambitious people at the start of their careers, who thought they were going to bring around a lot of good.”
For a while the new products did bring some good—the cost of capital went down, and credit moved faster than ever before through the global economy. That is, until Morgan’s rivals started to add mortgage-backed securities to the derivatives mix. When the real-estate bubble burst in 2006, derivatives and securities tied to subprime mortgages began to lose value. As it turned out, the fact that the derivatives had spread the risks throughout the system only worsened things. Dubious debt was all over the place, and nobody knew exactly where.
Still, Fool’s Gold is not simply the story of the good kids at Morgan who wanted to bring financial innovation to the world, and the bad kids at the other banks whose recklessness and greed almost destroyed the whole banking industry. “Much of the drive for innovation at J.P. Morgan came from the desire to get around existing regulation and was about finding ways to simply make more profits,” says Tett.
By the end of 2000, when competitors such as Bear Stearns, Lehman Brothers, and Merrill Lynch actually started to make much more money in the derivatives markets than Morgan itself, the derivatives team at Morgan reconsidered their earlier decision to stay away from mortgage-backed securities. But again, they deemed it too risky. Every time they revisited that decision, they came to that same conclusion.
Which brings up the question: If J.P. Morgan saw the risks of the mortgage-backed securities market, and didn’t enter it for that reason, why didn’t it speak out to the rest of the world?
“They never thought it was their job to save other people from their stupidity,” Tett says. “Some Morgan bankers even told me they assumed the regulators would step in—which seems terribly ironic, given that they fought for years to keep the regulators away.”
Toward the end of Fool’s Gold, one member from the original derivatives team takes a stand for her brain children, as she claims: "When car crashes happen, people don't blame cars or stop driving them, they blame the drivers! Derivatives are the same – it's not the tools at fault but the people who used those tools."
Tett, however, has seen enough financial innovation. "Its benefits are outweighed by the costs. Finance should go back to pushing money around the economy—it's a utility. Banks should be the servants of the economy, not the masters. Most bankers don't seem to realize this yet."
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. 293 pp. Free Press. $26
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Mars van Grunsven is a writer and editor whose work has appeared in many of Holland's leading magazines and newspapers, including De Groene Amsterdammer, HP De Tijd and NRC Handelsblad. He writes about arts, business, literature, media and social issues.