Demchak’s team furtively worked: For details of how this structure worked see “The J.P. Morgan Guide to Credit Derivatives,” Risk Publications, 1999. See also Das, Satyajit, Credit Derivatives (Wiley, 2005), for a very extensive discussion of the significance of BISTRO, in relation to the structures that proceeded, and the subsequent impact on the industry (322–344).
“Five years hence, commentators will look back”: Credit Derivatives—Five Years Out, DerivativesStrategy.com (July/August 1997), at http://www.derivativesstrategy.com/magazine/archive/1997/0797rtbl.asp.
Four: The Cuffs Come Off
BISTRO-style CDS trades quickly took off: For general discussions of that, see Das, Satyajit, Credit Derivatives.
“The pace of change in the way banks manage credit risk”: Asarnow, Elliot, The Journal of Lending and Credit Risk Management (September 1998), 13.
“Blythe Masters still looks more like a J.P. Morgan intern”: The Journal of Lending and Credit Risk Management, 8.
But they were also uneasy: For a debate about the problems of fitting existing regulations to securitizations and the Fed and OCC response, see Capital Interpretations, Synthetic Collateralized Loan Obligations, November 15, 1999, at http://www.occ.treas.gov/ftp/bulletin/99-43a.pdf and Supervisory Guidance for Credit Derivatives, Washington Federal Reserve, August 12, 1996, at http://www.federalreserve.gov/BOARDDOCS/SRLetters/1996/sr9617.htm.
Cassano happily agreed: See details about this and comments from Cassano in Conference Call Transcript, AIG Financial Services Group presentation, Thomson StreetEvents (May 31, 2007), 23.
Capital reserves could be cut only: See Capital Interpretations, Synthetic Collateralized Loan Obligations (November 15, 1999) at http://www.occ.treas.gov/ftp/bulletin/99-43a.pdf.
As the audience filed into the Cipriani: “The J.P. Morgan Guide to Credit Derivatives,” Risk Publications, 1999.
Five: Merger Mania
The fate of hedge fund maverick Long-Term Capital Management: For an excellent account of this see Lowenstein, Roger, When Genius Failed.
In 1999, the year after LTCM imploded: The study in question was called “Improving Counterparty Risk Management Practices,” Counterparty Risk Management Policy Group (July 1999).
“The fact that the OTC markets function”: Remarks by Chairman Alan Greenspan, Financial Derivatives, before the Futures Industry Association, Boca Raton, Florida (March 19, 1999).
“Congress nailed the door shut”: Brickell, Mark, “Zero to $200 Trillion,” ISDA 20th Anniversary Report (March 2005), 25.
“Beyond that, the advantages are less compelling”: Santoli, Michael, “Land of the Giants: Next in Line: How Would Chase Meld with Merrill? Time to Reunite the House of Morgan?” Barron’s (April 13, 1998).
The so-called noninterest income: Michael, Nancy, “Banking’s Top Performers,” ABA Banking Journal (June 1, 2000). Data from SEC filings and the magazine’s calculations.
“From a standing start in 1980”: Frank, Stephen E., “After Embracing Change, J.P. Morgan Is Struggling to Boost Its Bottom Line,” Wall Street Journal (May 27, 1998).
In 1999, the median ROE for the top one hundred banks was 18 percent: Ibid.
As Clayton Rose, one of the senior J.P. Morgan bankers, observed: Ibid.
But such has been the pace of change in global finance: “Wall Street’s Old Order Changes New York Chase Manhattan’s Acquisition,” The Economist (September 16, 2000).
Indeed, in early 2001, a few months after the merger was completed, the bank was named “Derivatives House of the Year”: Risk magazine.
“I believe we handled everything with integrity”: Chaffin, Joshua, “Companies and Finance: The Enron Collapse—J.P. Morgan Had Too Much Exposure, Says Chairman,” Financial Times (February 7, 2002).
“We did it according to accounting conventions”: Television interview: William Harrison, chairman and CEO of JPMorgan Chase, discusses his firm’s involvement in the Enron scandal, CNBC: Market Week with Maria Bartiromo, CNBC (August 5, 2002).
“It’s unnerving how the bad news keeps piling up at J.P. Morgan”: Timmons, Heather, and Palmeri, Christopher, “The Perils of J.P. Morgan,” BusinessWeek (January 21, 2002).
Or as the Evening Standard of London tartly declared: Chambliss, Lauren, “How a Banking Giant Was Laid Low,” Evening Standard (October 16, 2002).
“Credit derivatives are a mechanism for transferring risk”: Westlake, Melvyn, “Investment Banking—Surviving the Credit Crisis,” The Banker (May 1, 2002).
Six: Innovation Unleashed
“We can promote outstanding people quickly”: Chambers, Alex, “How JP Morgan Survived the Loss of a Generation,” Euromoney (May 1, 2006).
“It is unlikely that the sector would have grown”: Ibid.
In 2003, Risk magazine designated Deutsche Bank: Awards. Risk magazine (January 2003) at http://www.risk.net/public/showPage.html?page=9109.
Pension funds were now targeting: Hughes, Jennifer, Beales, Richard, and Tett, Gillian, “Investment—Even Governments Are Putting Money into Higher Yielding Instruments,” Financial Times (June 17, 2005).
“The product development now is incredibly fast”: Katrien van Acoleyen, comments to ESF Conference in Nice (April 2005).
Remarkably, that meant that almost half of all mortgage-linked bonds: BIS Annual Report (June 2007), 146.
Each player had its own twist on modeling, after all: Terri Duhon, comments to ESF and IMN conference in Nice (April 2005).
“People who are focused on ratings alone are prime fodder”: Charles Pardue, comments to ESF and IMN conference in Nice (April 2005).
“We are very transparent in everything we do”: Unpublished interview with the Financial Times, May 2005.
“The purest information to use is data on [historic] defaults”: Unpublished interview with the Financial Times, May 2005.
In March 2000, David Li, a researcher at J.P. Morgan: The paper in question was David Li, “On Default Correlation: A Copula Function Approach,” Journal of Fixed Income, vol. 9, no. 4 (March 2000).
As Alex Veroude, the manager of a CDO for Gulf International Bank: Alex Veroude, comments to ESF and IMN conference in Nice (April 2005).
As David Li himself said about the model he had fashioned: Whitehouse, Mark, “Slices of Risk: How a Formula Ignited Market That Burned Some Big Investors,” Wall Street Journal (September 12, 2005).
The revenues of the largest investment banks grew 14 percent between 2003 and 2004: Data taken from Boston Consulting Group. Investment Banking & Capital Markets Report, Q4 2005.
Seven: Mr. Dimon Takes Charge
The two leaders were near opposites: Tully, Shawn, “The Deal Maker and the Dynamo,” Fortune (February 9, 2004).
“Does it bother you?”: Television interview: William Harrison and Coach Dean Smith discuss business and basketball, Special Report with Maria Bartiromo, CNBC (February 23, 2004).
Instead of heading first to the headquarters in the City of London: Farrell, Greg, “Dimon Adds Sparkle to JPMorgan Chase; Ousted at Citigroup, Banker Fights His Way Back to Top,” USA Today (November 29, 2005).
“Yond Cassius has a lean and hungry look”: Stires, David, “At J.P. Morgan, Look Out for No. 2,” Fortune (October 18, 2004).
Eight: Risky Business
“His huge banking merger is not yet delivering”: “Waiting Game—The Lex Column,” Financial Times (August 22, 2005).
“He knows where all the bodies are buried in that monster derivatives portfolio”: Kerr, Ian, “Jamie Dimon and His ‘Terrible’ Results,” EuroWeek (October 29, 2004).
“Given the profile of JPMorgan as an institution”: Chambers, Alex, “How JPMorgan Survived the Loss of a Generation.”
Onlookers “should [not] be concerned that home prices are rising”: “Housing Bubble Prospects Q&A,” National Association of Realtors (August 2005) at http://www.realtor.org/research.nsf/files/bubbleq&a.pdf/$file/bubbleq&a.pdf.
“House prices have risen nearly 25 percent ove
r the past two years”: Bernanke, Ben S. “The Economic Outlook” (October 20, 2005), as cited in Shiller, Robert J. The Subprime Solution (Princeton University Press, 2008).
In 2005, American households extracted no less than $750 billion: “Sources and Uses of Equity Extracted from Homes,” U.S. Federal Reserve (March 2007).
In 2006, though: Shiller, Robert, The Subprime Solution, 35.
From early 2002 to early 2005: BIS 77th Annual Report (June 2007), 126.
Then, in January 2006, an index for tracking those offerings and their values was launched: For details of how the ABX works, see http://www.markit.com/information/products/category/indices/abx/about_abx.html.
Nine: Leveraging Lunacy
By mid-2005 there were $12 trillion in CDS contracts: Estimates of the size of the CDS market are usually reached by surveying the biggest deals. These estimates have varied considerably over time, depending on what process is used to collect the surveys. The British Bankers Association, for example, has different figures from ISDA. It should also be noted that there is a stark difference between the level of gross outstanding CDS contracts and the level of net market risk, since many outstanding contracts should cancel (or “net”) each other out. Net risk, or the replacement cost of contracts, is often a tenth of the size of gross outstanding risk. Figures on the gross outstanding size of the CDS market here and subsequently, unless otherwise stated, are drawn from ISDA data. See http://www.isda.org/statistics/pdf/ISDA-Market-Survey-annual-data.pdf.
“There is a type of euphoria”: Terri Duhon and Cynthia McNulty, comments to the ESF/IMN conference in Nice (April 2005).
“Those who are successful know this”: Brown, Mark, and Currie, Antony, “Yield Hunger Drives Structured Credit,” Euromoney (September 2004).
“Banks now face the challenging task”: Boston Consulting Group, Succeeding with Growth, report on the 2004 global banking industry.
He decided to bring Merrill into the securitization business with a vengeance: See Pulliam, Susan, Ng, Serena, and Smith, Randall, “Merrill Upped Ante as Boom in Mortgage Bonds Fizzled—Fresh $6 Billion Hit Is Expected as Toll of CDO Push Rises,” Wall Street Journal (April 16, 2008). Also Gregory, Michael, and O’Connor, Colleen, “Merrill Lynch Reinvesting in SanFran,” Private Placement Letter (July 7, 2003). This account has also drawn on the author’s interviews with Merrill employees.
By 2006, Merrill topped the league table: Data supplied by Dealogic.
One corner of the AIG empire: See Transcript of AIG Investor Group Meeting on December 5, 2007, 08.30, Thomson StreetEvents, P5; Guerrera, Francesco, and Felsted, Andrea, “Inadequate Cover,” Financial Times (October 6, 2008); Pullman, Ng, and Smith, “Merrill Upped Ante.” This account has also drawn on the author’s interviews with AIG employees.
Citi’s CDO machine began running at such a frenetic speed: See the 10-Q filing by Citigroup to the SEC for the third quarter of 2007 for details of the super-senior holdings that came back onto its balance sheet as a result of the liquidity puts. These related to CDO of ABS. See also the comments that Barney Frank made about his meeting with Chuck Prince, CEO of Citi, in Syre, Steven, “Frank Talk About Rules,” Boston Globe (March 20, 2008). This account has also drawn on the author’s interviews with Citi employees.
Arguably, the most aggressive player of all in Europe was UBS: Details on this, excluding extensive numbers, can be found in UBS, “Shareholder Report on UBS’s Writedowns,” (April 18, 2008) at http://www.ubs.com/1/e/investors/shareholderreport.html. This account has also drawn on the author’s interviews with UBS employees.
“most of us had not even heard the word super-senior”: Interview with the Financial Times in April 2008. See also Hughes, Chris, Simonian, Haig, and Thal-Larsen, Peter, “Corroded to the Core: How a Staid Swiss Bank Let Ambitions Lead It into Folly,” Financial Times (April 21, 2008).
“In the world I operate in”: Interview with Blythe Masters, February 2007, on womenworking2000.com. No author cited. http://www.womenworking2000.com/feature/index.php?id=94.
Ten: Tremors
In October 2006, Bill King, the man: Tully, Shawn, “Jamie Dimon’s Swat Team,” Fortune (September 15, 2008). Supplemented with author interviews.
“A housing crisis approaches”: Witter Lon, “The No-Money-Down Disaster,” Barron’s (August 21, 2006).
“Builders that built speculative homes”: Editorial comment, “Pop! Goes the U.S. Real Estate Bubble,” Toronto Star (September 6, 2006).
“When even Toll Brothers, the high-end builder”: Shilling, A. Gary, “Implosion: When Even Toll Brothers, the High-end Builder, Suffers Cancelations, You Know the Real Estate Boom Is Over,” Forbes (June 19, 2006).
The delinquency rate on subprime mortgages rose: BIS Annual Report 2007, 126.
Between October and December 2006 alone: Ibid., 110.
One particularly fast area of growth was so-called mezzanine-structured finance CDOs: Data from internal calculations from J.P. Morgan.
Over at Deutsche Bank, a group of traders: Based on author interviews. See also Pittman, Mark, “How Stage Was Set for Meltdown: Subprime Market Began with Talk over Chinese Takeout,” Bloomberg.com (December 23, 2007).
Goldman Sachs was also rolling the dice: Based on author interviews with Goldman employees. See also Kelly, Kate, “How Goldman Won Big on Mortgage Meltdown,” Wall Street Journal (December 14, 2007).
“The market has overreacted”: Kelly, Kate, “Behind a Subprime Call—Bear Stearns Analyst Dismissed the Fears and Now Feels Heat,” Wall Street Journal (July 12, 2007).
“We are responding to the new business environment”: Lambe, Geraldine, “Dow Kim: The copresident of global markets and investment banking at Merrill Lynch assures Geraldine Lambe that a spate of diversified acquisitions is all part of a disciplined strategy to reshape the company,” The Banker (February 5, 2007).
When Boston Consulting Group: Boston Consulting Group, “Investment Banking and Capital Markets,” Markets Report—Fourth Quarter 2006 (March 20, 2007).
The mania was so intense: 77th BIS Annual Report (June 24, 2007), 106.
“As long as the music is still playing”: Nakamoto, Michiyo, and Wighton, David, “Bullish Citigroup Is ‘Still Dancing’ to the Beat of the Buy-out Boom,” Financial Times (July 10, 2007).
However, as Basel’s BIS noted: “The Recent Behavior of Financial Market Volatility,” BIS Paper No. 29 (2006).
Such dispersion, it added, would help to “mitigate and absorb shocks to the financial system”: IMF’s Global Financial Stability Report of April 2006.
“may have potentially increased the scope for financial imbalances”: Borio, C., and White, W., “Whither Monetary and Financial Stability?” Paper presented to Reserve Bank of Kansas City Economic Symposium, Jackson Hole, Wyoming, August 30, 2003, but later published in various economic journals.
“What worries me is what might happen if—or when—the system starts to de-leverage”: Unpublished Financial Times interview in spring 2007.
“These developments have clear benefits, but they may also have side effects”: BIS 77th Annual Report (June 2007), 151.
“We are currently seeing elements in global financial markets”: Tett, Gillian, “Prepare for Asset Repricing, Warns Trichet,” Financial Times (January 29, 2007).
“In ten years’ time, we may therefore…be better informed”: Speech by Paul Tucker, executive director and member of the Monetary Policy Committee of the Bank of England, at Merrill Lynch Conference, “A Perspective on Recent Monetary and Financial System Developments,” London (April 26, 2007).
“A number of fundamental changes in the US financial system”: Remarks at the New York Bankers Association Financial Services Forum Chairman’s Reception, New York City (April 5, 2006).
“I want to call your particular attention to [our recommendations] which call for urgent industry-wide efforts”: “Toward Greater Financial Stability: A Private Sector Perspective,” The Report of the CRMPG II (July 27, 2005).
If nothing else, that would show that global leaders: For a summary of the views that Peer Steinbrück, the German finance minister, expressed to the meeting, see BBC report on the interview between Die Welt and Steinbrück, reported as Germany’s Steinbrück interviewed on hedge funds, industry policy, BBC Monitoring European, May 9, 2007. In this he said: “I fear the effects on the stability of the international financial system if hedge funds get into heavy water and their creditors take excessive risks because of lack of transparency. In this respect, I am in agreement with a number of international institutions…all are worried about these dangers that could result from insufficient transparency.”
Eleven: First Failures
“Hard hit by turmoil”: Kelly, Kate, and Ng, Serena, “Bear Stearns Fund Hurt by Subprime Loans,” Wall Street Journal (June 12, 2007).
“I’m fearful of these markets”: Quote taken from indictment filed by prosecutors in New York State law courts against Cioffi and Tannin. For details, see http://f11.findlaw.com/news.findlaw.com/nytimes/docs/crim/uscioffitannin61808ind.pdf. See also Landon, Thomas, “Prosecutors Build Bear Stearns Case on E-mails,” New York Times (June 20, 2008), or Hurtado, Patricia, and Scheer, David, “Former Bear Stearns Fund Managers Arrested by FBI,” Bloomberg.com (June 19, 2008).
“another illustration of the danger facing funds that rely”: Goldstein, Matthew, “Bear Stearns Subprime Bath,” BusinessWeek (June 12, 2007).
Moody’s announced it was cutting its ratings on 131 bonds: Ng, Serena, and Kelly, Kate, “Ills Deepen in Subprime-Bond Arena,” Wall Street Journal (June 18, 2008).
In late June, Bear Stearns publicly announced that it would: Creswell, Julie, and Bajaj, Vikas, “$3.2 Billion Move by Bear Stearns to Rescue Fund,” New York Times (June 23, 2007); Mackintosh, James, Scholtes, Saskia, and White, Ben, “Bear Hits Other Banks by Raising Exposure to Subprime Mortgages,” Financial Times (June 23, 2007).
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