Another was the downgrades that the ratings agencies themselves were starting to make: For a good timeline of those events, see BIS 78th Annual Report (June 2008), 95–99.
“The problem is that people just don’t know quite what to trust”: Unpublished interview with Donald Aiken with the Financial Times, August 2007.
Thus, while the IKB funds held more than $20 billion in assets: For accounts of this, see Gumbel, Peter, “Subprime on the Rhine,” Fortune (September 2, 2007); Mollenkamp, Carrick, Taylor, Edward, and McDonald, Ian, “Impact of Mortgage Crisis Spreads—How Subprime Mess Ensnared German Bank,” Wall Street Journal (August 10, 2007).
Twelve: Panic Takes Hold
“I see striking similarities today with the early stages of our own financial crisis”: Author interview. See also Tett, Gillian, “Financial Faith Found Wanting—Japan Offers a Salutary Tale in Banking Crises,” Financial Times (January 2, 2008); Tett, Gillian, “The Big Freeze: A Year That Shook Faith in Finance,” Financial Times (August 3, 2008).
Bernanke observed in a speech before the Federal Reserve of Chicago: Bernanke, Ben S., speech, “The Subprime Mortgage Market,” the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, Chicago, Illinois (May 17, 2007).
“in the order of around $50 billion to $100 billion”: See Del Bruno, Joe, “Subprime Fallout Overblown?” Associated Press (July 21, 2007); Aversa, Jeannine, “Fed Boss Reacts to Subprime Situation,” Associated Press (July 20, 2007).
Or as Bill Dudley, a senior figure at the New York Federal Reserve: Dudley, Bill, speech to a SIFMA Legal and Compliance conference, New York City (June 13, 2007).
In truth, only a third of those securities were thought to be directly linked to mortgages: Bank of England Financial Stability Report (October 2007), 19.
“Quite honestly, [the] funding ordinarily never kept us awake at night”: “Deal of the Year, Cairn High Grade SIV-Lite Restructuring,” Risk magazine (January 2007).
“We are certainly not going to protect people from unwise lending decisions”: Duncan, Gary, “Governor Warns Careless Lenders ‘The Bank Will Not Bail You Out,’” The Times (London) (August 9, 2007).
“There are a lot of investors who invested on a leveraged basis”: Comment taken from proceedings from Jackson Hole, Wyoming, conference, session on General Discussion; Housing and Monetary Policy, 480.
“What we are seeing right now is a total overreaction”: Ibid., 483.
“The real issue right now is a run”: Ibid., 485.
“It is stunning how little many policy makers know”: Tannenbaum, Carl, “Blog on Real Time Economics,” Wall Street Journal (September 4, 2007), http://blogs.wsj.com/economics/2007/09/04/economists-react-views-from-jackson-hole/.
Thirteen: Bank Run
At the start of 2007, the rate of default on subprime mortgages: Bank of England Financial Stability Report (October 2007), 17; drawing from data from Mortgage Bankers Association and Thomson Financial.
rising from 3.5 percent in late 2005: Calculation by Citi based on Bloomberg data, fr233, “Opportunities in Dislocation, Citi” (October 2007).
“There’s no model for what’s happening now”: Ivry, Bob, “Bernanke Was Wrong; Subprime Contagion Is Spreading,” Bloomberg.com (August 10, 2007).
“Owning a home has always been at the center of the American Dream”: “President Bush Discusses Homeownership Financing—Department of the US White House, FDCH,” FDCH Regulatory Intelligence Database (August 31, 2007).
“Although the firm remains profitable”: Peston, Robert, on News 24 BBC, 8:30 p.m., September 13, 2008.
At the turn of the century, the bank had embraced securitization with a vengeance: For data on this, see “The Funding Crisis at Northern Rock,” Bank of England Financial Stability Report (October 2007), 10–11.
At the start of that year, its website: Tett, Gillian, “Elaborate Debt Deals Spread Risk but Distort the Data,” Financial Times (January 15, 2007).
“I don’t know how anyone could characterize it as a bailout”: Holzer, Jessica, “Steel Downplays Government’s Role in ‘Superfund’ Aimed at Calming Markets,” The Hill (November 16, 2007).
“The performance, particularly in the US housing (and) mortgage sector”: Freeland, Chrystia, and Scholtes, Saskia, “View from the Top: Ray McDaniel, Chief Executive of Moody’s Investors Service,” Financial Times (October 12, 2007).
By September 2007, more than 30 percent of the subprime mortgage loans: Bank of England Financial Stability Report (October 2007), 17, sourced to Bloomberg.com.
“Whereas in a CLO [a CDO built of corporate loans] it is unlikely that all the loans default simultaneously”: King, Matt, and team, “Estimating CDO of ABS Writedowns,” Citi fixed-income quantitative research, reported in Financial Times (November 6, 2007).
One clue to what had gone so terribly wrong at Citi: Citigroup 10-Q filing to the SEC, for the third quarter of 2007, 9.
The losses at UBS were arguably even more shocking: UBS, “Shareholder Report on UBS’s Writedowns,” (April 18, 2008), at http://www.ubs.com/1/e/investors/shareholderreport.html.
“We had seen what happened after Enron”: Author interview with senior auditors and bankers.
In the first half of 2007, large Western banks had posted: Bank of England Financial Stability Report (October 2008), 14, for data on capital (note that global banks had tier-one capital of $3.4 trillion before the crisis).
“Huge quantities of money from the emerging world”: HSBC report, cited in Elliot, Larry, “Global Economy: Oil Money Is Coming—and There Is Little the West Can Do About It,” The Guardian (March 1, 2008).
Fourteen: Bear Blows Up
“This is a relatively small transaction, representing around two percent”: “Official Release and Statement: Northern Rock Sells Mortgage Assets to JP Morgan for £2.25 Billion,” Citywire (January 11, 2008).
In February 2008, Steve Black told analysts: In fact, at the bank’s investor day in February 2008, when asked if he would do a large overlapping investment bank transaction, Black said, “The only way we would do it would be if you could find something that filled some strategic gaps where you got the overlapping businesses for free.”
As the financial woes intensified in early 2008: This section is drawn from interviews with key participants. See also Kelly, Kate, “The Fall of Bear Stearns (part 1): Lost Opportunities Haunt Final Days of Bear Stearns”; “The Fall of Bear Stearns (part 2): Fear, Rumors Touched Off Fatal Run on Bear Stearns”; “The Fall of Bear Stearns (part 3): Bear Stearns Neared Collapse Twice in Frenzied Last Days—Paulson Pushed Low-Ball Bid, Relented; a Testy Time for Dimon,” Wall Street Journal (May 27, 28, 29, 2008). Burrough, Bryan, “Bringing Down Bear Stearns,” Vanity Fair (August 1, 2008). See also Bamber, Bill, and Spencer, Andrew, Bear Trap; The Fall of Bear Stearns and the Panic of 2008 (Brick Tower Press, 2008).
On March 5, Bear’s cash holdings, on paper, topped $20 billion: Data on liquidity levels from SEC, as cited in Bank of England Financial Stability Report (April 2008), 11.
“We had been on the brink of the biggest financial meltdown”: Quotes taken from Gruen, Abby, “Wall St. Dances at News of Fed’s Interest Rate Cut—Some Fear Relief Won’t Be Long-term,” Star-Ledger (Newark) (March 19, 2008).
“With that one jaw-dropping deal [to purchase Bear], Dimon”: Dash, Eric, “Chief Lives Up to the Morgan Tradition; in Purchasing Bear Stearns, Dimon Emerges as a Major Winner,” New York Times (March 19, 2008).
By 2007, the New York Fed calculated that the combined assets of all the SIVs: Geithner, Timothy F., remarks, “Reducing Systemic Risk in a Dynamic Financial System,” at the Economic Club of New York, New York City (June 9, 2008).
Fifteen: Free Fall
Also in the spring of 2008, the Institute for International Finance: Final Report of the IIF Committee on Market Practices: Principles of Conduct and Best Practices Recommendations, IIF Washington, DC, (July 17, 2008).
As Bricke
ll stood at the podium in the ballroom: Speech, ISDA annual conference in Vienna (April 16, 2008).
“Costly as these reforms will be, those costs will be minuscule”: Covering letter from E. Gerald Corrigan and Douglas Flint to Secretary Paulson and Governor Draghi (August 6, 2008), at http://www.crmpolicygroup.org/docs/CRMPG-III-Transmittal-Letter.pdf.
“we face a race”: Tucker, Paul, remarks, Conference on “The New Financial Frontiers,” Chatham House, London, June 13, 2008, www.bankofengland.co.uk/publications/speeches/2008/speech348.pdf.
Though some argued that those ABX-based prices had fallen too far: Bank of England Financial Stability Report (May 2008), 18.
On September 16, the $62 billion Reserve Primary Fund: http://www.reservefunds.com/pdfs/Press%20Release%202008_0916.pdf.
By the summer of 2008, AIG was holding around $560 billion in super-senior risk: The account of AIG is drawn from interviews with financiers previously at the group, supplemented by material drawn from conference call transcripts of AIG’s calls with investors on May 31, 2007, and December 5, 2007. See also Guerrera, Francesco, and Felsted, Andrea, “Inadequate Cover,” Financial Times (October 6, 2008); Morgenson, Gretchen, “Behind Crisis at AIG, a Fragile Web of Risks,” New York Times (September 29, 2008); O’Harrow, Robert, and Dennis, Brady, “Downgrades and Downfall; How Could a Single Unit of AIG Cause the Giant Company’s Near-Ruin and Become a Fulcrum of the Global Financial Crisis?” Washington Post (December 31, 2008).
On Sunday, October 13, 2008, Jamie Dimon received an urgent phone call: This is drawn from author interviews, supplemented with Landler, Mark, and Dash, Eric, “Drama Behind a Banking Deal,” New York Times (October 15, 2008). Under the scheme, the government initially agreed to invest $250 billion in senior preferred bank stock, half of which was earmarked for nine large banks; half will be available to thousands of small and regional banks. The investments count toward each bank’s base, or tier-one, capital ratio. Under the original plan, the minimum investment was supposed to be 1 percent of risk-weighted assets; the maximum up to $25 billion or 3 percent of risk-weighted assets, whichever is less.
Epilogue
mark-to-market credit losses had reached almost $3 trillion: See Bank of England Financial Stability Report, October 2008, 14. The estimate covers all three main currency areas and refers to mark-to-market losses on financial assets. These totaled $2.85 trillion in October, but were believed to have risen further in the subsequent two months.
Banks and insurance companies had already written down more than $1 trillion: See Capital Markets Monitor, February 2009. Institute of International Finance, Washington, DC. Banks accounted for more than $800 billion in write-downs, insurance companies for the rest.
When an industry dinner was held in London in January to hand out banking prizes: IFR Awards for 2008, presented in January 2009. J.P. Morgan won six out of the nine main categories, considerably more than any other bank had ever won.
“What we think of as the traditional hedge fund will shrink”: Freeland, Chrystia, and MacIntosh, Julie, “View from the Top—Andrew Feldstein, Chief Executive of BlueMountain Capital,” Financial Times (December 19, 2008).
One British newspaper dubbed her the woman: Teather, David, “Blythe Masters: The Woman Who Built Financial ‘Weapon of Mass Destruction,’” The Guardian (September 20, 2008).
Angry postings on the internet: see http://www.blogher.com/blame-game-global-financial-collapse-fingers-are-pointing-one-woman-blythe-masters#comments; http://zionistgoldreport.wordpress.com/2008/11/10/scam-artist-blythe-masters-speaks.
When she addressed a meeting of SIFMA in New York in late 2008: Masters, Blythe, opening comments; “Through the Turmoil,” Address to SIFMA annual meeting, New York City, October 28, 2008, at http://events.sifma.org/2008/292/event.aspx?id=8566.
GLOSSARY
Asset-Backed Commercial Paper (ABCP): A short-term security that commonly lasts between overnight and 180 days. It is typically issued by a bank or other financial institution, backed by physical assets such as trade receivables, commercial loans, or holdings of bonds. Until 2007 it provided cheap funding.
Asset-Backed Security (ABS): A security that is backed by a portfolio of assets or cash flows from assets that are normally placed in a specially designated vehicle. The assets often (but not always) are loans. The assets are usually diversified, ideally to help reduce risk.
Bank Capital: The margin by which creditors are covered if the bank’s assets are liquidated. A measure of a bank’s financial health is its capital/ asset ratio, which bank regulations require to be above a prescribed minimum.
Basel Accord: A set of regulations that establishes levels of bank capital, drawn up by the Basel Committee on Banking Supervision (BCBS), a committee of international central bankers and supervisors. The first accord, known as Basel I, was drawn up in 1988. In 2004, a Basel II accord was published that was designed to align capital with risk in a closer manner. The secretariat for the committee is in the Bank of International Settlements (BIS) in the Swiss city of Basel.
BISTRO (broad index secured trust offering): J.P. Morgan’s proprietary name for the idea of creating CDOs out of credit derivatives. It was first launched in 1997 and was the forerunner of the synthetic CDO structure that later became widespread.
Collateralized Debt Obligations (CDOs): A form of asset-backed security. They are typically created by bundling together a portfolio of fixed-income debt (such as bonds) and using those assets to back the issuance of notes. Such notes usually carry varying levels of risk. Cash CDOs are created from tangible bonds, bonds, or other debt; synthetic CDOs sare created from credit derivatives.
Collateralized Debt Obligations of Asset Backed Securities (CDO of ABS): CDOs built out of asset-backed securities, which are usually (but not always) types of mortgage-backed bonds.
Collateralized Loan Obligations: CDOs built out of loans, which are usually “leveraged loans” (those extended to companies whose debt is rated noninvestment grade).
Conduit: An entity that funds itself by issuing short-term debt and invests in assets such as trade receivables, commercial loans, or bonds. It is backed up by credit lines from a bank and closely affiliated with a bank, but it does not always appear on a bank balance sheet. Structured investment vehicles (SIVs) are closely related to conduits.
Correlation: The degree to which asset prices, events, or risks move in the same manner.
Credit Default Swap (CDS): A contract between two parties, where the buyer pays a regular fee to the seller in exchange for a guarantee that he will be compensated in the case of any default on a stipulated piece of debt. CDS contracts are similar to insurance in some senses, but they are not regulated in the same manner, can be freely traded, and can be struck even if the buyer does not own the debt he wishes to “insure.”
Credit Derivatives (CD): A bilateral contract between a buyer and seller whose value derives from the credit risk attached to an underlying bond, loan, or other financial asset. Typically, they are designed to compensate one party if that underlying asset goes into default. CDS (credit default swaps) are one form of credit derivatives, but not the only one.
Derivative: A financial instrument whose value derives from an underlying asset, most normally commodities, bonds, equities, or currencies.
Gaussian Copula: A statistical technique developed by David Li, a former J.P. Morgan analyst, for measuring the level of correlation and default probabilities in CDOs.
Leverage: Techniques that can magnify returns (or losses). The phrase is most commonly used to refer to debt, since the application of debt to a financial structure or strategy can magnify returns and losses. However, less commonly, the phrase can also be used to describe the manner in which the structure of a CDO, or other derivatives, magnifies investor exposure to price swings.
Leverage Ratio: Most commonly used to describe the ratio between equity and debt, or earnings and debt, in relation to a CDO or company.
Leveraged Finance: Fundi
ng for companies that carry a rating below investment grade. It included high-yield bonds (bonds to companies rated below investment grade) and leveraged loans (loans to the same category of companies.) In this decade it was widely used to fund private equity bids, also known as “leveraged buyouts.”
Liquidity: The degree to which assets can be traded freely or not.
Monoline: A specialist bond insurance company that insures investors against the default of municipal government bonds, structured credit, and other assets. The insurance premium is usually paid by the issuer, not by the investor.
Mortgage-Backed Bond: Bonds that are issued from a special-purpose vehicle that holds a portfolio of mortgages. These bonds are often issued in several tranches of riskiness.
Repurchase, or “Repo,” Market: A market where two participants agree that one will sell securities to another and make a commitment to repurchase equivalent securities on a future specified date, or on call, at a specified price. In effect, it is a way of borrowing or lending stock for cash, with the stock serving as collateral.
Special Purpose Vehicle (SPV): A shell company that is created to hold a portfolio of assets, such as bonds or derivatives contracts, and then issue securities backed by those assets. It may be created by a bank, but is a separate legal entity.
Structured Investment Vehicle (SIV): An entity that operates in a manner similar to a conduit but does not enjoy complete credit support from a bank, and has external equity investors who bear the first risk of losses.
Super-Senior Risk: The most senior part of the capital structure of a CDO, which is the least exposed to the risk of default. Such risk used to always carry triple-A designations from the credit ratings agencies.
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 Page 31
