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 (33 page)

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.

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:
Funding 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 repur
chase 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.

Tranche:
A class of securities that are issued by a collateralized debt obligation or asset-backed security that carries a certain level of risk. Normally, CDOs issue several different tranches of securities including a senior tranche (least risky), junior or equity tranche (most risky), and mezzanine tranche (in between).

This book could not have been written without the help of a vast number of people, on both sides of the Atlantic, who have generously given their time over many years to help me understand how the financial world works (and, more recently, how it ceased to function). These thoughts and conversations have entwined to create the tapestry of this book. Many of the bankers, regulators, and investors who have provided inspiration for this book have asked to remain anonymous. That is no surprise, given the current political climate. But while I have not cited their names, they know who they are, and I wish to stress that I am truly grateful for their time. Thanks should also be given to the numerous former and current staff of J.P. Morgan who have talked to me on many occasions since early 2005. The bank did not initiate this project, and it has not endorsed this book. On the contrary, some J.P. Morgan employees were extremely uneasy when they found out that I planned to write a book, and several actively tried to dissuade me. In the end, though, almost all graciously responded to my questions, and some devoted many hours trying to explain their story. If I have misunderstood their tale, the mistakes are entirely mine.

My employer, the
Financial Times,
generously allowed me to take time off to pursue this project, even in the middle of a credit crisis. I am most grateful to Lionel Barber and Martin Dickson, respectively editor and deputy editor. I first started trying to wade through the alphabet soup of the credit world back in 2005, in tandem with my
FT
colleagues, and along the way I have benefited enormously from their insights and help. Particular thanks are due to Richard Beales, Chris Brown-Humes,
Jamie Chisholm, Joanna Chung, Paul J. Davies, Aline Van Duyn, Francesco Guerrera, Jennifer Hughes, Sam Jones, Michael Mackenzie, David Oakley, Anousha Sakoui, Saskia Scholtes, Henny Sender, Gary Silverman, and Peter Thal-Larsen. Janet Tavakoli, Satyajit Das, and Arturo Cifuentes were some of the few mavericks who were willing to speak openly to
FT
about the looming credit dangers at an early stage. In various stages of writing, Adam Ridley, Charles Morris, Keith Hart, Henry Fajemirokun, and Satyajit Das read various drafts and offered extremely helpful comments. Henny Sender also offered very kind logistical support. Pascal Spreen, Shannon Gitlin, and Madhavi Pulapaka conducted research. Merryn Somerset Webb has been a wonderful source of support over the years. Sophia Arnold and Martha Mehta provided intellectual inspiration and welcome laughter. I am also very grateful to Keith Hart and other senior anthropologists for advice. The postgraduate work I did fifteen years ago in the social anthropology department of Cambridge University, under Ernest Gellner and Caroline Humphrey, instilled an analytical framework that deeply influences me, even today. More recently, I have also greatly benefited from debates at the London School of Economics and Westminster University.

My agent, Amanda (Binky) Urban at ICM in New York, was endlessly supportive about the book project, even back in early 2007, when it was wildly unfashionable to talk about CDOs and CDS. Karolina Sutton, at Curtis Brown in London, was very helpful too. Emily Loose at Simon & Schuster worked extremely hard under brutally tight deadlines to turn my text into a book that would be readable by a wide audience. She did a truly remarkable job. I am thankful to them all.

At critical junctures, Cynthia Fajemirokun, Esmond Naylor, and Peter and Romaine Tett all offered crucial domestic support. Priya Patel and Julie Philips provided help with child care. The biggest thanks, though, must go to Henry Fajemirokun, whose profound insights and determination to challenge the accepted wisdom have been a central source of intellectual inspiration for me over the years, in relation to this book and much else. His practical and emotional support has been deeply valued in recent months. Saying “thank you” sounds glib, but I mean it.