Fool's Gold

The worst of the storm seems to have passed, so it is time that people looked back to learn some lessons from the greatest financial meltdown in recent times. Fortunately we have the lessons of the Great Depression 80 years ago to thank. Had it not been for the lessons of that Depression, America would not have put in place certain policies that would prop up the banks and keep capital flowing. They got flak for it, but as  it turned out, the US government inadvertently profited from their massive spending of public money as it returned ownership of many banks it acquired a year ago at huge profit.

But why did the meltdown happen in the first place? I suppose this has been written about, dissected, argued in the press, books, TV, the World Wide Web, and any media that is available today. But for me, nothing beats sitting down with a book to learn about the background and history of this financial crisis. One of these is a book written by Gillian Tett - Fool's Gold, in which she recounts how 'unrestrained greed corrupted a dream, shattered global markets and unleashed a catastrophe'. Yes the financial crisis has its roots in investment banks looking for ways to minimise the risks on the loans that they advance to businesses, like the securitization of mortgage loans. They came up with the idea of aggregating such debt and selling them to the consumer, you and I, and enticing us with high interest returns. Bank interest rates has been depressed for a long time now, since the days of ex-Federal Reserve Chairman, Mr Alan Greenspan, so any investment that gave returns of more than 1% is attractive. Of course, the typical interest earned on these debt instruments was considerable higher.

Debt securitization is an accepted and valid method of spreading risks, and according to Ms Tett, that was what some finance whiz in JP Morgan, led by Peter Hancock, did. They created BISTRO - Broad Index Secured Trust Offering, which later, much to Hancock's original team at JP Morgan's concern, morphed in the synthetic collateralized debt obligation, or CDO for short. And so the train of financial engineering and innovation was sparked, but eventually turned for the worst as people threw risks to the wind to reap obscene amounts of money. Risks didn't matter so long as people were willing to buys these CDOs, until some people could no longer continue paying for their houses (they weren't credit worthy to start off with) and the whole deck of CDO cards began to crumble and the shockwave reverberated throughout the globe. Of course this is a highly summarised account of what happened. Much more was happening behind the scenes and this book tries to give an account of these goings on, to explain how the world got into such a financial mess.

As fascinating read indeed.