Tett turns the microscope on the elite team of bankers at JPMorgan that in the 1990s developed a family of new financial instruments — credit default swaps, synthetic collateralized debt obligations, and other so-called credit derivatives. These were seen as a way to manage risk more effectively, and to spread it around. Investors could fine-tune their exposure in more sophisticated ways, diversifying their risk or concentrating it, according to what made sense for them.
As these derivatives caught on, financial engineers at other firms married them to recent innovations in mortgage finance. Mortgage debt could now be sliced and diced, and the pieces traded every which way. The breakthrough was combining debt securitization and credit derivatives. Soon the traditional mortgage loan — lender, borrower, documented income and assets — was regarded as passé. The new technology encouraged the spread of much riskier arrangements, extending even to “ninja” loans (no income, job, or assets) that came close to sanctifying fraud. But the risk was always under control, you see, because those guys at JPMorgan really knew their stuff.
In a way, they did. Tett explains that despite coming up with the new techniques and selling them to others, the firm consistently exposed itself much less to the dangers, as they proved to be, than did more adventurous outfits such as Bear Stearns and Lehman. Partly for this reason, she has been accused of being too sympathetic toward her sources at JPMorgan. That was not my feeling. These people were not evil, and in a way, that is the point. They worked insanely hard and had brains to spare. They saw themselves as pioneers — getting rich, to be sure, but doing it by inventing a marvelous new technology, not by gulling anybody. However, despite the brains, the work, and the good intentions, the risk got out of control.
In House of Cards, Cohan does for the team at Bear Stearns what Tett does for JPMorgan — but with a tighter focus on the instant of Bear’s demise and everything that brought the firm to that point, plus amped-up disapproval of the principals. These characters might not actually be evil, but, in Cohan’s telling, they are certainly disagreeable: brash, bullying, loudmouthed, foulmouthed, and oozing testosterone — reminiscent of the sociopaths described by Michael Lewis in Liar’s Poker: Rising through the Wreckage on Wall Street (Norton, 1989), the seminal work (forgive the expression) of this genre. Of course that book was a fabulous, irresistible read, and so is House of Cards.
Cohan’s sourcing is especially impressive. The book is richly detailed and brilliantly constructed. Its only real flaw is that the Bear Stearns failure no longer seems as significant as it did pre-Lehman. That is an odd thing to say, admittedly. At any other time, the collapse of a once-mighty investment bank would have been regarded as a monstrous shock in its own right. From where we stand now, it looks like a lesser part of the story.
Fundamental Systemic Flaws?
Moving to the opposite extreme, two books zoom out wider even than Zandi’s encompassing perspective. They take in more than mere issues of economic management, and ask questions that are bigger still.
Richard A. Posner’s A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression tries to say what kind of calamity this really is — is it a breakdown caused by structural flaws in the market system, or the end result of an orgy of individual greed and irrationality? One could always say it was both, but Posner takes the more intriguing line of arguing it was the former and not the latter. The people involved were no more or less rational than usual, he says; on the whole, they acted in their own best interest. The problem is that an outright depression — for that is what we are in, according to Posner — is so rare an event that investors cannot sensibly take account of it. “The profit-maximizing businessman rationally ignores small probabilities that his conduct in conjunction with that of his competitors may bring down the entire economy,” he writes. Through the systemic vulnerability of the market economy, individual rationality conspires to cause a collective nervous breakdown.