All The Devils Are Here: Unmasking the Men Who Bankrupted the World by Joe Nocera, Bethany McLean Page B
Authors: Joe Nocera, Bethany McLean
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on very little risk, even as they were loading up on subprime securities. And they could use credit default swaps to off-load their own subprime risks onto some other entity willing to accept it. By the early 2000s, these two worlds—subprime and quantitative finance—were completely intertwined.
Not that anyone at J.P. Morgan could see what was coming. Like Ranieri in the 1980s, the bank’s eager young innovators were convinced they were making the financial world a better, safer world. But they weren’t.
The chairman and CEO of J.P. Morgan in the early 1990s was a calm, unflappable British expatriate named Sir Dennis Weatherstone. Knighted in 1990, the year he took over the bank, Weatherstone had the bearing of a patrician despite working-class roots; his first job, at the age of sixteen, was as a bookkeeper in the London office of a firm J.P. Morgan would acquire. When he died in 2008 at the age of seventy-seven, an obituary writer described him as “dapper, precise, soft-spoken … unfailingly polite … a man no one disliked.”
He was also a new kind of bank CEO. He had never been a commercial banker. His career had been spent as a trader in London. His last big assignment before moving to New York to join the J.P. Morgan executive suite was as the head of the firm’s foreign currency exchange desk.
A reserved man who rarely granted interviews, Weatherstone was little known outside the banking industry. But his influence on J.P. Morgan—indeed, on banking itself—was profound. In the early 1980s, J.P. Morgan earned most of its money by making commercial loans. By 1993, nearly 75 percent of its revenues derived from investment banking fees and trading profits, the result of the bank moving to what one British journalist described as “new forms of finance.” The most important of these new forms wasderivatives. By 1994, the year Weatherstone retired,
Fortune
could quote a bank executive calling them “the basic business of banking.”
The essential purpose of derivatives has always been to swap one kind of risk for another; that’s why many common derivatives are called swaps. The earliest derivatives attempted to mitigate interest rate risk and currency risk. In the volatile economic environment of the 1980s, when interest rates and currency values could swing suddenly and unpredictably, big companies were desperate for ways to protect themselves; derivatives became the way. An interest rate swap allowed a company to lock in an interest rate and pay a fee to another entity—a counterparty, as they were called on Wall Street—willing to take the risk that rates would suddenly jump. (If rates dropped instead, the counterparty would make a nice profit.) The counterparty, in turn, would often want to hedge, or reduce, its own risks by entering into an offsetting trade with another entity. Which would then want to hedge
its
risks. And so on. Trading derivatives could often seem like standing between two mirrors and seeing the reflection of your reflection of your reflection, ad infinitum. Hedging derivative risk was a classic example of the old Wall Street saw that “trading begets trading.”
Given his background, it is no surprise that Weatherstone was a big believer in derivatives; as a currency trader, he had undoubtedly structured his share of swaps. He was also very clear-eyed about the need for J.P. Morgan to move away from commercial lending and into more profitable areas like trading and derivatives.
Thus, one of Weatherstone’s first acts when he became CEO in 1990 was to persuade the Federal Reserve to allow the bank to begin trading securities in the United States. This was a huge shift in U.S. policy; ever since the Great Depression, the government had kept commercial banking and investment banking apart. (Glass-Steagall, the 1933 law that mandated this change, forced J.P. Morgan to spin off its investment banking arm, which was rechristened Morgan Stanley.) In recent years, though,
Not that anyone at J.P. Morgan could see what was coming. Like Ranieri in the 1980s, the bank’s eager young innovators were convinced they were making the financial world a better, safer world. But they weren’t.
The chairman and CEO of J.P. Morgan in the early 1990s was a calm, unflappable British expatriate named Sir Dennis Weatherstone. Knighted in 1990, the year he took over the bank, Weatherstone had the bearing of a patrician despite working-class roots; his first job, at the age of sixteen, was as a bookkeeper in the London office of a firm J.P. Morgan would acquire. When he died in 2008 at the age of seventy-seven, an obituary writer described him as “dapper, precise, soft-spoken … unfailingly polite … a man no one disliked.”
He was also a new kind of bank CEO. He had never been a commercial banker. His career had been spent as a trader in London. His last big assignment before moving to New York to join the J.P. Morgan executive suite was as the head of the firm’s foreign currency exchange desk.
A reserved man who rarely granted interviews, Weatherstone was little known outside the banking industry. But his influence on J.P. Morgan—indeed, on banking itself—was profound. In the early 1980s, J.P. Morgan earned most of its money by making commercial loans. By 1993, nearly 75 percent of its revenues derived from investment banking fees and trading profits, the result of the bank moving to what one British journalist described as “new forms of finance.” The most important of these new forms wasderivatives. By 1994, the year Weatherstone retired,
Fortune
could quote a bank executive calling them “the basic business of banking.”
The essential purpose of derivatives has always been to swap one kind of risk for another; that’s why many common derivatives are called swaps. The earliest derivatives attempted to mitigate interest rate risk and currency risk. In the volatile economic environment of the 1980s, when interest rates and currency values could swing suddenly and unpredictably, big companies were desperate for ways to protect themselves; derivatives became the way. An interest rate swap allowed a company to lock in an interest rate and pay a fee to another entity—a counterparty, as they were called on Wall Street—willing to take the risk that rates would suddenly jump. (If rates dropped instead, the counterparty would make a nice profit.) The counterparty, in turn, would often want to hedge, or reduce, its own risks by entering into an offsetting trade with another entity. Which would then want to hedge
its
risks. And so on. Trading derivatives could often seem like standing between two mirrors and seeing the reflection of your reflection of your reflection, ad infinitum. Hedging derivative risk was a classic example of the old Wall Street saw that “trading begets trading.”
Given his background, it is no surprise that Weatherstone was a big believer in derivatives; as a currency trader, he had undoubtedly structured his share of swaps. He was also very clear-eyed about the need for J.P. Morgan to move away from commercial lending and into more profitable areas like trading and derivatives.
Thus, one of Weatherstone’s first acts when he became CEO in 1990 was to persuade the Federal Reserve to allow the bank to begin trading securities in the United States. This was a huge shift in U.S. policy; ever since the Great Depression, the government had kept commercial banking and investment banking apart. (Glass-Steagall, the 1933 law that mandated this change, forced J.P. Morgan to spin off its investment banking arm, which was rechristened Morgan Stanley.) In recent years, though,
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