Women and the Roots of the Crisis - Building Gender Balanced Business

‘Men make the mess and women clear it up.’ This was the refrain coming from many quarters after the financial crisis struck in 2008.

But the story told by FT journalist Gillian Tett in her new book, Fool’s Gold, reveals that it is a little more complex than that.

Tett’s account shows that the crisis stemmed from a close-knit team of financial whizz kids at J.P. Morgan in the 1990s. Unbeknown to them, they were creating financial vehicles that would later be mishandled by other banks, leading to a monumental crash. The estimated total losses caused by the crisis in the banking sector are estimated at between $2000 billion and $4000 billion.

But at the time, the J.P. Morgan team thought they were inventing an innovative new product that would enable banks to make more profit, while managing risk in ever more sophisticated but effective ways.

The other fact about the team was that it was utterly meritocratic and included a number of women, who dedicated their prodigious energies and skills to the new business.

They cannot be blamed directly for the crisis. But it does highlight two key points:

• There were some serious female players whose work, energy, and brainpower must be factored into any account of the causes of the crisis.

• Gender balanced teams are innovative (as this story shows) but the outcome of the innovativeness can have extremely negative, unintended consequences.

“It irritated Masters (by then CFO and one of the highest ranking women in the financial sector, tipped by some to reach the top). It was like a ‘personal blow’ to her, writes Tett. ‘…it never occurred to her that the other banks might simply ignore all the risk controls J.P. Morgan had adhered to.’ Bill Winters, one of the J.P. Morgan experts, said: ‘This business just does not make sense’.”

Innovation at J.P. Morgan
The credit derivative was not new – they are basically contracts whose value derives from other assets such as a bond, a stock, or quantity of gold.

The innovation in the recent case is that the banks found a way to package up different derivatives into huge financial products, off-loading much of the risk to others in the process.

The derivatives team at J.P. Morgan in the 1990s included several women: British economist Blythe Masters (who later rose to become CFO), maths whizz Terry Dumon (who came from a poor family in Louisiana), Betsy Gile, and Indian-born credit expert, Romita Shetty.

Off-loading risk
Masters helped to pioneer a new approach to off-load risk from the bank’s balance sheet, which would enable it to reduce its capital reserves (they were required to hold to cover such loans). This would free up billions of dollars for more profitable trade in credit derivatives and other products.

The experiment was started with a big deal with Exxon (an early example of a credit default swap), in which the bank extended a credit line to Exxon while the European Bank for Reconstruction and Development assumed the risk of the loan for which J.P. Morgan paid them a fee.

To develop this new business, Masters and her colleagues got confirmation from the regulators that banks could reduce their capital reserves if they used credit derivatives in this way. This was happening in 1997 when the financial crisis in Asia was hurting J.P. Morgan’s loans business. As a result, the CEO Douglas ‘Sandy’ Warner gave the green light to credit derivatives. Following this, the bank worked out how to “industrialise” the derivatives into a mass-market product (piling them high and selling them cheap). They worked out how to slice them up and divide the parts into different levels of risk: the highest risk being “junior” and the lowest risk being “senior”. The senior bonds would always be safe, they thought, except in the event of a “truly major cataclysm” (Tett, 61).

Risk out of control
As we all know today, the business rocketed as other banks hungrily jumped onto the bandwagon. By 2004, J.P. Morgan was performing relatively poorly when compared to its rivals, because they were trading much less heavily in mortgage-backed securities. The whizz-kids at J.P. Morgan had looked at this business time and time again and could not understand why their rivals were taking so much risk on them, when the data available was unreliable.

It irritated Masters (by then CFO and one of the highest ranking women in the financial sector, tipped by some to reach the top). It was like a “personal blow” to her, writes Tett. “…it never occurred to her that the other banks might simply ignore all the risk controls J.P. Morgan had adhered to.” Bill Winters, one of the J.P. Morgan experts, said: “This business just does not make sense”. Fortunately for J.P. Morgan, Jamie Dimon, CEO at the time, stood by his experts in moving only very cautiously in the mortgage-backed securities business and helped the bank avoid the calamity that was awaiting its rivals.