Fool's Gold highly recommended!

Just finished Fool’s Gold by Gillian Tett and highly recommend it. It chronicles the creation of the credit derivative business though the near banking collapse in 2008. It shows how few people really understood these complicated devices and how the risk was shifted around, underestimated and virtually ignored by regulators and bank senior managements.

The derivatives themselves were not the problem – just a tool that was abused. The first hitch is that since there was no clearing of these trades a AAA company like AIG could take on over $500 billion in risk and not have to put up any collateral to cover its losses in the event it had to pay off. A clearing system where the instruments are standardized and every player has to put up margin would go a long way towards solving this problem. This needs to be solved soon.

A second major issue was that loans were sliced and diced in such esoteric ways that no one really knew what they had and the mathematical models radically underestimated the risk (especially the risk that the world might look different than the last several years).

And finally the ratings companies had their heads up their rear ends. What an antiquated system and this is an area that regulators have made no progress on correcting. And no one is correcting the conflicts of interests these companies had and continue to have.