How I Caused the Credit Crunch E-Book

Tetsuya Ishikawa

• Herausgeber: Icon Books
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 447

Veröffentlichungsjahr: 2009

Beschreibung

This is a vivid and personal account of 21st century banking excess. "How I Caused the Credit Crunch" traces seven years at the forefront of the credit markets - a tale from the heart of the bewildering banking maelstrom whose catastrophic collapse has plunged the world towards the worst recession since the 1930s. Tetsuya Ishikawa's story reveals how a young Oxford graduate finds himself in command of vast sums of other people's money; how a novice to the mysteries of hedge funds, subprime mortgages and CDOs can fix complex deals for billions of dollars in the exclusive bars, brothels and trading floors of London, New York, Frankfurt and Tokyo, and reap the benefits in a colossal annual bonus and an international luxury lifestyle. Ishikawa's book, which deftly explains the arcane financial instruments now grimly associated with the credit crunch, is both a powerful tale of lost innocence and an expose of the disturbing truth of the collective folly, frailty and greed at the heart of the banking crisis.

Leseprobe

HOW I CAUSED THE CREDIT CRUNCH

TETSUYA ISHIKAWA

HOW I CAUSED THE CREDIT CRUNCH

AN INSIDER'S STORY OF THE FINANCIAL MELTDOWN

TETSUYA ISHIKAWA

ICON BOOKS

Published in the UK in 2009 by Icon Books Ltd, Omnibus Business Centre, 39–41 North Road, London N7 9DP email: [email protected]

This electronic edition published in 2009 by Icon Books

ISBN: 978-1-84831-097-1 (ePub format)

ISBN: 978-1-84831-098-8 (BBeB format)

ISBN: 978-1-84831-099-5 (Adobe ebook format)

Printed edition (ISBN: 978-1-84831-067-4)

Sold in the UK, Europe, South Africa and Asia by Faber & Faber Ltd, Bloomsbury House, 74–77 Great Russell Street, London WC1B 3DA or their agents

Distributed in the UK, Europe, South Africa and Asia by TBS Ltd, TBS Distribution Centre, Colchester Road, Frating Green, Colchester CO7 7DW

Published in Australia in 2009 by Allen & Unwin Pty Ltd, PO Box 8500, 83 Alexander Street, Crows Nest, NSW 2065

Distributed in Canada by Penguin Books Canada, 90 Eglinton Avenue East, Suite 700, Toronto, Ontario M4P 2YE

Text copyright © 2009 Tetsuya Ishikawa The author has asserted his moral rights.

No part of this book may be reproduced in any form, or by any means, without prior permission in writing from the publisher.

Typeset in Sabon by Marie Doherty

About the author

Tetsuya Ishikawa, Japanese by birth, grew up in London and attended Eton College before reading Philosophy, Politics and Economics at Oxford University.

Throughout a banking career that included Goldman Sachs, Morgan Stanley and ABN AMRO, he structured, syndicated and sold credit derivative, CDO and securitisation (including subprime) products to investors globally. He was made redundant by Morgan Stanley in May 2008.

He currently lives in London with his wife and children.

For my wife, Simone

Contents

Preface

Chapter 1

Chapter 2

Chapter 3

Chapter 4

Chapter 5

Chapter 6

Chapter 7

Chapter 8

Chapter 9

Chapter 10

Chapter 11

Chapter 12

Chapter 13

Chapter 14

Chapter 15

Chapter 16

Chapter 17

Chapter 18

Chapter 19

Glossary

Preface

It was over a game of poker with my closest friends soon after I was fired from my investment banking job that I was given the idea of writing this book. Most around the table were non-finance professionals – in the media, fashion and the civil service – and, out of sympathy for someone who had lost their job, they asked me why I was fired. Usually at this point, most people just switch off despite their best efforts to stay focused and look attentive. But this time it was different. The more I told them, the more intrigued they were to hear about the clichéd high life I had been living while creating and selling billions upon billions of these securitisation and credit derivative products, now better known as 'toxic assets'.

'You should write a book called How I Caused the Credit Crunch,' one of them said, 'because it sounds like you did.'

This passing remark inspired me to write almost as soon as we had finished our poker game. In fact, even during the game, I had formed a vision for the book. That vision was galvanised by the paucity of the press coverage, which simply highlighted the sheer complexity of the products at the heart of the credit crunch. Having understood the products, known most of the players and played my part in the credit bubble and subsequent crunch, I felt that only a better understanding of the causes would help us learn from our mistakes and progress more constructively.

So I started writing a book which was very detailed, technically comprehensive and highly informative, but which explained things simply enough for even my mother to understand. I even gave the first few chapters to the friend who suggested writing the book.

'Informative,' he complimented me, 'but fucking boring. What about all the other shit you did? Your Brazilian stripper, the whores, the drugs, the booze. That's the shit people want to know.'

That didn't inspire me, especially because stories of drugs, whores, alcohol and the general excess of bankers were not new. But I had got the wrong end of the stick. What had made him suggest the idea in the first place was that he found my human story, and not the credit products, interesting. To him, the products were vaguely interesting but they would be locked away in the innermost corners of his brain after a few minutes. What he did care about was what drove us to these products in the first place.

So back to the drawing board. I knew I would keep the technical aspect of the book – the products – because even if they are at times complex, it's important to understand what drove us to create them the way we did, perhaps more so than the products themselves. (There is a glossary at the back of the book if you need it.)

I then mapped out everyone I had met in my career and their stories so I could piece the puzzle together. But before long I had run out of paper. There were thousands of real people at thousands of firms that were involved. Well aware of the orgy of scapegoating that the world had embarked upon, I didn't want to blame anyone, let alone run the risk of over-burdening some and under-burdening others with responsibility for the crunch. After all, I'm not one to say who's guilty or not, and ultimately it doesn't help us to move on anyway.

In any case, I was already thinking about a fictional construct for the story because it had its own merits. The creation of the fictitious Andrew Dover allowed me to take you through all the corners of the credit universe in a way that best explained how the credit crunch really did come about. Moreover, using real names and firms to explain the credit crunch would not only have apportioned blame unfairly but fuelled the frenzy of scapegoating, which would have distorted the lessons we can learn from this crisis. To that end, any resemblance to actual firms or persons in this book is entirely and genuinely coincidental. Hearing that may disappoint some of you, but if gratuitous naming and shaming is the ultimate goal, then the internet is a much better forum.

That is not to say that the individual events in this book didn't happen, even if a handful are out of context. After all, no story of the credit crunch would be complete or accurate without the specific sequence of events that unfolded. But as a result some will inevitably try to draw parallels between my fictional firms and characters and those in real life. To this, I can only say that this is futile, since I have at no point started my thinking with an actual firm or person, then thought of all the events that they were associated with, and then written about them. Quite the opposite: I have thought of all the relevant events that I knew happened, and assigned them to the fictional firms and characters with the sole purpose of telling the real story of the credit crunch – a story that I now believe, more than ever, needs to be told.

It's important to understand this, because I don't believe in the act of scapegoating at all. Nor do I believe in gratuitous exposés that serve no purpose. Instead, I believe that we all need to take responsibility for our own actions. I am genuinely apologetic for the part I played in causing the credit crunch, but without a collective recognition of all our failings, we as a society will never truly understand why we are where we are today. I hope the admission of my failings brings this to light so that we can rise from the ashes heeding the real lessons to be learnt.

Chapter 1

'Please can you go in to see Zoe? Room 3G.'

I put down the phone. Faye, my secretary, still refused to walk the four-metre divide between our desks after a year of working for me. Like other secretaries, she reserved this honour for those with the revered status of a Managing Director. Ultimately, though, it was Faye's ever-expanding backside that suffered, and it made me smile to know that today I'd be doing it a favour. Today was going to be the last day she would be calling me.

I had just taken the first bite of my muesli, part of a concerted diet to be healthy again after seven years of neglect and abuse to my once ripped body, a function of working hard and an irresponsible lifestyle. Usually I would peruse the emails I had received overnight, but with the credit crunch in full swing I didn't have any emails to look through – not this morning, nor any other morning for the last three months. Getting out of bed was harder and harder these days, completely deflated as I was by the prospect of having nothing to do. My BlackBerry was now just a play console with its one solitary game, BrickBreaker.

How I missed the days when I would wake up in the morning with a list of a hundred things to do, all of which would be profitable, and would frantically deal with as many emails as possible on my BlackBerry before reaching the office. Now I was getting fewer emails in a day than I used to receive in a minute. I missed the constant adrenalin rush of doing business, at the very least because it helped maintain some degree of order over my ever-growing waistline. The only other thing I could do was perhaps read some news articles, but I had got bored with that a long time ago, quickly realising that the only contribution made by the press was popularising the term 'credit crunch' with no idea what it was really about. Instead, I was thinking of a new job title to give to myself – Chief Websurfer, Chief Wikipedia Reader, Chief Movie Review Follower, Chief Bum.

Without the pleasure my breakfast usually gave me when it consisted of a crispy bacon butty, I gladly walked over to room 3G. I didn't care too much that I was about to be fired. There was no bitterness, no sense of 'why me', no regrets. I had enjoyed my seven years working in credit and I had profited well from it, but the journey was over. The journey was beginning to end as early as 2006 and by the time so-called financial experts had called the credit crunch in August 2007, those in the credit markets had already seen events unfolding for a very long time. With declining house prices, redundancies being commonplace (if anything, it was amazing I wasn't fired earlier) and the global economy heading into recession, it was perhaps only right that I was getting fired. Yet, walking through the trading floor on my way to room 3G, I saw my soon-to-be ex-colleagues still slogging away in self-denial, hoping that things would get better again soon.

The last year had been a soul-destroying time. Apart from a few exceptional individuals who had done very well during the credit crunch, almost everyone I knew hated their jobs. We were no longer building skyscrapers but using our bare hands to clear the rubble after every mighty tower we had ever built had collapsed down to its foundations. Moreover, I had begun to wonder how low I had stooped when I saw the credit crunch bringing out the worst in bankers. The drugs, prostitutes, strippers, booze and general excessive nightlife that many bankers were engaged in behind the respectable façade was one thing – despicable but harmless to others – but what I saw around me now was another: the office politicking to protect their own jobs at the expense of others; the even greater sense of self-importance that bankers adopted to protect their diminishing status in the industry and the world; the inevitable lack of support for clients who once bought the credit products that enabled the wealth creation that many bankers benefited from during the bubble, and who were now struggling to hold on to their much more modestly-paid jobs. We had moved on to hurting others in our quest for self-preservation.

I had had enough of the bullshit, the lack of honesty with ourselves. It seemed ridiculous to me that bankers who had profited so handsomely during a bubble were not prepared to take the pain when the bubble burst. In fact, I had already begun to positively despise those bankers who couldn't see a life beyond a job in the finance industry, no matter what. It was almost as if their existence was justified on them being able to call themselves an 'investment banker' so they could sit on the high ground with the respectability it supposedly brought. What respectability, I was wondering? That was it – any bitterness I felt was only for people I wasn't going to be seeing any more, not at losing my crap job. And that made me smile.

Zoe greeted me with an uncomfortable smile. She was my boss, the Global Head of Credit Sales at Irwin May, a genuinely kind and maternal figure who had an unnerving ability to clinically pick off her rivals one by one to move up the ranks. She was also the one who had hired me on a $3m guaranteed bonus the year before to do a job that didn't really exist by the time I had started. In all fairness, Irwin May had paid me a lot of money to cover clients that started folding from the day I joined. I had done nothing for them, yet it was a great return no matter how you looked at it.

'As you know, we've been resizing our business in this market downturn and we've had to make some harsh decisions.'

A human resources lady sat next to her, observing proceedings to make sure that only the lawyer-approved speech rolled off her tongue. What she really wanted to say was: 'You're expensive, you're not producing, and I don't particularly care how much of a superstar in credit we thought you were, there's nothing for you any more – you're out.'

'We'll endeavour to place you in another job at Irwin May as we have been expanding greatly in other regions, such as Dubai and Mumbai.' I just laughed. We both knew she was spouting total and utter crap, but she kept a straight face because of human resources, who probably did think I would relocate to Mumbai so I could work in a call-centre for the sake of having a job at an 'investment bank'.

'We do have to ask you to go back to your desk, collect all your belongings and leave the office immediately. Your security pass is no longer operational as of now and we ask that you leave all work-related documents and materials in the office.'

As the charade finished, I shook hands with Zoe, stood up, turned round and let off a big grin. Perhaps it was the realisation that my last seven years had been one big charade, and with it all over, I could now rediscover my true self. Yet walking back to my desk, it didn't seem like my epiphany was shared by many. There were some packing up their desks looking disappointed, others who seemed to accept it matter-of-factly. Some just looked angry, but no one seemed happy – truly happy. And then I saw one structurer crying, the emotional toll of being fired too much to handle. A few days earlier, he had been telling me there was no loyalty or integrity in the business. The sheer hypocrisy of this just stank. He had spent the last five years going after the next client that might buy his products, strangling them until they squealed 'I buy', before watching them get hurt by the credit crunch from afar, totally uninterested in their predicament. How many people did he get fired from their modest jobs, I wondered? He conveniently ignored the luxury that his six-figure salaries and bonuses had brought him for the last five years, even though one of his three Aston Martins was still waiting to be driven home to his drug-filled penthouse riverside apartment, a plethora of escorts waiting to be called from his phone book. What did he have to complain about?

As I got back to my desk, my muesli looking even more like bird droppings now that the milk had been soaked up, Jeff Nordberg came to my desk. He glanced at the muesli before deciding perhaps it might not be appropriate to comment. Jeff was the Global Head of Sales at Irwin May, or in layman's terms, the man who was responsible for all the firm's clients globally and who had pushed through my hire the previous year.

'I'm sorry,' he started sombrely, 'but we didn't have much say in this matter. We think there are still a lot of opportunities in this market and we need people like you, but we just had to let people go, and the decision was made by the CEO.'

'Jeff, I understand,' I replied unconvincingly. Look around us, Jeff! What opportunities? All the clients we ever made money off had either folded or were in such a bad state that we didn't even know if they were going to be in their job the next day. Sure, we could make some money helping those clients restructure the deals we sold them so they looked aesthetically better, but this was only going to make things worse in the future. Of course Jeff knew this, but he was first and foremost a very well-paid employee of Irwin May.

'I want you to know that personally, I was marking you out as a star of the future, so I'm sorry you've become a victim of this credit crunch.'

And that was it. My moment of clarity. I wasn't a victim of the credit crunch. None of us on that floor were victims of the credit crunch. Victims are those who get caught in the crossfire when they're minding their own business. The victims of the credit crunch were out there, everyday people who were unaware of what was unravelling, the general public who had been taken advantage of through a system that fed the credit bubble so that bankers like us could become rich. We weren't victims. We were the cause. Very much the cause. And it was this that made me so at peace with myself. This was why I was so happy to be fired. I had deserved it.

Chapter 2

'It's all about leverage!!'

Ben stormed into my room, excitedly waving the copy of Richard Branson's autobiography that I had given to him a few days earlier in hospital.

'It's all about leverage!! Leverage!! Leverage!! Leverage!!'

I was working frantically to get my politics essay done in time for my tutorial the next morning. This was a weekly ritual – I'd pick up some textbooks the day before from the New Bodleian which I'd speed read even though I couldn't speed read, get some ideas and rattle off an essay, all in eighteen hours.

'Andy, you have to listen to me. This guy is a genius.' I listened but pretended to ignore him, knowing that even if he had just come out of hospital and most people would expect a big hug and a nice cup of tea, he wouldn't take offence.

'The guy can't read or write but what use is that when there's leverage? Whether he knew it or not, he leveraged all over the place, investing small amounts of money and making millions. Actually, even better! He borrowed that money, multiplied it, paid back the original amount and walked off with the profits. I think it's genius.'

He waited for a response. It actually sounded great but I still needed to get my politics essay done.

'Let's do it. You and me. We can borrow, what, ­£2,000 between us and play the stock markets. If we can make ­£10,000 by the end of the year, we would have made £8,000 from nada!'

Ben Carrington had always been a perfect student before Oxford. He was not only bright and had never failed to get the top grade possible in any test he had ever taken, but, unlike most boarding school yuppies, he didn't smoke, had never done drugs and only drank modestly in respectable social circumstances such as family dinners, galas and balls. He sang in the choir at school – as a soprano until he was sixteen, so late did his voice break, and then as a tenor – although a major throat infection meant he missed out on the chance to be a choral scholar at Oxford.

Ben was the first person I met at Oxford. We were together when we interviewed for our places, and he told me of his vision to be in the clergy, to bring support, light and comfort through the teaching of God to many. He was one seriously committed seventeen-year-old, and that was the issue. He didn't know any better about how good that apple really tasted. But we became friends nevertheless; I was only too happy that there was some purity in my life.

Whether our friendship ultimately led to the infiltration of life's temptations into his purity or whether it would have happened regardless because his purity lacked inner conviction, I never figured out. But it didn't take long into our freshers' week at Oxford to realise that his purity was being undermined in a major way. Before the week was up, he had lost his virginity, gained one enormous hangover, and was on his way to becoming a reformed man.

The clergy was no longer part of the plan, his theology degree now nothing more than a nuisance. He just wanted to make money and get lots more of the sex he had just tasted for the first time. By virtue of humbly thinking small his entire life, his revised life plan was outrageously oversized. We went through the career possibilities. Modelling? Not good-looking enough, though money could change that. Acting? Couldn't act, but then Arnold Schwarzenegger got rich and got an acting tutor, and look where he was. Sportsman? Not talented enough. Start a business? Yes, but need money. Actually, for everything we talked about, money was the means to that end, or was it the end in itself?

Ben's father was a senior banker who had done very well for himself, even if he drove a four-year-old Volvo. But when Ben speculated that he made at least ­£5m a year, I guessed he must have been a senior investment banker, something I had only recently learnt was very different from a commercial banker. Commercial banks did the boring business that we deal with every day – provide bank accounts and make loans. Most commercial bankers earned a healthy but modest salary. Investment banks, on the other hand, were in a much more lucrative game, brokering deals for companies in 'corporate finance', and providing research and trading capabilities for investors in 'sales and trading'. Both businesses dealt with billion-dollar-plus deals and, accordingly, the fees that these investment banks reaped were enormous. Only investment bankers could earn as much as Ben thought his father did.

My guess was right. I soon discovered that he was a prominent TMT banker – one of the late-1990s banking masters of the universe who advised these telecom, media and technology companies into initial public offerings (IPOs) and mergers and acquisitions (M&A) which generated the highest fees in history – except he didn't act like a master of the universe. But he did know all the chief executives, presidents and board members of his clients and spent a lot of time with them playing golf and entertaining them in the trendiest restaurants, all in the name of winning business. And with the TMT bubble in full swing, Ben's father was at the forefront.

In contrast to his own career, his father was proud to see Ben wanting to go into the clergy – he always felt that banking was morally void, and even though he was now in a position of seniority, it was only the lack of opportunities in his childhood that spurred him on to give Ben a freedom of choice. Besides, he didn't want Ben to go through the hell of being a junior banker. With CEOs and Presidents not particularly keen on dealing with kids in their twenties, there was a distinct hierarchy where the junior bankers would slave away into the early hours of most mornings, drawing up Powerpoint presentation after Powerpoint presentation of possibilities and ideas that the senior guys would then pitch to their clients, often with no business to show for it and feedback consisting of a few typing errors.

Ben's take on investment banking changed considerably when I told him about the six months' work experience I had done on a sales and trading floor at an investment bank before our Oxford matriculation. Sitting alongside corporate finance as the other main business unit within most investment banks, sales and trading were involved in the financial markets – the 'movers and shakers' as it were of the equity, foreign exchange, interest rate, credit and commodities markets. Corporate finance bankers with important relationships were remunerated handsomely, but it meant waiting twenty years until reaching a position of seniority, whereas sales and trading bankers were remunerated on what they made through trading in their specialised market in any given year. Much more short-termist, it also had two major appeals for us. One, the easy measure of one's profitability to the firm meant that face time counted for nothing; and two, it was a truly meritocratic environment where 'kids' in their twenties would be running businesses or entire divisions, quite simply because it was not inconceivable that they would make ten times more than someone ten years their senior. After all, if a kid made $200m for their employers and they were not paid or promoted accordingly, someone else would happily pay the kid $30m so he could make the $200m for them instead. Our market value was much more easily defined.

The fact that corporate finance bankers had a degree of snobbery over the uncouth, low-class, uncultured business manner that sales and trading bankers seemed to epitomise, only spurred Ben on even more. Perhaps it was because corporate finance bankers, by the very nature of their work, were generally well-spoken and well-educated, while some traders had joined as apprentices at the age of sixteen or eighteen. Perhaps it was because corporate finance bankers worked late and had no life, while sales and trading bankers worked hard during the day, partied hard at night and slept with whatever else they could get. Ben wanted the lifestyle – sales and trading it was. Especially once I told him that from what I could see during my work experience, there were a ton of 'kids' in their twenties, living in phat pads in Chelsea and driving a Ferrari, Aston Martin or Lamborghini. Porsches were for the commoners.

And their jobs seemed simple enough. Research would analyse numerous stocks; sales talked to clients, who were usually an asset manager, pension fund, insurance company or hedge fund; and traders would 'make markets' for these clients whenever they wanted to buy or sell a stock, like a bureau de change but on a much larger scale. And in the same way bureaux de change made more profit by doing more transactions, so the traders that made most money were those that had the most 'flow', i.e. trading activity or volumes from clients. Research had to be creative and informative with trading ideas, which in turn helped sales to build strong relationships with clients to get as much 'flow' as possible.

With a new sense of purpose, Ben engrossed himself wholeheartedly in the lifestyle these bankers had, but without the job. After two weeks of champagne and cocktails, he found himself in hospital after a nasty bout of cirrhosis left him coughing up blood on a Tuesday morning. Warned by the doctors that any more alcohol might kill him, he was told to rest in hospital for a few days. Bored out of his mind, he begged me to bring him cigarettes and any bottle of wine. I agreed, but instead I took him a copy of the book that looked most interesting – Richard Branson's Losing My Virginity. This was to be the discovery of his guiding principle: leverage.

He was out partying the day he came out of hospital and within two months, amazed that he hadn't actually killed himself, he was unsurprisingly back in hospital. Again, he begged me to bring him cigarettes and champagne, but instead I brought him ten different Sunday newspapers. One series of articles captured his imagination: The Flaming Ferraris. So called after a journalist broke their life of extravagance that would start with a rum and Grand Marnier cocktail every night, the group of three made extraordinary profits trading equities, in particular the 24-year-old son of a very prominent Conservative party politician. They were later suspended, allegedly for unauthorised dealings, but the brashness of the three inspired Ben.

His plan evolved. These three traders had been trading proprietary (prop) positions. Prop traders had their own trading account, and using the firm's money they would buy stock (go long) or sell (go short) depending on their own thoughts about the market price. It was effectively a hedge fund within a bank. If Ben was given $500m to trade and had made a profit of $100m over the course of the year, he would be remunerated on his 20% return, typically like a hedge fund trader who could then expect to be paid anything from 5% to 20% of those returns. Yes, that's $5m to $20m. Given that the largest hedge funds were in the billions, it's easy to see how those remunerations went into the hundreds of millions. What allowed them to generate those kind of returns was leverage – that they could go long a lot more stock than $500m by borrowing money to do so, using their existing $500m as collateral (effectively a deposit). And they could go short more than $500m by borrowing stock which they could sell, using their $500m as collateral. In this sense, it was no different from the way any of us bought houses that cost a lot more than the cash we had through a mortgage. Leverage.

Ben left Oxford, rather conveniently because he failed his first-year theology exams, and somehow he managed to raise ­£500,000 for his hedge fund. This was enough because the rest would come through leverage, but however he managed to convince his father or whoever else put money into a nineteen-year-old failed theologian with a dodgy liver, it had to go down as one of the most remarkable commercial feats in history.

A few early trading gains only egged him on, but soon his lavish lifestyle was getting out of hand. Based out of a luxury penthouse apartment in Chelsea, he hosted champagne party after champagne party for his old and new (rich) friends, surrounded by beautiful women who were always touching him up. You almost expected him to disappear for a few minutes before the caped crusader came smashing through the window.

When I met up with him a year into his new post-Oxford adventure, Ben, never short on words, shared his newfound wisdom.

'Leverage is the multiple of how much you get out of what little you have. I have spent none of my money enjoying my life like this. Isn't that great!!?' His excitement was as intense as ever before, and he had become even more brash, cocky and confident; yet somewhere deep inside, Ben knew that his beloved notion of leverage, taken to the extreme like he did, was damaging and simply wrong.

'I was at dad's house last week and I saw his credit card bill. His limit was only ­£10,000 and you know how much I think he earns. So I asked him why he didn't increase his credit limit. For a start, he can get rid of that Volvo he loves and buy a Bentley, then buy a house with a swimming pool and ten bedrooms, get a maid, just anything. And if he didn't want any of this, then he could just leverage the cash to make even more money.'

'What did he say?'

'You know my dad is a wise guy, right, so he says, "Ben, money comes and goes. Lifestyle comes and stays. I don't need a bigger credit limit, so why would I have it?" Smart man, smart man.'

Little did we know at the time how right his dad was. Leverage can bring great things, but it's always important to have one hand in reality. The credit bubble was all about leverage, but too many people had failed to keep their feet on the ground because what was 'nice to have' became a 'need to have'. Ironically, Ben knew the dangers of leverage but still engrossed himself in all the joys it brought – very much like the credit markets, blissfully forgetting that money can come and go, but lifestyle comes and stays.

Chapter 3

'Andrew?' An urgent voice snapped on the other end of the phone.

'Yes.'

'Mike Fisher from Vandebor.' Mike had interviewed me the week before and I didn't think it had gone particularly well. Unlike the formality of calculated calmness that most interviews have, Mike was constantly excited, rocking back and forth with exaggerated facial expressions and excessive hand gesturing, whether he was laughing, mocking, being sarcastic or simply being serious. His patience, or distinct lack of, was no different – if an answer lasted more than four seconds he would interrupt me, like when I was telling him my reasons for wanting to work at Vandebor. 'You want to be rich but you can't get a job anywhere else in this industry because no one's really hiring, right?' Impatient but straight to the point.

'Listen mate, last week, I was slightly upset that you took a guess at Vandebor's market value even if you got it right, because I do think if you're interviewing, you should at least do some homework. Amateur mistake. Amateur. And there were a couple of other issues, but bottom line, you're smart and hungry and I think I can mould you into a great banker. So you have a job starting on our Fixed Income analyst programme and you're going to work for me. Congratulations, mate – you've just given your life away!', he laughed.

Despite the slightly unusual character that was Mike, I was delighted and relieved. Knowing that sales and trading was my calling but with the equity markets looking increasingly bad throughout 2000, I had decided to move my attention away to Fixed Income, which along with Equities made up the core business of sales and trading.

I was relieved because I had been offered a job in spite of the fact that Fixed Income still baffled me. 'Buying and selling stocks on the FTSE with my stock-broker' was one of the things we said to sound yuppie and important, rich and knowledgeable as a student. 'Fixed Income', though, just didn't have the same sex appeal. When the investment bankers came up to do their firm presentations at recruitment events in Oxford, there was always a token Fixed Income trader who would talk about how great it was to trade interest rates and bonds. Perhaps if we knew what it meant to trade interest rates or what a bond actually was, it might somehow be fascinating. Or perhaps I just wasn't that smart.

'So what do the two words fixed and income mean?' I asked a Fixed Income trader at a Farrell Parker recruitment event.

'Quite simple,' she began, her nose slightly stuck up. 'It's basically anything that has an income which is fixed. Fixed. Income.'

Simple, but still confused. So much for an Oxford education.

'So if you make me a loan,' she continued, 'and I pay you interest, that interest is fixed income to you. Same with a bond. If you buy a …'

'Sorry – what's a bond?' I had to ask.

She almost sniggered. 'It's like a loan. If you buy a bond from me, you are lending me money, and you get a piece of paper that binds us to an agreement of how much I owe you, plus the coupon which is the interest I have to pay you annually. It's literally a bond.'

I still felt that there was more to Fixed Income than just this, but for now I was happy that, having been rejected by every other investment bank on the street, I had received an offer from Vandebor – perhaps because they were the only bank stupid enough to take me on.

I was to join as an analyst in September 2001. An analyst was not a job description but a complimentary term they used instead of 'monkey' for the most junior rank in the industry. Mike worked in the Asset Backed Securities group, the most profitable business per head and the only business that was considered top-tier within their investment bank. What that meant or signified I had no idea, but their two-month analyst training programme I was hoping would fix that.

'As if!' Mike laughed when I met up for a quick lunch with him a week before. 'Mate, you're not going to learn anything useful on that training programme. It's a bunch of idiots who run it, but it's one of Vandebor's necessary evils.' He looked as if he was offering his condolences for sending me to a torture chamber. 'The most important thing is just to enjoy it as much as you can. I know places to go out if you need any tips. Do whatever you like, but make sure you make as many connections as you can. Those might come in handy.'

The training programme was indeed run by a bunch of failed bankers who never made the cut and were more confused about the basics of banking than my mother. But Mike was right – the connections I made were to become invaluable. A dinner had been arranged one evening at Vandebor's 18th-century country mansion an hour outside Frankfurt, near the village of Bad Homburg. This place was typically reserved for highly sensitive board meetings, but now all 30 analysts in sales and trading were given the pleasure of a ten-course dinner prepared by the in-house cordon bleu chef, complete with matching wine from their cellar, after a Dom Pérignon reception. As we looked at our seating plan in the ballroom with its massive Bohemian crystal chandeliers, I found myself placed next to none other than the board member responsible for Vandebor's investment bank, Kim Reinier. This was a good sign that I was at least impressing on the programme.

He seemed very personable and looked remarkably like Doc Brown from Back to the Future, but with a methodical Swiss Germanic manner and accent to match. After Kim had walked around the table and introduced himself to everyone, he took his seat next to me and instantly started talking about golf. Having difficulty understanding what he was saying in his heavy accent, and armed with the sole piece of information that golf involved a ball, a club and eighteen holes, I blagged convincingly as if I had just left a career in golf journalism for banking. After our conversation came to a natural end, he decided to share a pearl of wisdom with the table.

'Zis morning, I vas valking through ze trading floor and I noticed two people having a confersation, so I stopped to listen from exactly seffen yards avay and realised zat not only did I not understand vhat zey vere saying, I do not sink eizer of zem did.' Everyone laughed out of courtesy.

'Ja. I sink zis industry is full of people who like to sound like zey know vhat zey're talking about but I don't sink many do. So my point is zis – if you do know vhat you're talking about, fantastisch! But if not, you must make sure you at least sound like you know vhat you are talking about. Ja, because zis industry is like Darvin and you vill not survive ozervise.'

I found this honesty refreshing. And the more he spoke about himself, the more it became clear that what you saw was what you got with him. Having grown up in the Swiss town of Basle, a son of a banker, he learnt the basics of banking at the age of seven in primary school. He borrowed money from his father and charged 10% interest on lending that same money to his friends. And in typical Swiss banking fashion, no questions were asked – his father simply lent the money and he didn't ask his friends how they paid him back. He quickly built up a nice little pot of cash which he then surprised his father with one day, aged nine, so that he could buy shares in the bank his father worked for.

Unfortunately, his father worked for the Bank for International Settlements, which was created to help facilitate the payment of German reparations after the First World War. Over time, it had evolved into an intermediary and governing body for other central banks, but it meant that there were no shares little Kim could buy. Not entirely sure how to explain to his son what they actually did, Kim's father described a project he had been working on, which was looking at how to avoid the political and economic consequences of banks going bankrupt or insolvent. It was thought that banks should hold readily accessible cash – called regulatory capital – against all their investments as a precautionary measure, and his father was trying to figure out how much this amount should be. In Kim's little business empire, it simply meant that if he lent anyone money, he needed to put a small amount of cash aside.

Impressed by his attention to something that even he found a bit boring, his father continued to lend him money, but not for free any more – that would be too easy. He charged a funding rate of 1% per year. With this, little Kim could still make a 9% profit. And he built his business until it was making him a significant amount of money for a pre-teenage boy. He carried around a lot of his money and he was the girls' favourite, much to the annoyance of the other boys, because he would always be buying all of them sweets and dolls. He was a mini-charmer.

But still fascinated by the business aspect, Kim began to implement his father's ideas by understanding how his friends paid him back, so he could put the right amount of cash aside as a reserve. Those that stole from their parents were the biggest liability. So even though he continued lending to them, he'd charge much higher interest rates and put aside more cash. Those who had got into the cycle of borrowing money and then paying him back out of their monthly pocket money were the best business, as he was basically giving them a cash advance for a fee. He wanted to keep their business, because even though it was a low interest rate, it was stable and he didn't need to put aside as much cash, according to his calculations.

In fact, the more his mini-empire grew, the more he disliked investments where he had disciplined himself to put aside more cash than normal, because by putting that cash aside, he couldn't lend it and therefore didn't make a return on that money. The only way around this, he figured, was to try to sell his loan on to someone else.

So he shared his secret money-making scheme with the twins who lived on his road, and convinced them that they should do the same business. Showing them the wad of cash in his pocket, they were tempted. And Kim even offered to help. He gave them some of his loans, quite simply by asking the twins to pay him back the loan and then telling his friends to pay back the twins instead. This way, not only did he get his initial money back, but he could also spend the money he had decided to put aside.

But he had made two fatal mistakes that brought his business to a shuddering halt even before he had hit puberty, which meant all those sweets and dolls counted for nothing. Firstly, he had sold just the loans without trying to make a profit. In other words, for each loan the twins bought from him, the friends paid back the entire loan amount and interest to the twins. What he should have done was arranged it with the twins so he received some of the interest for introducing them to his friends, or even perhaps an 'introduction' fee. The second mistake was that he didn't tell his friends why he did what he did, and they just moved their customer loyalty to the twins. Little Kim's business was no more. And although he had made a tidy fortune, he didn't feel the same excitement as when he started aged seven, and decided to move on instead.

Ironically, the fine-tuning he had added to his banking model was ultimately to be accepted in 1988 by the Bank for International Settlements under agreement from all the central banks. Regulatory capital was now a reality. Banks around the world became obliged to hold aside cash for every investment they made, just as little Kim had done 30 years previously.

On graduating from university in the late 1970s, he had explored numerous career paths. In his late twenties by then, he had gone through every phase from academic to rocker to actor to scientist to just being a bum. But without much conviction in any of them, and left rather uninspired by life, he accepted an offer of a job that his father had arranged at the Frankfurt headquarters of Vandebor Bank, one of Europe's largest commercial banks, where he joined their mortgage department.

Not particularly thrilled, all he did day in day out was look at mortgage applications, assess each applicant's credit profile and decide if Vandebor should make the loan or not. But being just seven when he first started making loans, this was a step backwards as far as he was concerned. The only thing that kept him in the job was that at least he did his father proud. In fact, he turned out to be a good employee and before long he was asked to join the specialist mortgage taskforce.

For lack of a better alternative, he unenthusiastically accepted the role and was immediately tasked with figuring out how to make Vandebor's already substantial mortgage business more profitable. At first, it seemed as simple as writing more mortgages which they could fund by taking out loans or issuing more bonds themselves. But there was a bigger problem. Returns were diminishing, as Vandebor had already begun implementing their own version of regulatory capital.

In America, Salomon Brothers had created the first-ever Mortgage Backed Securities (MBS) in 1978, which were bundles of mortgages sold to other investors as bonds. Kim knew that this was in principle no different from him selling his loans to the twins, and he thought he had sussed the problem out. The only missing piece of the puzzle was to find investors to buy these MBS bonds. But when he explained this to his managers, they were blank-faced and responded by sending him to New York for six months to investigate.

Knowing what he was going to report back, he enjoyed himself in New York and on his return simply repeated his initial thoughts. The same managers who didn't understand the first time around congratulated him for his eye-opening conclusions with a DM10,000 bonus, which he used to buy a rather dour but typically functional DM100,000 German house – of course with a 6% Vandebor mortgage. But bored out of his mind, he would have packed it all in had it not been for a chance meeting with none other than one of the twins in Frankfurt. Married to one of the Basle girls they had inherited with the business, he was now working for Moody's, a rating agency. Along with Standard & Poor's and Fitch, Moody's was one of the three major rating agencies in the world, and they all specialised in giving credit ratings to Fixed Income securities – basically corporate bonds – going in descending order of quality from AAA to AA, A, BBB, BB, B, CCC, CC and C. The twin's job was simply to analyse the corporate and give it a credit rating, not dissimilar to Kim's analysis of his primary school clients, except that it was graded. What really captured Kim's imagination, though, was when the twin talked in passing about how investment banks had asked their Mortgage Backed Securities (MBS) to be rated in the same way that they rated a normal company.

And it clicked. The MBS market hadn't yet grown because there was nothing interesting or attractive about them on their own. But if they had a credit rating and their returns were better than similarly rated companies, then investors might consider buying in to them. So Kim played around with the idea of taking good-quality mortgages, such as his own, from Vandebor's mortgage book, pooling them together and seeing if the twin could give them the best credit rating – AAA. Unable to get there, he came out with different combinations of mortgages to see if he could ever get an AAA rating but he failed again. And he failed for quite a few years. Thanks to his newfound disregard for haircuts, he became indistinguishable from Doc Brown, so much so that he was once stopped in London by an American tourist seeking an autograph. If only he had a DeLorean to go with it.

But he did eventually find a solution – and a very simple one at that. He had had his house valued, and it was now worth DM150,000. He hadn't bothered paying back any of the principal on his mortgage, so that was still worth DM90,000, but his equity in the house was now worth DM60,000, an increase of 500% on his initial DM10,000. Furthermore, he was relieved that his dour but functional house price hadn't gone down more than 10%, because at that point his equity would be worth nothing while the value of the mortgage to Vandebor would also drop. Put another way, he was leveraged through his equity, returning 500% on the back of a 50% rise in his house value, but his mortgage was under-leveraged. So if the twin were to give it a credit rating, the intuition was that the under-leveraged mortgage would be rated AAA – the best rating possible.

So why not apply the same principles to 1,000 similar mortgages? Pool them together and then create a 90% 'senior bond' and a 10% 'equity piece', like his very own situation? After all, each mortgage would lose money only if Vandebor were unable to recoup the mortgage amount in the case of a repossession, where the house would be sold off in an auction. Likewise, the 90% senior bond would suffer losses only if the aggregate losses from these 1,000 mortgages exceeded the 10% equity amount. He was convinced that that would get the elusive AAA rating he had chased for ten years, and so he frantically scribbled down a basic trade structure.

He then ran to the twin, who told him that this very idea had already been done and a rated deal had already been publicly issued.

'Why did you not tell me about this?' Kim shouted at him in German. 'I just wasted ten years of my life for this project!'

'Well, it's basic accounting, Kim. You can carve out a debt and equity piece from anything. Your house through a mortgage, your car through a loan, a portfolio of these mortgages or loans, or a portfolio of anything really, like companies do with their assets. It's basic, basic accounting.'

What neither of them realised was that this basic principle of packaging something into a security – securitisation, as it came to be known – was to be applied over and over again in the credit markets, leading ultimately to the bubble and crunch.

Kim didn't re-invent the wheel, but the Vandebor management thought otherwise and deified him. Now he could embark on Vandebor's first-ever Mortgage Backed Securities deal, a securitisation of high-quality UK mortgages – simply because other banks had done similar UK deals and there was definitely investor demand for UK mortgage risk. For a £100m deal where they offered £90m AAA-rated bonds (referred to as the AAA tranche), there had to be aggregate losses of at least £10m from the 100 mortgages in this deal before the AAA tranche was hit with a loss. To give it additional credibility, the AAA tranche had AAA ratings not only from Moody's but also Standard & Poor's and Fitch.

But the attraction of the AAAs was not only in the rating but in the returns. As with all Fixed Income investments, they offered a coupon rate which had two components – the risk-free component which consisted of LIBOR, and the risky component, referred to as the credit spread. LIBOR – the London Interbank Offer Rate, published every day by the British Bankers' Association – is a suite of interest rates in multiple currencies that is the global benchmark interest rate at which banks lend to each other. As lending periods can be anything from overnight up to a year and longer, LIBOR publish overnight, one-day, one-week, one-month, three-month, six-month and twelve-month rates. Moreover, banks were often considered integral to the economy, such that there was an implicit understanding that they would never go bankrupt. LIBOR was therefore considered risk-free.