Turmoil Shatters Faith in "Creative" Products
Financial Times - December 29, 2009
by Gillian Tett

What has been the most useful innovation from the financial world in recent decades? That is a question Paul Volcker, the former head of the US Federal Reserve, likes to pose to investors and bankers.

His [a]nswer might make some financiers seethe: instead of highlighting any derivative or complex financial product, Mr Volcker nominates the automatic teller machine (ATM)...His scepticism is echoed in the political and regulatory world. "Wall Street was chiefly responsible for the 'financial innovation' that did massive damage to the US economy," says Janet Tavakoli, a structured finance consultant, expressing a widely held view.

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JT Note: Most of the attendees at the WSJ's December 2009 Future of Finance Conference at which Paul Volker repeated his remarks about ATM's and "financial innovation" were oblivious to this "widely held view," as I mentioned in my comments on the conference.

At the WSJ's conference, in which I participated, Paul Volcker said: "Wake up, gentlemen. I can only say that your response [to the crisis] is inadequate. I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy, just one shred of information. I am getting a bit wound up here."

If this is now a widely held view, it is also news to many reporters at the Financial Times. Gillian Tett was one of the first journalists to follow the saga of questionable financial practices. We disagree on the need for widespread investigations and felony indictments. I am for them, she is against. The problem is much more profound than shattered faith in a flawed product; the manufacturers knew or should have known they poisoned the global financial food supply. In fact, in the financial community, the fact that abuse of financial innovation did widespread damage is not a "widely held view," and Wall Street has successfully diluted regulation of "financial innovation."

In late 2008, John Gapper told me he was the first and best stop to review an advance copy of Dear Mr. Buffett, my book on the financial crisis. He never wrote a word, and buried it. In late February 2009, Paul Davies, an FT reporter who was in the forefront of exposing dodgy financial products, wrote a good review shortly after I sent him the already published book. I clearly state that the relationship between imploded mortgage lenders and Wall Street's securitization and sales process was the largest Ponzi scheme in the history of the capital markets. Ponzi schemes are illegal in the United States. Problems were not limited to mortgage products and numerous players were involved: investment banks, certain banks and thrifts, credit rating agencies, hedge funds, CDO "managers,' monoline insurers, mortgage brokers, regulators, and Congress.

I do not know whether the book's content had anything to do with John Gapper's not writing a review. Perhaps as Gapper claimed, he was busy with a new project. John Gapper recently authored a hagiography of Goldman CEO Lloyd Blankfein and dubbed him "Man of the Year" without mentioning the "widely held view." Christopher Whalen cancelled his FT subscription after reading Gapper's profile of Blankfein.

Goldman Sachs recently acknowledged that I warned (using fact based analysis) about these grave risks at the time it manufactured value-destroying CDOs, but it said my opinion was in the "minority." Goldman would have you believe it is the financial equivalent of a member of the Flat Earth Society in the lifetime of Galileo Galilei. Just as a competent long-distance navigator does not care how many nonprofessionals are members of the flat earth society, one does not rely on whether an opinion is in the minority or majority as a basis for performing appropriate due diligence when underwriting a securitization.

A reasonable man expects a long-distance navigator to have some competence in his craft, and a reasonable man can expect a certain level of competence (and standards) from underwriters. A basic investigation of the underlying collateral revealed grave risks--not reflected by the ratings--compounded by suspect securitization practices. Public money was used to bailout AIG in an extraordinary crisis, and the general public are not sophisticated investors. The argument that AIG was a sophisticated investor no longer applies as a reason to avoid consequences of this behavior.


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Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008), and
Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (John Wiley & Sons January 2009)

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