How panic gripped the world’s biggest banks

Part one here.


When a young team at investment bank JP Morgan pioneered credit derivatives in the 1990s, it classified some of them as “super-senior”, safer even than a triple-A rating. But 10 years later, as the US housing crash gained momentum, the world’s biggest banks were awash with mortgage-backed securities that were proving to be super-toxic. In the second extract from her book, Fool’s Gold, the FT’s Gillian Tett reveals how subprime spoiled the banking binge.

On October 11 2007, Moody’s cut its credit ratings on some $32bn of mortgage-backed bonds. Those had largely been issued in 2006 with medium-risk ratings of A or double-B. The ratings agency also warned that it might downgrade more than $20bn of mortgage-backed bonds that carried the triple-A stamp, and also downgrade collateralised debt obligations (CDOs) – credit derivatives made up of those bonds. All told, the cuts affected $50bn of securities.

The statement caused alarm among investors. Worse still, Moody’s seemed unsure how much further the downgrades might go. “The performance, particularly in the US housing [and] mortgage sector, [has been] deteriorating more quickly and more deeply than the ratings agencies or most other participants in the market anticipated,” Raymond McDaniel, chief executive of Moody’s, told the Financial Times on October 12. The subprime mortgage market was not behaving as the models had predicted. The “class of 2005 and 2006” borrowers were defaulting much faster than households which had taken out mortgages before those dates.