>> [inaudible] from jpmorgan, rightsome. >> yeah. >> and worked very hard, did you not, mark, to prevent it from being regulated. do you think he was right? >> well, i'll say what i would like to say, and then maybe we should let mark say in the interest of fairness. .. self-correcting mechanisms and you improve the success in finding its own rhythm. and the problem with that was really twofold. which is one when you had -- when it was a very small part of the overall financial system then perhaps you could afford to have a few ebbs and flows even in the extreme not stabilizing all of it. and initially when derivatives were developing you were talking about numbers now seem small. the problems came when the expansions became so explosive that in a sense suddenly it stopped just being a small part of the financial system and began to populate the system in a way that that if you have ebbs and flows that could be destabilizing but the other problem was that you didn't really have a free market in a sense of having true information flow, equal access information and equal competition. you always had big banks distorting methods and you always had murky information flows. so you never really have proper free markets and even in this supposedly free market system. it's quite ridiculous we have a free market system where vast majority of complex products sat on bank balance sheets and there was no tradeable price. it was accounting imagination. [inaudible] >> i think it should be regulated. >> what? [laughter] >> you're definitely putting me on the spot. [laughter] >> when we set out to design a framework for the tradeable derivatives, there were shifts from a place where it shouldn't be in the mind of the beholder reflecting the risk preference of taking the risk allowing him to shift it someplace else and we wanted to set up a framework where the market participation would be a guide to good behavior. you could look at the financial difficulties that we have around the globe today and ascribe them to a particular product, credit default swaps. i'm not sure that gillian has done in that your book. he talks about cds but she also talks about cdos. these collateralized debt obligations are heavily securitized. so both of those things are involved in some ways here. i would test the this if every person was current on his mortgage payments and i think the answer is clearly no. ask yourself if we would have these problems in the financial system if credit default swaps had been outlawed on the date they had been invented and had never come in to existence, the answer is definitely yes. the problem we have is a housing finance problem. it's not a credit default swap problem. if there were no credit default swaps we would still have this housing finance crisis. it would just be harder to manage because it would be harder to move the risks from one place to another. so it doesn't seem to me that there's a clear case to make that a lack of regulation of credit default swaps contributed to the problem if they had been outlawed we would still have this problem today. >> well, i have two things i want to say about that. one is -- i think credit default swaps did exacerbate the problem for three reasons, firstly, that they made people confident about earning more. the good people thought they could shift the risk and they kept lending and the volume of lending and it expanded dramatically. and the option of writing credit default swaps there it provided another mechanism for investors to basically place more bets on the subprime market. in 2005 when i was writing the book when they actually started to run out of subprime loans, they were pumping subprime loans as fast as they could and they ran out of the prime loans and there wasn't enough to actually put into cdos, that was a point when the two intellectuals dreams really happened and became so deadly 'cause essentially using credit default swaps mimic the subprime mortgages which allowed investors to keep loaning more and more and more on the subprime world. and thirdly, the sheer credit world that it went under for a very, very long time. you basically add situation where people i describe this in my book in the spring of 2007 everyone could feel by then something was going very badly wrong in the credit world and, in fact, regulators were getting together something is wrong. what should we do and could we get a sense to do how wrong things are and quite apart from the fact you had you had those germans who were insisting talking about the hedge funds and nothing anything else was not particularly helpful one of the problems it was very hard to pinpoint the scale of leverage and the scale of the risk was not in the data and people were looking in other places. the scale was built up on the balance sheets such as merrill lynch which had utterly disastrous implcations toward the end of 2007. it wasn't being debated. there was very little ways to detract that. one thing i could come on this this is really critical something which i think they battled in 2005, 2006 and i talk about some of the initiatives. the theory that somehow in a market all the actors have a self-interest in acting in a a longer term and competitive pressures will somehow lead to turning it out behaviorally. you have seen that in a very tragedible way in a settlement in a cbs bang. if you had a perfect rational free market the type of situation where every bank would say i have an incentive of making sure i have huge backlogs of paper building up in my office because that ain't rational. paper we're losing papers. it's not an thing to have an efficient market. the problem was when innovation occurs in finance, you never actually know which products are going to be successful and which aren't and which ones is worth investing in infrastructure and which was not until several months until it was launched. if it took several months until which products grew and the products grew slowly you could have each bank basically up the structure process or deal with these new products. the growth was so fast, the banks had no time to actually invest in the infrastructure. and certainly they had time or incentives to invest in infrastructure. that was the problem. that was the back office guys in the banks. so you have all these reasons why they weren't behaving rationally. there was distortions and incentives. and the situation where all the banks are competing furiously to try to grab a slice of the new market and none of them not only want to stop to build up their infrastructure but nor do they want to spend any money because that will hit their p & l and their bonuses and there isn't in that situation -- it isn't a case that there's a rational self-healing mechanism to get everyone to invest collectively. it actually wasn't until tim geithner stepped in, let's get earn around the table and they began to do that. now, they could do that and they did it with a degree of success but it was actually in some ways pretty late in the day -- they could do that in the case of on the credit derivatives with the supplement problems because it was tangible and if you like there was an issue where everyone agreed it was a problem. no one quite knew how to act. it was clear that free market forces alone wasn't solving it but you'd get the banks around the table. the terrible tragedy that hurt the regulators back in 2007 although in the settlement area it was clear. there was a problem and you could identify there was data showing the problem but but how many backlogs there were, you know, in the general question of the g8 countries to get together and say, listen, the system is spun out of control. it's mad. and free market forces is not fixing the problem. it was amorphous and moving too past. >> talk a little bit how jp morgan's exposure to risk went dead. was there something about the institution either having to do with its culture or its management and process or was it simply a lucky -- a lucky coincidence? >> well, i think there was actually a lucky collision that happened at jp morgan. basically, they had a pretty conservative attitudes toward risk and back in the 1990s and partly because they were less commercial than some of their rivals and they were less intensely focused on the short-term p & l and partly because they had this rather bizarre internal corporate culture where people joined there and stayed a long time. they joined the corps jp morgan weren't bouncing to bank to bank all the time. most of them joined straight off graduation and stayed there for 10, 20, 30 years and that created quite a strong sense of team spirit and it paid the luxury of being able to share ideas and the collegiate matter. i take a broader attitude toward risk than some of their competitors. it's interesting the way internal corporate cultures and the old jp morgan had quite a conservative attitude toward risk. but then they merged with chase, somewhat disastrously. and that created like enron. and when he brought with him a set of attitudes toward risk in a strange kind of way or a lucky kind of way timed very well a lot of the existing risk management culture that was there against the old jp morgan guide and so from 2005 onward, they do appear to have taken as far as i can tell on the jp morgan guys they took a risk that was like their competitives. they were systemic and analyze it. they just weren't analyzeing on a few models. i mean, the case of bbs, for example, where essentially they were looking a model with disastrous effects using a very unidimensional way of measuring risk. it wasn't the case of jp morgan even though ironically jp morgan had invented it. and saying yes, it's kind of useful but it's only useful as a part of a set of techniques measuring risk. so i think that contributed to the risk they took. and the other about diamond he was actually prepared to face up to the analysts on wall street and say here. that's critically important. actually jp morgan wasn't doing that brilliantly. and there was a huge chorus of criticism from the analysts saying, why are you guys lacking behind. we thought diamond was going to come in and basically solve the problems and the revenues ain't that great. there were other banks who were responding to that intense shareholder pressure, spot market pressure and saying, yes, we got to try to start chasing after credit revenues as fast as we can. and they had goldman envy and be as good as goldman sachs. diamond on a number of occasions said no, we ain't going to go down that route and beat everyone purely through chasing after the quick and easy p & l. but again, it doesn't mean they didn't make mistakes. i don't want to paint these guys as perfect angels because they have made mistakes but there were decisions that were taken which was a very instructive lesson. [inaudible] >> in terms of what was going wrong? >> yes. well, for example, when the bank started down cbo abs business which is taking chunks of mortgage debt either through the actual tangible loans or increasingly toward the end through the derivatives of those loans there was a number of occasions where internally the jp morgan investment bank tried to work out why the competitives were making more money than him. and there was a huge debate on a number of occasions about whether they should do the same. should they dash down that route with a bshcbo and they kept wor number unless you take crazy risk. and they said no. and to say no was amazing because everyone was dashing down that route very fast. and other people were dashing down that road even in late 2006 when there was already evidence that the u.s. housing market was starting to turn, i mean, that's one of the astonishing things so much of the crazy risk-taking and crazy breaches of normal controls occurred even when there was evidence that the subprime mortgage market was starting to turn sour and mortgage lending was starting to go bust. >> as an armchair economic theorist i see kind of a schism developing in economics. are those people who think the problem was a maldesign of institutions leading to excessive short-termism and there's another group in economics who think that the problem was the failure to recognize that the market doesn't have any magic. that there's hardly any way to put prices on these exotic new fangled assets and the future is highly uncertain and if you can't do your own due diligence to figure out whether -- what the risk is of holding an asset, it doesn't really make any sense from a social point of view that you can sell to somebody else who's naive enough to take on the risk because he won't know any better what the risks are than anybody else. so there's just a huge amount of ignorance of darkness of impenetrable future that was sort of dogging the market without any awareness. it sounds like your book is more toward the latter view than the first. >> yeah. that would be fair. yes. >> my question you were describing this very well in the book the way jp morgan -- people at jp morgan kept looking at what else was going on in the market and somehow through some combination of luck and smarts resisted going for it but is there something about the financial center that competitive pressure especially when you got these publicly traded companies sort of inevitably leads to not some optimal market when you have myopic investors and also people within the companies dealing with short-term incentives, i guess the question is, what do you do -- clearly there's one place, jp morgan that were smart and resistant but it seemed the logic of these marketplaces is to move to the point where everybody actually is. i mean, do we go back to partnerships for these firms? do we -- can regulation do it. all the regulators get caught up in the crazy logic. >> i happen to say when it comes to risk-taking partnerships would be a good idea. simply because we need to create an incentive inside banks or brokers to actually try and monitor each department to try to monitor the other department and there has to be a sense of collective scrutiny. one of the banks appears to have been better at ducking is goldman sachs where there is more of a sense of one department looking over the shoulder looking over the other departments. they are not operating inside which is fierce competition with each other and actually as secretive with each other as they are with the outside world and that's largely -- or not partly because of goldman sack partnership with history which manages to imbue some of the corporate culture today. so i think -- one way to go down it. i think, unfortunately, that although people those who would disagree that i think regulators need to get much more hands on and much more involved and, you know, having a system whereby, you know, a group of financiers or banks are allowed to innovate to a degree they want with votes external oversight be it from journalists, regulators or politicians and somehowç hope that they will through sheer goodness of spirit, through collective rationality will keep their activities in check. they don't go mad is naive. it's not going to happen. banking is too important. and another analogy i draw if people run mutual powerñr plant were paid per kilowatt of energy they pump out, okay, so you have to pump out what you can and get the more they pump out, the more great they look, we would have blown somewhat over now. they're not. we need to look at banking to other spheres of activity, the industry, it pharmaceuticals and actually ask what lessons can we learn of control? one of the ironies everyone talked about financial engineering until they're blue in the face. if you're an engineer building bridges you're talked about safety margins, you're taught to actually debate with other engineers webs other scientists. you're taught to think about the wider contact you're doing and you're taught about things like ethics and again, some of those lessons outside finance need to be brought into finance as well. >> what sort of -- anyw [inaudible] >> what would be helpful going forward? >> i could talk an hour about that. joined up regulation is critical. one of the key reasons that we developed is we live in a isolated world. as the world becomes more complex there's a great tendency for everyone to keep stirring around their silo but the tension is when a new specialist has the details of each silo we need to see how they fit together be it inside banks, it be between banks and see how banking fits in the rest of the economy. so i'm actually very much in favor of moving towards more unified systems of regulation or regulatory oversight for starters. [inaudible] >> in the u.s. it will be a good start to actually have not, you know, half a dozen feuding fragment regulators that reflect the pattern inside the banking system. you have a bunch of siloized private sectors and i'm starting to talk like a anthropologist. you have warring thiefdoms inside banks and between banks, complete lack of information disclosure everyone is suspicious of everyone else and competing furiously and guess what you have regulators reflecting those patterns there. there was no one to tape the joined-up picture how the system worked together and how the system was building overall. >> what do you think the -- taking as it's given financial journalists didn't discover what was going on. do you think that's a problem on journalistic side of lack of expertise or lack of incentives. >> it's both. a lot of the press, in the early part of this decade, you know, the sexy parts of the market were -- the equity market and things like that because guess what? that would have been sexy at the start of the decade with the i.t. boon and with regard to a bit of a back-water and so you didn't have the kind of high status, you know, label attached to that area of activity. so that was one problem. another problem was that actually not having lots of journalists pour all over the credit works was fine. i'm not saying it's deliberate of let's go and hide what we're doing but it was just one of those situations that kind of suited everyone just well. you know, the bankers became like, you know, the financial priest if you'd like who spoke financial latin. the congregation just sat there. the congregation by and large were quite happy to let the priest, you know, carrying on speaking the latin doing what they did up in the altar just as long as he blessed everyone from time to time and the-piece didn't think to talk other than financial latin well, this is all rather complicated and let him go on with it. and, of course,, you know, politicians didn't have much incentive to rock the boat either because it was a fantastic credit boon. and so everyone was going along and joining the party. there was also the simple problem that almost anyone who understood what was going on in credit, as i say tended to work in the credit world because guess what? they got paid 10, 20, 50 times more than journalists so the structures inside the media and the media relative to finance reflected the bigger partner in society, too. [inaudible] >> or bankers less. >> i get the feeling that you're a little too easy on jp morgan. you actually highlight some of the mistakes they made and underlying the mistakes perhaps and maybe i'm wrong. >> uh-huh. >> you talk -- they sort of say well, the insurers are insured and they can blow off capital and they are not there when we need smell but they get their cdos or cdss insured by aig. well, we found out aig was no different. it could blow up as well. so aig wasn't really there when the big default that said, that wasn't supposed to happen but happened. so what's the difference between merrill lynch did or aig did? >> in what scale? jp morgan used aig a bit, not that much. and partly because they had internal line limits. so, yes, back in 1998, they cut the first time aig joined it was back in 1998 when, you know, they went to see cassano and you get this crazy thing called super senior and he said are you interested, yes, bring it on. they spotted due to regulation arbitrage they could basically do whatever they wanted and be a super senior they could limit capital and it made a lot of sense. yes, jp morgan did deal with aig quite a bit at the very beginning and, yes, it had dealt -- >> was it by the government would jp morgan never would have lost a lot of money. >> not to the scale of its other competitors. if you broke it into, it's pretty stark. jp morgan is not even up there in the top half dozen from my memory. yeah, you can actually see the breakdown who benefited most from the rescue. i think jp morgan was somewhere around 10 or 11 but i can get the figures for you >> but what about -- >> and the model i think -- they thought it was nuts. there was a discussion with bill -- one of the fascinating things about telling this story is so many of the mistakes and the terrible things, you know, egregious things that were done in 2005/2006 were discussed by the original jp morgan team back in 1998/1999. and, in fact, one of the things that he used to do was traveled so many shorts on the lines because he thought they were stupid. very prescient. and, you know, in 2005/2006 when they were having a discussion of shall we see the pdo of abs what should we do? there was a discussion about shall we basically gee what's called the negative bases and trace it with model lines, they recognize it if you use a model line you could exploit all the accounting rules and make it seem as if the risk could magically disappeared which is basically what ubs and merrill were doing but actually the genuine risk having disappeared because if there was ever a situation bad enough to blow up the super senior it could modelize too it was intellectually stupid to use model lines to protect yourself from super senior risk. >> what about in order to respond -- i mean, that wasn't again in a way similar to in concept of citigroup with all its cbos and they were buying cbos from all kinds of banks and jp morgan and that's why he went on to be the biggest to the hedge fund because they had sold them the cbos but it came back to them because they had loaned 90% of the money it was supposed to pay them. >> steve black and others would say over and over again, we made mistakes. and they're very scared thinking they lived too well. in japan the last decade nobody wanted to look at a profit because guess what? they get too much attraction so, in fact, in the course of interviewing they kept saying we made mistakes and they'd list all their mistakes just in case i hadn't gotten them down and i mentioned them all in the book, you can look at the results. you can look at who made the big writeoffs in the last two or three years and simply see, you know, the scale the mistakes jp morgan made so far and there are plenty of things that can go wrong in the future. they have got consumer credit exposure. they have got -- there are mistakes there. but the scale of writeoffs that jp morgan made are nowhere near the scale of most bank competitors, citi, merrill, ubs, morgan stanley. guess what they're not being