The New Yorker has a long review of a couple of financial books, including Fool’s Gold: How the Bold Dream of a Small Tribe at J.P. Morgan Was Corrupted by Wall Street Greed and Unleashed a Catastrophe. It details the history of the CDS, an idea that came out of a June 1994 JP Morgan off-site in Boca Raton (where “binge drinking occurred” and “a senior colleague’s nose was broken”):
The Boca Raton meeting first bore fruit when Exxon needed to open a line of credit to cover potential damages of five billion dollars resulting from the 1989 Exxon Valdez oil spill. J. P. Morgan was reluctant to turn down Exxon, which was an old client, but the deal would tie up a lot of reserve cash to provide for the risk of the loans going bad. The so-called Basel rules, named for the town in Switzerland where they were formulated, required that the banks hold eight per cent of their capital in reserve against the risk of outstanding loans. That limited the amount of lending bankers could do, the amount of risk they could take on, and therefore the amount of profit they could make. But, if the risk of the loans could be sold, it logically followed that the loans were now risk-free; and, if that were the case, what would have been the reserve cash could now be freely loaned out. No need to suck up useful capital.
In late 1994, Blythe Masters, a member of the J. P. Morgan swaps team, pitched the idea of selling the credit risk to the European Bank of Reconstruction and Development. So, if Exxon defaulted, the E.B.R.D. would be on the hook for it””and, in return for taking on the risk, would receive a fee from J. P. Morgan. Exxon would get its credit line, and J. P. Morgan would get to honor its client relationship but also to keep its credit lines intact for sexier activities. The deal was so new that it didn’t even have a name: eventually, the one settled on was “credit-default swap.”
The story doesn’t have a happy ending for the American economy, of course, but things turned out all right for ExxonMobil.
The oil giant appealed all the way to the Supreme Court and in 2008 the corporate-friendly justices slashed a lower court’s award of punitive damages down to half a billion dollars and ultimately “Exxon recovered a significant portion of clean-up and legal expenses through insurance claims.”
ExxonMobil made $295 billion in profits from 2001-09 and more than $6 billion in the first quarter of 2010. Who ever said justice delayed is justice denied?