The Devil's Derivatives

CHAPTER ONE

The Bets That Made Banking Sexy

Starting in the late 1980s, a new emphasis on shareholder value forced large banks to improve their return on capital and start acting more like traders. This sparked an innovation race between two ways of transferring credit risk: the old-fashioned “letter of credit” versus a recent invention, the credit default swap (CDS). Behind this race were two ways of looking at credit: the long-term actuarial approach versus the market approach. The champion of the market approach, Goldman Sachs, quickly moved to exploit the CDS approach and was richly rewarded for its ambition—and ruthlessness.

Something Derived from Nothing

There was a burst of tropical thunder in Singapore on the autumn night in 1997 when ...