One of the key features of the financial crash was the explosion in the complexity of financial markets.
The derivatives market became fiendishly complicated, with credit default swaps, CDS squared and even CDS cubed.
The securitisation market can also be shrouded in mystery for the average broker and is only really understood by experts in the field.
When financial advisers struggle to get to grips with some concepts of the modern financial system just imagine what it’s like for the man on the Clapham Omnibus.
This is why Philip Coggan has written an easy-to-read introduction to the financial services industry – The Money Machine: How the City Works.
He explores the entire financial system, explaining the difficult concepts in terms most people can understand. There is a particularly helpful guide to personal finance covering property, pensions, life insurance and shares.
Coggan gives a potted history of the building society sector and how it has coped with demutualisation and the credit crisis. There is an analysis of the US sub-prime lending crisis, the use of securitisation and how the contagion spread through the financial system.
The best section is about the international bond markets and their control over large businesses and countries. It says that a debt-ridden planet has become beholden to bond markets and credit rating agencies, and it can help explain the eurozone’s woes.
Bond investors’ preferences dominate the headlines, determine national budgets and can push countries into recession. The market itself is a simple concept that acts in the same way as a traditional loan.
“A bond is merely a piece of paper which promises, in return for an immediate loan, to pay the holder interest until the loan is repaid,” the book explains.
This clear-sighted explanation helps put it into context.
It says bond auctions are simply an attempt by businesses or countries to raise more money on a larger scale than they could lend from banks. Credit rating agencies then provide bond investors with an independent guide to the credit-worthiness of those selling bonds.
The less credit-worthy a seller the higher interest rate they will have to pay to get the money.
It’s the same principle as mortgages being given to sub-prime borrowers and facing an extra cost for the privilege.
But European countries are so heavily indebted they are now over-reliant on bonds to remain solvent, turning to the bond markets out of desperate necessity.
Wealthy Western nations are residing in the equivalent of a Victorian debtors’ prison where they must respond to every whim of their guards.
Understanding the bond market is crucial to the sovereign debt crisis and the future of the world economy.
Coggan provides good overviews of complicated areas of the bond market such as syndicated loans and getting a bond rating, as well as explanations of LIBOR, EURIBOR and the London Inter-bank Bid Rate.
Overall the book is a compelling read that will enhance knowledge of the financial system. Financial experts will not find much that is revelatory but it provides a digestible summary of the money markets and is a simple guide to the terminology behind the headlines.
Book review by Samuel Dale