Conversations With Wall Street. Peter Ressler
for gain. The end result was not always clear, but hard work, resilience and resourcefulness were part of the plan.
In the later subprime mortgage products, no effort went into creating these loans or securities. One loan underwriter at a big commercial bank said: “We were under pressure by top management to produce more products and post bigger profits. After a while, prime borrower demand for loans diminished, and we lowered standards for subprime borrowers. When the original subprime loan demands decreased, the industry reduced standards again. In the end, there were few standards remaining.” As I interviewed dozens of unemployed and worried professionals, a picture of market chaos appeared. Producers and management ran a race to the finish but had not realized the prize at the end was not worth the price. Wall Street was set up for profit, not philosophy. Yet the human connection was precisely the missing ingredient. Profits had obscured people. From Main Street to Wall Street, the human aspect of money had been neglected; more to the point, it had been completely ignored. Somehow the nature of the financial industry, or business itself, had written into the code that none of it was personal. The mortgage industry forgot that human beings were tied to the end of the loans. It was a simple fact ignored by too many. I sat and discussed this omission with industry pros, some of whom I had known and respected for years. While there were and are self-serving and ruthless people in finance, there are good guys too. Some are devoted fathers; others are great philanthropists. Many, as hard as it may be to believe for those outside the industry, are truly honorable people who simply never added two plus two to get four. They missed the obvious, thinking only of the bottom line and the push for profit. The profit margins had not represented people or family homes; they were simply numbers on a screen. When the dust cleared, the good guys in the industry were as shocked and horrified as everyone else.
A clear picture of Wall Street as both a perpetrator and victim of a fundamentally flawed model emerged. The financial industry had not seen itself as a public service directly tied to Main Street. Yet the industry functioned on service—to clients, customers, investors and consumers. If it forgot that human connection, its purpose was obscured. And therein lay the inherent misunderstanding, the false principle that finance is based solely on bottom line profits. Where were people in this bottom line? That was the financial model’s greatest flaw - its neglect of the direct connection to society. In a real sense it was a moral crisis, one that few in America and fewer still in the industry had recognized.
The Twenty-Eight Dollar Tomato
“Gerry” was a mathematical genius. In his Docker slacks and tasseled loafers, he sported a “preppy” collegiate look with a Poindexter IQ. Built like a teenage boy, the 38-year-old calculus whiz looked 15 years younger than his age. Frail and thin, he spoke with a deliberate seriousness that belied his childlike frame. As he explained the mortgage models he had created, it became obvious he spent large portions of his days building algorithms. Yet for all his brilliance, he was humble and warm with a sharp engaging wit. A quant (PhD in complex mathematics) educated at Berkeley and MIT, Gerry explained how the industry forgot the fundamental rules of risk and reward. When the Street began to securitize NINJA loans (no income, no job, no assets), some analysts like Gerry voiced their objection. The research quant’s job was to analyze products and reveal market strengths and weaknesses. Gerry discovered early in the subprime era that many of the lesser quality securities were “too risky” and not worth their stated value. Upper management was virtually high on profit, refusing to acknowledge any flaws in the system. Every time Gerry expressed his concerns about questionable securities, he was told to, “Sit the fuck down and shut up, you negative dude.” Top managers believed he was looking at the glass as half empty, not half full. When the market tanked, the firm was left with tens of billions of dollars of defaulting assets on their books. Management called Gerry and his group in to analyze their assets to see if they had any remaining value. Gerry remarked that the head of fixed income “looked like a puppy who had just pooped in the corner and asked, Can you help us?” Gerry said to me, “It is a sad day when you find out your company behaves like that. Every time you dupe someone, you lose future business.” I asked Gerry the Genius what went wrong with management and their business model. He believed it was “a failure in leadership.” Top management forgot about cost and value. Gerry compared the mortgage-backed securities market to selling tomatoes. The MIT trained quant explained: “I sell you a tomato for twenty-three dollars. You sell it to someone else for twenty-five dollars, who then sells it to someone else for twenty-eight dollars. Yet in reality that tomato is only worth twenty-three cents. That is what went on in the mortgage markets.” The financial industry was left with billions of rotting tomatoes on its books after the crisis. Like tomatoes, defaulting loans have a short shelf life and are doomed to spoil. A senior vice president responsible for the origination and structuring of mortgage-backed securities at Lehman said: “The market was so hot for so long everyone just got caught up. There were other times when spreads widened and we made it through. We thought we could make it through again. No one expected the markets to seize up overnight. Add to that lax underwriting and ratings, and you have a time bomb waiting to explode.”
The value of a product is in the service it provides. Marking up a product to increase profits does not increase its value beyond the moment. The industry forgot the original intent of subprime mortgages was to give otherwise qualified borrowers a “second chance at homeownership.” Once the service behind the product was obscured, all bets were off—literally. When the markets “innovated” mortgage products that required no investment or down payment or credit risk from borrowers, the question for the industry should have been the following: “What value do these unsupported loans, which we are wrapping into complex securities and hedging with derivative products, contribute to society beyond a small group on Wall Street?” Since that question was neither asked nor answered, the market time bomb was set to explode. I asked Jeff the Lehman trader if he thought the crisis would enlighten the Street. He replied emphatically: “No, the Street has a short memory. Regulation may have to keep the memories fresh. The human element is too far removed.”
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