Read Online The Greatest Trade Ever by Gregory Zuckerman - Free Book Online Page B

headquarters. The pipeline usually went through Wall Street. After New Century issued a mortgage, it was bundled together with other mortgages and sold to firms like Merrill Lynch, Morgan Stanley, and Lehman Brothers forready cash. New Century used the money to run its operations and make new loan commitments. The quasi-government companies Fannie Mae and Freddie Mac, pushing for growth, also became hungry for the high-interest mortgages from New Century and others, egged on by politicians pushing for wider home ownership.
    “I believe there has been more alarm raised about potential unsafety and unsoundness than, in fact, exists.… I want to roll the dice a little bit more in this situation towards subsidized housing,” Massachusetts Democrat Barney Frank, then the ranking minority member of the House Financial Services Committee, said about Fannie Mae and Freddie Mac in September 2003. Sen. Charles Schumer (D-New York) expressed worries that restricting the big companies might “curtail Fannie and Freddie’s [affordable-housing] mission.”
    By selling its loans to Fannie and Freddie, as well as to the ravenous Wall Street investment firms, companies like New Century didn’t need to worry much if they sometimes handed out mortgages that might not be repaid. Like playing hot potato, they quickly got them off their books. Checks and balances in the system were almost nonexistent. Home appraisers, for example, placed inflated values on homes, paving the way for the mortgage deals, knowing that if they didn’t play along, their competitors would.
    Banks like Lehman Brothers were eager to buy as many mortgages as they could get their hands on because the game of hot potato usually didn’t stop with them. Wall Street used the mortgages as the raw material for a slew of “securitized” investments sold to investors. Indeed, one of the things the United States excelled at was slicing up mortgages and other loans into complex investments with esoteric names—such as mortgage-backed securities, collateralized-debt obligations, asset-backed commercial paper, and auction-rate securities—and selling them to Japanese pension plans, Swiss banks, British hedge funds, U.S. insurance companies, and others around the globe.
    Though these instruments usually didn’t trade on public exchanges, and this booming world was foreign to most investors and home owners, the securitization process was less mysterious than it seemed.
    Here’s how it worked: Wall Street firms set up investment structures to buy thousands of home mortgages or other kinds of debt; the regular payments on these loans provided revenue to these vehicles. The firms then sold interests in this pool of cash payments to investors, creating an investment for every taste. Though the loans in the pool might have an average annual interest rate of 7 percent, some investors might want a higher yield, say 9 percent. The Wall Street underwriter would sell that investor an interest in the cash pool with a 9 percent yield. In exchange for this higher rate, these investors would be at the most risk for losses if borrowers started missing their mortgage payments and the pool’s revenue was lower than expected. Moody’s or Standard & Poor’s might give this slice, or “tranche,” of the pool a BBB rating, or just a rung above the “junk” category.
    Other investors, though, might be content with that 7 percent yield; they wouldn’t see any losses until the BBB slice was hit. As such, these claims might command a higher, AA rating. Still other investors might want a safer investment yet and be comfortable getting only 5 percent a year; they would receive a slice of the pool with a much higher rating, say AAA.
    Dozens of tranches, or claims on the packaged pools of assets, were created in a typical securitization, most rated AAA or close to it, and each paying investors interest based on expected payments of the pool. When Joe Sixpack sent his $1,500 monthly mortgage