All the Devils Are Here [6]
These men were no saints, and they all knew there were fortunes at stake. But the idea that mortgage-backed securities would also lead inexorably to the rise of the subprime industry, that they would create hidden, systemic risks the likes of which the financial world had never before seen, that they would undo the connection between borrowers and lenders in ways that were truly dangerous—that wasn’t even in their frame of reference. Or, as Ranieri told Fortune magazine after it was all over: “I wasn’t out to invent the biggest floating craps game of all time, but that’s what happened.”
It was the late 1970s. The baby boom generation was growing up. Boomers were going to want their own homes, just like their parents. But given their vast numbers—there were 76 million births between 1949 and 1964—many economists worried that there wouldn’t be enough capital to fund all their mortgages. This worry was exacerbated by the fact that the main provider of mortgages, the savings and loan, or thrift, industry, was in terrible straits. The thrifts financed their loans by offering depositors savings accounts, which paid an interest rate set by law at 5¾ percent. Yet because the late 1970s was also a time of high inflation and double-digit interest rates, customers were moving their money out of S&Ls and into new vehicles like money market funds, which paid much higher interest. “The thrifts were becoming destabilized,” Ranieri would later recall. “The funding mechanism was broken.”
Besides, the mortgage market was highly inefficient. In certain areas of the country, at certain times, there might be a shortage of funds. In other places and other times, there might be a surplus. There was no mechanism for tapping into a broader pool of funds. As Dick Pratt, the former chairman of the Federal Home Loan Bank Board, once told Congress, “It’s the largest capital market in the world, virtually, and it is one which was sheltered from the normal processes of the capital markets.” In theory at least, putting capital to its most efficient use was what Wall Street did.
The story as it would later be told is that Ranieri and Fink succeeded by inventing the process of securitization—a process that would become so commonplace on Wall Street that in time it would be used to bundle not just mortgages but auto loans, credit card loans, commercial loans, you name it. Ranieri named the process “securitization” because, as he described it at the time, it was a “technology that in essence enables us to convert a mortgage into a bond”—that is, a security. Fink developed a key technique called tranching, which allowed the securitizer to carve up a mortgage bond into pieces (tranches), according to the different risks it entailed, so that it could be sold to investors who had an appetite for those particular risks. The cash flows from the mortgages were meted out accordingly.
The truth is, though, that the creation of mortgage-backed securities was never something Wall Street did entirely on its own. As clever and driven as Fink and Ranieri were, they would never have succeeded if the government hadn’t paved the way, changing laws, for instance, that stood in the way of this new market. More important, they couldn’t have done