Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [71]
I had worked at Bear Stearns in the late 1980s and remembered amiable newcomer Ralph Cioffi to be Bear Stearns’ most talented and successful salesman of mortgage-backed securities. He was usually even tempered, always hard working, and thoughtful. I headed marketing for the quantitative group run by both Stanley Diller, one of the original Wall Street “quants,” and Ed Rappa (now CEO of R.W. Pressprich & Co, Inc.), a managing partner. Ralph was a popular salesman with my colleagues and a heavy user of our quantitative research. In gratitude for analytical work that helped him make sales, Ralph presented our group with an $800 portable bond calculator purchased out of his own pocket. When I was lured away from Bear Stearns by Goldman Sachs, Ralph Cioffi tried to persuade me to stay, matching the offer. Around 20 years had passed and since then we occasionally stayed in touch, but we were not close friends.
I knew Warren Spector, too. He had been a talented trader of exotic mortgage products, which at the time meant collateralized mortgage obligations including the volatile interest-only and principal-only slices of those deals. He had come a long way from the somewhat awkward young man who spilled red wine all over a white linen tablecloth at one of our client dinners. Before CDOs undid his career, he was a Bear Stearns favored son with a good shot at taking over Jimmy Cayne’s position as CEO.
We did not correspond. However, a couple of years previously I shared my concerns with Spector about a call I received from a fund representative. He claimed that Bear Stearns had agreed to underwrite his firm’s securitization backed by life insurance policies. The macabre idea was that when policyholders died, investors got the money from the life insurance policies net of expenses and fees—very heavy fees. Documents posted on the SEC’s Web site showed that if the holders of the life insurance policies did not die before additional money was needed to pay ongoing policy premiums, investors would be asked for more money. Investors could lose more than their initial investment if policyholders inconvenienced them by living a long life. I had done a quick background check on the fund representative. The SEC was conducting an investigation and alleged that the fund representative’s former employer was a Ponzi scheme. My concerns were bad news to Warren Spector as well. He checked into it and I missed his return call, so he left me a voice message: “There are lots of people peddling this idea and it’s extremely unlikely that we will do anything with any of them, so I appreciate knowing who’s dropping our name.”
The last time I spoke to Warren Spector, we discussed the hedging of synthetic CDOs that were constructed using credit derivatives. Bear Stearns’ proprietary trading desk had large derivatives positions with a number of investment banks. After JPMorgan Chase purchased Bear Stearns, the New York Fed estimated that Bear had around 750,000 derivatives contracts outstanding.11 Based on what I knew, I thought Bear Stearns had scary volume in tricky credit derivatives. Keeping track of the true risk and long-term profit is a complex task. As I discussed with Warren Spector, any manager would have difficulty determining whether traders were actually making money (or losing money) relative to a risk-neutral fully hedged position. One could temporarily create huge revenues, but enormous risk could soon turn revenues into losses. In contrast, Warren Buffett worked hard to reduce the number and complexity of derivatives contracts owned by Berkshire Hathaway. Warren Buffett told me that after years of whittling down Gen Re’s derivatives positions, he knows (and understands) every derivative contract owned by Berkshire Hathaway.
Buffett and Spector are very different Warrens. Warren Buffett used derivatives to turn junk into gold.Warren Spector oversaw at least one Bear Stearns affiliate