My Front Row Seat to the Mortgage Boom and Bust, Part I
Part I - Riding the Rails to Wall Street
A few days ago, I shared an email sent to me by the CEO of the mortgage trading firm where I cut my teeth on Wall Street.
In it, he scorched me, completely and totally. As I described it:
The email still haunts me. It stings to read it even now, 20 years later, because it was so accurate. I was young, naive, maybe a bit lazy and certainly unprepared for the role in which I found myself.
We learn from what hurts us most.
The response online sparked me to tell the rest of the story.
Here’s the first installment, stay tuned for Parts II and III! (the email comes in Part III)
Part 1: The Arrival
After a stint in mortgage finance in New York from 2002-03, I took a year off to be a bum: couch surf in San Francisco, road trip around the US, camp, and otherwise enjoy being a 24-year old no responsibilities and savings to burn.
But money ran short and I reluctantly reached out to my fledgling network in NYC for job leads.
As luck would have it, mortgages were booming and two of my former bosses were building teams at new firms. They were hiring.
One moved more quickly than the other, and with a tidy signing bonus and promise of future riches I signed back up for the Wall Street grind.
To round out my year of vagabonding in style, I hopped on the California Zephyr and rode the rails all the way to Chicago.
Which if you've never done it is 52 hours of old timey bliss, rocking through the western deserts, the southern Rockies and cornfields of the American plains. The final leg from Chicago to New York was forgettable, but I was able to finish The Fountainhead, an appropriate preparation for my triumphant return to the big city.
There I joined a ragtag group of mortgage traders and bond slingers led by one of the pioneers of the mortgage securities industry.
The firm created and sold residential mortgage backed securities, or RMBS, backed by subprime and Alt-A loans.
Yeah, I was right in the thick of it.
Jammed into truly mediocre office space at 3 Park Ave, I was tasked with being the operations manager for a new warehouse lending facility for correspondent bankers.
A couple sidebars.
First, if you want to really learn a business, go into operations. Also, if you really want to make money, DO NOT go into operations. I learned that part too late.
Second, WTF is a warehouse lending facility for correspondent lenders?
In 2004 the residential mortgage market was red hot, with subprime lending fueling home price appreciation across the country.
Our group issued credit lines to mortgage bankers who used our cash to fund loans for home purchases and refinances. Our clients would accumulate loans on their credit line with us before selling them off to a bunch of banks that don't exist anymore, who'd then repackage them into securities.
Our mother company purchased a handful of the loans too, but we were small potatoes compared to Countrywide, Bear Stearns, Lehman, Wells Fargo, Washington Mutual and the like who were hoovering up these crappy loans, packaging them into opaque securities and hawking them to insurance companies, pensions and hedge funds.
Like any lender, we made money on a spread, charging more to our borrowers we paid to our bankers.
In our case, we borrowed cheap from a big bank in Germany and relent the money to these smaller mortgage banks, taking the rake in between.
To give you a sense of the amount of leverage in the system, our capital structure was about like this:
+ 96% of the loan amount from our senior lender
+ 2.5% of the loan amount from our mezzanine lender
+ 1.5% equity put up by our firm
= 100% of the loans we made
Our initial senior credit line was $250MM (see, small potatoes), which meant for the privilege of lending out a quarter of a billion dollars, we had to put up less than $4,000,000 of our own cash.
Which was almost certainly borrowed from some other line of credit, because that's the way we rolled back then.
On the borrower side, we lent out up to 98% of the mortgage amount, with the balance posted by the loan originator (ie, the mortgage banker). So if we gave out a $20,000,000 credit line, the mortgage bankers needed less than $1 million in cash.
Many of these mortgages were 100% LTV (80% first with a 20% second behind it), so no one really had any skin in the game except for some bankers half a world away. Sure, we had a underwriting procedures and monitored customer balance sheets, but in those days the only job lower on the totem pole than operations was compliance.
And we were off, funding our first loans as 2004 wound to a close, right around when the Indian Ocean blew up, where a tsunami killed more than 200,000 people.
Another wave was building stateside, but this one man made and fueled by pure, unadulterated, good old American greed.
Stay tuned for Part 2, in which business goes gangbusters, we run out of room on our line, my boss turns out to be a less than stellar leader and I hire a buddy from California who will ultimately become my business partner and co-GP as later we tried to pick up the pieces from the mess that we played a very, very, very, very tiny role in creating.