savings and loans get a tax break and a monster is created -- 2/26/18

Today's selection -- from Liar's Poker by Michael Lewis. Lew Ranieri ran a nascent, money-losing mortgage trading department for Wall Street giant Salomon Brothers. He was desperate to buy and sell mortgages, but the volume was simply not forthcoming. In 1979, the Federal Reserve, led by Chairman Paul Volcker, raised interest rates to very high levels in a mission to stamp out inflation. But in the process, it crushed the U.S. Savings and Loan industry, since that industry made low and fixed rate mortgages, but was funded by Volcker's now very high interest rate deposits. The presidents of these S&Ls were desperate for a solution when, in 1981, Congress enacted a law which allowed them to sell their underwater mortgages, but spread the loss over 30 years. It also enabled them to offset losses against gains from up to ten years in the past. Suddenly, Ranieri's phones started ringing, helping to launch a mortgage bond industry that was central to the financial crises of both 1987 and 2008:

"Lights began to flash on the mortgage trading desk in Octo­ber 1981, and at first no one knew why. On the other end of the telephones were nervous savings and loan presidents from across America wanting to speak to a Salomon mortgage trader. They were desperate to sell their loans. Every home mort­gage in America, one trillion dollars' worth of debt, seemed to be for sale. There were a thousand sellers, and no buyers. Correction. One buyer. Lewie Ranieri and his traders. The force of the imbal­ance between supply and demand was stunning. It was as if a fire hydrant burst directly upon a group of thirsty street urchins. One trillion dollars came barreling through the phone lines, and all the traders had to do was open their mouths and swallow as much as they could.

"What was going on? From the moment the Federal Reserve lifted interest rates in October 1979, thrifts hemorrhaged money. The entire structure of home lending was on the verge of collapse. There was a time when it seemed that if nothing were done, all thrifts would go bankrupt. So on September 30, 1981, Congress passed a nifty tax break for its beloved thrift industry. It pro­vided massive relief for thrifts. To take advantage of it, however, the thrifts had to sell their mortgage loans. They did. And it led to hundreds of billions of dollars in turnover on Wall Street. Wall Street hadn't suggested the tax breaks, and indeed, Ranieri's trad­ers hadn't known about the legislation until after it happened. Still, it amounted to a massive subsidy to Wall Street from Con­gress. Long live motherhood and home ownership! The United States Congress had just rescued Ranieri & Co. The only fully staffed mortgage department on Wall Street was no longer awk­ward and expensive; it was a thriving monopoly. ...

Lew Ranieri father of mortgage-backed bonds

"Bond traders tend to treat each day of trading as if it were their last. This short-term outlook enables them to exploit the weakness of their customers without worrying about the long-term effects on customer relations. They get away with whatever they can. A desperate seller is in a weak position. He's less concerned about how much he is paid than when he is paid. Thrift presidents were desperate. They arrived at the Salomon Brothers mortgage trad­ing desk hat in hand. If they were going to be so obvious about their weakness, they might as well have written a check to Salo­mon Brothers.

"The situation was aggravated by the ignorance of the thrifts. The 3-6-3 Club members [S&Ls, since they borrow at 3%, lend at 6%, hit the golf course at 3p.m.) had not been stress-tested for the bond market; they didn't know how to play Liar's Poker. They didn't know the mentality of the people they were up against. They didn't know the value of what they were selling. In some cases, they didn't even know the terms (years to maturity, rates of inter­est) of their own loans. The only thing the thrift managers knew was how much they wanted to sell. The truly incredible thing about them, noted by all the Salomon traders, was that no mat­ter how roughly they were treated, they kept coming back for more. They were like ducks I once saw on a corporate hunt that were trained to fly repeatedly over the same field of hunters until shot dead. You didn't have to be Charles Darwin to see that this breed was doomed.

The Eccles Building in Washington, D.C., which serves as the Federal Reserve System's headquarters

"Trader Tom DiNapoli fondly remembers a call from one thrift president. 'He wanted to sell a hundred million dollars' worth of his thirty-year loans [bearing the same rate of interest], and buy a hundred million dollars of some other loans with the cash from the sale. I told him I'd bid [buy] his loans at seventy-five [cents on the dollar] and offer him the others at eighty-five.' The thrift president scratched his head at the numbers. He was selling loans nearly identical to those he was buying, but the difference in yield would leave him out of pocket an unheard-of ten million dollars. Or, to put it another way, the thrift was being asked to pay a transaction fee of ten million dollars to Salomon Brothers. 'That doesn't sound like a very good trade for me,' he said. DiNapoli was ready for that one. 'It isn't, from an economic point of view,' he said, 'but look at it this way, if you don't do it, you're out of a job.' A fellow trader talking to another thrift president on another line overheard DiNapoli and cracked up. It was the funniest thing he had heard all day. He could picture the man on the other end of the phone, just oozing desperation.

" 'October 1981 was the most irresponsible period in the his­tory of the capital markets,' says Larry Fink, a partner with Steven Schwartzman, Peter Peterson, and David Stockman in the Blackstone Group. In October 1981 Fink was head of the small mortgage trading department at First Boston, which would soon grow large and become Lewie Ranieri's major competitor. 'The thrifts that did the best did nothing. The ones that did the big trades got raped.' "



Michael Lewis


Liar's Poker


W.W. Norton & Company


Copyright 1989 by Michael Lewis


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