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My Manhattan Project

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The economy improved. The Feds raised rates. Kidder was in trouble. We had no risk management. According to an internal report, there were management deficiencies across the board. If I remember correctly, one top executive had a contract stipulating that he would only work one day a week for his seven-figure wage. So Kidder was in bad shape when it was hit by the scandal involving the infamous Joseph Jett, who allegedly fabricated hundreds of millions of dollars in trades, more or less taking down the whole firm. Back then, a major Wall Street failure didn’t panic the entire country. Kidder may have handled a fifth of the country’s mortgage-backed securities, but in the wake of its demise, the American economy did not wither. Though securitization slowed to a crawl, breadlines weren’t forming. Homeowners made their payments. Bonuses, if you got one, were halved. People stood pat. Paine Webber cherry-picked traders and programmers. G.E. sold the assets of the firm. One of those assets, to my great surprise, was my software, purchased by Intex Solutions in Boston.

During the transition, I used the time to extend our structuring model to subordinated bonds. Allow me to expand Professor Gesiak’s analogy a bit: For deals with non-agency loans—that is, not Freddie or Fannie—in addition to the sirloin that comes out of the grinder, there is a small percentage of offal. By running that offal through the grinder again, in effect bundling together all the pieces from various deals that absorbed the default risk, we then created some andouille and some real dog food. The rise in price of the sausage over the offal more than compensated for the unsalable leftovers. That junk typically couldn’t be sold and stayed in-house, eventually becoming known as a “toxic asset.”

Times were lean at Paine Webber. The mortgage market, notoriously illiquid in bad times, petered out. Mortgage refinancings dwindled. The supply of raw material, new mortgages, disappeared. We had to lay off half of research. After a day of bloodletting, one of the bosses cornered me in the hallway. Did I get a sexual thrill out of firing people, he wanted to know, because it had always worked for him, big time.

That was 1995. I had been on Wall Street for ten years. I was fed up with the life, all day staring at a screen, the jockeying for bonuses. I wanted something different. I biked up to Boston and proposed to the people who had bought the Kidder software that I run it for them. “Don’t pay me a cent,” I told them. “I’ll integrate with your existing software, market it, maintain it, and enhance it. We’ll split the money, if any comes in, 50-50.”

They sent me a five-year contract with a subsequent five-year noncompete. That noncompete would retire me if enforced. I stared at it. Another five years was all I could take. Without consulting my lawyer, I signed it. Those pen strokes effectively capped my Wall Street career. Now it was up to me to chop some wood.

We had a deal. Intex was the largest supplier of cash flows on existing CMOs, but the company could not create new structures. That’s why Intex had bought my software from G.E. But it could not get it to run, much less sell it. I spent six months in my apartment, over the phone with one of the Intex programmers, integrating the two softwares. Within a year, we had sold it to four large investment banks; by the end of 1997, we had fifteen. We were it! By the end of ’98, we had 25. If a firm wanted to be in the mortgage business, they needed us. Instead of hiring a large staff to write the software, you could buy it from us, at half what it would cost you to create it from scratch. Price per copy was $500,000, plus annual maintenance. Not only did the big banks buy, but major mortgage servicers decided they could end-run the banks by taking the loans and ramming them through the grinder themselves.

For a decade, every firm had written its own proprietary structuring tool for securitizing mortgages. Now we had commoditized it. Firms liked using the same piece of software. Intex became the King of Mortgages. Bonds were traded without showing up on the Bloomberg screens!

Up until that point, almost all my securitization work had involved prime mortgages—those mortgages given to people who had an extremely high probability of paying them back. When a client wanted me to enhance my software to include “subprime” debt, well, that was something new, and I have to admit, I was kind of excited. This would greatly enlarge my universe of clients, because the subprime market was then split among many smaller players, each of whom needed my software.


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