jerseyshorejohnny
Well-known member
Lewis “Lew” Ranieri was in many respects the polar opposite of Milken. Milken was tall and lanky, came from a middle-class Californian background and had always been obsessed with high finance. Ranieri, by contrast, was a rotund, uncouth, working-class Brooklyn kid, who wanted to be a chef until he discovered that his asthma would make it difficult to work in smoke-filled kitchens.
His first job on Wall Street was working the night shift in Salomon Brothers’ mailroom, which he did to pay for tuition at St John’s University, where he studied English. When he was offered the job of full-time mailroom supervisor, he dropped out.
By 1974, he was offered a “front office” job trading the bonds of US utility companies and, in 1979, he began leading Salomon’s mortgage-trading desk. There he assembled a team in his own aggressive image. “He was a bull in a china shop,” Robert Dall, Ranieri’s boss at Salomon for a time, told The New York Times in 2013.
But what made Ranieri’s name was not his persona. Wall Street has had plenty of bombastic bond traders with a penchant for coarse practical jokes. It was what he did to make a dime: packaging up individual mortgages into bonds and then trading chunks of those bonds, a process known as securitisation.
Securitisation is an old concept. Back in 1774, the very first mutual fund bought bonds backed by loans from plantations in the Caribbean and toll roads in Denmark. US mortgage-backed bonds existed as early as the 19th century. But these bonds only used the underlying loans as collateral. In 1970, the US Government National Mortgage Association (known as Ginnie Mae) engineered the first “passthrough” mortgage-backed securities, where the underlying individual loan payments flowed directly through to the bond investor.
This was followed by similar deals by other US mortgage agencies such as Freddie Mac and Fannie Mae, to little fanfare. Ranieri did for securitisation what Milken had done for the junk bond market; he transformed it from the backwaters into a global and massively lucrative industry.
The first fillip was the crisis that struck the US “savings and loans” industry when the Federal Reserve ratcheted up rates in the early 1980s. Congress passed a jammy tax break to make it easier for the banks to shed entire portfolios of mortgages at fire-sale prices. Ranieri’s Salomon was there to scoop them up and flip them to other investors.
Money began to course through Salomon’s mortgage trading desk. Ranieri realised that he needed to turn a one-off vein into an entire gold mine that could be exploited year after year. Luckily, he found some in-house inspiration: an innovative deal his former boss Dall had done with Bank of America in 1977, which sought to tackle the difficulty of valuing the cash flows of mortgage-backed securities with a technique called “tranching”.
It sliced them up into different portions each with their own interest rates, maturities and riskiness. That way, each investor could simply choose what kind of exposure they might like — a buffet rather than a set-course meal of variable quality. Ranieri ran with the idea. Rather than just take the mortgage of one bank, he pooled together bunches of mortgages from lots of them.
To handle the complexity, he hired a lot of bright young mathematicians to complement the mini-Ranieris on the trading desk. He then lobbied vociferously for government blessing of the tranching structure, knowing this would add to the products’ lustre with investors. He succeeded.
By the mid-1980s, the market took off. The arrival of personal computers on trading desks was a crucial lubricant, according to BlackRock’s Fink, who ran First Boston’s rival mortgage-backed securities team at the time and worked on a pioneering tranched $1bn Freddie Mac deal in 1983. “Before that, we just had Monroe calculators on our desk, and you had no ability to really understand the cash flow characteristics of various pools of mortgages — for example, the variability between prepayments in California and Oklahoma,” he says.
The story had an unhappy ending: the new market proliferated until it nearly brought the global financial system down in 2008, something that later weighed on Ranieri. “I will never, ever, ever, ever live out that scar that I carry for what happened with something I created,” he told The Wall Street Journal in 2018. But the fundamental idea — packaging up smaller loans into bigger bonds and thereby bringing together more people who needed money with those who had it — was sound.
Done judiciously, it actually makes banks less risky, by shifting the inherent danger of extending loans out of banks and into markets. (This is why securitisation has bounced back since 2008, and is starting to gain ground outside the US as well, often with government encouragement.) “Like everything else, it started off with great intentions.
The market just went off kilter from 2004 to 2007,” argues Fink. “It was just a lack of supervision and regulation, and bad behaviour… But the mortgage-backed security market is flourishing again now. Markets become irrationally exuberant, and then correct. We’ve seen that time and time again.”
His first job on Wall Street was working the night shift in Salomon Brothers’ mailroom, which he did to pay for tuition at St John’s University, where he studied English. When he was offered the job of full-time mailroom supervisor, he dropped out.
By 1974, he was offered a “front office” job trading the bonds of US utility companies and, in 1979, he began leading Salomon’s mortgage-trading desk. There he assembled a team in his own aggressive image. “He was a bull in a china shop,” Robert Dall, Ranieri’s boss at Salomon for a time, told The New York Times in 2013.
But what made Ranieri’s name was not his persona. Wall Street has had plenty of bombastic bond traders with a penchant for coarse practical jokes. It was what he did to make a dime: packaging up individual mortgages into bonds and then trading chunks of those bonds, a process known as securitisation.
Securitisation is an old concept. Back in 1774, the very first mutual fund bought bonds backed by loans from plantations in the Caribbean and toll roads in Denmark. US mortgage-backed bonds existed as early as the 19th century. But these bonds only used the underlying loans as collateral. In 1970, the US Government National Mortgage Association (known as Ginnie Mae) engineered the first “passthrough” mortgage-backed securities, where the underlying individual loan payments flowed directly through to the bond investor.
This was followed by similar deals by other US mortgage agencies such as Freddie Mac and Fannie Mae, to little fanfare. Ranieri did for securitisation what Milken had done for the junk bond market; he transformed it from the backwaters into a global and massively lucrative industry.
The first fillip was the crisis that struck the US “savings and loans” industry when the Federal Reserve ratcheted up rates in the early 1980s. Congress passed a jammy tax break to make it easier for the banks to shed entire portfolios of mortgages at fire-sale prices. Ranieri’s Salomon was there to scoop them up and flip them to other investors.
Money began to course through Salomon’s mortgage trading desk. Ranieri realised that he needed to turn a one-off vein into an entire gold mine that could be exploited year after year. Luckily, he found some in-house inspiration: an innovative deal his former boss Dall had done with Bank of America in 1977, which sought to tackle the difficulty of valuing the cash flows of mortgage-backed securities with a technique called “tranching”.
It sliced them up into different portions each with their own interest rates, maturities and riskiness. That way, each investor could simply choose what kind of exposure they might like — a buffet rather than a set-course meal of variable quality. Ranieri ran with the idea. Rather than just take the mortgage of one bank, he pooled together bunches of mortgages from lots of them.
To handle the complexity, he hired a lot of bright young mathematicians to complement the mini-Ranieris on the trading desk. He then lobbied vociferously for government blessing of the tranching structure, knowing this would add to the products’ lustre with investors. He succeeded.
By the mid-1980s, the market took off. The arrival of personal computers on trading desks was a crucial lubricant, according to BlackRock’s Fink, who ran First Boston’s rival mortgage-backed securities team at the time and worked on a pioneering tranched $1bn Freddie Mac deal in 1983. “Before that, we just had Monroe calculators on our desk, and you had no ability to really understand the cash flow characteristics of various pools of mortgages — for example, the variability between prepayments in California and Oklahoma,” he says.
The story had an unhappy ending: the new market proliferated until it nearly brought the global financial system down in 2008, something that later weighed on Ranieri. “I will never, ever, ever, ever live out that scar that I carry for what happened with something I created,” he told The Wall Street Journal in 2018. But the fundamental idea — packaging up smaller loans into bigger bonds and thereby bringing together more people who needed money with those who had it — was sound.
Done judiciously, it actually makes banks less risky, by shifting the inherent danger of extending loans out of banks and into markets. (This is why securitisation has bounced back since 2008, and is starting to gain ground outside the US as well, often with government encouragement.) “Like everything else, it started off with great intentions.
The market just went off kilter from 2004 to 2007,” argues Fink. “It was just a lack of supervision and regulation, and bad behaviour… But the mortgage-backed security market is flourishing again now. Markets become irrationally exuberant, and then correct. We’ve seen that time and time again.”
