Dear Money (25 page)

It was good to own. But we didn't have that kind of money. By New York standards, we were poor. We had nothing. Anywhere else we would have been rich. Even so, we were advised to "buy something." So we looked at a studio, a bunker-like dwelling that smelled of cat pee in the hall, had a view onto an air shaft and a hot plate for a stove, an apartment that could be purchased for a price that was best shouted at the top of one's lungs. Anything better than the price of that studio would mean shouldering a debt that started at a million dollars. To Theodor this seemed outside the bounds of sanity, but others were willing. Lily Starr was in the paper for buying a million-dollar house in Amagan-sett: "New Starr of Literary World Builds Nest Among Long Island's Elite."

Harlem was hot. Queens was hot. Staten Island was hot. Just about anywhere was hot, actually, and everyone had an opinion. The cobbler on the corner was telling a customer about a house he was buying in Crown Heights. I remember a long taxi ride with a driver who wore a cell phone earpiece and spoke to clients about real estate deals in East New York. The airwaves sang of the abiding enterprise: home improvement shows, house-hunting shows, gut-renovation shows, flip-the-house shows. Up, up, up. In rural towns, homes replaced farmland, McMansions shooting up like mushrooms all across this great land.

Mortgages were easier to get than flu shots. They came in every color, every configuration: thirty-year fixed; fifteen-year fixed; jumbo; conforming; two-, three-, four-, five-year teaser rates; ARMs; balloons; no-interest; interest-only; no-doc loans; no-down-payment loans. No closing costs. No middlemen. No points. No processing fees. No credit report necessary. Were you breathing? You could get a mortgage, it seemed. Real estate was the ticket. Mansions were being built on apartment building rooftops on West End Avenue. Multifamily brownstones, SROs, schoolhouses, fire stations, churches, an old cancer hospital—everything was being turned into a home. Those who had primary homes now had second homes. Those with second homes now had third homes. And there were those who bought, not because they wanted the home, but because they knew someone else would—a whole new breed of speculators. Homeowners comprised 68.6 percent of the American population, the highest percentage ever. In 2004 the real estate market weighed in at $8 trillion, and three years later it would rise to an astonishing $11 trillion. This ascent would never change. The population was growing, and land was a finite resource. It was as simple as that. "It all boils down to real estate," a mother who was reading her daughter the Old Testament (a child's version) said to me in jest, but with the insight of conviction. "The entire story is about real estate. You know, the Promised Land, getting it, keeping it, getting it back, etc., etc."

Remember the Hovs of Maine? Remember their conventional mortgage, how we followed it up to the end of the 1970s when everything changed? Now comes the sequel, an important part of this autobiography, for without it my story would not have happened. Real estate allowed two exceedingly talented financial wizards, a little bored with the monotony of always getting it right, to pluck an artist from the streets of despair and place her in the center of the beautiful, wild storm that was the mortgage securities market. A swirling storm, a wonderful whipping blizzard—the kind that settles over the city like magic.

A family like the Hovs, buying their first home in the 1980s, went to the local savings and loan and took out their $100,000 mortgage, a thirty-year fixed, at 12.5 percent. (Remember those days?) But this time the mortgage did not stay with the bank. Instead it was sold off to a Wall Street investment bank, where it was pooled with other mortgages to form an investment vehicle so large that it would be attractive to the corporate, long-term investor—a pension fund, an insurance company, a foreign government even. The homeowners' monthly payments, interest and principal, became a revenue stream to pay the investors. Selling the mortgages gave the banks more liquidity, and this in turn was used to make more loans, and so the cycle grew.

What would happen, my new mentors would patiently explain, giving me the most basic sort of example, is that they'd take the $100,000 and divide it by ten, each investor then having $10,000 (this example, a microcosm of the pool). That would be the bond, with a thirty-year amortization and the interest at 12 percent (37bps), most going to Fannie/Freddie for the guarantee and 12.5bps going to the servicing company as payment for sending out the monthly bills. But creating bonds out of mortgages wasn't quite so simple. The neat little bundles of debt changed as homeowners paid off a portion of the principal along with the interest, which meant that interest payments to investors diminished over time. And homeowners sometimes did unpredictable things: they sometimes defaulted or, more likely, prepaid the debt, if by chance they got a windfall or if interest rates went down significantly or if they needed to sell their house. This left the investor with sudden capital that couldn't be easily reinvested for returns that were as attractive. Known as pass-through securities, mortgage-backed bonds had been around for quite some time but did not hold wide appeal because of these inherent problems. But this had rapidly changed.

The investment structure that I was swiftly learning about is the foundation of the proliferation of the American dream of homeownership. It became the cornerstone of a new generation of property barons (large and minuscule) and was fueled by an ethos first inscribed in our nation's birth document as the right to life, liberty and "the means of acquiring, possessing and protecting property." "Property" was changed by others to mean "happiness," and no one has looked back since. Owning property meant owning one's tangible share of happiness. And now, some 230 years later, a few roads converged to bestow this right on the American man and woman unequivocally and without bias—such a solid part of who we are as a people that foreigners (governments and businesses) wagered hefty sums on the lucrative American MBS market.

This information I absorbed from Frank J. Fabozzi's
Handbook of Mortgage-Backed Securities
(the bible of the market)
and countless other books I read over the next few weeks, in order to understand the history and the finer points of how the system worked.

I developed my understanding of the contribution that Radalpieno, along with others, had made to the MBS market with the creation of the collateralized mortgage obligation, a product that addressed the underlying prepayment risks and thus structured the bonds in a more attractive fashion. The CMO divided the pools of mortgages into two-, five-, and ten-year bonds that would appeal to a broader sweep of investors with various maturity requirements and—a significant factor in the explosion of MBS trading in the late 1980s—by more closely defining those return dates.

In other words, the CMO made it possible to reduce the wildcards for the investor so he'd have a more certain sense of when he'd get his principal back. The so-called tranches pay back principal according to a schedule, with the first tranche taking on the highest level of risk by absorbing the first prepayments. The second tranche absorbs the subsequent losses in case the equity tranche goes under. The third tranche, the least risky, absorbs whatever is left over. This form of CMO came to be known as "sequential pay" or "plain vanilla."

With the restructuring of the mortgage pools came an explosion of other mortgage-backed security products—PACs and TACs and Z bonds and IOs and POs and floating-rate bonds and stripped MBS bonds and countless other derivative products that only the creators truly understood and that politicians had allowed to become deregulated—a proliferation that rivaled any boom but that quietly grew during the 1990s to a mega-scale. Also growing were ways to hedge. Insurance products were created, swap options and calls and puts and the like. With the secondary market, the shadow market, set up and ready to go, with the variety of possibilities for dicing and slicing the bonds (companies in France and in Texas, for example, owning the same mortgages) and for hedging them, the demand and need for mortgages from the primary market (that is, originating mortgages) multiplied exponentially. There was such a demand for mortgages that the primary market couldn't furnish them to the secondary market fast enough. And so with time, mortgage products in all colors, sizes and shapes were created and offered to home buyers. The secondary market soared. And the benefit: those 12.5 percent mortgage rates tumbled.

At first, there were good reasons for the fancy mortgage products, for the teaser loans and the adjustable-rate mortgages, as they were designed to help wealthy people like bankers and lawyers, whose money came in lump sums at bonus time, to buy a house before the bonus arrived. Will Chapman, for example, bought Maine with one of these exotic loans. He put 0 percent down and got an initial teaser rate. He was betting that he'd sell his book to a publisher for a bundle and then be able to refinance the house in a way that created more certainty for the monthly payments. The advance from the book sale was not money he needed to live on. He had budgeted domestic expenses from money he'd made in the refinancing of his apartment and from a mass of accumulated savings from his days as a banker. Since his book was so long, he made a calculated judgment (with the advice of his agent, Sig Blankman—yes, she did become his agent) to divide the book in two. This, therefore, would bring him two hefty advances rather than one. If all else failed, he'd go back to the Street to fill his coffers. He'd been very good at what he did, and well liked. If they wouldn't have him back on the Street, he could sell Tribeca and move to Harlem and he'd be all right. (I loved the way these guys spoke, as though they were buying the whole state, the whole neighborhood: Maine, Tribeca, Harlem.)

So when the housing market exploded, a product designed for the wealthy became an asset for just about anyone, servicing those who dreamed tomorrow would bring more—those who never counted on tomorrow bringing less. A Mexican strawberry picker in Bakersfield earning $14,000 annually is loaned all he needs to buy a $720,000 house. The arithmetic was easy: property values could only go up; our homes only become more valuable; we'd refinance and lower our rates once our home's value rose. Banks were on to this. It was an elaborate design but a simple creed: tomorrow was the great American hope, and today there was money to be made.

And so the lesson continues. I spoke of roads converging. One road was our national belief in homeownership, a notion nurtured since the Declaration of Independence, fortified by President Franklin Roosevelt during the Depression with the creation of the New Deal and the Government National Mortgage Association (or Ginnie Mae) and again after World War II and up to the present. The second road was created by the dot-com bust, followed immediately by the September 11 terrorist attacks and the recession of 2001, which caused the Federal Reserve fund to be reduced from 6 percent to 1.25 percent, an action, Win explained, that led to lower rates or drops in LIBOR (the London interbank offered rate), which is used by banks to set adjustable-rate-mortgage rates.

The third road was the mortgage-backed-security market with its primary and secondary markets waiting and ready to thrive. Since the cost of borrowing money plummeted, money was easy to get. A house worth $600,000 could now be bought with a mortgage that would have the equivalent monthly payment of a $300,000 mortgage taken out only a few years before. Who wouldn't want to own? Why should the strawberry picker forgo such a chance? Why should the banker let him? The banker, after all, could pass off the loan to a financial institution in the shadow market, which could chop it up and ship it off to China and France and Sausalito, say, and in turn those institutions could hedge with swap options and derivatives and ... And that big, beautiful home with the Viking kitchen and bathrooms so sleek they seemed to belong in expensive hotels—heated chrome towel racks and piping for the shower that looked so elaborate it could steer you to the moon, not to mention the Jacuzzi and the marble bath and the travertine walls imported from quarries outside Rome, quarries once used by Brunelleschi and Michelangelo and Bernini—could be yours.

Demand for houses skyrocketed. Suddenly everyone wanted to buy a house. Suddenly the American right to homeownership was powerfully recalled, and you were not quite American, not quite up there with the prospering class if, like Theodor and I, you rented. Cheap mortgages made expensive houses cheap, and demand kept the prices going up, up, up. Supply and demand—supply low, demand high—the only equation that means anything on the Street.

So the fourth road comes into play, the need for capital—the money to be loaned to finance all these dreams. Where did it come from? It came from those investors in China and France and Germany and Waco. Here the roads begin to intersect, an elaborate freeway with exit ramps and on-ramps and cloverleafs. And there you have it: home values rose, homeowners tapped into their newfound wealth, squeezing every last drop of value from their houses. Houses became ATM machines, allowing us the means to fund our desires. Appliances became fancier, trips more exotic, children more numerous—three was the new two, four the new three, credit the new savings. In 2004, when I went to Wall Street, this was the party I joined.

I lied to Theodor those first weeks at B&B. I told him I was doing research for a story I wanted to write, that I'd be leaving the apartment early every morning for a few weeks, that he couldn't ask me about it. "Mysterious," he said with a big, sincere smile. "A story? About what? You don't write stories." It was Saturday and we were making pancakes for the girls. Behind me was the old life, worn and comfortable and familiar. In front of me was Monday, hard, unfathomable, exhilarating.

"No questions," I said. He continued smiling, his mind filling with relief, I could tell. His smile recalled the old days, the woman I no longer was. He had always been happy when I went from not writing to writing—as if it justified some truth for him about the creative process, about us. In the past, the smile, the dimples, the knowledge that sat on his lips, had been reassuring, a sign that I'd made it back. Now, however, the smile annoyed me. I was tired of where we existed, the soft hope that things wouldn't always be this way. You see, I could no longer equate tomorrow with hope, tomorrow bringing it as surely as a tide brings water. But I did not say anything, of course.