been called the devil by strangers and “the Facilitator” by friends.
It’s not uncommon for people, when I tell them what I used to do, to
ask if I feel guilty. I do, somewhat, and it nags at me. When I put it
out of mind, it inevitably resurfaces, like a shipwreck at low tide.
It’s been eight years since I compiled a program, but the last one
lived on, becoming the industry standard that seeded itself into every
investment bank in the world.
I wrote the software that turned mortgages into bonds.
Because of the news, you probably know more about this than
you ever wanted to. The packaging of heterogeneous home mortgages into
uniform securities that can be accurately priced and exchanged has been
singled out by many critics as one of the root causes of the mess we’re
in. I don’t completely disagree. But in my view, and of course I’m
inescapably biased, there’s nothing inherently flawed about
securitization. Done correctly and conservatively, it increases the
efficiency with which banks can loan money and tailor risks to the
needs of investors. Once upon a time, this seemed like a very good
idea, and it might well again, provided banks don’t resume writing
mortgages to people who can’t afford them. Here’s one thing that’s
definitely true: The software proved to be more sophisticated than the
people who used it, and that has caused the whole world a lot of
The first collateralized mortgage obligation, or
CMO, was created in 1983 by First Boston and Salomon Brothers, but it
would be years before computer technology advanced sufficiently to
allow the practice to become widespread. Massive databases were
required to track every mortgage in the country. You needed models to
create the intricate network of bonds based on the homeowners’
payments, models to predict prepayment rates, and models to predict
defaults. You needed the Internet to sail these bonds back and forth
across the world, massaging their content to fit an investor’s needs at
a moment’s notice. Add to all this the complacency, greed, entitlement,
and callous stupidity that characterized banks in post-2001 America,
and you have a recipe for disaster.
started on Wall Street on October 5, 1985. I was 30 years old and had
been writing software for six years. I originally got into it when my
wife became ill and I took a job entering data, the bottom of the
computer industry, at Emory University, so her rare kidney ailment
could be treated. Before that, I had risked my life for $200 a week
hauling shrimp 100 miles offshore from Cape Canaveral, and I had been
the only white boy in my crew digging ditches in Alabama. Compared to
all that, Wall Street was a country club. I recall my first day at
Salomon Brothers, lingering at the windows by the elevator banks on the
25th floor of 55 Water Street. While groups of the well dressed and the
professionally coiffed headed to their cubicles and offices, I stared
out at the harbor, watching freighters, tankers, ferries, and garbage
scows cross the great harbor. The perfection of the place was profound,
the feng shui was palpable. As John Gutfreund, then the CEO, expected, I was ready to grab the balls of the bear.
first assignment was to write a “machine-to-machine interrupt handler.”
That was not exactly sexy in the world of finance, or in any world, and
I won’t bore you by trying to explain. It was plumbing. As was all the
programming, which, on the firm’s hierarchy, ranked somewhere above the
secretarial pool but well below, literally and figuratively, the
trading floor. I didn’t mind. To me, it was good, well-paying work. My
manager, a former mathematics professor named Leszek Gesiak, an
immigrant from Poland, became a friend. Neither one of us was on track,
but we both enjoyed the challenges and pace of the job. We lunched at
either Yip’s, a Chinese culinary cul-de-sac, or on Front Street, in the
seaport, where you could get fresh fish cafeteria style across the
street from the market. It was a different New York, still picking
itself up from the seventies. Drug dealers loitered at the door of the
brokerages, and taxis often smelled of pot from their previous
occupants. Just a few years before, Michael Bloomberg had been fired
from Salomon. He had the crazy idea that the data was as valuable as
the firm’s capital.
When I asked Leszek what the busy
group did that sat next to us, he told me they created mortgage-backed
securities. It was an instrument, he claimed, designed to keep
programmers employed. Having started to overcome my aversion to the
overpaid life—I had recently bought a suit at Barneys, the old one on
Seventh Avenue—I asked him how the bonds worked.
“You put chicken into the grinder”—he laughed with that infectious Wall Street black humor—“and out comes sirloin.”
I wanted a piece of that. But first, I kept a promise to my wife—that if she recovered, we would backpack around the world.
to New York a year later, I had an interview at Shearson Lehman’s
mortgage-research department. Again, I sought advice from Professor
Gesiak. I drove to his apartment in Greenpoint and confessed to him
that I had never studied finance, and I had only taken one course in
computers. Over the kitchen table, while his wife minded the toddlers,
he gave me a quick tutorial on the “present value of future cash
flows.” It was only freshman calculus, after all.
Out the back window, clotheslines on pulleys ran across the courtyard to adjoining apartments, like a scene from The Honeymooners.
Once I demonstrated that I understood how to discount a cash flow,
Leszek brought out the hard stuff. Over glasses of vodka chased by raw
garlic and butter on rye, he recounted how he had black-marketed goods
in communist Poland. Halfway through the bottle, he claimed that the
Polish zloty had been on the vodka standard—that is, the conversion
ratio of zlotys to dollars on the black market was always the same as
the price, in zlotys, of a half-liter of vodka.
back to Manhattan that night, I smashed my car on the ramp up to the
BQE. But the good news was that I got the job. I was in the
Lehman, I began a thirteen-year effort to streamline the process of
securitizing home mortgages, as well as other forms of debt. That was
1988, around the time of the savings-and-loan crisis. Remember that
one? Lenders had gone nuts with, what else, real estate, and as they
went bust, the government was stepping into the breach. Mortgage
securitization was the answer. Retail lenders could make the loan, take
a fee, then sell the mortgage to an investment bank. The bank, after
bundling thousands of the mortgages together, could, through a little
software magic, issue bonds based on that bundle of loans. Now, an
investor does not want a single person’s mortgage, much the same as you
may not want to underwrite your sibling’s purchase of an overpriced
McMansion. But when 1,000 similar loans are combined, and the U.S.
government, through Freddie Mac and Fannie Mae, absorbs the default
risk, you now have a nifty little AAA-rated piece of paper paying one
or two points above Treasury bills. And if the value of the loans is in
excess of the limit set by the government agencies, your savvy friends
on Wall Street can create a class of subordinated bonds that will
absorb all the defaults in the deal. With friends like these …
I slaved away at the sausage grinder, CMOs took off—$6 billion were
issued in 1983, and by 1988, the annual output had jumped to $94
billion. This was the era described in Liar’s Poker. Wall
Street guys felt cool and funny; people who were getting ripped off
were dumb and ugly and deserved it. I got a $50,000 bonus check, a 50
percent dollop on top of my salary. Peanuts to the traders, but a
bloody fortune to me, for the easiest work I’d ever done. I could
afford to rent a nicer place in Greenwich Village, go out to jazz
clubs, bike in France. But even then, I was wondering why I was making
more than anyone in my family, maybe as much as all my siblings
combined. Hey, I had higher SAT scores. I could do all the arithmetic
in my head. I was very good at programming a computer. And that
computer, with my software, touched billions of dollars of the firm’s
money. Every week. That justified it. When you’re close to the money,
you get the first cut. Oyster farmers eat lots of oysters, don’t they?
never would have thought, in my most extreme paranoid fantasies, that
my software, and the others like it, would have enabled Wall Street to
decimate the investments of everyone in my family. Not even the most
jaded observer saw that coming. I can’t deny that it allowed a
privileged few to exploit the unsuspecting many. But catastrophe,
depression, busted banks, forced auctions of entire tracts of houses?
The fact that my software, over which I would labor for a decade,
facilitated these events is numbing. Is capitalism inherently corrupt?
I don’t think the free flow of goods in and of itself is the culprit.
No, it’s the complexity masked by thousands of unseen whirring widgets
that beguiles people into a sense of power, a feeling of dominion over
for mortgage bonds rose, mortgage rates went down. This was the late
eighties. Through CMOs, the sheikhs whom we paid to fill up our SUVs
could finance our mortgages, the core of the American Dream, as could
the Chinese government—all the while getting an extra point or two
above the Treasury. Ample financing allowed more people to buy their
own homes. The world came full circle. Bonuses got bigger because the
Wall Street boys were doing good for themselves and the world.
CMOs became more complicated, my job was to make everything seem
simple—to, in effect, mask the complexity that would’ve made the bonds
difficult to trade. We invented a language for mortgage-backed bonds. I
called it BondTalk. Lehman was a runner-up in CMO underwriting. I was
told to rewrite the entire system. Make it all push-button. Flexible
and faster. Traders told us what they wanted, and we wrote the software
code to make it possible. We were on the cutting edge. When I finished
that project, I approached my former boss to ask if I could move to the
trading desk, to where the big money was.
“Mike,” he told
me when denying my request, “can you really look for people dumber than
you and then take advantage of them? That’s what trading is all about.”
I assured him, yes, yes. But no deal. The next month, after I pocketed
my $100,000 bonus, I left Lehman for Kidder, Peabody, which was the No.
1 underwriter of CMOs but had outdated software.
with another programmer, I wrote a new mortgage-backed system that
enabled investors to choose the specific combinations of yield and risk
that they wanted by slicing and dicing bonds to create new bonds. It
was endlessly versatile and flexible. It was the proverbial money tree.
recession began, which, in the perverse world of the bond market, was
good for business. As the government lowered interest rates to
stimulate the economy, bonds increased in price. With a drop in rates,
more people refinanced. There was more product for the securitization
process, more meat for the grinder. Our software was rolled out to ride
the latest wave. Traders loved it. What had taken days before now took
minutes. They could design bonds out of bonds, to provide the precise
rate of return that an investor wanted. I used to go to the trading
floor and watch my software in use amid the sea of screens. A
programmer doesn’t admire his creation so much for what it does but for
how it does it. This stuff was beautiful and elegant.
aim of software is, in a sense, to create an alternative reality. After
all, when you use your cell phone, you simply want to push the fewest
buttons possible and call, text, purchase, listen, download, e-mail, or
browse. The power we all hold in our hands is shocking, yet it’s
controlled by a few swipes of a finger. The drive to simplify the
user’s contact with the machine has an inherent side effect of
disguising the complexity of a given task. Over time, the users of any
software are inured to the intricate nature of what they are doing.
Also, as the software does more of the “thinking,” the user does less.
made $125,000 in my bonus that year and bought an apartment on Gramercy
Park. I had first-tier seats to the ballet, but I still rode my bike to
work. The traders pocketed multiple millions. I wasn’t poor, but I
wasn’t a plutocrat. I could live with myself. If there was a deception
going on, I was but a small cog, I thought.
around me, though, had become bizarre. At the time, I had an odd
sensation that mortgage traders felt they had to outdo the loutish
behavior in Liar’s Poker. The more money they made, the more
juvenile they became. What do you expect from 30-year-old
megamillionaires whose overwhelming aspiration was something vaguely
called Hugeness? They had wrestling matches on the floor. Food-eating
contests. Like little kids, they scrambled to hide the evidence when
the head of fixed income paid his rare visits to the floor.
that I was spending more time on the floor, I wondered why the men’s
room always stank. Then one afternoon at three, when I was in there
taking a leak, I discovered the hideous truth. Traders had a contest.
Coming in at eight, they never left their desks all day, eating and
drinking while working. Then, at three o’clock, they marched into the
men’s room and stood at the wall opposite the urinals. Dropping their
pants, they bet $100 on who could train his stream the longest on the
urinals across the lavatory. As their hydraulic pressure waned, the
three traders waddled, pants at their ankles, across the floor,
desperately trying to keep their pee on target. This is what $2 million
of bonus can do to grown men.
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.
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
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
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
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!
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.
I quickly learned how fishy this
world could be. A client I knew who specialized in auto loans invited
me up to his desk to show me how to structure subprime debt. Eager to
please, I promised I could enhance my software to model his deals in
less than a month. But when I glanced at the takeout in the deal, I
couldn’t believe my eyes. Normally, in a prime-mortgage deal, an
investment bank makes only a tiny margin. But this deal had two whole
percentage points of juice! Looking at the underlying loans, I was
“Who’s paying 16 percent for a car loan?” I asked. The current loan rate was then around 8 percent.
people who have defaulted on loans in the past. That’s why they’re
called subprime,” he informed me. I had known this guy off and on for
years. He was an intelligent, articulate, pleasant fellow. He and his
wife came to my house for dinner. He had the comfortable manner of
someone who had been to good schools—he was not one of the “dudes”
trying to jam bonds into a Palm Beach widow’s account. (Those guys were
also my clients.)
“But if they defaulted on loans at 8, how can they ever pay back a loan at 16 percent?” I asked.
doesn’t matter,” he confided. “As long as they pay for a while. With
all that excess spread, we can make a ton. If they pay for three years,
they will cure their credit and re-fi at a lower rate.”
That never happened.
2001, when my five-year contract expired, Intex let me go. I guess I
had become too expensive, and Intex thought they’d be fine without me.
Why I had been able to retire at 45 for simply writing a computer
program befuddled me and aggravated others who felt they had worked as
hard. Life is not always fair, I told them. Right place at the right
time. Besides, I explained, the mortgage market is as big, if not
bigger, than the stock market. When they screwed up their faces in
disbelief, I told them to look around. Every house, every building,
every car, plane, boat, and piece of plastic in your wallet has a loan
tied to it. It’s all about cash flow.
Within a few months,
the World Trade Center was attacked. The country became single-minded
in its concerns. As segments of the economy weakened, the American home
carried the day. Prices soared, more homes were built, everyone bought
granite countertops, new plumbing, new mortgages. Home equity was the
piggy bank. It kept Main Street working and Wall Street gorging. By
2003, more than $1 trillion in CMOs were being issued annually.
from Wall Street, I discovered that my summer house, on the North Fork
of Long Island, included five acres of underwater land. I applied for
permits to grow oysters. I had something to do. In many ways, farming
oysters is more difficult, demanding, and frustrating than writing
software. Errors take seasons and years to emerge, whereas software is
instantaneous. Nature does not give you explicit warning messages; her
ways are more subtle and take a lifetime to penetrate. I forgot the day
of the week but knew instinctively the tide and the phase of the moon.
however, is a larger drama. The daily tango of interest rates, money
supply, and government debt continued to have an irresistible allure.
By 2003, a financial-data firm approached me about writing a
structuring tool for collateralized debt obligations, or CDOs. I asked
my colleagues, what was a CDO exactly? Like CMOs, they were structured
products, but the underlying collateral was not limited to home
mortgages. They could be anything—corporate bonds, subprime-mortgage
bonds, swaps, or simply air, like the synthetic CDOs: They could be
CDOs underwritten by the bonds of other CDOs, CDOs squared. Chicken,
pork, offal, chitterlings, tofu salad, fish guts—anything could be run
through the grinder. “Diversity of collateral” was the pitch. Some
things could go bad, but not everything at once. It never has, except
during the Depression, and we’re so much smarter now. That could never
With prime mortgages, the complexity of the
structure is on the bond side: tweaking and fitting hundreds of
different bonds from the same bundle of mortgages. But when the
underlying collateral is subprime, or the subordinated bonds are
supporting several subprime-mortgage deals, then the difficult task is
deciding when and if these loans will go under. Default models were the
rage. Throw some epsilons and thetas on a paper, hoist a few Ph.D.’s
behind your name, and now you’re an expert in divining the future.
As much as anyone, I had already
chased that. Why was I doing it again? As crude as it may sound, I
can’t say I was motivated by anything more than the opportunity to make
more money. It was sitting there, for me to take, and even for a
relatively private person like me, who never dreamed of building my own
castle in Greenwich or anything like that, it was hard to resist.
for me, Intex threatened to sue. They claimed that CDOs were so similar
to CMOs that my noncompete applied. To take the job would mean a legal
battle. In a sense, I was saved from my own base instincts. But my
oystering permits had been approved. When I looked at myself in the
mirror, after working all day hauling 400-pound cages of oysters off
the bottom, I looked healthier and more satisfied than I ever remember
being when I wore $3,000 Versace suits and thought of myself as a Wall
Street success story.
So that’s where I was when the world
I had helped create started falling apart. I hadn’t anticipated it, but
at the same time, nothing about it surprised me.
month, my neighbor, a retired schoolteacher, offered to deliver my
oysters into the city. He had lost half his savings, and his pension
had been cut by 30 percent. The chain of events from my computer to
this guy’s pension is lengthy and intricate. But it’s there, somewhere.
Buried like a keel in the sand. If you dive deep enough, you’ll see it.
To know that a dozen years of diligent work somehow soured, and instead
of benefiting society unhinged it, is humbling. I was never a player, a
big swinger. I was behind the scenes, inside the boxes. My hard work,
in its time and place, merited a reward, but it also contributed to
what has become a massive, ever-expanding failure. For that, I must
make a mea culpa. Not a mea maxima culpa, mind you, but some measure of
responsibility, a few basis points of shame. Give my ego a haircut.
hurts when people say I caused this mess. I was and am quite proud of
the work I did. My software was a delicate, intricate web of logic.
They don’t understand, I tell myself. Perhaps it was too complicated.
But we live in a world largely of our own device. How to adjust and
control these complexities, without stifling innovation, is the problem.
other day, Professor Gesiak brought me a pitcher of his basement-brewed
beer, bartering for oysters. He mused that the U.S. government would,
like Poland’s, make the currency worthless. What do we have, I wonder,
that like the vodka in communist Poland, can be counted on to hold its
value in this age?