Dead Men Can't Sell Loans: A CEO Has it Out with the Head of Capital Markets

Dead Men Can't Sell Loans:
A CEO Has it Out with the Head of Capital Markets

An excerpt from Chapter 1 of Volume III of The Mortgage Professional's Handbook

Jess Lederman

It’s been noted that any financial professional can prove what physics is still wrestling with —
namely, that time travel is impossible. You see, if it were possible to goback in time, then you
could set the dial back some five or six hundred years, use the spare change found in your couch and under your car seat to make a modest deposit at the Medici Bank (if you want to visualize the Casa de Medici, just imagine if Goldman Sachs merged with Bank of America, Wells Fargo, the Federal Reserve, and, well, everybody), and by the magic of compound interest it will have multiplied into a mighty fortune by the present time.

Pretty soon, the internet would be thick with ads: Travel back to sunny Renaissance Italy, eat and drink like a king, and return home a multi-billionaire! Ah, but Economics 101 teaches us that
prices equalize supply and demand, and interest rates are the price of money. If time travel were possible, the rates on short-term bank deposits would eventually be driven down to zero, and, as can be plainly seen —

Woah, wait a minute… (feverishly checking CD rates on the internet)

Hey!  Maybe time travel is possible after all!

This is wonderful news, because I’ve long wanted to travel back to the early 1980’s, when my
younger self was just getting started in the mortgage industry. Okay, before we launch into the
main part of this chapter, let’s give it a try (queue the eerie music and blur the image on your


And there I am, in my cubicle! My first job was at the headquarters of a mortgage insurance
company, which was fortunate, because back then most of the top secondary marketing talent — people who later moved to Wall Street, Fannie, and Freddie, and created the mortgage capital markets—  worked for the MI companies (trust me on this).                        

"Hey, pal. This is Jess 2016, I’ve come to share all the wisdom I’ve learned over the past thirty five years.”

“Huh? Really? Wow, you’re looking kind of gnarly, dude. What happened to my hair?”

“Hair’s the least of it, buddy. But never mind that — I noticed you were looking depressed, reading the Wall Street Journal. What’s got you down?”

“Well, duh, mortgage rates are like, 14%, and last month there were only three loans originated in the entire United States. I’m wondering if I made a big mistake getting into this business.  So
what will things be like in 2016?”

“I’ve got good news and bad news.  Which do you want first?"

“Hit me with the good news man, I could use some cheering up.”

“Okay, well, 30-year fixed-rate mortgages will be priced at 3.875% with no points.”

“No way! That is totally tubular! Everyone must be stoked! So what’s the bad news?”

“The government won’t allow us to make any loans.”

“Bummer, man. What a tease! But tell me, since some of us MI guys are trying to invent something called a private conduit, will there ever be a day when there’s a liquid market for non-agency loans? And the only deals we’ve ever done have been rated double-A, will a private MBS ever receive a triple-A?”

“I’ve got good news and bad news.”

“Uh oh.”

“The good news is that over the next twenty five years, Wall Street will develop a vast market for jumbos and other non-Agency product — in fact, by the mid-2000’s, investors worldwide will have developed a virtually insatiable appetite for rated, private label MBS.  And everything will be rated triple-A. ”

“Radical, dude!  What could possibly be the bad news after hearing that?”

“In 2007, the entire mortgage market will melt down and jumbos will become as illiquid as the
Mojave Desert; in fact, they’ll nearly blow up the entire global financial system, threatening
Western civilization as we know it. And, by the way, if you ever meet anyone from Reykjavik, as far as they’re concerned, you don’t even know how to spell mortgage.”

“Double triple bummer! But thanks for the warning. Well, then let me ask you this: to try to gin up volume, some banks are planning on offering 95 LTV neg-am GPARMs {historical note: graduated payment adjustable-rate mortgages, pronounced gyp-ARMs}; basically,payments steadily increase and equity evaporates. And we’re thinking, with this product, who really needs income documentation, anyway? Home builders in Texas can’t get enough of them, and since predictions are that oil prices will keep going up, like, forever, we mortgage insurers figure, why not! What could possibly go wrong?”

“Other than high double-digit cumulative default rates and mind-blowing loss severity, not much. Fortunately, after those loans helped to finish off the last of the savings and loans, the mortgage industry completely swore off of high-LTV neg-am low-doc ARMs, except for maybe $750 billion made in the 2000’s.”

“Woah, dude. Will we never learn?”

“It’s all a moot point now, though. Congress decided to make any such loans illegal. In fact,
pretty much the only loans you’ll be able to make in 2016 are 30- and 15-year fixed- rate mortgages to people who don’t need them. But hang in there, pal. This industry has always been pretty good at finding its way back to sanity, eventually steering past the Scylla of production madness and the Charybdis of regulatory and political excess.”

“Okay, will do, Jess 2016. But I’m gonna invest in better hair-care products from here on, I’m
telling you that.”


So, you’ve just taken over as CEO of a modest-size mortgage banker which does its own hedging, or of a large aggregator buying from correspondents and brokers nationwide. It’s your first gig as Top Dog, and your background is in sales, or accounting, or ops. The capital markets area (used to be called Secondary Marketing, but Capital Markets sounds so much cooler!) is impressive, with intense-looking nerdy types each staring at three monitors (makes browsing Facebook, ordering on Amazon, and sorting out one’s Fantasy Football strategy so much easier!).

Your EVP of Capital Markets, an impressive-looking fellow in his thirties sporting a Stanford MBA, motions for you to come in to his office while he finishes up a Very Important Trade.

“Sorry, I’ve just been adjusting our synthetic put position — and I’m happy to explain what that is if it’s not something you’re already familiar with.  What can I do for you?”

What do you say?

Being an old codger, and since this is my chapter in my own book, I’ll get around to the answer,
but by way of a few stories about the old days.

My first job at the MI company was being the proverbial junior bottle-washer; but I did pretty well at it, so I was invited to go to the firm’s annual sales conference that first year. The
motivational speaker was a famous guy whose announced topic was The Secret of Success. Now, I figured that was pretty incredible; most folks probably had to work for years, decades even, before figuring out the Secret, and here I was, getting it handed to me right off the bat.

So, I got to my seat early, notebook and pen in hand; and, to make a long story short, it finally
turned out the Secret of Success was — Just Show Up. I was disgusted. What a rip! Surely the Secret was something subtler, more ingenious, than that!

It was wasted on me; but, of course, years later, I came to understand that “just showing up” is
indeed one of the things that most differentiates everyone who is successful in sales (or business,
or life!).

With experience, I’ve added my own corollary, however: And don’t blow up.

Long-term success does not go to the smartest, or the most polished, or the best at marketing, or the most efficient at operations, or, for that matter, to the best at best execution.  It goes to
those who survive.

Hey, the EVP just asked if he can do something for you!

“You sure can. Don’t blow up.”

“Oh,” says your EVP, after a brief pause. He seems a bit let down that you didn’t give him a chance to explain synthetic puts (for a terrific discussion of synthetic puts, see Appendix One to Chapter 2 of this volume). “You’re worried about our betting on interest rates? Don’t worry, that’s something only old-time Secondary Neanderthal-types would do. We never assume we’re smart enough to know which way rates are going to go, sir. No, all our focus is on the spreads — the price or yield difference — between various hedge instruments and the actual assets we’re hedging.”

The EVP gestures to a number of graphs that are taped up on the wall, and a bevy of Bloomberg screens showing the price relationships among various MBS coupons and Treasury futures. What do you say now? Hold your horses; perhaps it would be best if I told you another tale.

During the 1980’s, I helped to build two of the first jumbo securitization conduits, one of them at a storied Wall Street firm famous for its trading expertise. Years later, this firm would be a
casualty of the Great Mortgage Meltdown; but when I worked there, blowing up was unthinkable.  And here’s why.

The Fixed Income department had been created not that many years earlier by two of the smartest, most successful — and most unusual — men on Wall Street.    Jimmy (not his real name) was short, soft-spoken, intensely intellectual; Mannie (ditto) was a man mountain, tough-talking, the guy you’d want to have on your side in a street brawl. Together, they
were a money machine. But it wasn’t always that way.

During the 1970’s, at the dawn of the era of financial futures, they’d been partners in a small
hedge fund which made tremendous amounts of money trading the cash- futures basis, which is a perfect example of a theoretically low-risk spread trade. And everything went swimmingly.

Until it didn’t.

One day, the basis got way out of whack. Well, it would surely eventually revert to the normal
relationship, so that just meant they could make money shorting more of what was rich and buying more of what was cheap.

And then the basis got even more out of whack.

Now, spreads may or may not revert back to the mean. But even when they do, you have to be able to hang on long enough to book the profit. And that can take truckloads of capital. That can take sell-everything-you-own-and-then-borrow-and-you-still-don’t- have-nearly-enough capital.

Losing money may or may not make you broke. Running out of cash — a liquidity crisis — will always make you broke. And that’s what happened to Jimmy and Mannie. If they could have ridden the trade out, they would have made big money. But they’d put on a trade that they couldn’t ride out. Now, some computer models will tell you that those market conditions come around only once every hundred, or every thousand, or even only every two thousand years. And then all of a sudden it’s 2007, and those once- every-other-millennium market moves take place twice in one week.

Stuff happens.

So Jimmy and Mannie went broke. But they got even smarter. They’d learned their lesson; now, they were determined to become volatility commandos. Nothing was ever going to blow them up again. And that’s the philosophy they put in place when they set up Fixed Income at that storied firm I joined in 1985.

Does that mean they’d become Wall Street Wimps, content with mediocre returns? Not a bit. In fact, this firm epitomized a style of doing business that is common to many of the most successful mortgage firms I’ve known over the past 35 years, from the smallest mom-and-pop broker to the largest aggregator: a blend of hard-hitting aggression on the one hand, and obsessive, paranoid oversight on the other. You just have to learn to drive with one foot on the accelerator and one foot on the brake. It’s an acquired skill.

“So let me ask you something,” you say to your EVP of Capital Markets. “Have you ever lost money or been part of a secondary operation that lost money? I mean, big money?”

“No sir,” says the EVP.  “And I’ve been hedging mortgage pipelines since 2010.”

“That’s a pity,” you mutter. In your mind you’re leaning back and lighting up a really fine cigar,
but of course that’s not possible these days.


“How about pull-through behavior? When’s the last time you got together with operations to talk about fallout trends?”

“I assure you, we’re on top of that.” Your EVP frowns. “I can show you a dozen charts and graphs. We regularly update our pull-through functions and feed those into our hedging model.”

“That’s not what I asked,” you say. “Is it.”


Now, the smart young man might one day be molded into just the right man for the job. But you want a volatility commando running Secondary. In fact, you want a team of volatility commandos working for you: Ops commandos, Compliance commandos, Legal commandos!

We’ll explore this more in the next section.

Read the rest of this chapter in The Mortgage Professional's Handbook!

Jess Lederman is a co-founder of two of the first private-sector counterparts to Fannie Mae and Freddie Mac, and one of the pioneers of modern mortgage finance over the past four decades. He can be reached at