There can be many motives for mergers. Mergers and acquisitions are sometimes about limiting competition or about getting ahold of resources or talent. The year 2011 saw a spate of mergers to avoid taxes.
A merger can certainly be part of a plan to grow. But in the 1990s, when companies were competing for declining business, the primary goal of most mergers was to downsize. The M&A loans Chase made in the 1990s were paid back out of the savings from staff cuts. The bigger the cuts, the higher the stock price rose. But with each round of mergers the companies got smaller. I wondered back then how long this no-growth lending could go on.
But the bankers who made the big M&A loans and got the big bonuses often looked down at Russell Wynn’s middle-market lending and not only because of the smaller scale. “Loans should be made only to the twenty largest companies in each country,” one big lender told me. “To known quantities. That way the debt can be chopped up into chunks and sold on the Euro markets.” In other words, it could be securitized.
But Russell’s mid-market loan applicants were unknown quantities—a fish importer in Brooklyn or a dental plate maker in Queens. His job was to investigate their business prospects individually and to lend depositors’ money to those he found creditworthy. That’s called “intermediation.” In textbooks it’s the basic function of a bank.
Each of Russell’s mid-market borrowers ran a unique business and got a unique “handcrafted” loan for specific purposes. The bank held those unique loans on its books and collected the interest through the life of the loan. But “no one wants an asset on their books,” a Chase executive had explained to me in the 1990s. “Liquidity is everything to a money-center bank.”
I called Russell back and read those quotations to him. That kind of thinking still applied, he said, and he’d be happy to explain. But first he wanted to thank me. After our lunch he’d called several of his old customers and asked them directly about a job. It hadn’t produced any offers yet, but it was the least humiliating networking he’d done so far. “I forgot how down-to-earth those people are.”
The experience was so positive that he’d decided to follow through systematically—going through his old client book from A to Z. He thought he might even drop by some places in person the way he used to when he was their banker. “It’s a long shot but …”
“But all you need is one,” I said, and he agreed.
Russell sounded a lot better than the day we’d met for lunch. Maybe it was because he had a project with tasks to check off each day, maybe because it was ego boosting to talk to people who admired him from his years as their banker, or maybe he felt better because it wasn’t a Monday after Sunday evening’s existential fright.
I brought Russell’s attention back to the criticism of lending to “unknown quantities” like these businesses whose owners he’d been calling. Russell acknowledged that if you lend to big corporations, you then syndicate or even securitize the debt. At the other end of the loan-size spectrum, you can get small standard loans off your books by bundling them together into securities that you sell to investors. “Subprime mortgage loans are a handy example of that,” he pointed out. “They don’t have to be good loans, just standard enough to bundle.
“Of course it’s exciting,” he acknowledged, “to do 100 million in mortgage loans, sell them off the same day, use the money to make more loans that you can also sell immediately, keep spinning the same money around and booking fees each time. That will obviously generate more immediate returns than if you hold the loan till it’s paid back. So, yes, that’s where the action is.
“But that doesn’t mean that the bank doesn’t want mid-market loans also,” Russell insisted. “They wanted me to make every good loan that I could. The limitation is that my customers don’t need new money.”
“Even now?” I asked.
“Especially now. Look, factories flip the ‘on’ switch when orders come in. No one borrows to buy material or equipment, no matter how low the interest rate, unless they know they’ll have orders to fill. It’s a problem of demand. I was just speaking to a guy that sells …” Then he remembered he was talking to a writer. “Your banker is like your doctor or your lawyer. That holds for your exbanker too.
“So, yes,” Russell summarized more generally, “securitization, syndication, derivatives, all the spinning stuff, it’s more profitable, more prestigious than plain-vanilla lending. But the bank still wanted me to make as many vanilla loans as I could. The problem is to find businesses that can put the money to use.”
Russell left me with a lot to think about. For more than a decade I’d been shaking my head over what he called “the spinning stuff.” In February 2011, I heard Phil Angelides, the chairman of the Financial Crisis Inquiry Commission, speak on The Brian Lehrer Show on public radio. After a year of investigation, his commission had issued a report on the causes of the financial crisis. Here’s part of what he said: “I had spent a lot of my life in the private sector, in finance, and I was stunned by what I learned this year. I was shocked. The extent to which our financial system went from being a system to support the real economy—companies, job creation, wealth creation in this country—to a system that was money making money, financial engineering alone, to the great detriment of the country.”
So he too had noticed how much financial activity was about “the spinning stuff.” Chairman Angelides gave the impression that if you could slow down the spin and require banks to lend to real businesses for productive purposes, then the economy would recover. But Russell Wynn claims that he’d been free to make all the good middle-market loans he could find; he just couldn’t locate qualified borrowers.
The catch is that a bank can’t lend unless the borrower can pay back. And that depends on making enough additional profit to cover the principal plus the interest. Normally, that means that a business must be expanding. The borrower must use the bank’s money to make and sell more. That in turn depends on buyers. But Americans’ wages had been stagnant for forty years. Still, economic life had sputtered along and sometimes accelerated for another two decades despite my fears. A lot of that turned out to depend upon consumer credit.
One scheme to keep people borrowing and spending, the one that triggered the Great Recession, involved lending money to house buyers who didn’t earn enough to pay it back. These borrowers were told that they could repay their loans by borrowing yet again against the increasing value of their houses. Their wages might not be going up, but house prices would rise forever.
The trick for the loan originators was to get the mortgages off their own books before the scheme crashed. That involved bundling the mortgages into bonds and selling them off to investors immediately. Some banks hadn’t acted fast enough, it seems. Some were even foolish enough to buy the damn things as an investment themselves. When the housing bubble burst, many financial institutions were stuck holding what came to be called toxic assets. I was fortunate enough to meet an unemployed young man who had been right at the center of the mortgage securitization business creating those poisonous bonds.
Creating Value
August Treslow has the gawky charm of a four-year-old Labrador retriever. That’s twenty-eight in human years. Gus was, in fact, thirty-four, but he’s very youthful. He’d been an unemployed banker for seven months when we met in May 2009.
When I arrived at the restaurant, I found him reading The Kite Runner. “I just started reading books a few months ago,” he said. “This is the third. A friend recommended Liar’s Poker. That took a month, but it’s not really hard writing.”
In addition to reading three books, Gus had worked on a Habitat for Humanity housing project in the Bronx, he’d started to learn the language of his birth country (he was adopted), he was “doing stuff” with his old friends, “not just hanging out with the ones who are unemployed,” and he was studying for a test that would give him a certificate as a CFA (chartered financial analyst). “That would prepare me for a job on the sell side.”
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p; Before the recession, Gus used his mathematical skills to help create the mortgage-backed securities that were central to the financial crisis and ensuing recession. But he did not, himself, sell these or any other products to investors.
“Are you going out on job interviews?” I asked.
“A couple, but I’m really just studying for the exam. In July, I’ll try to interview. Right now I’m just testing the waters. I don’t want to be one of those people who makes a full-time job out of finding a job, because the jobs come back when the market comes back and you can’t control the market.”
In the decade since he’d gotten his MBA, Gus has worked at two major financial institutions, where he had securitized both mortgages and some kinds of corporate loans.
When I asked exactly how he securitized things, Gus took my notebook, reached for a pencil, and covered many pages with diagrams featuring circles inside boxes connected by arrows with the labels MBS, CDS, CDO, CLO, and so on.
Leaving aside the TLAs (three-letter acronyms), this is what I gathered from reviewing the notes. The underlying assets for the bonds Gus created might be 200,000 mortgage loans or some kind of corporate debt. These had been gathered together by the deal manager. The manager was going to sell the right to collect the fruits of these loans to investors. But first they had to be turned into bonds divided into different tranches or slices according to their risk.
Institutions like pension funds that were legally required to be cautious might agree to take a low interest, like 4.5 percent, for the right to collect the first 15 percent of the money that comes in every month. More daring or unregulated investors, like hedge funds, might buy the bottom tranche. They would get 7 percent, perhaps, but they’d collect out of the last 15 percent of the payments that came in on those same 200,000 mortgages.
To make things a little more complicated, some investors were going to be paid out of the interest on the mortgages, some out of the principal, and some out of both. Sometimes groups of bonds were themselves chopped up and bundled together into new securities yet one level further removed from the underlying house mortgages.
Gus’s job was to figure out the proper size for each tranche in a way that kept the right balance between the risk and the return. His work was mostly mathematical, but there was some personal interaction too, he told me. Different parties had conflicting interests in having the various tranches smaller or larger, and Gus received many “human inputs” as he worked.
Sometimes the manager of the deal would bring Gus in when he talked to potential investors. “He’d turn to me as the expert to answer specific questions.”
But finding buyers wasn’t what slowed a bank down. The limiting factor during the heyday of such bonds was getting enough “raw material”—that is, enough mortgages to securitize.
“In business,” Gus said as if quoting from one of his MBA courses, “one way of controlling efficiency is to control the pipeline so you can have a steady flow of the raw material. If you’re in the copper business, you can buy copper, or you can buy a copper mine. Well, if you were in the mortgage securitization business, you can get a steady flow of mortgages the way everyone else was doing it. Bank of America bought Countrywide, Merrill bought Franklin.” These were two big subprime mortgage lenders.
Eventually, a lawyer would incorporate Gus’s tranche work and other elements of the deal into a formal contract for investors called an indenture. “It could be a three-hundred-page book,” Gus told me.
“My book could be three hundred pages,” I said.
“But I’ll be paid more,” Gus remarked. He knew my kind of writing could be difficult too, he quickly added. But there was a reason for the pay difference. “One person’s research might generate hundreds of millions in profits, but what could an academic researcher at a college generate—a million-dollar grant that gets spread over several years, maybe?
“It’s not the skills; it’s what value can be generated from the skills,” Gus explained. “It might not be fair, but it’s the capitalist system. My work creates a lot of value.”
When Gus says his work generates “value,” he means profit for shareholders. And since his bank’s shareholders retained the profits made from the sale of his tranches in the good years, the shareholders he worked for did indeed come out ahead. By that definition Gus created value.
There was no sense asking him about social value. You can’t undo a master’s in business administration in one afternoon.
The redeeming thing about Gus is that he didn’t complain about his own job loss or any other personal consequences from a system that, in his words, “might not be fair.” Gus had an almost spiritual acceptance of capitalist business cycles.
I told him about the hedge fund stock picker who was so determined to stay in his high-bonus industry no matter what.
“A lot of people are determined,” Gus responded, “and some will get back. But the truth is a lot of them will leave finance forever. What you have is a pool that gets expanded in good times. In bad times it dries up, gets small. When it expands again, you have a new class of MBAs and undergraduates that can fill in those spaces.”
Did that mean that a recent graduate might occupy Gus’s old niche when the waters rose again?
Gus wasn’t a particularly philosophical fellow, but he seemed, for a moment, to gaze past me into the eons of time in which flowerings and extinctions, recessions and recoveries lay down their layers in the geological record.
“Will the new people eventually be paid as well as you were?” I asked.
“Yeah, I think. In 2000–2001 there was a lot of flak about high-paid analysts doing biased research. Their pay went down for a while, but it went back up because they create value.
“There’s always cycles. In bad economies the employer has more power. When the economy is good and there’s more money around, the employee has more power. When you have people in finance working sixteen, eighteen hours a day plus weekends, if you don’t pay them well, you’re not going to have finance.
“And what people are learning from this recession is that finance makes the world go around. An employer can take advantage in a bad economy. But if they don’t adjust in a good economy, the good people will leave.”
“So it finds its balance,” I said. My hands moved like balance scales gradually coming to rest in the middle.
“I don’t know if there’s ever a balance,” Gus corrected me dialectically. “It’s a continual shift of power from one side to another.” His own imaginary scales kept moving through the full range and back.
Gus seemed to find comfort in viewing his own ups and downs as part of the eternal cycle of booms and busts. He was part of economic evolution even if he himself wound up fossilized in a recessionary stratum. There is a grandeur in that view of life, I suppose.
Two years after he lost his bank job, Gus landed a position at the Federal Reserve Bank applying his mathematical skills to risk models.
“The pay is not as good,” he told me, “but I have twenty-two days of vacation, nine-hour days, no weekends, and every other Friday off.” (I happen to know that the Fed also has a fantastic pension plan, though Gus wasn’t thinking that far ahead yet.)
“Which job do you like better?” I asked.
“I liked being part of the pressure before,” he answered, “but I also like it that now when I come home, I can go work out or see people.”
I couldn’t tell whether Gus considered himself back in the pool or fossilized. But I told him that he was the first person I interviewed who had found a permanent, full-time job.
“If you give it more time,” he said, “they’ll all land somewhere.”
The Mystery of the Missing Unemployed Man*
Sizing the tranches of mortgage-backed securities put Gus at the dead center of the financial crisis. But the center of a storm is sometimes calm and quiet. I wanted to talk to one of those high-bonus guys who’d worked a few paces off center, at the turbulent trading desks where Gus’
s bonds were bought and sold. Traders have a reputation for arrogance, but I suspected I’d find them as innocently enthusiastic as Gus. Alas, the banality of evil makes it difficult to find any villains to interview. Or if they were there, they were too busy to talk to me. Everyone really is just doing his job.
Since mortgage-backed securities had been the downfall of Lehman Brothers, Bear Stearns, Merrill Lynch, the world’s largest insurance company, AIG, and many other Wall Street institutions, there had to be plenty of unemployed toxic-asset traders roaming feral on the streets of downtown Manhattan. The “do-you-happen-to-know-anyone-who-worked-at” research method usually works surprisingly well. But I couldn’t find a single mortgage-backed securities trader.
Eventually, I phoned Outtent & Golden LLP, a law firm representing Lehman Brothers’ former employees in a suit for severance pay. The lawyer’s job was to make sure they got their fair share of what was left when the bankrupt company’s assets were sold off.
I asked partner Jack Raisner if he could possibly inquire among his unemployed plaintiffs for someone who had traded mortgage-backed securities and might be willing to talk to me about how he was managing now. “I don’t use real names,” I assured him. I knew it was a touchy request.
“Most of them were snapped up immediately by Barclays,” Mr. Raisner answered.
“What for?”
He represented many other financial clients too, and he thought that the kind of person I was looking for just hadn’t remained unemployed very long. Mr. Raisner sounded like an honest and helpful man, but I still thought he might be brushing me off to protect his unemployed clients. How could those toxic-asset traders still be working?
Then I met a banker who confirmed that traders at his company were still busy with asset-backed securities. In fact, he thought he noticed a couple of new chairs at their trading desk. He speculated that “those damn things” had become so complex that the people who put them together were needed to “unwind the bank’s positions”—that is, to get them out of the deals. That made sense to me.
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