The European Bank for Reconstruction and Development was established in London in 1991. Its stated mission, Payne explained, was to invest in market economies in the formerly Communist countries of Europe. In 1994, it had considerable credit, which it was looking to extend to the right borrower. JPMorgan—which meant she—grabbed an opportunity and negotiated a deal with EBRD under the terms of which EBRD would cover JPMorgan in the event that Exxon failed to meet any repayments once Exxon began drawing on the credit line. EBRD would effectively insure JPMorgan against the credit risk posed by Exxon, and in return JPMorgan would pay EBRD a modest annual premium. The deal was the first, or the first to garner attention. Because of the European aspect of the deal and the prospective business it had opened up, Payne moved to JPMorgan’s London office, after receiving promotions so fast even the rubberneckers got whiplash.
With this arrangement in hand (it had recently been given a name: credit default swap), Payne went to the SEC and successfully argued that JPMorgan had effectively removed the credit risk exposure incurred by extending a credit line to Exxon and should therefore be excused from having to set aside vast amounts of capital to cover default by Exxon.
When my firm asked me to find out about these credit default swaps, I jumped at the opportunity. There’s a lot of money to be made as a market innovator, but the number two position also has its benefits. Number one takes on the costs of developing a bold idea and the risk it might fall flat, while number two can avoid number one’s mistakes. After all, it’s the second mouse that gets the cheese.
After the presentation, I dropped Payne an email suggesting we meet over coffee to discuss her ideas. She agreed, and we met at a bistro near the Bank of England. She wore a figure-hugging black skirt stopping above her knees, with a matching jacket, which she slipped off before sitting down. Beneath this she wore a white cotton shirt, with upturned collars, fitted to her figure, tapering down to a narrow waist and cinched into her skirt. The shirt was unbuttoned down to her cleavage. It seems appropriate to mention these matters in order to set the scene.
What Payne told me over coffee changed my life. The scheme is easy enough to explain because, once I got to grips with it in my own time, it came to form the basis of pretty much everything I did for more than a decade.
In a securitization, a so-called sponsor takes mortgages or corporate loans, things that promise a stream of cash flows, and synthesizes securities out of them. Like any bright idea, it was really startlingly simple, once someone had it. You create a special company, somewhere offshore for perfectly legal tax reasons, and then have that company buy a pool of mortgages, say, so that it stands to receive mortgage repayments. The company then offers to sell to investors a security of its own creation that promises a series of payments funded by the pool of mortgage repayments. When I say pool of mortgage repayments, I mean repayments from upward of tens of thousands of mortgages. That was part of the point: Investors who might be interested in buying these synthetic securities, pension funds and hedge funds, for instance, had no interest in an anemic dribble from a few mortgages.
As I gather my thoughts here in order to get to the point, I am reminded of a joke Zafar made when he was still in banking. I say joke, but Zafar was always rather serious about banking and often talked about accountability, as he called it. This stuff is so esoteric, he once said, that the only people who understand it are in the business. What about regulators? I asked. Regulators, he replied, have one eye on the revolving door. Academics make money teaching traders their latest research, and politicians don’t know their arses from their elbows. Can you imagine the people on a march against finance? The guy on a megaphone shouting: What do we want? And everyone answering: Specific curbs on short selling in certain circumstances. When do we want it? In phases and at appropriate times.
That’s the joke. It was funny at the time.
However important the details of securitization may be, the important thing here is what I took away from my conversation with Payne.*
The synthetic securities we offered to investors had to be assessed for risk. Potential investors needed to know how likely it was that the mortgage repayments behind the securities would dry up. Rating agencies have the job of assessing the risk in a security before it’s offered for sale and of giving it a credit rating, as if its being a separate company from the ones arranging the creation of the securities guaranteed independence! Not so much arm’s length as shoulder to shoulder. Securities with triple-A ratings, the same ratings enjoyed by U.S. government bonds, are considered the safest. And the ratings go down the list, all the way down to subinvestment grade, the ratings given to so-called junk bonds or distressed debt (or where there’s no rating at all). The triple-A rating is the one that’s prized, the one investors in CDOs were looking for.
At our meeting, Payne described the difficulties she’d been having persuading ratings agencies to give the securities a high rating.
I’m sure you can be very persuasive, I said.
Yellow-bellied, spineless chickenshits. Ask what’s bugging them and they can’t say. If they weren’t so gutless, they’d be making money as traders and not working nine to five as actuaries in ratings agencies. Fucking salarymen.
How do they rate the securities?
They haven’t yet.
I mean, what’s the methodology?
Can’t get their heads around them. We asked them to work with us. Moody’s, S&P, they’ll work with you on a consultancy basis. But they’re just so damn slow. We’re going round the fucking houses with them. We need one of them to bite, and the others will climb aboard. They actually stand to make a fuckload of money in fees.
What about Forrester?
No.
Might be worth a try.
If the big ones won’t touch it—
Not being the biggest might mean they’re hungry.
Maybe.
What happens to the lowest tranche? That has to be a hard sell, I said. I had a few technical questions about what she’d told me. And, besides, I rather enjoyed trying to test her.
The sponsor holds on to the equity tranche; shows the sponsor’s got some skin in the game.
How do you deal with the risk?
What do you mean?
What if the mortgage market goes belly-up?
Really?
Humor me.
Well … you can use a credit derivative, a credit default swap—you could even use it just to enhance the credit of the securities.
Who writes those credit default swaps?
Anyone could. Insurance companies have the stomach. AIG will want a piece of the pie.
Here’s a question for you. What’s to stop the sponsor taking the equity tranche—you called it equity tranche presumably because it behaves more like equity than a bond?
Right.
What’s to stop the sponsor taking the equity tranche, funding it, and getting it off their books?
Using it as collateral to borrow against?
Yup.
The market wouldn’t like that. Potential investors will get jittery about the sponsor’s valuations. Then there’s the fact the sponsor will still be on the hook for services to the SPV, so that means investors will want the sponsor to keep a dog in the fight.
But what’s to stop my bank helping the sponsor fund the equity tranche, once the securities are issued?
Nothing. Just bad risk management. Why would a bank want to take on that risk? Especially a bank advising on the issue. Anyhow, you like it, don’t you?
Very attractive. Incredible it’s not been snapped up already.
The ratings agencies are a bottleneck, for one thing. It’s new, and new always scares the accountants.
All this must be keeping you busy.
Keeps me off the streets.
Can’t leave you much time for other things?
If I wanted a part-time job, I’d run for office or shine trophies for the Red Sox.
What I understood from Payne w
as that getting one ratings agency onside was the next step. I knew that putting the structure together and gaining the market’s interest would take some time, but, of course, I was already thinking of Forrester.
Just when I thought the whole thing was a wash, Payne Cutler surprised me.
You wanna get a cocktail tomorrow night?
Sure.
I’ll call you when I leave the office.
Sounds good.
I stayed late at the office, but I didn’t hear from her until a half hour before midnight.
It’s Payne, she said. Heading out now. See you at the Soho Tavern in fifteen.
* * *
By the time my father arrived, the evening had ended and the guests had left. We were tired and after a nightcap we all turned in. The next morning, the three of us had a long breakfast of bacon, eggs, and French toast, after which my mother left for the Sunday farmers’ market.
Zafar once told me that his parents had never asked him if anything was troubling him, never asked what the matter was. He had wondered in later life if that was because he had never let on or because they had never picked up on anything, or because, despite picking up on something, they could not bring themselves to ask. I found this last proposition difficult to grasp, when it seemed to me that the natural instinct of parents—biological or otherwise—was to respond to the faintest distress of those they rear. That basic level of sensitivity and solicitousness is something one finds even in good friends.
It was noon already, and my father suggested we go to the pub. If we stay there long enough, he said, your mother can join us and we can all have a Sunday roast together.
We drove out to the Trout in Wolvercote, north of Oxford, right on the water. My father came back to the table with two pints of bitter and a broad smile. The man doesn’t like bitter, but when I pointed it out, his reply was that he likes having bitter in an English pub: when in Rome.
Quite the Englishman, I quipped.
Look out the window, he replied.
And?
I didn’t grow up with this, you know.
With what?
What do you see?
The river.
He smiled.
I’m not mocking you, he said. But your answer is funny.
I should see electrons and photons and so on?
That you could do, but I see something else, the river, yes, and also a cold blue sky, autumn leaves, the episodic retreat of life, the willows mourning over the water.
Quite the poet this morning.
If you are not familiar with it, you notice the weir in the brook or the brook in the weir. I have no idea what the words are for such things. God bless them, they have these Anglo-Saxon words that show up nowhere but in places like this. I’ve read T. S. Eliot, a lot of Rudyard Kipling, and something of Thomas Gray, and so I see England in the manner of a foreigner, a place forever defending the past, doing quiet battle with the future, and in its very own way a country of charm. But if all that you see is what you saw in your youth, the prospect of Eton an unnoticed backdrop of an adolescent boy, the antique towers that crown the watery glade, as Gray said, then you see something else. Like breathing air, English air. What do you see?
I see a river, I said, smiling at him.
Tell me what you wanted to talk about.
How do you know I’ve got something to talk about?
When you don’t have something to talk about, you don’t avoid talking.
He gave me a wink and took a sip of his beer.
I began by telling him what had been happening in the world of finance, giving him some detail, most of which I had the impression he knew because he had been following the news carefully, not for his own sake, I think, since he’d never paid much attention to finance before, but because of what the turmoil might mean for me and Meena. When I got to telling him that I thought the firm was about to let me go and would possibly even try to hang me out to dry, my father did not make reassuring sounds, did not contradict me with the groundless optimism of someone reassuring himself as much as another—that was never his way. He simply listened. (Some years ago, he explained to me his belief that that kind of hollow consolation was disrespectful because it presumed that the person being consoled wouldn’t see or care about the absence of reason. The thing to do first and foremost, he believed, was not to talk but to listen, and listening, like anything difficult, is easier said than done.) I talked for some time, finding more and more details to tell him. Even things I hadn’t consciously thought much about I brought up, understanding then how much they had actually been weighing on my mind. I set out my analysis and explained that I’d spoken to a couple of friends also in finance, and they couldn’t fault my reasoning. Congressional subcommittees, now sprouting like weeds, were identifying witnesses to call to hearings. They know two things. Of all the people closest to structured products, mortgages, and securitization in my firm, I was the most senior; and my firm would cut me loose faster than I could say scapegoat. If the firm saw even the slightest benefit for them in front of Congress, they’d pin everything on me. That’s the point of blaming a rogue trader: It’s the trader that’s rogue, not the bank’s checks and balances, not the bank.
At a certain point I stopped talking. I felt I’d poured out everything, everything I’d been holding in, even when I didn’t know I’d been doing so.
What does Meena think? he asked me.
My reply did not come immediately. I had not mentioned Meena once. My omission must have been as obvious to him as it now was to me.
As you must know, things aren’t going well there either.
I’m sorry to hear that. We’d love to see her.
She spends a lot of time away right now.
How is your health?
Fine.
That’s good. I’m glad. So at least you have your health.
He smiled. Dear me, don’t lose your sense of humor!
I forced a grin.
I’d appreciate any advice, I said.
Eat more vegetables. And whole grains.
My father, who had been sitting opposite me, got up and took the chair beside me, at a right angle to mine. It was how my mother liked to sit. There’s something less confrontational this way, she’d said. This way you see the person’s good side.
The view is different from here, he said, taking another sip of his beer as he looked out over the river. He took his time, collecting his thoughts, it seemed, before resuming.
There is a funny little story about Charles II and the Royal Society, said my father. The king was regarded as rather pompous and obscurantist, an idiot, really, and one not to be duly impressed by members of the esteemed society. At a dinner to mark the founding of the society, he put a question to them that quite confounded the great scientists. Why, he asked, does a dead fish weigh more than a live one? Despite their great and learned efforts, the members failed to arrive at a compelling answer, when finally someone pointed out that they did not in fact have different weights. Perhaps the king was a buffoon, or perhaps he wasn’t quite so dumb after all.
It is possible, continued my father, that we accept premises more readily than we should. False dichotomies are the stock of politicians only because too many are ready to accept the premises as given. Anyhow, that is by the by. Before I make good the point I’m groping to make, which really, after all, is not an especially significant one, let me say that I don’t presume your woes can be resolved by recourse to reason alone or even with reason in the mix at all. Everyone knows in the intimacy of his self, if not his reason, that when the soul is under siege reason is not up to the fight.
What’s going on?
What do you mean?
Why do you sound like a classics professor?
A bit stuffy?
You said it, not me.
Maybe I’m not sure of what I’m saying. I don’t think I’m unsure. Am I unsure?
He chuckled.
Philosophers talk about solving problems, con
tinued my father, but also about dissolving them. Wittgenstein, for example. Sometimes, when properly regarded, the problem in front of us is understood to be no problem at all, or at least not of the kind we believe it to be. We tend to favor the status quo. It seems to me we see every adverse situation as a challenge to restore ourselves to the status quo ante. You know the refrain: I just want to go back to how things were. This seems shortsighted. How things were might well have led you to the way things have woefully become.
Are you doing any theoretical physics these days, or are you just reading cognitive science papers?
As physics goes, I’m past my prime. Besides, one must play to avoid Jack’s fate. If I were setting out on the academic road today, I’d go into cognitive science. Don’t get me wrong. I love theoretical physics, but right now, meaning at this point in human history, we’ve finally got to working on the brain using those precious scientific methods that we’ve been using to work on everything but, and cognitive science is where … is where it’s at, as you Americans would say. You laugh, and maybe I set too much store in science, but I do believe cognitive science really is where it’s at. Granted, some of these chaps claim more for their science than their science has earned. But it’s still early days, and in the excitement of finding something new, one has to expect a degree of overreaching. Look at the Internet: Not so long ago everyone thought it was the beginning of a new kind of economy, but now one can quite legitimately doubt this is true. Nevertheless, the Internet has brought about great changes. If we give the new cognitive sciences a little time, it seems very likely, to me, at any rate, that their ideas will also translate into applications in daily life. There’s a cognitive scientist here in Oxford who told me that he and his wife now spend much less money on things and prefer to spend on experiences, such as interesting holidays, because, he says, research has established that it’s the experiences that have an enduring effect. Material things appear to be swallowed up by the hedonic beast in us and all too soon lose whatever power they had—or we believed they had—to give us pleasure. He and his wife have changed the way they live.
In the Light of What We Know: A Novel Page 30
