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THE MORTGAGE MACHINE
million, went to more than institutional investors around the world, spread-
ing the risk globally. These triple-A tranches represented of the deal. Among
the buyers were foreign banks and funds in China, Italy, France, and Germany; the
Federal Home Loan Bank of Chicago; the Kentucky Retirement Systems; a hospital;
and JP Morgan, which purchased part of the tranche using cash from its securities-
lending operation. (In other words, JP Morgan lent securities held by its clients to
other financial institutions in exchange for cash collateral, and then put that cash to
work investing in this deal. Securities lending was a large, but ultimately unstable,
source of cash that flowed into this market.)
The middle, mezzanine tranches in this deal constituted about of the total
value of the security. If losses rose above to (by design the threshold would in-
crease over time), investors in the residual tranches would be wiped out, and the
mezzanine investors would start to lose money. Creators of collateralized debt obliga-
tions, or CDOs—discussed in the next chapter—bought most of the mezzanine
tranches rated below triple-A and nearly all those rated below AA. Only a few of the
highest-rated mezzanine tranches were not put into CDOs. For example, Cheyne Fi-
nance Limited purchased million of the top mezzanine tranche. Cheyne—a struc-
tured investment vehicle (SIV)—would be one of the first casualties of the crisis,
sparking panic during the summer of . Parvest ABS Euribor, which purchased
million of the second mezzanine tranche, would be one of the BNP Paribas
funds which helped ignite the financial crisis that summer.
Typically, investors seeking high returns, such as hedge funds, would buy the eq-
uity tranches of mortgage-backed securities; they would be the first to lose if there
were problems. These investors anticipated returns of , , or even . Citi-
group retained part of the residual or “first-loss” tranches, sharing the rest with Cap-
mark Financial Group.
“Compensated very well”
The business of structuring, selling, and distributing this deal, and the thousands like
it, was lucrative for the banks. The mortgage originators profited when they sold
loans for securitization. Some of this profit flowed down to employees—particularly
those generating mortgage volume.
Part of the million premium received by New Century for the deal we ana-
lyzed went to pay the many employees who participated. “The originators, the loan
officers, account executives, basically the salespeople [who] were the reason our loans
came in . . . were compensated very well,” New Century’s Patricia Lindsay told the
FCIC. And volume mattered more than quality. She noted, “Wall Street was very
hungry for our product. We had our loans sold three months in advance, before they
were even made at one point.”
Similar incentives were at work at Long Beach Mortgage, the subprime division of
Washington Mutual, which organized its Incentive Plan by volume. As WaMu
showed in a plan, “Home Loans Product Strategy,” the goals were also product-
specific: to drive “growth in higher margin products (Option ARM, Alt A, Home Equity,
