Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

Not satisfied that this should remain a public monopoly, Lewis Ranieri and his team at hard-driving investment bank Salomon Brothers put together the first private securitization of mortgages for Bank of America in 1977.20 But it took a brave investor to buy a package of fixed interest mortgages at that moment. It was in the aftermath of the interest rate shock of the early 1980s that securitization came to the fore. The mortgage lender stranded with portfolios of low-interest mortgages turned to the market to recover whatever value they would yield by securitizing them and selling them off. From the 1980s, the GSEs, working with the investment banks, created not just pass-through mortgage-backed securities (MBS) but so-called collateralized mortgage obligations (CMO) that allowed a pool of MBS to be tranched into separate risk tiers profiles. This was the origin of so-called structured finance. Those with the top-tier first claim on the revenue stream had low risk of both default and early repayment. Tranches lower down the pecking order could be sold off to investors looking for riskier investments. The top-tier senior tranches would pay out except in the highly unlikely event of massive, collective default. Those top tranches, even if they were based on a pool of high-yielding, high-risk debt, could be designated as low risk, and the ratings agencies obliged by classifying them as AAA (80 percent of most securitizations were designated as senior and given the AAA rating).