Tuesday June 16, 2009
Breaking the Laws of Probability
“Until the spring of 1978, when Salomon Brothers formed Wall Street’s first mortgage security department, the term borrower referred to large corporations and to federal, state, and local governments. It did not include homeowners. A Salomon Brothers partner named Robert Dall thought this strange...
”The problem [with the inability to see big business in home mortgages] was more fundamental than a disdain for Middle America. Mortgages were not tradable pieces of paper; they were not bonds. They were loans made by savings banks that were never supposed to leave the saving banks. A single home mortgage was a messy investment for Wall Street, which was used to dealing in bigger numbers. No trader or investor wanted to poke around suburbs to find out whether the homeowner to whom he had just lent money was creditworthy. For the home mortgage to become a bond, it had to be depersonalized.
“At the very least, a mortgage had to be pooled with other mortgages of other homeowners. Traders and investors would trust statistics and buy into a pool of several thousand mortgage loans made by a savings and loan, of which, by the laws of probability, only a small fraction should default...”
— from Michael Lewis’ “Liar’s Poker,” pp. 83-85