the “markets as politics” argument that firms in a crisis will try and stabilize their positions (Fligstein, 1996). Reporting on discussions at the June 2004 American Securitization Forum in Las Vegas, the trade journal Asset Securitization Report noted that limited mortgage supply remained the “hot topic”, but also noted the generally “harmonious agreement” amongst analysts from the major banks that the largely untapped nonconventional market segments could offer a solution to the supply crunch (Asset Securitization Review, p.10, June 14, 2004). An editorial in National Mortgage News from March 2005 also highlighted the compensatory logic driving the growth of the nonconventional markets: “The nonconventional market is booming this year. Taking up the slack (as it did last year) for the big drop off in prime lending, and keeping record numbers of people employed in the mortgage industry” (March 2005). Countrywide Financial was one of the most successful beneficiaries of this shift, and they became a model that other firms emulated in order to profit from nonconventional lending. Their annual report boasted: “Countrywide’s well balanced business model continues to produce strong operational results amidst a transitional environment. Compared to a year ago, the total mortgage origination market is smaller as a result of lower refinance volume. This impact has been mitigated by Countrywide’s dramatic growth in purchase funding and record volumes of adjustable rate, home equity, and nonconventional loans”. (2005) The rapidity with which the main players reoriented toward nonconventional lending and securitization after 2003 is evident in figure 3. By 2005, the formerly niche nonconventional lending and securitization sectors had been rapidly transformed into a core business for the largest financial institutions in the country. In 2001 the largest conventional originator (Citibank) did 91% of its origination business in the conventional market, and only 9% in the non-prime market. In contrast, by 2005 the largest conventional originator (Countrywide) was doing less
riskier nature of the mortgages allowed the issuing and underwriting firms to charge a higher percentage fee for the more elaborate financial engineering which these non-agency-backed MBS required. The resulting MBS also paid out higher returns as riskier loans had higher interest rates attached to them. Given the continuously rising price of housing, the credit rating agencies’ models kept finding that these loans could be packaged into low-risk securities. Attaining AAA ratings for nonconventional MBS made them appear to be one of the best investments around (for a thoughtful sociological discussion of why ratings work to produce confidence in financial markets, see Carruthers and Stinchcombe, 1999). After 2003, the large banks invaded nonconventional segments aggressively, and, along with a few of the larger new mortgage firms like Countrywide, applied the vertically integrated business model, and grew these formerly marginal niche segments into a multi-trillion dollar a year business. Vertical Integration Explored The expansion of the nonconventional market inadvertently promoted the final integration of the industrial mass-production model. Investment banks that had eschewed the messy and unglamorous world of retail lending began acquiring nonconventional originators aggressively after 2003 in a bid to feed their securitization machines (McGarity 2006; Levine 2007). Investment banks were also the leaders in the new CDO products, and integrating backwards into origination assured them of additional material for these financial products. By 2005 Lehman Brothers was self-originating almost two-thirds of the mortgages contained in its $133 billion of MBS/CDO issues (Currie 2007: 24). Meanwhile, the larger commercial bank holding companies who already had nonconventional mortgage origination operations as part of
explained the need for backward integration because the industrial model was viable only so long as a firm could secure a ready supply of inputs: "Wall Street firms require a major investment to maintain a successful securitization platform in the areas of research, sales and trading. To optimize this investment requires a steady source of raw materials--mortgages--which can be packaged into securities to support the capital-markets activities" (quoted in McGarity 2006). Anthony Tufariello, head of the Morgan Stanley’s Securitized Products Group, voiced a similar logic in announcing Morgan Stanley’s purchase of mortgage originator Saxon Capital: “The addition of Saxon to Morgan Stanley’s global mortgage franchise will help us to capture the full economic value inherent in this business. This acquisition facilitates our goal of achieving vertical integration in the residential mortgage business, with ownership and control of the entire value chain, from origination to capital markets execution to active risk management” (Morgan Stanley, 2006) According to Jeff Verschleiser, then co-head of mortgage trading at Bear Stearns: “The key point to remember is that it’s not just the buying that counts. It’s the integration. Simply buying a mortgage originator and having it operate in a stand-alone capacity without leveraging the infrastructure of your institution is not something I would consider vertical integration.” (quoted in Currie 2007). Of course, this integration was never entirely complete throughout the industry. Some medium-sized mortgage originators remained independent and continued to sell mortgages to issuers in an originate-to-distribute model. Many others integrated forward into nonconventional MBS issuance, but hired investment banks to underwrite the deals. A few underwriters like Goldman Sachs never integrated backwards into origination. Nonetheless, integration was the dominant logic. By 2006, three quarters of all subprime mortgage originations were conducted by firms who also issued MBS (authors’ calculation from Inside Mortgage Data). CDO and the Completion of Vertical Integration