In 2001, I audited the valuation on a bunch of mortgage-backed securities representing about $3B of loans.1
This calculation was done, I kid you not, in an Excel file made up by this one guy.
I was a already a weirdo amongst my peers, so when my co-workers warned me against Spreadsheet Guy, saying shit like “he’s really smart, but he’s weird. He gets food on his shirt at lunch. Just be careful with this guy” etc. I thought it might be someone I would like more than my co workers.2
I knew that the weirdest, most fucked up manager in the building full of accountants had to exist within a very narrow range of human typology so was only slightly taken aback when this overweight guy with food on his shirt shouted me in with no formality, “So you’re the new auditor, huh, OK, here’s the file, come back when you understand it and then we’ll talk".” Out the door.
Let me point out how bizarre it was that it was done on an Excel spreadsheet by some guy. In a too-big-to-fail bank, the air is crackling with the sound of proprietary software.
It took me about three days to actually figure out how the whole thing worked and tie it back and forward to records. It was a shit ton of cash flows representing all sorts of weird untestable categories.
To explain briefly: Each individual loan can be broken into parts representing future cash flows. Principal, interest, servicing fees, and then each of these broken over time periods, so first five years, second, etc.
That’s one loan. Now add many thousands of loans, sort them along some axis, say, risk of default. Then break all of them them into their parts.
Then, you mix all of it together in a black box (where the math guys made their millions) and stack them into new sets of future cash flows.
Got it? Good, because that’s what it took me many days of applying all of my previous knowledge to mostly kinda understand.
So there were pages and pages of cash flows, and they all totaled up to Tab 1, Cell B2 next to an account number. This is the value that would appear in SEC filings, and if anything was off about it, it could be traceable to me.
Ha ha ha, no. If you work it in that world, you know how accountability works.3
Below that final valuation were about 30 variables. And it took me just a few minutes playing around to see how sensitive these things were. Prepayment rates >10 years, prepayments < 10 years, various interest rate %, various variable interest rate %, average six month LIBOR, average change in LIBOR rate. etc etc. A few hundred million here and there. OK
I went back to Spreadsheet Guy, and this time, I broke every rule I had spent years hammering into myself, walked right in and plopped myself down in a chair, and said. OK. I mostly understand what you did, but the model is sensitive?
“Yeah, well do what you gotta do, but for each one they’ll tell you that it’s fine.” He was at least smiling agreeably at me rather than dismissively.
And yes, that was my job. For each variable, there was a manager somewhere whose department was in charge of that number. (Yes, in large-ass banks the whole place is one gigantic accounting department such that there can be a whole team of people responsible for one line on the trial balance of accounts—and still the suicide rate is almost zero.)
The question and answer I had for each manager was essentially, “If this worked last year, it should work again this year, right?” “Yes. Exactly.”
That was all that mattered, but we were all very interested in how we spent our days, and I was like a friendly reporter pretending to dig around, and most people are happy talking about their jobs. So I got the full explanation and met some of the women in the trenches (I can tell you about gender roles in accounting offices circa 2001 if you need a history, the prevalence of the matriarchal head of accounts payable applying to businesses up to a certain size, but non-existent in too-big organizations)
I really did learn a lot at each spot, but I came back to Spreadsheet Guy, and I said sarcastically, “so do you see anything in the external environment that has changed in the last year?” He laughed, and out of all the people I dealt with in that quasi-colleague way, he seemed to me the most honest. “You got it.”
And so I went back and wrote it all up beautifully, which means in accounting jargon, exactly enough to seem to make perfect sense, to draw you in with its sense of clarity and honesty, but most importantly to also say nothing. There really is a skill element to this, and I had it.
Bim, bam, boom, and this large pile of real estate investment conduit securities had passed the test of its private auditors.
It worked last year, so it must work this year is a perfectly good rule until it isn’t.
Even though I knew, and Spreadsheet Guy knew, that we were all just there to be bodies in place to absorb the pressure if it all blew up, I honestly didn’t even think about asking the one question, “what if housing prices collapse?”
At the time, I thought it was more likely that a data entry mistake could throw shit off and no one would even know what happened. But what if the whole thing is a lie? That was my general assumption, that everything was a lie, but it was way too vague to suggest the housing bubble thing.
Now let me be fair. The bank I was auditing was too big to completely fail, but six years later it mostly failed and was wrapped up in a larger deal under a larger bank. It kept its valuable brand name though as a subsidiary.
It also didn’t play a role in the frauds that were later exposed. These mortgages were for the very wealthy. The only reason the mortgage bank existed was to service the existing big spenders on the trading side. Very rich people borrowing large sums for large amounts. I also walked up and down the aisles of the loan files and had to read through a sample of them. Families with death certificates in the file (as things passed by generations, and where I learned how rich people seem to live a long time) and also sports celebrities, a name I would vaguely recognize and shout over at my cohorts, hey you know this name? Hahah yeah. Well he’s got a 12m in Miami. And there was never a chance of gossip being carried out of the room. Not because we were sworn to to non-disclosure, although we were, but because it was boring.
Also know that our job was not the same thing as the credit rating agencies. They rated the value of those securities standing alone as a thing for sale. That’s where more of the blame lie. I audited them as a line on the balance sheet of this bank, and my test was whether they could make a material difference there, and as long as nothing changed, they were fine.
Six years later when the world economy almost crashed into nothing over this shit, and the first bits and pieces of news started coming out and people were wondering, “How could this possibly happen?” I at least had a good idea about how it could possibly happen.
We didn’t know them as “mortgage backed securities”. That would only become the common term for them some seven or eight years later. To us at the time they were “real-estate investment conduits”.
Both more than my coworkers would like him or I would like my coworkers.
I found my niche in the banking world because I had been an English teacher and could describe complicated financial shit in clear language and then redescribe it to the file so that anyone who looked at it glazed past it. We knew we only had jobs to spread accountability.
So I have been right all along. The numbers guys are there to find a way to keep the tax people busy and bored out of their minds so they go away and let the pirates go back to their plundering.
I highly recommend the book "Debt: The First 5000 Years" by David Graeber. Made me understand why I have never understood anything about finance etc.
Dude this was very good I wish you started writing again I think you have an interesting take on things from a unique perspective (that doesn't usually write or is normally very dull no offense to your ilk).