Seth Goldstein

SG: Go back 30 years, and it’s 1976.  What was the mortgage market like prior to securitization?

LR: We made a lot of money then.  In many ways it looks like the lead generation business in that there were no simple definitions for a basic mortgage.

SG: What was the perception of a mortgage back then?

LR: Well, there wasn’t a mortgage-back security then.  The first mortgage-backed security (MBS) was created in 1979 and it was a total failure.  It’s now the biggest market in the world but it didn’t start so well.  The MBS was created for Bank of America at the end of 1978 / early 1979 after seven years worth of work and it was a AAA-rated security and the deal was a total bomb.

SG: And what did you have to do with it?

LR:  Eat it. The mortgage security market grew up over a long period of time and required a safety net of regulations and customs to support them.  The mortgage security business existed inside my head.  It was no such thing and we were fortunate enough to make it happen in a few years.

SG: How did you see a mortgage differently than other people perceive them?

LR:  The system that came out of WWII was a specialized system of lends.  So, banks because their liabilities were short-term through money markets, made short-term loans.  They’d lend to corporations on a floating rate or fixed basis.  Insurance companies, because they made life policies, which were very long and therefore were long-term liability, made the infrastructural loans.  They lent to corporations and they’d build highways because they had long-term liabilities.  Thrifts were chartered for a special purpose, to support the soldiers coming home and the need for new family formation housings. Thrifts were specialized housing lenders.  So you would go to your friendly neighborhood thrift and get a mortgage and he’d put it in the portfolio and never be seen again.  Mortgage was not an asset you could trade because everybody had his own underwriting criteria, even his own documents. The first problem with this thrift was to figure out how to take this amorphous mass of things and turn it into a vehicle that could be traded; which is again a terrific analogy to the lead generation industry today.  The leads business, whether you talk about mortgage leads or credit card leads or car leads, is the same sort amorphous mass of things.  They are not designed to be traded, but rather to be moved in a first mover way – I sell it to a guy who then tries to originate the loan, he puts it away and end of story.  But you don’t hear anybody trying to create a futures market on leads or short a lead or write an option on a lead or guarantee a conversion price or all kinds of things that more normal markets would do.  They’ll come.  All of those things will come.  That’s our vision for RootExchange.

SG: How did you force standardization?

LR:  Money: the same way the leads business will do it.  If you look at the pricing of a lead versus the value of the underlying asset and assume a reasonable conversion rate, they are much more attractive as an origination channel than wholesale or retail or builder or realtor or any one of the normal mortgage channels.  The real issue is the conversion rate.  And so a mortgage company could pay a tremendous amount more for a lead if he had any confidence in the conversion rate,  because of the disparity between the value of the servicing and what people pay for leads.  If the conversion rate is 1-2%, just do the math yourself.  If the two of them convert, and you’re converting as you would now in refi land into 7/1 servicing, then it’s worth a point and a half and you’d pay a lot for leads. 

SG: More than 30 or 40 bucks.

LR: Yes.  Well, think about, it’s simple math.  A 7/1 is worth 1.5%.  Think about 1.5% and then attach whatever conversion rate you want and see what you can pay for leads.  I mean, that really should be the math because of what you’re converting into.  Right now there are very few traditional 1 year ARMs, but if you want to use those as a California ARM, that servicing is worth, actually right now it’s close to three-fourths because there’s so little of it but normally it’s worth five-eighths.  So work backwards.  You can go to a screen.  You can go to Bloomberg and look at the value of the servicing.  People buy and sell servicing all day so you can tell what the end value of whatever you’re talking about is by simply looking at the servicing and then if you want to make a simple algorithm, just times it by the conversion rate. 

SG: So does price discovery and quality discovery help move the mortgage leads market into and through securitization?

LR: Yeah, markets are like humans. They like the way things are done, they’re used to it.  So you need to pull them off that inertia in some way and it’s usually the old fashioned American way.  It’s called money.  You generally get people to pay attention because you’re willing to pay for it.  If the market can’t pay you, you’ll do it the way you’ve been doing it for 20 years because it’s comfortable and you know what the risks are.  We used to say:  “We know who the pioneers are.  They’re easy to identify.  They’re the guys in the road with the arrows in their back.”  So unless I give you a financial incentive to go and try to do it differently, you don’t want to volunteer to be one of the guys in the road with the arrows in your back. 

(thread 3 of RootExchange/s speaker series: #2 June 13, 2006 with Seth Goldstein interviewing Lew Ranieri at NY office of Root Markets)

SG: Will the housing bubble burst?

LR:  I do not believe almost anywhere in the country this supply demand situation is so out of whack that you’re going to see a traditional bust.  Mortgage lines rarely actually bust.  In fact, I think that in the entire history of mortgages post WWII, we’ve only actually had five busts.  When mortgage markets reach a problem, they generically stop going up and stay the same for 5 or 6 years. That’s how they work themselves out.  They rarely drop out of bed.  In the five instances where mortgage markets have dropped out of bed, it was because of extraordinary circumstances.  Texas during the 80’s when the oil patch blew up and people left Houston hand over fist so the reason housing went down so much is not that interest rates were too high or the price of the house was too high, there was just nobody to sell them to.  I mean, there were more people trying to sell houses than there was anybody to sell them to.  That was the same situation in Southern California in the early 90’s when the inland empire looked like it was about to become Atlantis.  It wasn’t a matter of rates; it wasn’t a matter of anything other than just overcapacity and lack of buyers at any price.  So, housing’s slowing down, but I don’t expect it to be a disaster.  I think where there may very well be problems, significantly in the sub-prime area.  Sub-prime is a creature of the last 5 or 6 years.  It historically has never really existed so it did not exist through a cycle.  This will be the first cycle, and the combination of high loan values and somewhat aggressive underwriting makes those loans susceptible to even a marginal decline in housing values. 

(thread 2 of RootExchange/s speaker series: #2 June 13, 2006 with Seth Goldstein interviewing Lew Ranieri at NY office of Root Markets)