The next morning Barton took a cab to Wall Street. It was disappointing. Apart from admiring the New York Stock Exchange, its magnificent Corinthian columns and the sculpted figures that decorated its marble pediment; Integrity Protecting the Works of Man according to his guidebook, watched over benignly by a bronze statue of George Washington standing before the Federal Hall, there was little to else to do. As for the famous charging bull he finally discovered it a couple of blocks away from the Street in a park.
Barton felt disappointed and annoyed when he discovered the Stock Exchange was closed to non-professional visitors. After several fruitless enquiries he returned to the hotel and explained his predicament to the concierge who encouraged by a hefty tip promised to help. It would take a few calls he explained suggesting Barton in the meantime take lunch in the coffee shop. An hour later as he settled the check the concierge appeared and after whispering a discrete word slipped him an envelope containing an invitation. Then, noting Barton’s casual wear, politely informed him formal business wear was de rigueur.
Barton was invited to celebrate the listing of a new name on the big board. The VIP cocktail was to take place on the NYSE trading floor that same afternoon at the end of the day’s session.
The NYSE, the largest stock exchange in the world, was the ultimate symbol of American capitalism, where ringing the bell on the platform above the trading floor had long been a public relations must for top executives, visiting dignitaries and celebrities, with a long to be cherished souvenir photo. Disappointingly the experience was not only like that he had often watched on Bloomberg TV, that was of course to be expected, but the excitement seemed a little forced. It was not a good time for Wall Street or its traders considering the recent performance of its key index: the Dow Jones.
The crisis had originated on Wall Street, a point Barton did not miss, which went a long way to explaining why he found himself in New York that summer day. It was there on the NYSE the mortgages of almost six million, not very credit worthy American homeowners, were traded in the form of CDOs. Homeowners who had borrowed one hundred percent of the value of their house at the peak of the housing bubble, now known to the world as sub-prime borrowers.
Lending banks had not been especially concerned about the risk of default, since sub-prime mortgages had been bundled together and converted into bonds called MBSs by investment banks, these bundles were then sliced into tranches called CDOs. Certain tranches bore higher risks, carrying higher rates of interest. Others, about eighty percent, were classed as medium or low risk investment grade bonds and naturally bore a lower interest rate.
Investment banks earned money by selling CDOs to financial institutions with the riskier tranches were sold to hedge funds. During the course of the boom years, when it seemed the value of property would go on rising forever, risk was considered low, and the value of CDOs rose. Few investors imagined borrowers would default. Thus it did not seem unreasonable for hedge fund managers to use these bonds as collateral to borrow money.
The market thrived; an abundance of cheap money was available with the promise of huge profits for all as the value of CDOs rose. Banks put more and more money at the disposal of hedge funds to buy more and more CDOs in the belief they were covered if hedge funds got into difficulty. It provoked a seemingly unstoppable chain reaction with hedge funds buying more CDOs from investment banks, who in turn bought more mortgage backed securities from mortgage lenders, who loaned more money to sub-prime borrowers, who bought more homes, forcing the value of property higher and higher.
Once the bubble started to deflate banks wanted the money they had loaned to the hedge funds back. The trouble was the hedge funds no longer had it. All their money had been invested in CDOs. The only way out was to sell the bonds held in collateral. Therein lay the catch; they were unsaleable as buyers, if there were any, had no way of estimating their value. The banks were caught in a trap and the question of their capacity to weather the storm sent a series of violent tremors through the market.
Alarmed, the banks pointed to their insurers and the cover they had contracted against the default of CDOs. Amongst the insurers was the giant AIG that had underwritten the risk with credit default swaps, or CDSs, which were insurance policies designed to protect the banks.