The Rise of Countrywide Financial

Countrywide Financial collapsed in the fall of 2008. Many media observers came to see Countrywide as a central actor in causing the financial crisis (see, for example, Huffington Post, 2014; Fortune, 2010; Time, 2010; McLean and Noc- era, 2010).

The bitter and abrupt demise of Countrywide Financial makes it hard to re­member that Countrywide Financial was the financial firm that pioneered a suc­cessful strategy in the brave new world of mortgage securitization that emerged in the 1980s when the savings and loan banks collapsed. Countrywide Financial, which was founded by David Loeb and Angelo Mozilo as a two-person opera­tion in 1969, had by 2001 come to be the dominant firm in the US mortgage mar­ket. Their company had a top five market share in almost every market segment including origination, securitization, and servicing and in both the convention­al and unconventional markets. Circa 2001, Loeb and Mozilo were viewed as pathbreaking entrepreneurs from within the industry, and their company was a case study for business schools (see, for example, Kurland and Flamholtz, 2005). Countrywide Financial, by being a presence in all of the main market segments of the mortgage securitization industry, presented a model of the vertically inte­grated financial corporation. My purpose here is to try to understand how Loeb and Mozilo conceived of their business strategy and how this eventually revolu­tionized the mortgage industry.

Their firm was consistently one of the most entrepreneurial of all the firms in the industry. Their analysis of market conditions in the mortgage industry and their position within that industry brought them to create new products and seek out new opportunities. While not all of these innovations turned out to be successful, they took risks and entered new businesses in a fearless fashion. They did so because they saw opportunity where others did not. Frequently, they were right. They, of course, also made mistakes. They understood how the existence of the GSEs could help them build a bigger firm, and they carved out market space for themselves. One of the most important things they recognized were market spaces where customers were potentially underserved. Their constant search for new opportunities brought them to diversify their customer base and, as a result, their product base.

Loeb and Mozilo never intended to build a vertically integrated mortgage bank involved in both conventional and unconventional mortgages. But they ended up doing so, because the opportunities to grow and stabilize the bank were pushed by entering into multiple market segments during the 1980s and 1990s. Instead, Mozilos goal very early on for the firm was to create a full-service provider of financial services. For example, in November 1993, Countrywide be­gan to try to sell insurance, mutual funds, and home equity lines to its mortgage customers (National Mortgage News, 1993a: 5). In 2002, they changed the name of the company to Countrywide Financial from Countrywide Credit to signify this strategic decision. But even with this aspiration, the core of the firm's busi­ness was the market for mortgage origination and securitization until its demise.

In the world of 1969, the savings and loan model of mortgage origination was still dominant. Loeb and Mozilo called their company Countrywide Credit be­cause they wanted to build a national mortgage bank. It is useful to understand the business model they employed.

The emergence of the GSEs in the 1970s and early 1980s provided a large and stable customer for newly originated conventional mortgages. Loeb and Mozilo recognized the opportunity that the existence of the GSEs presented early on. They built their business over this period as both an originator and an aggregator of conventional mortgages destined to be made into MBSs for the GSEs. To do this, Countrywide needed to obey the rules that the GSEs had laid down about obtaining the loans. That meant that they could only purchase conventional mortgages that met the GSEs' criteria. These rules worked to Countrywide's fa­vor as they quickly gained a reputation as a company that originated only “good” mortgages. Countrywide's rise was facilitated by hitching themselves to the ris­ing GSEs.

Loeb and Mozilo understood that to attract customers, they needed to offer loans that had attractive interest rates, lower fees, and quick approval and closing dates.

From the 1970s through the 1990s, Countrywide pioneered the use of com­puter technology to speed the process of application and approval along. By the mid-1980s, Countrywide would guarantee an interest rate and a closing date within thirty to ninety days of an application. In 1990, the company introduced its own origination service, which significantly reduced origination and process­ing costs while accelerating funding time to less than thirty days on convention­al loans. They were able to do this because of computerization that recorded a potential mortgagor's information once and was then able to copy the informa­tion to other files automatically. In 1991, Countrywide made another advance by creating a new system that expedited loan processing by using an algorithm to decide whether a mortgage was approved automatically. The system was able to approve a routine application in less than a minute. The 15 percent of mortgages that were more complex were then sent to underwriters, who considered them more closely.

Loeb and Mozilo displayed an uncanny sense of where interest rates were headed. For example, during the high-interest-rate period of the late 1970s and early 1980s, Countrywide sold off its rights to service mortgages in order to raise capital. They helped promote the adjustable-rate mortgage as way to make home buying more affordable. By the mid-1980s, it was already becoming apparent that interest rates were going to fall. As the market for refinancing mortgages took off, Countrywide was in a good position to take advantage. By the end of the 1980s, Countrywide could see that interest rates were going up, suggesting that the boom in refinancing was going to end. To deal with this downturn in their origination business, they decided to invest heavily in mortgage servicing, going so far as to set up a division to purchase servicing rights, and they helped to create a market in those rights. They increased their mortgages serviced from about $1 billion in 1987 to $100 billion by 1994. Mozilo described this tactic as a “hedge” for when times went bad. He argued that when interest rates were low, the origination business was great. But when interest rates rose, that mar­ket dried up (National Mortgage News, 1994b). By taking on servicing in such a large-scale fashion, Countrywide diversified its business and entered a business that would be stable no matter what was going on in the housing market.

The explosive growth period for the company came during the collapse of the savings and loan industry. This was the opportunity that took Countrywide from a medium-sized mortgage bank to a national leader in the industry. From 1989 to 1993, the total number of loans increased from 39,634 to 234,407. The number of conventional mortgages that the company originated increased from 19,304 in 1989 to 192,385 in 1993, a tenfold increase in four years (Countrywide Financial, 1993). Countrywide was among the largest mortgage originators in the country.

By 1993, Countrywide was engaged in a wide variety of activities and could be already described as vertically integrated. The firm originated mortgages, turned them into MBSs, sold them, held some on their own accounts, and serviced loans. Every year, publicly held corporations have to submit a document to the

Securities and Exchange Commission that is called a 10-K. These documents outline how the company conceives of its products, challenges, and prospects. They make an excellent source of information about the firm. The 1993 10-K described the company in the following terms:

Countrywide Credit Industries, Inc. (the “Company”) is a holding com­pany which through its principal subsidiary Countrywide Funding Cor­poration (“CFC”) is engaged in primarily the mortgage banking business and as such originates, purchases, sells and services mortgage loans. The Company, through its other wholly owned subsidiaries offers products and services complementary to its mortgage banking business. A subsidi­ary makes and sells mortgage backed securities. In addition, another sub­sidiary acts as agent for homeowner’s insurance in connection with CFC's mortgage banking operations. Another subsidiary receives fee income for managing the investments and operations of Countrywide Mortgage In­vestments including a real estate investment trust and the investment in individual mortgages and mortgage backed securities. The Company also acts to broker servicing of mortgages and runs an operation to service its own mortgages. (1993: 2)

The 10-K from 1993 describes the company’s business model is the follow­ing way:

The principal sources of revenue from the Company’s mortgage banking business are (i) loan origination fees; (ii) gains from the sale of loans; (iii) interest earned on mortgage loans during the period they are held by the Company pending sale; and (iv) loan servicing fees.... The Company, similar to other mortgage bankers, customarily sells all loans it originates or purchases as part of its mortgage banking operations. The Company packages substantially all of its FHA-insured and VA-guaranteed first mortgage loans into pools of loans. It sells these pools in the form of mod­ified mortgage-backed securities guaranteed by the Government National Mortgage Association to national or regional brokers. Conforming con­ventional loans may be pooled by the Company and exchanged for secu­rities guaranteed by FNMA or FHLMC, which securities are then sold to national or regional broker dealers. (1993: 3-4).

The product divisions of Countrywide acted relatively autonomously of one another. This reflects the fact that they had come into existence at different his­torical moments to be participants in particular markets. For example, the re­tail division ran the storefronts the company had around the country, while the wholesale division purchased loans from other originators. Countrywide also ran a consumer division that serviced mortgages. This division tried to sell refi­nancing to already existing mortgagors and other services such as homeowner's insurance. When Countrywide decided to enter a new market or produce a new product, it would do so by setting up a new product division.

During the 1990s, Countrywide worked to create several new markets for mortgages, what we would now call nonconventional mortgages. I have already noted that Countrywide began to make what came to be called jumbo loans. The FHA has a limit on how much money mortgagors can borrow that is adjusted over time for inflation. Because prices in California and parts of the East Coast had risen so fast, many potential home buyers fund that while they could sup­port a larger mortgage, they lacked a large enough down payment. This caused mortgage originators to create jumbo mortgages, which frequently came with additional fees and higher interest rates. Countrywide also pioneered home eq­uity loans. These are loans that allow mortgagors to borrow money against the equity in their homes.

In 1993, Countrywide opened a special facility to originate and securitize nonconventional mortgages (National Mortgage News, 1993b: 1). This facility is called a “conduit” in the jargon of the industry. They introduced several new mortgage loan products. They created a loan with a 95 percent financing and another with a 100 percent financing, which they began to package into MBSs. In that same year, they also began to originate and securitize jumbo mortgages (National Mortgage News, 1993b: 1). Countrywide, which was one of the firms that pioneered home equity loans, began securitizing those loans in 1994 (Asset Securitization Report, 1994: 1).

Countrywide continued to invest in computer technology and to gain more control over the loan process. In March 1994, they began to offer loan applica­tions online (National Mortgage News, 1994d: 8). They also created a comput­er system called CLUES that allowed people to enter their information into a form once and have it applied to multiple parts of an application. This system was marketed to other companies and brokers more generally (National Mort­gage News, 1994c: 18). They also bought a title company that spring to lower the costs of closing a mortgage (National Mortgage News, 1994b: 1). In 1990-1998, the company invested heavily in mortgage servicing. By 1994, they had a $100 billion portfolio, and this grew to over $150 billion in 1998.

Countrywide began to buy subprime mortgages in the wholesale market in 1993. In 1996, they began to originate subprime mortgages themselves (Nation­al Mortgage News, 1996a: 7). Subprime mortgagors are people who have a less- than-stellar credit history. During the mid-1990s, companies began to realize that this market could be offered mortgages by charging higher rates of interest and additional fees. Since the GSEs were not inclined to be involved in this mar­ket, private banks were able to get into the issuance of MBSs. Countrywide was a pioneer in these markets. Countrywide and other MBS producers began to cre­ate exotic securities by 1998 (Asset Securitization Report, 1998b: 1). These markets soared in the mid-1990s, albeit from a small base.

Countrywide's mortgage production and sales unit increased dramatically in size in the late 1990s as well. In 1999, they hired Ranjit Kripalani to head their MBS department. Mr. Kripalani had previously headed the MBS unit at Chase Securities. Countrywide also opened a New York office and, by the end of 1999, employed fifty people in that office to trade and sell securities (Asset Securitiza­tion Report, 1998a: 1). It hired a number of Wall Street veterans to create a more powerful group of sellers and traders (Asset Securitization Report, 1998a: 5).

By 2001, Countrywide Financial was a large and diversified corporation that participated in many market segments. Conventional mortgages grew from about 192,000 in 1993 to 327,000 in 2001 (Countrywide Financial, 2002: 2). FHA / VA mortgages increased from around 42,000 in 1993 to 143,000 in 1997 only to de­cline to 118,000 in 2001. Home equity loans increased dramatically from 2,000 in 1993 to 20,000 in 1997 and over 119,000 in 2001. Subprime mortgages totaled 2,000 in 1996 and grew to 52,000 in 2001. Alternative loan products increased their share of Countrywide's business dramatically over the eight-year period from 0 percent in 1993 to 16.8 percent in 2001 (Countrywide Financial, 2002: 2).

Countrywide entered the 2000s as a highly diversified mortgage originator, mortgage security issuer, and mortgage servicer. It was one of the main partici­pants in the conventional market for mortgages and securities organized by the GSEs. But it also was a pioneer in the nonconventional mortgage market. The firm entered the 2000s poised to lead the industry into the largest refinancing boom in American history and the incredible expansion of the nonconventional mortgage market. Its tactics epitomized the industry and served as a role model for all of the large financial firms that were engaged in the mortgage market.

Bear Stearns: From Investment Bank to Vertically Integrated Mortgage Bank Another of the villains of the financial crisis was Bear Stearns. The popular me­dia came to view the investment bank as the poster child for all that had gone wrong in the financial markets (for example, see Wall Street Journal, 2009; At- Iantic, 2010; Fortune, 2008). Bear Stearns had the unfortunate honor of being the first of the big banks to stumble and fail because of its participation in the MBS market. In 2006 and 2007, it suffered large losses on its MBS-related business. In March 2008, the Federal Reserve Bank of New York provided an emergency loan to try to avert a sudden collapse of the company. The company could not be saved, however, and was sold to JPMorgan Chase. The collapse of the company proved to be a dress rehearsal for the problems of the entire banking sector in the United States and elsewhere that culminated in the global financial crisis of 2008-2009.

In the usual telling of the story, the demise of Bear Stearns is seen as a result of the risk-taking behavior of the firm, particularly its high level of debt used to fund its MBS and CDO business (Cohan, 2010). What is less well understood is how Bear Stearns transformed itself from a conventional investment bank in the 1980s to a vertically integrated bank whose main business was the production of mortgage-related financial instruments. Bear Stearns was a pioneer in the MBS market and one of the most innovative firms in the creation of new financial instruments throughout the 1980s and 1990s and into the 2000s. As a result of this creativity and the growth and profits it produced, the firm was viewed as one of the most innovative of the investment banks. For example, from 2005 to 2007, Bear Stearns was recognized as the “Most Admired” securities firm in For­tune magazine's annual “America's Most Admired Companies” survey (Fortune, 2007). This honor seems hard to square with what happened subsequently to the firm. Most observers have suggested that the firm was not really an innovator but was hiding its true nature as a firm taking outsized risks that resulted in its demise (Lowenstein, 2010; Cohan, 2010).

The truth about Bear Stearns involves understanding it as both an innovator and a risk taker. The opportunity presented by the MBS markets from the 1980s onward and its role as an innovator of products in those markets earned Bear Stearns its reputation as a most admired firm. One of the innovations that Bear Stearns decided to undertake was to secure itself a supply of mortgages by be­coming a mortgage originator and wholesaler in the early 1990s. They pioneered the origination of nonconventional mortgages, including the extensive use of adjustable-rate mortgages, and used these mortgages to fuel their MBS business. By 2001, financial instruments based on mortgages had become the dominant source of profits for their business.

Another of their innovations was to massively borrow money to fund the origination of mortgages and their securities operation. It has been estimated that they had debt that was thirty-three times the amount of capital they owned when they collapsed in 2008 (Brunnermeier, 2009). Even as house prices stopped rising and home sales began to stall in 2005, Bear Stearns was under continued pressure to continue to originate mortgages to keep their securitization machine going. These pressures caused the firm to commit illegal acts of both predatory lending and securities fraud (Fligstein and Roehrkasse, 2016). When the MBS market came under scrutiny, Bear Stearns was so heavily exposed by having bor­rowed money to keep its vertically integrated securities pipeline going that it collapsed under its own weight.

Like Countrywide Financial, the executives at Bear Stearns did not start out to create a vertically integrated MBS business but ended up doing so because of the opportunities to earn outsize profits. Indeed, the company spent most of its existence as a more conventional investment bank. But the opportunity to participate in the MBS market after the collapse of the savings and loan industry was heavily exploited by Bear Stearns. They pioneered not just mortgage-backed securities but also other asset-backed securities. They also created a wide variety of credit debt obligation instruments and other forms of derivatives including credit default swaps. They sold these securities at home and abroad. The sheer size of the mortgage market meant that the supply of such instruments was quite large. Securitization meant that investors could buy yield and risk that fit their needs.

Bear Stearns was primarily an investment bank. This meant that its main busi­ness was in the creation, buying, and selling of financial instruments, both stocks and bonds. It came at the business of mortgages from the perspective of creating fixed-income securities and selling them to investors. Bear Stearns also traded on its own account and was thus a large investor in MBSs. During the 1990s, it saw nonconventional mortgages as an opportunity to make more money by providing bonds with higher yields. In order to guarantee itself a share of that market, it became the first investment bank to buy a mortgage originator, EMC, which originated nonconventional mortgages and participated in the wholesale market. EMC was a leader in the provision of subprime mortgages. By relying on EMC to provide it with the raw materials for securities, Bear Stearns ensured that it could supply its investors with high-yield bonds.

The paths that Countrywide Financial and Bear Stearns took to become ver­tically integrated are strikingly different. Countrywide Financial started as an originator and later took on the investment banking functions of issuing, un­derwriting, and trading securities. Bear Stearns started out as a trading firm that underwrote and issued stocks and bonds for corporations and government. But beginning in the 1980s, the growing opportunities associated with the housing market and more generally asset securitization brought the firm to change the course of its business. To make sure they had enough mortgages to package for sale into the securities markets, they eventually became an originator and whole­saler of mortgages. What observers of Bear Stearns have missed is just how com­plete the transformation of the company was. By 2001, Bear Stearns no longer was a conventional investment bank, but like Countrywide Financial it had become a vertically integrated producer of MBSs. Its traders sold mostly MBSs and re­lated products. The production of those products was directed by those traders, who told the investment banking arm of the firm and the origination side what they could sell most profitably. The bank also was one of its own best customers, holding lots of MBSs, particularly for nonconventional mortgages, on its own ac­count. It did all of this with borrowed money. As long as house values went up and mortgages were paid off, the company made large amounts of profit. But when the value of its MBS portfolio that featured so many nonconventional mortgages came under pressure, it was so highly leveraged that it was unable to borrow any more. What looked like a low risk in 2005 became a death event in 2007.

Bear Stearns was founded by Joseph Bear, Robert Stearns, and Harold Mayer on May 1, 1923 (Ryback, 2010). The firm was viewed as an outsider to Wall Street for almost all of its existence. As such, it tended to act aggressively in markets where there were new opportunities. It did not have access to vast pools of cap­ital, so it learned to use its own capital and to mobilize other people's money. Its main business was the buying and selling of stocks, and it bought and sold on its own account as much as it did serving customers. When the Depression hit, the company shifted its main market away from the stock market and toward the trading of government debt. They were able to survive and even prosper throughout the 1930s.

In 1933, the firm hired Salim Lewis (known in the firm as “Cy”) to start to build a business packaging and selling corporate bonds. At the time, there was very little business in corporate bonds because of the Depression. But Bear Stea­rns took one of its first gambles and invested in trying to build such a division. Lewis was a former football player from a modest background whose main busi­ness experience had been selling shoes. Lewis used the company's money to buy and sell corporate debt. During World War II, he bought a large quantity of rail­road bonds whose price had fallen dramatically during the war. He borrowed money to buy these bonds and aggressively sold government war bonds to pay the interest on the money he borrowed. After the war, the value of the bonds rose dramatically, and the company profited enormously. Lewis rose in the firm because of his bet and was the managing partner of the company from 1949 to 1978. He oversaw the dramatic rise in the size and fortunes of the company.

During the 1950s, Bear Stearns pioneered several new businesses. First, Lewis began to trade large blocks of stock for large investors. A second new business was arbitrage, the tactic of buying the stock of a firm that was thought to be a merger candidate in order to profit from the rise in the share price that would occur when a bid was made. In 1949, Alan Greenberg, known as “Ace,” entered the firm. He was born in Oklahoma, and his father was an entrepreneur who founded a chain of women's clothing stores in that state. Greenberg never com­pleted college. But he wanted a chance to work on Wall Street because he liked the idea of risk taking, and he, of course, wanted to get rich. He began working on the arbitrage desk. During the 1950s and in particular during the 1960s, the mergers and acquisitions market heated up. Greenberg was a natural trader who made huge sums of money by using the firm's money to place bets on future mergers. Greenberg eventually succeeded Lewis as managing partner in 1978, and he remained in that position until 1993.

In the late 1960s, Greenberg wanted to expand the firm's retail brokerage busi­ness. Greenberg reasoned that baby boomers would start moving into their peak earning years and would have money to invest. Greenberg hired James Cayne to help start this new line of business. Cayne came from a middle-class Chi­cago family, where his father was a lawyer. He too never finished college, and he worked for a while in his father-in-law's scrap metal business as a salesman. Cayne was a world-class bridge player, and he began to play bridge professional­ly. This brought him to New York City. After realizing that earning a living play­ing bridge was impossible, he became a successful bond salesman at Lebenthal and Company. He then moved on to Bear Stearns. Cayne was a natural sales­man who specialized in taking risks. He was extremely successful at finding and keeping individuals who had lots of money to invest. Cayne eventually became managing partner from 1993 until the firm's demise in 2008.

During the 1970s, the firm prospered by trading on its own accounts as well as those of its customers. It entered the business of “clearing trades” (i.e., settling stock trades at the end of each day). This business proved quite lucrative. Cayne made his name in the firm by buying and selling New York City municipal bonds in the 1970s. New York City was in dire financial straits in this era and almost went bankrupt. But Cayne figured out how to make a market buying such bonds at a low price and then selling them to others at a slightly higher price. Bear Stearns kept a large inventory of such bonds. When New York City's debt was refinanced, the bond bounced back in price. In essence, Cayne made money in a very similar way to how Lewis had done so during the 1940s on railroad bonds.

Not surprisingly, Bear Stearns's reputation entering the 1980s reflected the swashbuckling bet-the-firm tactics of an outsider organization that used its own money to aggressively make trades. It entered and helped create new markets. Moreover, its corporate culture emphasized results. The organization took pride in hiring people not for their academic credentials but for their willingness to work. If they failed to succeed, they left the firm. Bear Stearns was also run as a very opportunistic investment bank. They would use their own capital to enter and cultivate markets where there might be growth and the opportunity to make profits. They never had a strategy that caused them to focus on a particular set of businesses. Over time, they had developed the clearing, brokerage, and fixed-in­come businesses. They did so because they saw opportunity and were successful. It was this strategic openness (some might call it pragmatism) that succeeded for the firm through good and bad times. I note that this aggressive take-what-the- system-gives attitude toward one's business was akin to the way that Loeb and Mozilo ran Countrywide Financial. It was this openness that eventually led them to make the investments that led them to vertically integrate their fixed-income MBS and CDO businesses.

During the 1980s, there were several important changes in the firm. First, the firm was a leader in helping orchestrate the merger wave from 1978 to 1987. They helped many companies pursue mergers and acquisitions and were one of the leading investment banks involved in these deals. Second, in 1985, the firm moved from a partnership to a publicly held corporation. This made the partners in the firm instant millionaires. It also had the subtle effect over time of making the traders in the firm even more aggressive and likely to take on risks. Since their pay was tied to the profits from their trades and not their stakes in the investment funds of the firm, traders were more likely to engage in activities to make money quickly. The firm was no longer playing with the partners' cap­ital when it made trades on its own account. It was playing with shareholders' money.

From my perspective, the most important change was the entry of the firm into the mortgage-related securities business. Bear Stearns created a mort­gage-related securities department in 1981 with John Sites as head. They began act as underwriters for the securities produced by the GSEs. They also sold and traded those securities. Early on, they even acted as wholesalers who bought and sold pools of mortgages that had not been securitized, acting as a broker between originators and wholesalers and eventually investors. They were not at this time point involved in the origination of mortgages.

This business started small. But as with many of the firm's other businesses, Bear Stearns saw the market opportunity presented by the emergence of mort­gage-backed securities and the GSEs. They observed that Salomon Brothers was making money buying mortgages from savings and loan banks on a deeply dis­counted basis and then turning around, creating MBSs, and selling those to in­vestors. As the savings and loan banks unloaded their existing mortgages at low cost, Bear Stearns entered that market. When the savings and loans began to col­lapse and the mortgage market shifted to become the mortgage securities market dominated by the GSEs, Bear Stearns was there to act as an issuer, underwriter, and trader of GSE-backed securities. Bear Stearns also began to hold GSE bonds on their own account as an investment.

Bear Stearns helped pioneer the use of REMICs—real estate mortgage in­vestment conduits. REMICs were the legal vehicle by which mortgages could be made into securities in the mid-1980s (National Mortgage News, 1986c). In 1986, they began to use REMICs to issue securities based on jumbo mortgages, mortgages that were too large for FHA standard loans (National Mortgage News, 1986a). They also helped pioneer securities based on other nonconventional mortgages. The securities created from mortgages began to morph into more varied products. For example, securities were produced that allowed investors to invest in the part of mortgages that paid for interest and the part paid for prin­cipal (National Mortgage News, 1987b). They pioneered creating securities that blended various income streams in complex ways that fit the desires of investors.

But the real growth came in the late 1980s when Bear Stearns hired Howard Rubin. Rubin had worked at Salomon Brothers for Lewis Ranieri. In 1986, the year before Rubin was hired, Bear Stearns was already the fifth-largest under­writer of MBSs (National Mortgage News, 1986b). Upon Rubin's arrival, the firm became the largest underwriter in the market in 1989. By the early 1990s, the mortgage market had become the single largest business at Bear Stearns (Ry- back, 2010).

Bear Stearns was not the only investment bank to enter the MBS market, par­ticularly the market to be underwriters for the GSEs. All of the other investment banks expanded into this business as part of their production of fixed-income securities. The expertise that banks like Goldman Sachs, Lehman Brothers, Salo­mon Brothers, Morgan Stanley, and Merrill Lynch had in issuing and underwrit­ing corporate bonds was applied to MBSs and related products from the mid- 1980s onward. The investment banks helped the GSEs make and market MBSs as the GSEs rose and the savings and loan industry collapsed. This market grew dramatically, and the investment banks helped expand the production of MBSs radically. This entry of the investment banks to underwrite mortgage securities issued by the GSEs opened the link between Wall Street and Main Street.

The financial innovation that was centered on securitization was creating a plethora of new products, and no investment bank ignored this vast and expand­ing market. By 1988, all of the main investment banks were competing to create and sell MBSs for the GSEs (National Mortgage News, 1988). But Bear Stearns was one of the clear leaders in this. By the mid-1990s, their fixed-income secu-

rities business focusing on mortgages dominated the firm in a way that few of the others, except Lehman Brothers, followed. In an earlier era, Bear Stearns had “bet the bank” on other financial products. By the mid-1990s, MBSs were their new bet. The other banks eventually followed Bear Stearns into expanding these businesses quite rapidly, particularly after 2001.

Bear Stearns was an innovator and a participant in every kind of product. They were one of the largest underwriters, and they participated in introducing a wide variety of derivatives based on MBSs. They sold these not just to institu­tional investors but also beginning in 1990 to retail investors (National Mortgage News, 1990a). It should also be noted that Bear Stearns participated in not just securitizing mortgages but all other asset classes as well. They led the way in creating securities in auto loans, credit card debt, student loans, and corporate receivables.

While most of the mortgage underwriting was done for the GSEs, Bear Stea­rns was also a pioneer in private label issuance. This was the business of creating securities for loans that did not meet the standards required by the GSEs for inclusion into their bonds. They were one of the two or three largest players in that market beginning in 1988 (National Mortgage News, 1990b). In the wake of the collapse of the savings and loan industry, the Resolution Trust Corporation was formed to liquidate the assets of the defunct banks. Many of these assets were securitized, and Bear Stearns commanded a substantial portion of the un­derwriting of these securities. This helped propel them in the early 1990s to a leading position in the industry.

It was this leadership in becoming an issuer that eventually pushed Bear Stea­rns to vertically integrate. Most of the mortgages that they were packaging into MBSs were nonconventional mortgages. It followed that in order to expand this business, they needed to have access to these mortgages. Bear Stearns established EMC in 1990 as its mortgage arm to facilitate the purchasing and servicing of mortgage loans. EMC was both an originator and a wholesaler of such mort­gages. They contributed greatly to Bear Stearns's rise to the very top of the mort­gage-finance industry by purchasing over $200 billion in residential whole loans and servicing rights over the next decade. EMC was able to do this by funding the purchase of mortgages by borrowing money from the repo or asset-backed commercial paper markets through the Bear Stearns parent company. This fund­ing was typically very short term, less than ninety days, and mortgages were typically securitized within a forty-five- to ninety-day window. This created an incentive to try to create and sell the securities as quickly as possible to pay off these loans and minimize costs. It was possible to roll over the loans, but of course, that cost money.

Bear Stearns also bought a large number of these securities on its own ac­count. Because it was an investment bank, it did not have depositors to provide it with capital. Instead, it had to borrow capital. It pioneered the tactic of bor­rowing money to purchase these securities for its own account. In the firm, the traders had direct authority over the securitization division and the mortgage origination and mortgage conduits. They instructed those up the pipeline what kinds of mortgages to buy and securitize. By the end of the decade, Bear Stearns, through its operating entities, was a mortgage originator, mortgage wholesaler, creator of mortgage securities, and mortgage securities trader. When it was tak­en over in 2007, it had about $30 billion of MBSs on its own account.