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How The Indians Finally Won The World Series--And Saved Cleveland

 

How The Indians Finally Won The World Series—And Saved Cleveland

Or, The Birth Of The Betting Slip-Backed Security (the BSBS)

A Parable For Our Time

By David N. Brown

Part 1 of 2

 

Winter’s Grip

The wind howled fiercely down Lorain Avenue, swirled around people huddled at the bus shelters, and then, having gathered up their diminishing hopes,  swept  them away as it blew eastward past the West Side Market, across Hope Memorial Bridge, and past Progressive Field.

It was deep winter on Cleveland’s West Side, and Mike O’Malley, like Cleveland itself, was in trouble. Two years ago he had lost his job, and now he was close to losing his house. The 2008 Wall Street crash was still having its way with Mike O’Malley and so much of the city he loved.

The crash had first devastated poorer areas of the city; now it had reached his own middle class neighborhood near Ohio City, with seemingly every fourth house in foreclosure. His parish church and many others were being forced to close because of financial problems. Small stores and corner bars and other local businesses were also going under. Everyone was out of money.

A 60-year old widower, Mike was a bit paunchy and more than a bit gray but still a passably good looking man. He had worked his entire adult life as an in-house bookkeeper for a small, family-owned plumbing supply house which had gone under during the housing crash. He had been looking for work ever since but had found nothing. Mike was bewildered and angry about what had happened to him. 

Though only a high school graduate, after finishing a stint in the Army he had taken accounting courses at the local community college. When he finished them, he was hired by DiRossi Plumbing Supply where his buddies, Jack Hanrahan and Sam Bartolo, also worked. All three of them were to work there for more than thirty years.

Mike was a conscientious, hard-working guy. To keep up on matters that might affect the company’s business, he always took the Wall Street Journal home from work every day after the owner was finished with it. He read it for stories about the economy in general and the construction industry in particular.

By the end of 2006, he didn’t like what he was reading and what he was seeing in the city around him. Loan sharks were pushing second mortgages, and the WSJ was carrying stories about constantly-increasing housing prices, which sometimes ran side by side with interviews with Wall Street types who were saying that housing prices simply never went down. The paper carried still other stories about how people were taking out second mortgages on their homes because they were being told that they could always refinance again because their houses would keep going up in value. There were also stories about something called securitization, which was somehow supposed to keep everything running smoothly.

From his years with the company, Mike could easily remember some long periods of time when housing prices had gone down, so he couldn’t understand how these experts were saying the opposite. And he could also remember that during those times when housing prices had gone down the plumbers who did business with the company had faced some real financial problems.

Mike had started to develop a queasy feeling about his company. DiRossi Plumbing Supply was extending credit to many plumbers who worked on home remodeling jobs. He had talked to the company’s owner about his concerns, but the original owner was in bad health and living in a nursing home. His son now owned and ran the company, and he had faith in Wall Street and felt that he owed a duty to the plumbers who had bought from the company for decades. He told Mike to keep allowing the plumbers to buy their supplies on credit.

By the fall of 2008, everything had come crashing down. Wall Street investment banks were either going under or just about to. The stock market had crashed. Housing prices were falling sharply across the city and across the country.

The plumbers who bought from his company weren’t getting paid by their customers, who had started to lose their jobs. So the plumbers couldn’t pay Mike’s employer, which now had to start laying people off. Indeed, as the housing crash and subsequent recession took hold the effects were being felt all over Cleveland, where large-scale plant closings had begun and widespread foreclosures were following in their wake. Finally, his company closed, and Mike, Jack, and Sam were out of work.

Beginning the day after he was laid off, Mike looked for work every day, but at his age there just wasn’t anything for him. The few jobs that were available always went to people thirty years younger than him. His job hunt had now gone on for two years, with no employment prospects in sight.

In the several years before he lost his job, he had used up almost all of his savings to pay the prescription drug costs and the health insurance co-pays during his wife’s long illness. The bills had become so large that he was forced to take out a second mortgage on his home. And now he was falling behind on his mortgage payments and getting default notices from the bank. He felt sick to his stomach about the fact that Mike O’Malley—careful, hard-working, thrifty Mike O’Malley—was now facing bankruptcy.

The crash started affecting Mike in another way, too. He began to see attendance declining at the games of his beloved Cleveland Indians. Mike and his two buddies shared a life-long passion for the Tribe. They used to go to two or three games every week the Indians were at home, though now they went only when they could get free tickets. They sat in the bleachers, a couple rows in front of the designated drummer. They had been there through the bad teams of the 70’s and 80’s and for the great teams of the 90’s. They had stuck with the team through the early 2000’s, when it had had to rebuild, and they were sticking with as it had started to rebuild again at the end of the decade.

Now, however, the sounds of the drumbeats were echoing around increasingly empty stands, as Clevelanders, who were finding it increasingly hard to buy tickets, stopped coming to games. And Mike and his friends began wondering if the franchise would survive.

 

Too Small To Fail

With a lot of time on his hands, Mike decided to try to find out how all these bad things could have happened to his neighbors and himself. So he went to the local public library, where a bright middle-aged librarian made up a reading list for him about how Wall Street had been operating the previous ten years.

He spent months teaching himself the lingo of Wall Street. He read about derivatives and securitized mortgages like mortgage-backed securities (called MBS) and asset-backed securities (ABS). He also read about credit rating agencies that said all these MBS were great and about investment banks that were making hundreds of millions of dollars a year by packaging and selling mortgages and by making huge bets on the direction of the mortgage market. He learned to his amazement that sometimes the investment bankers even bet against the mortgage-backed securities that they had recently created and sold.

He wrote out lists of questions as he read, and the librarian, who was nice looking and who he had begun to grow friendly with, did her best to find new books or online articles that answered the questions.

A couple of nights a week Mike met Jack and Sam for a hamburger at Kozlowski’s, one of the few beer joints in the neighborhood that was still open. They compared notes on their job searches, and then Jack and Sam always asked if Mike had figured out yet what had happened to them.

Mike said that he thought he was starting to get the answer: that Wall Street had developed some computer programs which proved that risky loans were actually not risky at all and had gotten some expert opinions saying that these bad loans were actually good ones and could therefore be packaged and sold to overseas investors or held on American banks’ books as valuable assets.  But the loans had actually turned out to be bad loans after all, so the banking system had almost collapsed and had to be bailed out by the federal government. But the bailout hadn’t kept the economy from crashing, and all three of them, like many other people in Cleveland, were simply out of work and out of luck.

Jack and Sam really didn’t understand how computers could turn bad loans into good ones. They kept telling Mike that a lot of these Wall Street types were going to end up in jail before long. But Mike told them that that wasn’t going to happen because somehow everything the Wall Street people had done was perfectly legal.

So week in and week out the three of them kept looking for work and kept muttering to each other that something just wasn’t right in America if guys like them could get screwed out of their jobs by people who had made a fortune selling bogus securities and then gotten bailed out by the government.  And week in and week out they worried about the future of the Indians franchise.

And then Mike caught a huge break. He had begun dating the librarian, named Sally Johnson, who really admired his tenacity and his good looks.  He was bothered by the fact that because he had no money the dates almost always consisted of Sally cooking dinner for him and then the two of them watching a movie borrowed from the library, but Sally didn’t seem to mind. For her part, Sally was spending some time after work doing research that might help Mike.

One day Sally came across an article that described some of the computer programs that Wall Street had used to turn the risky securities into good ones. The article also said that one of these programs, which had been used by an investment bank that went under after all its partners had become rich, was subpoenaed by Senate investigators, who were trying to determine if it was fraudulent. So she contacted her U.S. senator, who was leading one of the investigations to see if she could get a copy of this program for Mike. One arrived in her mail on a disk several days later.

That night she gave it to Mike. He took it home and loaded it into his old personal computer and began to use the computer skills that he had learned at his old job.  For the next few weeks he kept looking through the program and trying to use its various features by matching the parts of the program to the concepts he had learned while doing his research into Wall Street.

The program was amazing. It was designed to allow you to put loans into one of three categories—from riskiest to least risky. These categories were called tranches. Then after you had input all the information about these loans, you could make them less risky. In fact, you could turn the riskiest tranche into a less risky one just by highlighting the loans in the tranche and then pressing "Ctl-Alt-Enter", which moved some of them to a higher tranche.  Another feature of the program then allowed you to create securities out of the loans by holding down another three keys. And then you could—just  by hitting another key—order  up an expert opinion saying that the securities were really great ones, and the opinion letter came back by e-mail in an hour. And then the securities could be sold as safe and secure. In fact, because they were said to be so safe by the experts, they could be sold for a lot more money than they looked like they might really be worth.

And then Mike had an idea that he thought just might save his buddies, his neighborhood, his church, his city, and his beloved Indians.

Mike might not have known a heck of a lot about mortgage-backed securities or investment banking before he started his reading, but he knew a lot about baseball. Over the last five years he had been reading about how  statistical analysis had become a big part of the way baseball players were evaluated by various teams. In fact, one of his favorite books wasMoneyball by Michael Lewis, which had taught him to understand how baseball players were now looked at from a risk perspective, including the risk that they wouldn’t perform up to their previous standards.

So he said to himself: "I’m going to bring baseball and betting and investment banking together. If this stuff was legal for Wall Street to do, it’s also got to be legal for us. If they could sell tricked-out bets as securities, so can we.  And if the investments bankers got to keep the money they got from selling these things, so should we. If I can make this thing work the way I think I can, some unemployed West Siders are going to become investment bankers for the next month or two. We’re going to see if we can get ourselves into the securitization business and help a lot of innocent victims make back every dime that they’ve lost in this crash."

And so was born the concept of the betting slip-backed security—forever after known as the BSBS, the security that saved Cleveland.

Tomorrow—Conclusion

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