Financial Instruments and Markets: A Casebook

11

Mortgage Backs at Ticonderoga

On an early spring morning in April 2005, David Talbot came in to the offices of London-based hedge fund group Ticonderoga Management and, before even taking off his coat, asked, “So, Margaret, how are the Fannies, Freddies and Ginnies doing today? Any possibilities out there?”

Coming from careers in large investment banks, Talbot and Margaret Stanway had recently founded Ticonderoga Management. Focused on trading in traditional fixed income instruments, such as corporate and sovereign bonds, the fund had recently also begun to trade in mortgage-backed securities (MBS). MBSs were securities created from pooled mortgage loans. As the underlying mortgages were paid off by the homeowners, the investors received periodic payments of interest and principal. Most such pooled mortgage securities in the U.S. were issued by one of three U.S. government agencies, known by their nicknames Ginnie Mae, Fannie Mae or Freddie Mac. These securities, called “pass-throughs,” could then be pooled again to create collateral for a more complex type of mortgage security known as a Collateralized Mortgage Obligation (CMO). CMOs allowed the cash flows from the underlying pass-throughs to be split up so that different classes of securities—so called “tranches”—with different maturities, coupons and risk profiles were created.

Ticonderoga had experienced good luck in raising capital since its founding, and founders Talbot and Stanway had gathered a small team of seasoned ...