The Long and Short of It Is...
If you won the lottery, would you spend it all at once, or sock it all away to use later? Most people would try to do a combination of both, balancing their long- and short-term financial goals. The same should be true with how companies deal with customers. There has got to be a balance between getting as much money from customers as possible at once, and building loyalty and lifetime value over time. Move over too far in either direction, and you may destroy customer value or run your business into the ground. Or both. Which is what happened with many mortgage lenders that took advantage of the subprime loan market.
Today's issue of 1to1 Weekly looks at the mortgage industry meltdown from a customer strategy angle. Looking through the customer lens, it's easy to see that the decisions some of these lenders made were only looking out for short-term financial interests. And as interest rates rose, homeowners and their lenders suffered negative consequences.
This situation solidly illustrates the need for balance. And there are many companies doing a great balancing act. We want to hear your stories. How does your company balance its short- and long-term strategies?
Your comments regarding the subprime mortgage meltdown place the blame squarely on the shoulders of financial services companies that offered the loans. I agree that some of the industry’s practices over the past few years have been wrong, but assert that you’ve missed other important considerations. First, you’ve placed none of the blame on the consumer. Many subprime loans were attempts to avoid the inevitable. People wracked up thousands in credit card debt and were looking for a get-out-of-jail-free card. Subprime lenders offered a way for these consumers to get their financial lives back on track. Consolidate the debt using the equity in your house. People with the financial discipline to take their medicine and pay down the debt benefited from this tactic. You mentioned that interest rates have gone up. 30 year fixed rates are approximately 6.25% - still near record lows. Customers that properly used the leverage subprime loans provided, have paid down their debt (and improved their credit score) and will probably convert to lower interest rate fixed loans. Those that did not possess the discipline went right back out and racked up their credit cards AGAIN. The combined debt was too much. Instead of declaring bankruptcy (new laws have eliminated the “clean slate” that previously came with bankruptcy) they stopped making their house payment. What would have been write-offs for the credit card industry are now foreclosures for mortgage companies.
Also, other parties were involved in the decision to make bad loans. Appraisers over-inflated the value of some properties. In many cases it wasn’t really a question of how much a house was worth (what it might actually sell for) as how much equity the borrower needed to cash out. Somehow, mysteriously the amount needed showed up on the appraisal. Appraisers that got caught simply switched companies (or changed company names) and were quickly doing appraisals for the same companies again.
Finally, you suggest that subprime mortgage companies took a short-term view. Many were suppliers of niche products – not banks with other products to cross-sell like checking, savings, auto loans, etc. Statistics suggest that only about 15% of people use the same mortgage company for more than one transaction. So, many in the market view subprime mortgages as transactional business. Salespeople in that business work off a 30 day cycle, just like any other commission-based profession. They were paid to close loans just like automotive dealer reps are paid to sell cars and office machine sales people are paid to sell copiers. Ongoing loyalty is left to the marketing guys. I’m not saying that’s right, but it is consistent in organizations where sales people earn commission.
Asking mortgage lenders to take a long-term view is not the solution to the problem. Consumers, lenders, vendors, and regulators all must take ownership for the subprime mortgage meltdown. Unprecedented access to credit has created unprecedented credit debt. Is it the fault of the creditor or the borrower? It’s a hard lesson, but consumers need to learn to stop buying things they can’t afford.
Tim, I agree wholeheartedly that we should try to avoid having to protect consumers against themselves by nanny-state regulations. I lived in the UK for several years myself, and I’m quite happy now to be back in the “land of the free.” But the loan-to-income ratios and other guides used by mortgage originators to determine loan eligibility are not designed to protect the borrowers from themselves so much as to protect the investors whose money is lent to them. In most cases these investors are not the banks and loan originators, but others – people who trust the banks to steward their funds wisely.
What happened in the US over the last few years was that some more aggressive mortgage lenders encouraged tens of thousands of consumers to borrow unwisely. In the Ameriquest example in our story, loans were often granted based on numbers that were completely fraudulent. But then by securitizing and packaging mortgages to be sold off to other, anonymous investors, these unscrupulous lenders were able to reap the fees and profits from originating the loans while escaping any responsibility for the long-term consequences. Once this practice was finally understood by a few more savvy investors, it undermined confidence in the safety of all mortgage-backed investments, and doubts cascaded through the system to cause a liquidity crisis, in which everyone felt less confident investing in anything.
Northern Rock, if it’s the only UK institution that has been guilty of this kind of over-lending, may simply be an anomaly. But if Northern Rock could get away with such lending practices, chances are others could, too – and I humbly predict that if one or two other institutions get into similar trouble it will cause a major problem for your whole financial establishment.
Ultimately, of course, the most reckless US mortgage originators themselves are getting pummeled in the marketplace now, and several have gone out of business. I think this proves that even though they generated marvelous current earnings by lending aggressively during the “feeding frenzy” near the end of the housing boom, what they were also doing was destroying a good deal of their own shareholder value. Nearly bringing down the financial system itself, and substantially damaging the values of even the best, most upright lenders, as well – that was all just collateral damage.
I want to stay with your mortgage lender motif for the moment. in the UK we're having a run on Northern Rock at present. They lent up to 8 times people's salary on mortgages.
This got them an excellent mortgage book and loyal borrowers. How anyone can pay back a mortgage of 8 times their salary is beyond me, though. Back when the UK had ~15% mortgage interest I struggled to repay one two and a half times my salary.
The thing about borrowing is that we don't have to borrow all the lender wants to lend. We don't have to max out our credit cards. We need to use our brains and know that interest rates rise periodically.
The mortgage collapses are not a simple issue for the lender or for the borrower. Each of them enters a contract with the other in order to create this market. So do we ask the lender to give the borrower a financial intelligence exam? Even stupid peole deserve credit if the are ready, willing and able to repay it.
I'm not sure that this market readjustment is anything to do with long or short termism. A mortgage is long term. There are no fast profits in mortgages, except buying or selling mortgages between lenders. A mortgage is simply a money purchase plan over a relatively large number of years. Mortgages deliver significant profits, but you have to be in the game for a good while, and balance your own borrowings with your lendings in order to get it right.
The solution is to impose "nanny state" regulations to legislate for those who lend or borrow large amounts. We had that here, once. Now we don't. The genii is out of the bottle.