The Financial Crisis: Short-Termism Coming Home to Roost
The actual cause of the current financial crisis is very complex. Everyone points the finger of blame, but so far we have no confessions of guilt.
The Democrats blame Republican-style deregulation, while the Republicans blame the Democrats' coddling of Fannie Mae and Freddie Mac. The truth is that no one is totally at fault - not even those greedy merchants of avarice on Wall Street - while everyone shares some of the responsibility, including politicians on both sides of the aisle. (My own opinion isn't germane to this posting, but if you want to see what I think about the political wrangling, you can click here.
Whatever the spark was that set it off, the fuel feeding this economic conflagration has come in the form of billions of dollars' worth of low-quality mortgages now at risk of default.
And it was a very familiar business impulse - the desire to generate short-term results, no matter what the long-term cost - that led to this over-supply of "toxic assets" now clogging our credit markets. Many mortgage lenders were so focused on booking the revenue from loan transaction fees that they paid little attention to the true risk of default. Some lenders actually encouraged borrowers to take on more mortgage than they could afford. Below-market introductory interest rates were a classic mechanism for what, in other industries, could probably be called "bait and switch."
This scenario was complicated by the fact that most mortgage lenders didn't actually assume final responsibility for collecting on the loans they made, but instead bundled these mortgages up into big packages (mortgage-backed securities), and sold them off to other investors, who were then on the hook if default actually occurred.
I'm sorry, but I feel like I've been here before. "It's déjà vu all over again," to quote Yogi Berra. Lenders were booking transaction fees without regard to their borrowers' long-term value or risk, in an effort to put as much short-term revenue on the books each quarter as possible. In a frenzy to sell sell sell, these transaction-hungry lenders offloaded a bunch of inappropriate products onto thousands of anonymous customers. Why? Because they could, that's why. Because the bonuses paid to company executives were almost certainly tied to the volume of loan transactions, and not to the value of the borrowers themselves, or to any back-end measurement of default rates.
The result: We now have a serious financial problem caused largely by short-termism, which is far and away the single most destructive business impulse today.
In the mobile telecom business, short-termism results in carriers scrambling so hard to acquire new customers that they substantially impair their customers' average lifetime values, and the result is they often destroy more in customer equity than they gain in new business. In the automotive industry, short-termism prompts companies to prop up quarterly sales by offering incredibly big discounts on new car models, even though they are largely cannibalizing future sales by doing so, and the result is that their long-term prospects dim even further, while their brands take a beating. In the mortgage lending business, the transaction fee from a bad loan generates just as much current revenue as a good one, but the result is a global financial crisis.
Don't let your own business get caught up in this crisis of short-termism. Break the cycle. Beat the crisis. Read our book: Rules to Break & Laws to Follow: How Your Business Can Beat the Crisis of Short-Termism.
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Many factors have contributed to the current sharp decline in mortgage brokers; and many articles have been published in recent months about the dramatic decrease in the number of active mortgage brokers (the WSJ has published several articles on this topic). Mortgage-industry experts estimate that there are somewhere between 40 and 60 percent fewer mortgage brokers active today than in 2006.
You can visit http://ml-implode.com for an overview of the nearly 300 mortgage lenders who have gone bankrupt, closed their wholesale or subprime operations, or are on life support. Many if not most of the mortgage-banking organizations listed sold their mortgages through brokers. So with hundreds of loan sources gone, brokers have far fewer products to sell.
Also, as you noted in your original blog entry, subprime lenders often pressured on their brokers to sell their fee-intensive products.
As a result (like it or not), I'm sorry to say that mortgage brokers in general have earned a less-than-stellar business reputation in the lest few years -- comparable to that of used-car salespeople. Certainly there are many individual brokers who are caring, honest, and deeply customer-focused. But that's not the way most people view them.
As to whether or not there is something inherent in the mortgage-broker business model that would prevent brokers from having a long-term customer focus, I would say "no." In fact, the mortgage brokers who survive today are most likely the ones who have a strong customer focus.
Ultimately it comes down to one's personal commitment to the principles of quality and customer satisfaction. If I truly believe in those principles, I will live them out as a dry cleaner, a carpenter, an auto manufacturer, or a mortgage broker.
Well, we all agree, I think, that when you have companies that are closer to their customers, whether these customers are mortgage borrowers or mortgage lenders (i.e., investors), the policies instituted tend to be more even-handed, fair, and well balanced.
But I really didn't know, Jeff, that the majority of mortgage brokers had now "vanished." And while I applaud the more customer-oriented approach of local banks and community lenders, do you think there is something in the mortgage broker business model that mitigates against being more long-term oriented? In other words, do you think this is a structural issue?
Don, thanks for your incisive analysis of the current credit crisis.
However, you failed to mention that the vast majority of America's banks, savings institutions, and credit unions are currently doing well (as attested to by articles in USA TODAY, the Wall Street Journal, and other leading publications).
The good news -- which is difficult to find in the media -- is that most of America's regulated mortgage lenders are led by careful, customer-focused financial managers who did not join the subprime mortgage feeding frenzy. As a result, these "trusted advisors" have money to lend at competitive rates -- and they have few if any loans in default.
In fact, now that the majority of mortgage brokers have vanished, the local bank or credit union has become the lender of choice for many thousands of Americans who can now finally afford a home because of low interest rates and falling house prices.
The bottom line is that the mortgage departments of most banks and credit unions ARE customer-focused, actually DID take a long view of the subprime mortgage market and its consequences, and continue to provide good service to their customers and members.
Don,
You are totally, profoundly right. (In my humble opinion, anyway).
The short-termism you diagnose is closely related to some other -isms. I think they're all different aspects of a common theme.
One is the substitution of transactions for relationships. Transactions promote a one-off view of business, which is of necessity a shorter-time view of things than relationships, which require multiple transactions over time.
Another is the drive to break down, dis-aggregate and disconnect things. This was fed by business process re-engineering, and the desire for global outsourcing. The more we break things into tiny pieces to outsource, the more we turn relationships into third-party transactions, and again shorten the timeframe of the players involved. The gains of scale economies are increasingly offset by the costs of this disaggregation. You can't ask the corner store to "trust me" for the candy bar you want when you forgot to bring your wallet, because they need to scan it to replenish the inventory.
Finally, there's the increasing reliance on legal contracts, CYA and gotcha language. If you work for a large company, every email you send probably has a crap signature at the end loaded with legalese; it just reinforces the idea that we are divided by transactions, and united by not much. Get yours while you can, is the message, before someone else gets it from you.
I like your theme of short-termism; it perfectly captures the "do unto others before they do unto you" mentality that has guided so much of our society as sellers, consumers and citizens over the past decade or two.
Real value will always only come from longer term relationships and linkages; thanks for doing your part to remind us of that.