Thinking outside the box destroys another U.S. company.
With frustrated amazement I have witnessed first hand the demolition of several American brands at the hands of a new generation of managers clinging to the mantra of ‘think outside the box’ A new generation that is steadfast in its certainty that it knows better how to run things than any before it.
A perfect case in point is the news today of Countrywide Mortgages demise. It appears Bank of America will be purchasing the mortgage giant at a sizeable discount.
What happened at Countrywide? One of the Nations largest originators, in business for forty years, and now poof they are to be absorbed in the belly of the BofA whale.
Oh it’s just a casualty of the Sub-Prime crisis our first instincts cry out.
But in all the words the media pundits have spoken on the subject none have gotten to the causational factors that allowed the crisis to happen, or the underlying disease that has infected American Business culture.
The disease I will coin ‘Out of box exposure’, it is caused by;
1) Abandoning the foundational and fundamental processes of a business.
2) Placing in managerial control, persons who have no working knowledge of the business they are in.
I will get right to the point on the credit crash we are experiencing right now.
In the seventies when I wanted to qualify someone for a loan, I first took a credit application and then I ran a credit report. The credit reporting agency back then was TRW and it came with no computer generated algorithm to determine the likelihood of the applicant repaying the debt as agreed. It simply was what it was. And a finance professional’s job was to interpret the data, and interpret the report with your eyes and brain, and answer these basic questions;
1) Does the applicant’s story make sense?
2) Is the applicant able to repay this debt as agreed?
3) Does the applicant show the necessary character in his/her history to assume him/her will repay as agreed?
This was standard protocol for the automotive and mortgage lending industry.
Then several people would look over the same data and discuss the feasibility for funding to take place, seller, buyer, seller, buyer, as many levels as it took to achieve final funding. All parties had to sign off, and the loan was funded.
Loan officers were paid upon their abilities to get it right. An experienced and talented loan officer had default rates in their portfolios of less than 1%
The first bump in road came when computer scanning of applications became possible, these crude scanners started popping up in the late 70’s and they basically checked the application for the ‘basics’ before it was pre-scored and then handed to an officer.
Humans being lazy, this was the first opportunity for some sellers to throw fastballs by the buyers who had learned to let the computer pre-score the app, check the credit bureau for any blips and stamp an OK on a loan without even looking at the application.
I saw an application for Lassie T. Dog get pre-approval for funding from Bank of America for an auto loan as an April fools joke. But Lassie would have had to document her existence. More on documentation later.
Then came competition in the Credit Reporting business, and the insane idea that a computer generated algorithm can be used to determine an applicant’s propensity to pay back a loan as well as a loan officer looking at the application and credit report.
Someone thought that if insurance actuaries could predict in numerical charts the ‘odds’ if you will, of someone dying or becoming involved in an accident then you could surely do it to predict the propensity of an applicant to pay back a loan.
Wrong. Human behavior doesn’t graph on a mathematical table.
Yes the credit scoring system was born.
It was then and is now, horribly flawed.
Within ten years no-one was looking at the application.
Enter, generation ‘We know Better’ lets think outside the box, and show all those old fogies how to make money. With supercomputers becoming available on desktops
Loan programs could be created more simply than ever before. Somewhere some genius
Came to this conclusion, If the credit reporting algorithm says this score will produce these results,(lets say 650 equals 90% paid as agreed, hypothetically) well then lets create a default rate for Sub-Prime B, C and D grade applications, apply the math and determine how much we need to charge in order make a profit.
Here is where the disease comes in. Anyone with first hand knowledge of the lending business, anyone who came up the ranks from taking applications could have, would have, should have, stopped that whole thinking process right there. Simply put, someone should have screamed out, “hey these folks that the scoring system is giving 600 and below scores to are not going to pay back the loans”, the default rate is going to skyrocket with individuals who don’t pay back as agreed. Not smoothly graph off into visions of profit sugar plums.
The American family might have had 2.3 children at the time, but that didn’t mean there was literally a third of a child in the back seat, or three families shared a child.
The concept that people who don’t pay their bills were simply going to perform x percent less than those who did, is equally as inane.
But the we know better folks thinking outside of the box that had worked for a hundred years weren’t going to listen to any of that. And the entire process by which mortgage loans were originated changed. And then the real Voodoo was added to the mantra.
You don’t need to document as long as you can produce a score. We will just add a couple of points of interest and viola we will get rich. Yeah right.
Outside the box? How about outside the universe of common sense. So now Lassie T. Dog really can get a loan, Lassie can buy a 4 unit Condominium Project, resell it and take a profit, without ever having been a real dog at all. And if she gets distemper in the process, no problem default, what are you going to do, send her to Canine Court? No-one is talking but I would venture to say, half of the no-documentation paper was pure fraud. When you put up a billboard that says, frauds apply here. What do you think you are going to get? But it all scored out. Outside of the box.
Now the disease can’t progress without the second most important cause. No one is watching with any knowledge of what is going on. The Professional Certified Project Manager Syndrome. We have the notion in business culture today, that someone who has either proven their ability to manage in one field or proven they can pass a test on management organization, is ready and qualified to manage in a field or practice they have no practical hands on experience in. How hard can it be? I mean that project manager test was a doozy, and I passed it. So we have brand new Loan Officers at ABC Brokers taking applications and Country Wide sub-prime buyer reps fresh out of college canvassing for business taking those applications and scanning them into computers for approval, the loans are packaged and the rating services like Moodys drooling at the prospects of ten percent interest paybacks on 2/28 jump ups, are rating this paper A+. No-one in the whole process has looked at the applicant, looked at the credit report and said, Gee no way is this guy going to pay back the loan. Does he even exist? Has anyone ever seen him? Most of this was telephone internet business? No alarms are sounding anywhere.
There were upper level managers overseeing production managers who had never personally written a mortgage by hand. I spoke with a friend with 20 years at Countrywide today that said exactly that.
Somehow, the joke of ‘But I spent the night at Holiday Inn Express last night’ was on every investment house who bought paper, a used car special finance (sub-prime) manager could have told them rightly not to touch.
Billions of dollars are being written off as we speak, a global banking black eye.
Hopefully American business will start thinking of getting back in the box, before another Icon falls by the wayside, from ‘Out of Box Exposure’.