Expensive Mistakes
The WSJ recently reviewed a book called “Billion Dollar Lessons”
Here is one of the stories from the book (and the review):
Some years back an outfit called Green Tree Financial Corp. soared into the stratosphere by making 30-year mortgages to buyers of trailer homes (instead of the standard 10 or 15 year mortgages on trailer homes).
From 1991 to 1997, a span in which Green Tree’s chief executive was paid $200 million, the company’s stock shot up 30-fold. But since all the relevant players at Green Tree made their money by signing off on loans, no one paid close attention to the inconvenient fact that trailer homes, unlike houses, do not increase in value over the long run. On the contrary, trailers depreciate rapidly and last only 10 or 15 years, by which time a 30-year loan isn’t close to being paid off. So after just a few years, Green Tree borrowers discovered that they owed far more than the underlying asset was worth. You can imagine how all this turned out. …..
The basic premise is that there is much we can learn from mistakes, although it is clearly very painful.
The Upside of Irrationality, explores some positive and some negative ways that irrationality plays out in our lives.
Adam Smith covered this scam fairly completely in “Wealth of Nations.” Everything revolves around selling the notes quickly to suckers, so that when the house of cards collapses, you have only a few notes for which you haven’t yet found a sucker: the rest have been converted to cash.
But the new wrinkle seems to be that the cash goes to the CEO, who milks his doomed corporation for enormous amounts of compensation. Thus, the corporation (its employees, stockholders, and directors) are the suckers, and the swindle is neatly encapsulated within a single organization. (Suckering outsiders is also a possibility, but it’s not necessary.)
If the CEO keeps his mouth shut, I suppose that criminal intent can’t be proven, so it’s the perfect crime.
From a psychological point of view, this looks like it ought to provide fertile fields for you, Dan. With a swindler at the top, subject only to the directors’ and stockholders’ management-by-committee (which hardly counts), how likely is it that anyone will fight him very hard? Especially when only the swindler himself knows that it’s a swindle and not a “calculated risk” — assuming he admits this even to himself.
It’s a house of mirrors!
Building on Robert’s comment, another wrinkle in the modern variant of this strategy is that the company relies on short-term financing as it packages and securitizes the loans. When confidence is lost and the house of cards begins to crumble, the short term financing dries up. Usually, it is this immediate credit crunch, not the long term problems with the loans, that brings the house down. (Not unlike the problem that we’re facing with our economy.)
The notion that it is swindlers at the top that are responsible for such failures is too simplistic, or at least might be easier to solve. The more difficult problem is when everyone believes they are acting on good intentions and thorough analysis. The failures happen to well-intention managers and great companies as well.
For anyone interested in exploring this particular failure pattern, we’ve made the relevant chapter free at our website:
http://www.billiondollarlessons.com/88
We offer our own suggestion on how to address the more general problem of poorly designed strategy:
http://www.billiondollarlessons.com/89
Regards,
Chunka Mui
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http://www.billiondollarlessons.com
This is kind of an “I told you so” but years ago I worked for a credit union preparing loan documents after the details had been agreed upon by the loan officer and borrower. One loan officer in particular granted oh, so many loans. Her numbers were terrific, but oh, so many of the loans were outside our written lending guidelines. Now, as a lowly “loan writer” I couldn’t actually refuse to prepare the documents for her questionable loans, but I did ask her to state, much to her disgruntlement, that yes, the loan was outside guidelines. We butted heads over that situation for months until she was promoted to branch manager at another location. I moved on myself and after a few years and had the opportunity to catch that same employee “kiting” checks (writing a check for say $100. from one account and depositing it into another account so a check written from the 2nd account would clear…). She was fired as a result and I think I knew from when she made so many questionable loans–and then got away from them before they could go bad–that she was someone whose decisions were likely to be in favor of the fast buck, regardless of later cost. I think that the “well-intentioned managers” may have avoided acknowledging that more and more of their decisions were likewise in favor of the fast buck with less and less consideration of eventually having to “pay the piper”.
I really think this whole mess just happened a little earlier than the Bush Whitehouse expected–they thought it would happen on the next President’s watch.