These perilous economic times lead all of us outside of our comfort zone, and these thoughts certainly don’t fall directly into my current sphere of expertise as a payments industry consultant. But I did start my business career as a corporate lending officer – trained at Bank of America and Citibank in the late ‘70’s and early ‘80’s – so I’ll use that as my credential.
I am dismayed at much of the talk of economic “recovery”. Like recovering addicts everywhere, we are discovering hard truths – that consumers, enterprises of all sizes and stripes, and governments at all levels, have been borrowing too much, and borrowing to finance not just investment, but spending. So, does “recovery” imply that we return to that?
In this morning’s New York Times, Vikas Bajaj writes:
”Most banks no longer hold the loans they make, content to collect interest until the debt comes due. Instead, the loans are bundled into securities that are sold to investors, a process known as securitization…..But the securitization markets broke down last summer after investors suffered steep losses on these investments….The Obama administration hopes to jump-start this crucial machinery by effectively subsidizing the profits of big private investment firms in the bond market….Investors would not be liable for any losses beyond the 5 percent to 16 percent equity that they retain in the investment.”
In credit training, it was hammered into our heads that responsible lending was impossible without understanding the character of the borrower. I still think that’s generally true. If so, maybe the problem is with securitization itself?
In recent months I’ve been thinking about what scenarios played out in bank ALCO’s in 2007 and 2008. For those of you who aren’t familiar with the term, the ALCO is the bank’s Asset and Liability Committee – in most banks, the entity responsible to management and the board for review of of lending and investment policies and portfolios. I keep thinking about this meeting:
The senior mortgage guy walks into ALCO, a bit nervously, and makes his monthly presentation and pitch for approval. “Sure”, he says, “we’ve been walking a bit too far down the line in making some risky loans – but the rates and fees have been very attractive. And in any case, we’ve sold off all the really bad stuff – so we’re covered.”
The ALCO members hem and haw, but decide he’s right. So the mortgage guy leaves the room, and in walks the next senior manager – the one responsible for the bank’s investment portfolio. This guy, not nervous at all, says: “I’ve been getting some really great returns on these interesting investments…. derivatives related to subprime lending….”
Did no one at the ALCO connect the dots?
Now, I don’t like to think of myself as naive, or, frankly, as conservative. And I don’t know how to square these thoughts with the obvious necessity to act on the deep consumer pain that the recession is causing. But for the financial services industry, surely the solution is to change what we’ve been doing, not to return to it.
I’d welcome your thoughts – please share them in the comments below.