fundamentally flawed bank underwriting

A lot of friends, who weren’t bankers, have asked me to explain the whole financial crisis thing to them.  So far, I do not know of anyone who has made the explanatory point I share below; but I am sure someone has.  Regardless of whether someone has published this explanation, one thing about the financial crisis really has me confounded.

I just find it hard to believe that professional bankers with decades of banking experience didn’t realize they were helping “blow up the bubble” and push home prices higher with the generous liquidity they were providing to home buyers.  Lenders providing financing to consumers enabled consumers to then make  higher bids on real estate properties, and these generous bids then become the sales prices at which the property was sold, which is then fed back into the bankers financing decisions in the form of “comp” values, which bankers use to determine how much they can lend against the property, which is the collateral securing the loan.

So what’s the solution?   Shouldn’t real estate lending practices simply be a simple function of the borrower’s ability to pay the proposed mortgage; not on a forecasted sales price the property could be expected to sell for at some point in the future?   That is, bankers can simply look at the borrowers income and expenses and determine how much the borrower can afford in terms of monthly mortgage payments; and then back into how much the borrower can afford to borrow given the market interest rates and time duration of the loan.

Had lending practices been based on these exogenous means for affording real estate properties, I think it would have been very easy to see the “bubble” forming, because a “safe demand” (i.e. people’s ability to afford mortgage payments) for real estate properties could have been measured by measuring people’s income and wealth, minus the value of the real estate properties owned by people.

Paradoux of Choice

In our quest to maximize freedom, we maximize choice, but is this maximization of choice leading to maximization of happiness?

In his TedTalk, Psychologist Barry Swartz helps me understand why I hate large restaurant menus.  He articulates nicely, ideas that strongly suggest maximizing choice does not maximize our happiness; rather it is in fact reducing our happiness!   I don’t think there is anything more important to ponder than things that directly affect our collective (he mentions the possibility of Pareto Inefficient economies) and individual  happiness, and I highly recommend watching the entire 19 minute TedTalk (below); but some of the major takeaways are below.

The cost of choices includes:

  • paralysis, the resulting procrastination, and the resulting consequences of not taking action create huge costs for individuals
  • the opportunity costs of not choosing another available choice, subtracts from the satisfaction of making the choice that I made
  • with so many choices, we expect one of those choices to be a perfect fit; and high expectations that prevent us from being presently surprised and “The key to happiness is low expectations!”

Some takeaways:

  • “Everything was better back when things were worse”
  • “…pretty confident we have long since passed the point [number of choices] where choices are adding to our welfare”

What can us business strategists learn from the recent implementation of radical data-driven defense strategies used by some very successful baseball managers.

As baseball teams look for competitive advantage, they have come back to playing unconventional defenses as a means for attacking some players tendencies to hit the ball consistently to certain parts of the field.   Take for example, moving your 3rd baseman to shallow right field to take away line drives from a left-handed pull hitter (Devil Rays did this to NY Yankees hitter Mark Teshara).  This shift essentially created an extra outfielder and one less infielders.   The Toronto Blue Jays have started doing similar defensive maneuvers, but only after they saw Devil Rays manager, Joe Maddon, do it with such success.   As I think this video correctly pointed out, a substantial amount of thought has to be invested in the design and implementation of this type of strategy, because the hitter’s tendency to hit balls to certain spots on the field is a function of where the pitcher locates his pitches.

Applications to the world of business strategy

But what has me thinking about all this is the possibility of parallels being from this story of baseball strategy to the world of business strategy.   How are businesses using data to exploit their customer preferences, or to better understand their competitor’s strategy; and ultimately creating competitive advantage through defensive strategy?

Then, my further question, is what is the answer to this data-driven and defensive approach to strategy design; and is the answer for business strategists similar to the answer for baseball strategists (i.e. baseball team managers and batters)?   That is, in baseball, the answer for the batter seems to be simply to focus only on what you can control and therefor focus on “going with” the pitch and hitting strikes as hard and as accurately as you can.   For the most part, a batter can’t directly control where the defense positions its defenders or where the pitcher will throw the ball, but he can control what pitches he swings at and how well he hits those pitches.   Does this idea extend to business?

In business, we generally think that good strategy takes into consideration what our competition can do, and if we tap into game theory, this expectation of what our competition will then do feeds the competition’s decision making process, and then this loops back to our decision, and the loop continues ad nauseam.    So here is my thought for us business strategists, should we–like the good  baseball batter–start thinking a little less about what our competition will do and instead focus more on what we can control?   For example, should we simply focus on: a) what are our visions for the future of our customer and distributor markets, and b) the unique capabilities we possess or will develop for executing on that vision.

This data-driven approach to managing a baseball team is an evolutionary change in baseball, perhaps due to the great accuracy and volume of data being collected today, as compared to earlier decades of the game.   Maddon and the Devil Ray’s are the vanguard of this data analysis movement in baseball, and I think it is worth studying him for how he crafts and implements his strategies, and also for the courage it takes to do something so radical.

Takeaways in business and innovation from an internet icon

Marc Andreessen was recently recognized as a Wired Icon and pioneer of the internet.   Given his 20+ year history within the industry as an entrepreneur and now venture capitalist, his perspective has proven to be an insightful one; and so I read the transcript from his interview Chris Anderson.

At one point, Andreessen said something that I think is pretty powerful for innovators and business:

But making it [the internet] easier to use also made it more apparent how to use it, all the different things that people could do with it—which then made people want it more. And it’s also clear that we helped drive faster bandwidth: By creating the demand, we helped increase the supply.

This quote is dense.   It is a comment on multi-sided business models.   It is also a comment on the power of user-centered and service (since we cannot design experiences) design.

Another interesting strategic business lesson to learn came is Andreessen’s comment on why the LoudCloud business didn’t work:

Well, it worked beautifully right up to the point when all the startups went bankrupt, and then all our big clients decided they didn’t have to worry about competing with the startups anymore. After that, it went completely sideways.   ….

and the pivot:

So we just went back to basics and we said, OK, we couldn’t make it work as a service provider, but we think we can make it work as a software company, selling the back-end software to manage big networks of servers. We changed our name to Opsware. That ultimately worked, as a business.

On the importance of timing to market adoption and overall success of an innovative product/business:

Andreessen:  We see [social] playing out in retail, where ecommerce is becoming a group activity. Long before Ning, actually, in 1999, I invested in a company called Mobshop, which was Reed’s law applied to commerce, through group sales. It didn’t work back then. But 10 years later, I invested in Groupon, because I could see it was the same idea—finding, on the fly, a group of people who want the same product and using their massive numbers to command steep discounts. …

Anderson: What changed between 1999 and 2009 that made Groupon—and Facebook, and all these other profitable consumer Internet companies—possible?

Andreessen:A big part of it was broadband. Ironically, it was during the nuclear winter, from 2000 to 2005, that broadband happened. DSL got built out, cable modems got built out. So then you started to have 100, 200, 300 million people worldwide on broadband.

How society and culture changes influence success of innovations:

Andreessen: I often wonder if we should have built social into the browser from the start. The idea that you want to be connected with your friends, your social circle, the people you work with—we could have built that into Mosaic. But at the time, the culture on the Internet revolved around anonymity and pseudonyms.

On the power of optimism or the lack of cynicism, Andreessen comments that this is one of the reasons Zuckerberg and Andrew Mason were able to pursue their ideas (i.e. they weren’t burned by the previous dotcom bust).

On which industries are closest on the horizon to being improved by internet technologies:

Andreessen:  The next stops, I believe, are education, financial services, health care, and then ultimately government—the huge swaths of the economy that historically have not been addressable by technology, that haven’t been amenable to the entrance of Silicon Valley-style software companies. But increasingly I think they’re going to be.

On “software expressed as hardware”:

Andreessen:  … There’s a lot of hardware engineering that goes into it, but 90 percent of the intellectual property is software.  So we look at Lytro and we look at Jawbone and we see software expressed as hardware—highly specialized hardware that will be hard to clone.

Are Non-biodegradable plastics a thing of the past?!!!

Researchers have found a fungi in the Amazon rainforest that can degrade and utilize the common plastic polyurethane (PUR) for energy.   What a thought…that after all our destructive consumption of plastic has done to hurt mother nature, that she might hold the fix to this problem!!!?     Amazing!   The fungi can survive on polyurethane alone and is uniquely able to do so in an oxygen-free environment (I’m thinking landfills).

As someone who cringes at the thought of how much plastics are being put into landfills and our environment, this is fantastically exciting news, and I want to see it implemented if it works, so I wonder about two practical matters:

  1. Can we force these fungi to consume the PUR, or–given other options–will it choose to consume other materials?   That is, if we put them in the landfill, will they choose to eat paper instead of the PURs we want them to eat?
  2. What byproduct(s) if any are produced by the fungi when it degrades/consumes the PUR; and is it good/better for the environment?

I hope the scientists have come up with great answers for these questions!!

The Yale University team of researchers have published its findings in the article ‘Biodegradation of Polyester Polyurethane by Endophytic Fungi’ for the Applied and Environmental Microbiology journal.