The American financial meltdown has opened up a lot of dialog addressing various questions that desperately need answers. How could this happen? How could it go on so long? Will we ever recover? Perhaps we are part of the way to some answers by the time this column is published. I contend that the answers will in part involve some measure of information management - after the large measure of realigned priorities.
How Did We Get Here?
Motivated to simply get mortgages out the door, financial institutions repeatedly lowered standards. Agents pushed paper in the market knowing full well many of the loans had little chance of being repaid. Clearly, an Enron-style euphoria took over at some point. This is easy. I wrote $1 million in mortgages today! You wont believe this one.
So, how did such toxic mortgages become so common? Arent these financial institutions motivated to receive the payments on the mortgages? Not really - not when they sell the mortgages for present values that approximate full payment. In other words, let someone else hold the bag. The problem is, while the clever folks on the inbound side were writing the mortgages and the clever folks were selling them, there had to be buyers - and on the outbound side many of the buying institutions also happened to be the same selling institutions! While toxicity was going out the back door, it was coming in the front door.
The complex packaging of loans that had been subdivided into little pieces (called tranches) elevated the valuation of some pieces to that of some of the better loans in the package. This made it difficult to tell what was being bought. You would think prudence would be in order, given that the financial buying institutions were selling in the same fashion, but within the companies, the back room didnt know what the front room was doing and vice versa.
Or maybe these financial behemoths had grown so large and important on paper that they believed they could not fail or would be saved somehow. Some won at this level, and others did not.
What Can Be Done?
Many lives have been affected, and our grandchildren may still be paying off this one. As we work to get back on track, we must first get a handle on what our priorities are and if they are acceptable. Without executive commitment to and sponsorship of acceptable priorities, this certainly could happen again.
Next, we should realize that visibility and transparency inside our financial institutions is there for the taking with information management.
In considering the many nonfinancial institutions that I deal with that sit between sellers and buyers, the ongoing challenge is fleshing out the numerous potential deals into take it/leave it categories supported by business intelligence (BI). If implemented properly and supported by data, the technology exists to mine the offers and consider factors such as demand, location, temperature and other product requirements, warehouse space and price. Technology also exists to suggest a recommended decision with confidence. Without compounding bad decisions, companies that make informed decisions based on information from their BI systems have healthy bottom lines.
Financial institutions have been slower to adopt such technology, and I believe I know why. If clean data is not captured and integrated, there is nothing valuable for the technology to work on.
It all starts with the common refrain I find myself saying daily in my consulting or training activities: Get the data act together first. In the context of acceptable risk determination, with no further bailouts looming, institutions will need to bring data to bear in two areas of the business: 1) the business (mortgages) they write and 2) the packages they buy. The mortgages written by the institution will need to be tighter as the buying market for toxic loans dries up. Supported by data, toxic loans will no longer be able to be sold. Institutions will hold the bag.
However, I believe this all starts with the market controlling itself in terms of the packages they buy. Full loan lineage within each package must be made accessible. In our business, we call this metadata. It needs to consist of:
- Who took out this mortgage initially?
- What hands did it pass through before coming into the package being presented?
- What is the probable distribution for how each loan or tranche will be paid off by the mortgagee?
- What is the probable distribution for repayment of the package?
- Does this fit my current risk/reward profile? Just because something is available does not mean it is beneficial.
Full visibility into exposure and liquidity is going to be a necessity. Getting the data act together in financial institutions will not be an overnight sensation, but neither was this mess created overnight. With realigned priorities, the financial industry competitive battlefield will move to the information front, where most industries are today.
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