Tuesday, June 19, 2007

Sub-prime Reputation = Failure to consider the "long tail” of customer relationships.
(By Paul Allen)

Doesn’t it seem as if the mortgage business is always in the news? Well, that’s because it is. After all, the industry is connected to interest rates, demography, real estate values, state and federal regulation, tax law, design trends and personal tastes, just to name a few.

But when the mortgage business hits the airwaves and really pings a nerve, it’s about reputation and trust issues. And lately there’s been a growing perception that this is an industry of hollow promises trolling for short-term profit.

As chairman of one of the country’s larger independent advertising agencies, I think a lot about marketing claims. Probably too much. And I don’t like some of what I see in this industry. “Low or no closing costs and fees” are among the evergreen promises and part of the lure to seek financing. And almost without question, where one cost seems low, there will be another price to pay somewhere during the life of the mortgage. Which brings me to the industry’s current challenge: the sub-prime lending scandal.

Cheap, easy money makes for a powerful claim and is an intoxicating thing. For consumers, it makes the previously unaffordable seem within reach. And the current collapse of sub-prime lending practices is a vivid demonstration of what happens when the lust for a cheap mortgage transaction completely clouds the realities of long-term home ownership. Which, by the way, is really the business mortgage brokers are in (or should be) – affordable, long-term home ownership. Not pseudo-cheap, short-term, largely undisclosed financing schemes.

Just the name “sub-prime” reeks of something low. And guess what, it is. (I, for one, wouldn’t eat “sub-prime” beef). So one lesson learned here is that clever financial engineering won’t create a sustainable market if it’s constructed to feed itself, but starve its customers. Literally.

How could this happen? One reason is that the evolution of sub-prime lending from a local niche business to a national and global market ultimately shifted the incentives. Lenders transferred their risk from their own balance sheets to Wall Street investors. And pretty soon, lo and behold, no one was paying attention to the fundamental credit risk of the underlying loans themselves. Who were these people borrowing the money and could they pay it back if interest rates rose?

We now know the answer was “no.” But the most important impact of the “sub-prime” lending scandal is not losses from defaulted loans, but losses from defrauded lives. Families are losing their homes, their pride and their future belief in what they can achieve and own as part of the American dream. And that, my friends, will undoubtedly wreak havoc on the reputation of those who perpetrated the “sub-prime” model. (For some gory details on communities destroyed by “sub-prime” lending click HERE.

Despite veiled attempts to dodge accountability, the sub-prime culprits will become visible. Unfortunately for the basically decent and prudent companies in the financial services industry – and there are still many – the “ball and chain” of public distrust has gotten heavier.

It is interesting to note that some well-known institutions executed their sub-prime strategies through specialized divisions that did not bear the name of their parent brand. One example appears to be AIG, a relatively high awareness, high-quality brand that has lost significant reputational capital in recent years.

So have you heard of Wilmington Finance? They are the AIG unit that originated sub-prime loans that ignored consumer-protection issues and were “slapped by regulators.” In a web-based world affording much greater transparency, if Wilmington was “slapped”, then AIG has been slapped as well. Its reputation again tarnished. Big time.

This is only one of many similar set-ups that are easy to identify and dissect by those who are considering doing business with a lending institution.

So what are the reputational lessons here for corporate trustmeisters?

1. Keep the end consumer’s welfare top-of-mind. Transactions create outcomes between people, not just institutions. Positive reputation, trust and loyalty are in the minds of the customer, not simply in the signed contracts or the “done deal.”

2. Consider the Long-tail.
It is imperative to think through the long tail of customer relationships. Today’s purportedly satisfied customers can turn into tomorrow’s reputational nightmare. Thinking through the sustainability of a business promise over the length of a customer relationship is an imperative. How many companies do this in their quest to meet quarterly results?

3. Understand Your Reputation Value at Risk (VAR). The violations of trust that can tarnish reputation live long in customer memory. Sales-prevention could last well beyond traditional business cycles and impact future growth across your brand portfolio. So identify the risks and make sure you properly address all the issues, both the convenient and the inconvenient.

In the end, this mortgage debacle could give rise (hopefully) to a new breed of hyper-transparent players - firms who will make clear how the financing mechanism works, take steps to ensure the long-term success and viability of every transaction, and deeply understand and respect the responsibility of being in the affordable home ownership business.

1 comment:

  1. Thanks, Paul, for the excellent post!

    Checking in from Maine, where "An Act to Protect Maine Homeowners From Predatory Lending" was signed into law on the 11th of this month. The mortgage industry in Maine, as in many other parts of the country, has gotten well out of hand, and I am happy to say that the State is responding. As both a homeowner and as a co-owner of a mortgage company, I am very pleased to see some much-needed regulation coming into view. What's legal is not always what's ethical, and those two seem to be drawing closer as a result of the mess that is the mortgage industry. At least, here in Maine.

    This past fall, I worked for a very short time in a mortgage company that was not a 'predatory lending' shop per se, but its primary business was with sub-prime borrowers and the primary source of leads was from credit score 'trigger leads'. These are generated when a person clicks on the 'Get your FREE Credit Score' button that you have all seen so frequently on your browsers. True enough, you don't have to pay to obtain your credit report, but the companies that provide said report immediately turn around and sell the person's information to a wide variety of salespeople. Over and over again. This would explain the proliferation of calls from telemarketers (many of them 'mortgage brokers')that begin within 24 hours of the person's 'free' inquiry. Again, what is legal is not necessarily what is ethical.

    A confluence of events and conditions - not the least of which was my frustration with my former employer regarding the company's practices - led me to open New England Mortgage Company with a friend of mine. Our idea, at the outset, was to base our practice on integrity, honesty, and straightforward dealings. Shocking, yes, but we thought this simple foundation would make us stick out considerably from the pack, and would allow us to offer a service that we feel is actually a service, and one that we enjoy coming to work to promote and maintain.

    While getting things going in the winter and early spring of this year, we read a number of articles about the Sub-prime debacle, about transparency (see Wired Magazine http://www.wired.com/wired/archive/15.04/wired40_ceo.html for a great example), and about an Integral approach to business (http://www.wie.org/j28/). Add in a steady flow of the Reputation Garage's posts (full disclosure: my brother, Jarvis, is a Reputation Garage Trustmeister and founder)and we upped our elemental ideas about integrity to include 'radical transparency'.

    Your last paragraph hits it on the head for us and what we are trying to do. New England Mortgage Company is exactly that new breed of hyper-transparent broker that you mention. That is our goal.

    I apologize for going on a bit, but I am very excited about your post and its parallels to what our mission is. For those that are interested in reading a bit more please feel free to visit http://www.newenglandmortgagecompany.com (the "About the Industry" page may be of special interest).

    Thanks again for the post. I look forward to the next one....
    Lance Cromwell