Tuesday, 22 November 2011

Return of the Cash Cow

Yesterday news (UK Government to underwrite 95% mortgages)  brought me back, back to the good old days of unlimited lending and the first time I was responsible for the development and delivery of a loan origination system for specialist lending.

I had joined the company a couple of months before, when I was called into my Boss’ office.  He told me that our mortgage banking expert had been fired because “we have found out he is an idiot”, and they needed me to go and talk to the CEO, CTO and head underwriter of a new lender, about building them a mortgage loan origination system. TOMORROW.  So I said okay, what am I selling them? I was told that the company a few years prior had developed a bespoke traditional (i.e. 5 products) loan processing system for another client, that we just needed to update it. So I studied the user guide and Wikipedia all night and the next day I sat in front of these people who were a subprime lender, funded by a large global bank, and, it turned out, about as clueless as myself. So they bought the system. There might have been a couple of brown envelopes I don’t know about ,so I can’t claim all the credit but still, it was an achievement, in 24 hours I had become an “expert” in mortgage lending systems, specifically subprime, and I spent the next 3-4 years living up to this reputation .  

My first problem was that I had no resources. It was a very busy time and all the developers were on other projects. When I complained about this to my Boss, he told me to find some people myself.  Almost my entire team was therefore made of part-timers shared with other projects, contractors and I hired one foreign guy based on a quick look at his CV. The guy (now a very good friend whom I have worked with on several projects since) didn’t actually have a work permit, and for a number of months we paid him in one4all vouchers, so at least he and his wife could eat. Anyway we hacked the system, ripped out the old products, and introduced a new more advanced product engine that would determine the price/interest rate in accordance with an algorithm (basically the risk profile used for securitisation). Word spread about our “Specialist Lending Product” and we were suddenly working on delivering the system to 3 subprime lenders simultaneously.  

The banks we were working for were all quite similar; they would get all their business from IFA’s and intermediaries, contracted a 3rd party to service the accounts, and was ultimately looking to securitize all the loans. So you have a bank that never talks to the customer, making decisions based on a spreadsheet (portfolio risk) and a pretty unproven IT vendor developing the systems. I didn’t have much of an attitude to right and wrong in the beginning, it came later when I realised that 5% for example meant 5% of the category would default. It was just a number.  It was these kinds of businesses that were responsible for hoovering up all customers the traditional banks wouldn’t touch (although we know now they ended up with the hot potato anyway through the trade of asset backed securities), but they were allowed, even encouraged, to operate by governments and regulators that had a huge vested interest in stamp duty income and house price inflation.  Having been quite deeply involved, I find it hard to accept the one-dimensional critique of the lenders. They were operating in a regulated market where it was do-or-die, you had to lend on those terms, lend to everybody, because if you didn’t you couldn’t compete. So when the system failed, governments around the world established commissions for this and that, how we can discourage excessive risk taking and greed by the banks. Some of it is certainly reasonable but my point is they have always had the opportunity to regulate, but they needed the income (look at the state of national budgets after the cash cow disappeared). Reading the news yesterday felt like I had travelled back in time, the UK government once again encourage irresponsible lending, only this time they choose to underwrite the risk directly, no bailout necessary.  Look out for FTB stamp duty next.  Although news of growth gets you more votes than austerity, I hope the government will do the right thing and continue to focus on long term sustainable growth.  This scheme is a step in the wrong direction.

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