Monday, June 1, 2009

Lender Groupthink

Here’s an excerpt from Michael Skapinker’s opinion piece in the Financial Times, “Diversity Fails to End Boardroom Groupthink”:

Disagreeing with the company’s direction is hard enough. Doing so when an entire industry is going in the same direction is harder still. It is not just boards that suffer from groupthink; entire sectors do. The banking industry did.

Any investment banking chief executive who had listened to a director’s warning that complex financial instruments spelt trouble would have been in trouble himself. As Peter Hahn, a fellow at Cass Business School, told the Treasury committee: “If one of those banks in 2005 decided to be more conservative and hold back in their activity, they more than likely would have had their CEO and board replaced in 2006 for failing to take advantage of the opportunities.”

The implication is that we should heed the advice of dissidents, but real life is not so simple. In the 1980’s a lender I worked for had losses in Las Vegas, and as a result of that experience and my general distrust of low constraint markets, I believed Las Vegas was a dangerous place to lend. Today, I’m right – lenders who made loans in Las Vegas after 2005 are going to take losses. But, I was wrong for 20 years. 12 month change in employment growth is a good proxy for the health of CRE in a market, and the chart below shows went went on in Vegas:


CRE loans in general went through an extended period of virtually no losses, and the lenders making speculative land development, condo, and aggressively underwritten loans enjoyed an extended run of success. In at least some cases more conservative lenders decided to join the party at the end, and are now paying the price.

I discuss how difficult it is for credit officers to go against the flow in the post below:

Fox Guarding the Henhouse: Bear Stearns Risk Manager Now at the Federal Reserve