Tuesday, December 18, 2007

A Banking Christmas Carol Part 1

As all you aspiring, junior, deputy, official or otherwise economists out there know, I the Captain, write a fair amount. However, what you did not know is that during this past summer I decided to start writing a book on the housing scandal based on what I had seen behind the scenes in the banking industry. I thought it was a great idea, timed rather well, and I could churn out a good book in a short time, and make millions and then retire with Selma Hayek in the Caymans. However, after tendering the book to many, MANY publishers, I had no takers. Thus I've decided to post the three chapters I did write here on Cappy Cap so that at least you my favorite readers could read a good old fashioned Christmas story about bankers, corruption, a heroic economist protagonist and scantily clad, cheerleading banking assistants serving martini's...well maybe not the scantily clad banking assistants, but that might be added in the movie version;

Glut is a Four Letter Word

I was always under the impression that the term “president” was reserved for people that were pretty high up the chain of command. Akin to “general” or “admiral” you wouldn’t have that title unless you were more or less in command of an entire division of the company, if not the entire company itself. But the bank I was working for sure seemed to have a lot of “presidents.” Last I counted there were 11 “community bank” presidents, 3 “regional bank” presidents, 40 some “vice” presidents and one guy who I surmised was the actual “president” president.

Such a level of senior management I could understand if the bank was called “Citigroup” but the bank I was working for was no Citigroup. Matter of fact it was all of 2% the size of Citigroup. Regardless, its small size did not prevent this bank from having so many presidents.

Ultimately I concluded that the bank was very much like the militaries of dictatorships or one of those African rebel groups where seemingly everybody is a “general.” Where all the enlisted men curiously start off as “captains,” giving themselves inflated ranks and titles to boost their egos. Therefore if you filed, faxed and made the coffee at my bank you were considered a “reserve vice president.”

However, euphemistic titles were not just the symptom of a bunch of middle aged men trying to pad their resumes with impressive titles. They were also evidence of something else; top heavy management.

As far as I could tell in our division the ratio of “officers” or “bosses” to the regular ground troops was about 2 to 1. There were literally two managers for every one employee. Other banks I worked at weren’t so high, but still above 1 to 1. This runs contrary to common sense and defies the concepts of “management” and “organization.” In the military you have many soldiers under the command of one officer in order to achieve various military objectives. In schools you have many students instructed by one teacher because that way you can educate the masses efficiently and affordably. And in most businesses a manager or executive has multiple people under them for the purpose of achieving economies to scale and increasing profits. The military, the education system and the business world could not function otherwise, but this bank did. Or at least it tried to.

Looking at their income statement and comparing it to banking industry averages I found that the bank was spending nearly 40% more on salaries than was the industry. And aside from the losses they were taking from the now ever-increasing loan defaults, the primary reason for their losses was the excessive amount of labor. So naturally when they decided to hire some additional staff to help boost sales they decided to hire…

another community bank president.

I didn’t know why they hired this guy, nor did any of the other ground troops, but we were told he had a hybrid role as both senior banker and boss. So now when loans and research were submitted for review it would go to him first and then slowly up three more levels of management.

At first we were hopeful that this new guy would bring some desperately needed common sense to management. That process and procedure would be employed. That when we’d submit our findings and research he would look at them, believe them and not ask us to revise our figures. Our hopes were quickly dashed when I submitted my first report.

“Can I talk to you in my office for a second?” he asked.

Thinking it was impossible for me to get into trouble this quickly I said, “Sure.”

“What’s this?” as he threw my report on the desk. It was marked in red all over. Things he was questioning me on. Wanting more data to substantiate my findings and results. And crossing out entire paragraphs that seemingly and ironically had “too much” data.

“That’s the report for the XYZ real estate development project.”

“Yes I know that, but this right here,” he pointed at a word he circled in red.

I looked and the word “glut” was circled. Not sure what he was trying to get at, I responded, “Uh, that’s the word “glut.”

“Yes, why is it in the report?”

Completely confused by now and having no idea what this guy was talking about, I answered questioningly, “Because there is one?”

And that’s when I learned that “glut” is a four letter word.

For you see “glut,” as this newest community bank president explained to me, has a negative connotation. It meant “excessive” or “too much.” It also happened to be the Latin base for “gluttony” one of the seven deadly sins. Using the word “glut” in a report was unprofessional I was told. And that more adroit and diplomatic phrases could be used instead. Phrases such as “slight oversupply.” Or “higher than average levels of inventory.” But “glut,” now that was inciting and abrasive and over stated the severity of true housing market.

Little did I know “glut” was such an offensive word. Odd they didn’t mention it at Sunday school. And here I was thinking all those other four letter words I used profusely were the really bad ones.

But there was just one small problem. Above the word “glut” was a chart. And in this chart I showed the supply of housing for the area that the proposed development was in. And not only was the supply of unsold housing increasing, it was at an all time record high. 17 months it would take to sell out of the current inventory of housing and adding these new homes would only make it worse. This was more than 3 times the level of housing that was deemed a “balanced” market. It was the most literal, quintessential definition and example of the word glut. A more accurate and descriptive word in the entire English language and history of the world did not exist. It was indeed a glut.

Ignoring our differences over the use of the word glut, I pointed to the chart, trying to convey my point that the housing situation was something a little bit worse than “slightly oversupplied.”

“Doesn’t it concern you though that there’s 17 months supply of housing out there?”

And that’s when I discovered the true motives of our new community bank president.

“Well I’ve known these guys for a long time, they know what they’re doing.”

How stupid of me. Why didn’t I see this earlier? This was his loan. These were his clients. No wonder he was fighting me every inch of the way. No wonder he painted my report red. The report I wrote was condemning of the loan. And not only did I recommend it be declined, I documented and presented compelling supporting data. This would cost him a hefty commission and arguably lose him his long time client that generated who knows how much in commission for him over the years. So no matter what I said, this loan was going to be approved, regardless of the risks. I could travel into the future, film these guys defaulting on the loan, return back to the present and show him the footage and he’d still want it approved. There was nothing I could do.

“Well, what would you recommend we do then?”

“We’ll you’re going to have to redo this report. You highlight some of the risks here, but you don’t list any of the mitigating factors.” He continued on with a litany of things that were “wrong” with the report, but I wasn’t buying it. His dishonesty was sickening and I saw through it. All of the sudden it wasn’t that the market was bad or that the loan was bad, or that he brought a rotten deal to the table. It was the analyst’s fault for not doing a good enough job analyzing the loan. It was the economist’s fault for painting a bad housing market picture. That somehow the realities of the economy and housing market were not to blame, but that the analyst didn’t concoct enough reasons to approve the loan. Not to mention the unforgivable sin of the use of the word glut. And thinking I was too stupid to realize this was his game enraged me further.

But by this time I was too experienced to get any idealistic notions of going over his head and voicing my concerns to management. I already knew what would happen. I would approach management. Management, in a desperate bid to increase sales (and get their bonuses), would ignore my concerns and back him up like they did all the previous bankers. I’d have to revise my research and report. And then somewhere in there I’d get a lecture about not being a team player. And so, despite the near impossibility of the loan ever being paid back I decided to play ball once again, keep my job and redo the report.

However, this time something was different. Fed up with the constant fighting, the constant resistance and questioning I’d get about my research and analysis, I took a more sadistic approach. If these idiots were in such a rush to lose their money, so be it. Why stop them? If these morons wanted to get fired so quickly, so be it. Why get in their way? Any time I or any of the other economists, analysts and employees would try to stop a bad loan from going through, we were summarily silenced, if not disciplined and the end result was just a huge headache, a waste of time, lower performance evaluations, all for a loan that was going to be approved anyway. Nobody seemed to care about quality, so why fight it? It only served against our best interests. So I capitulated. If they wanted a glowing evaluation of the loan, then they sure as hell were going to get one.

The revised report may have taken over 12 hours to write but it was a brilliant work of art. The problem wasn’t so much writing what he wanted to hear, but the grueling, if not impossible task of reconciling what he wanted to hear with reality. Not to mention all those pesky facts and statistics I had dug up previously kept getting in the way. How, exactly do you look at a chart showing three times the normal supply of housing and say, “It’s all good. There’s nothing to worry about here!” It was literally like taking a plate of garbage and convincing people it was filet mignon. Regardless the end result was a beautifully crafted lie that danced around hard facts, exaggerated and focused on the positive, completely ignored the negatives (otherwise known as reality) and provided management the rationalization they needed to throw even more of the shareholders’ money away.

I was a bit proud of myself and started thinking I might actually be able to enjoy some job satisfaction if I were to approach each loan more like a game, not a serious transaction involving other people’s money. That somehow if I threw away all morals and integrity and found a way to spin every loan in the best light, I could hasten the inevitable collapse of the bank and do my part to send these inept managers to the unemployment line. Of course I wouldn’t have a job, but I figured I was on track to get fired sooner if I didn’t play ball, so why not make a game out of it? So I capitulated. And for the next several months was a good little boy and played ball. Unfortunately, there was an even larger problem; I wasn’t the only one thinking this way.

If it was just me and this one bank the consequences would largely be kept within the bank. If one bank wants to make outlandish investments and literally throw away their money, fine, so be it, that’s just one less bank. But it wasn’t just this one bank. It was industry wide.

Every bank I worked for before and after, the political pressure to approve bad loans was immense. Even as the housing market deteriorated, the pressure increased as management tried to save their bonuses and avoid a year where sales had declined. Loans significantly worse than this one were being proposed and if anyone dared point out their weaknesses and drawbacks they were fought, complained about, lectured and maybe disciplined.

Additionally, the phenomenon of having the realities of the housing market and the economy blamed on staff were not relegated to my lowly bank. In speaking with some banking industry colleagues, I found this problem was also industry wide. Bankers, economists, sales people and analysts were getting disciplined, if not, fired for failing to produce enough loans. The drop in sales was not blamed on increasing interest rates, an already oversupplied housing market, crashing prices or the fact that anybody who wanted a house already had one and therefore the market was satiated. No, it was because banking staff was not working hard enough and slacking off. It was like Hitler blaming his losses on his commanders in the later years of the World War II, when it reality his commanders were geniuses, they were just hopelessly out-supplied and out-gunned by the Allies.

Nor was the problem confined to just the smaller community banks. Larger, well known national banks were blaming their staff for the housing market. A friend of mine who also was accused of being pessimistic and not a team player, forwarded me a company-wide memo from one of the nation’s largest and most well-known banks notifying all staff that his company realized there “may” have been a “slight adjustment” in the housing market and that they were changing management styles, tacitly admitting their staff was not to blame. Of course this was in late 2007, nearly a full year into the crash.

Regardless, tempting as it was to “play ball” and just hold onto our jobs, there were severe ramifications for innocent parties outside the banking industry if everybody did. Namely American home owners. Never before had homeownership been so high. More people than ever before owned houses in America. And not only did they own houses, but for the vast majority of these people, their house was the single largest asset they owned and therefore their single largest source of wealth. But in pushing for all these real estate developments to go through these banks and bankers effectively flooded the market with such excess housing that it lowered the value of the average American’s home.

The reason is very simple. Management and bankers put their bonuses and commissions ahead of the American public. Anybody, even those without formal training in finance and economics could have looked at the market data and seen that the housing market was flooded with housing. And anybody, even those with no banking experience, could have told you the likelihood of getting paid back on these real estate development deals was near zero. But that was not the bankers’ primary concern. Their primary concern was getting that commission check. Even when faced with a 17 month supply of housing, the research to prove it, and absolutely no hope whatsoever of getting paid back, bankers still held no reservations of putting their own commissions ahead of the net worth and well being of practically all 300 million Americans, and approved such wretched deals anyway.

The effect was that they exacerbated an already bad situation. A market already flooded with housing was flooded even further. This resulted in even longer sales times for people trying to sell their houses and even lower property values further decreasing the wealth of Americans. But most damaging were the overall effects on the economy.

Because of the size and severity of the housing bubble, as well as the fact that these questionable lending practices were widespread throughout the banking industry this increased the chance the overall economy would be adversely affected and increased the country’s chances of heading into a recession. It was no longer foolish banks and sub prime borrowers that would feel the effects of the housing crash, but your everyday average working Joe that now faced an increasing chance of unemployment. And as the value of people’s homes decreased, so too did consumer confidence, and with it the economy. Furthermore, as more and more mortgage lenders filed for bankruptcy the stock markets suffered as well, tanking in fear their housing troubles would spill over into the larger economy. All of this because a bunch of greedy bankers wanted their commissions and put themselves ahead of literally everybody else. All of this because Banker Bob’s commission was more important than Everyday Joe’s solvency. And all of this because the desire of legions of senior managers in the banking industry to purchase luxury cars was more important than the overall health and well being of the American economy. It made me sick.

Sadly, there was nothing I could do. If I continued to played ball then I would be complicit in advancing the problems of the housing market and would be no better than the bankers. And if I didn’t play ball, then I’d probably get canned within a couple months. And I was in this position because bankers and management cared more about themselves than running a good business and thought nothing of putting themselves above the rest of society. So the only thing I could do was hate. I hated them. I loathed them with every cell in my body. Never before had I had such hatred for a profession or a group of people...

that is until I met some real estate developers.


Anonymous said...

That was a good read. I'm looking forward to more.

she said: said...

While I'm happy to put a light on the corruption in the banking area. And frankly downright fraud. I'm a little pissed that the greedy homeowner doesn't get any blame.

And - I'll even admit my lender tried to get me to say my investment house was my primary residence. When I told them I wasn't into doing that, and asked what happened if you got caught - I was told there was virtually no policing. The lenders didn't have staff for that. When I pressed further, they finally told me it was lender fraud. So I know full well the fraud involved in the industry.

But for every story like that, I know tons people who tapped every bit of equity from their houses to buy jet ski's and other luxuries they could have lived without. They are not blameless. They were equally greedy.

Captain Capitalism said...

One point that has never been made by anybody in the media to my knowledge is how bankers had influenced the supply side of the equation. They only look at how banks lent money out and artificially drove up demand.

Nobody looks at how bankers and banks PERMANENTLY flooding the market with supply.

Anonymous said...

Good read, I am looking forward to what you write on the real-estate developers, especially since I have plans to become a big developer someday in the future (I want to become a big resort developer and marry Ivanka Trump and we can build skyscrapers together :) that's probably a fantasy though, but you never know :D ).

she said, yes I truly don't understand these people who leverage their homes to buy all these extra luxuries. I could understand say if you are a die-hard videogames and sports fan and desperately want a plasma screen TV, so you use your home to buy ONE plasma screen TV and THAT'S IT and you concentrate on making the payments each month to pay it off, until it's paid off, and you enjoy it plenty, that I can see, but not leveraging your home to buy SUVs, plasmas, jet skis, etc...I have a friend who knows some people who are about to lose their home because of this, they have like two expensive cars, two jet skis, two snowmobiles, and other stuff, and are like three months behind on their mortgage, last I heard they were seeking help from family members.

People could avoid such trouble so simply!!

Captain Capitalism, keep pitching your book to publishers, plenty of authors have had to pitch to tons of publishers before getting accepted.

If you can't get one to accept it, maybe you could get a PDF distribution for free online, which then might lead to a published distribution in the future if the PDF version becomes popular...? (depends on how long the book is I'd imagine).

Good luck.

Anonymous said...

A good read, captain. I too, am looking for more.

Unfortunately, this dishonesty and greed is not limited to the banking game - we have the very same thing happening in the company for which I work, a major computer hardware, software and services company.

Basically, you can't tell the truth to anyone in the management chain - the whole 10 layer management chain above your direct manager spoon feeds (false) positive spin and blocks any truth that isn't positive because that's what the next level wants to hear. The execs running the company never see what's wrong with their strategies and decisions because they're totally isolated from reality.

If you tell the truth, you get your career destroyed and you get ignored anyway, so that's a verse from the same hymnal you're singing from.

The motivation is the same - greed, bonuses and stock options. Our execs have been global resourcing everything that can possibly be moved with no regard for service quality, labor productivity, communications skills and the basic ability to do the job, then cutting as much US resource as possible regardless of impact to the business. This is simply to cut labor costs, so the execs get their bonuses and stock options for the short term.

Like the banking industry, there will be a day of reckoning at my company, they are propping up the short term results at the expense of long term viability of the corporation.

Anonymous said...

It reminds me of the famous phrase "creative destruction" from Joseph Schumpeter. The economy needs some creative destruction right now to take some of these idiots out of the market. Unfortunately, the government and the Fed is trying very hard to avert recession and rescue the bankers. Let's just hope that the bankers will get their lesson some time.

CapitalBabs said...

interestingly enough, it reminds me of a bit from the Wizard of Oz (not the movie version) where there are 24 Generals and 1 Private.. at the end of the bit, the Private figures out that he's the one who DOES everything so he can pretty much call his own shots. You'd like that part...

Anonymous said...

You would probably have to self-publish to get this into printed circulation. Either that, or find a very small independent publishing house. The big guys aren't going to want to buy what you're selling.

That said, I think it's a very interesting and basically well-written chapter. I'm sure a good editor could make it even better. Can't wait to read the rest.

Carlito said...

Good read Cap! thanks!

Anonymous said...

I'll just echo the previous posters. This is great stuff. The more I read about this sort of thing, the more I think about how much of an influence corporate culture and incentives have on overall economic performance. Unfortunately, it's almost impossible to quantify that sort of thing or even model it with anything more than completely arbitrary fudge factors, so I doubt anybody will do any actual research on this even though it's certainly of enormous importance.

Anonymous said...

Good read Cap'n. I figured as much years ago. I play golf with some bankers and man are they proud about how the sales job they've done. I've spent the last couple of months showing people how to get out of debt and refi the ARM they fell for. Grandpa always said, "Stay out of banks boy, the only thing sell is debt."

Steve said...

I enjoyed this. Can't wait to read the rest. Keep trying to get it published as I want an autographed copy.

Anonymous said...

Is there an email where you can be reached? I am an editor at a magazine and am interested in your writing.

Captain Capitalism said...

Sure, shoot me an e-mail at


Be sure to copy and paste, it's CAPTcapitalism@yahoo.com

Not CAPTAINcapitalism@yahoo.com

Anonymous said...

I thought banks had more vice presidents for the purposes of signing contracts (non-officers can't legally represent the bank or something). Of course, the banks can still be overstaffed and bloated...