The Oracle of Omaha has Spoken

Patricia Sherlock

The hottest question at the executive level is “When will lenders change their compensation packages for originators?” I’ve heard managers say that if someone will be the first to do it, they will follow but the reality is that no one wants to take the lead on this issue. If compensation metrics don’t change, more lenders will not survive in today’s volatile marketplace. So, why is there a lack of leadership on compensation?

Certainly, managers know that something has to be done because personnel costs account for a large part of their total expenses and with tight margins, this translates into being unprofitable. But, taking a stand on compensation is perceived by managers as risky to their jobs, especially if other lenders don’t follow suit and their originators are recruited away. Thus, nothing changes and the dynamic of paying high splits and guarantees continues on. Why won’t lenders address this critical topic? Haven’t we learned anything from the collapse of 2008?

With the 10-year anniversary of Lehman’s bankruptcy upon us, there has been much discussion about why the collapse happened and how to prevent the next one. A number of financial experts have been weighing in on the issue including Warren Buffett, the Oracle of Omaha.

On CNBC’s “Crisis on Wall Street,” Buffett explained that the last collapse and a future one is unavoidable due to basic human characteristics including jealousy and greed. “People start being interested in something because it’s going up, not because they understand it or anything else. But the guy next door, who they know is dumber than they are, is getting rich and they aren’t,” he said. “It is contagious. So that’s a permanent part of the system.”

Buffet and other industry experts contend that it boils down to human nature and our inability to learn from past mistakes. While we like to think of ourselves as logical, reasonable and that we will act accordingly when faced with warnings, this is often not the case. Time and again, a disaster unfolds even though it was fairly clear what was coming.

It turns out that there is research on what Buffett calls “human nature.” Professor Robert Meyer of Wharton’s Center for Risk Management and Decision Processes has observed that when humans make poor decisions (even when they have been forewarned), it is typically driven by three conditions:

  1. cognitive bias of optimism
  2. bias of herd thinking
  3. myopia or nearsightedness i.e. an unwillingness to invest now to prevent a future loss.

Meyer further notes that people tend to forget what it felt like the last time they experienced a disaster. He calls this a form of amnesia. While people may remember the bare facts of the disaster event, they forget the details of it. He cites the financial meltdown of 2008-2009, where there were calls to curb excessive risk-taking to minimize the possibility of a recurrence. But once the recovery happens, people have a hard time envisioning the next financial collapse and instead wrongly believe that it will not happen again.

On top of all this, when individuals are faced with a crisis situation, they tend to become overwhelmed and stick to the status quo or simply do nothing when action is required.

This raises two questions. If this is simply human nature, is there any hope that things can be changed to prevent poor decisions? And, what does this mean for mortgage banking, an industry facing sweeping changes where critical decisions must be made to ensure survival?

According to Meyer, the first step is to be aware that our cognitive DNA has these biases. He recommends that leaders employ better preparedness systems that anticipate and work around these inherent biases. The first part of this solution is to know and understand your financial numbers. Unfortunately, I do not often see a real understanding of sales performance numbers by everyone in the sales group.

Today’s mortgage environment looks very much like what happened back in 2008. There is imbalance in supply and demand plus we are experiencing generational shifts and technological advances such as artificial intelligence. These changes are like the Industrial Revolution but on steroids.

There is no question that lenders and their managers are facing difficult decisions that will enable them to survive and thrive in such a turbulent marketplace. One of the toughest issues is how to design a sales structure that aligns originators with the consumers’ interests while providing transparency and an excellent customer experience at the same time? Companies that want to avoid the financial mistakes of the past must take a proactive approach to these issues before history repeats itself.

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