IF CAPITALISM TRULY ENCOURAGES FREE markets, open competition and the pursuit of profit, then why has the industry found itself tangled in an ever-widening web of government regulation? Did a few industry participants, in the immortal words of Wall Street movie character Gordon Gecko, overly embrace the concept that "Greed is good"? Or more to the point, do lawmakers and regulators perceive that to be the case? Worse yet--does the industry now find itself in a situation where a segment of its own customers feels exploited? Has our industry not done enough to protect an invaluable asset--the public's trust? Or have others overreacted to isolated incidents and anecdotes at the expense of overall well-intentioned financial services organizations?
Prior to the Great Depression, the U.S. economy had relatively limited government intervention and flourished largely unchecked. However, that single seminal event influenced the role of government and created an environment in which regulation became an acceptable means for achieving economic and social objectives.
This evolved even further after President John F. Kennedy outlined his thoughts on the Consumer Bill of Rights and launched a wave of consumer-protection legislation. For the financial services industry this has led to what today appears as a puzzling mess of federal, state and local laws, rules and regulations designed to "protect" the consumer.
Over the past decade, challenges have emerged as the industry quickly evolved with multi-jurisdictional lenders aggressively pursuing market share. Poorly conceived incentive-based compensation structures and the relative ease with which participants could move in and out of the market created an opportunity for public distrust to develop. Each isolated transgression that became public, in its own way, helped lay the foundation for things to come--progressively more regulation by an increasing number of governmental authorities.
For the financial services industry overall, the complexity of financial transactions and political sensitivities to problems experienced by constituents produced substantial regulation designed to supplement the operation of free markets and to support customer protection. Would regulation have been less onerous if the industry had done a better of job of protecting its reputation for stability, quality of service and trust?
Unquestionably, the industry has made positive inroads toward educating the public, isolating bad actors and improving its image. However, steps such as pursuing a national predatory lending standard or satisfying minimal compliance requirements do not of themselves constitute a long-term strategy for addressing the broader image issues facing the industry. Smart organizations that quickly recognize this will find themselves with a golden opportunity to increase shareholder value by earning the public's trust through responsible leadership in the marketplace.
Why being right matters
The public focus on the mortgage industry's behavior affects all participants. Instead of being congratulated for providing broader access to credit with new mortgage products and enhancing homeownership opportunities, the industry increasingly finds itself having to react defensively. This defensive posture forces even those firms that consistently make a sincere effort toward serving the best interests of the customer to expend resources otherwise earmarked for more productive purposes. To a certain degree, some consumers are beginning to question their confidence in what historically has been perceived as a trustworthy industry.
And who can blame them when articles and politicians constantly question the tactics of some industry participants, especially those serving the nonprime mortgage market? Clearly, any instances of consumer dissatisfaction must be well-managed throughout all levels of the mortgage industry before they lead to a more difficult situation for all participants.
Taking a minimalist approach designed to avoid regulatory scrutiny does little to enhance a company's reputation or reduce the possibility of brand damage. Moving to the next level requires building in the public's mind an image of superior value and trust. This entails a companywide commitment to constantly meet and exceed customer expectations.
While these values are embraced at the executive levels of most large organizations, the requisite behavior does not translate often enough to production personnel or brokers who play a large role in servicing the very customers a market-leading organization seeks to attract and retain. Market leaders must expect from themselves, and each participant in the mortgage process, a higher standard of performance that addresses the issues relevant to all stakeholders.
Smart companies know that embracing a strong public commitment to act responsibly does many favorable things for a company. It creates brand loyalty; favorably influences customer preferences; attracts, retains and motivates quality employees; effectively reduces avoidable risk; and minimizes the impact of crisis situations. Corporate reputations and brand images are major shareholder assets that can be damaged easily--but not readily repaired. Long-term success depends on effectively managing these resources in a dynamic environment. Companies that successfully navigate these waters earn and maintain sterling reputations and strengthen brand value, key elements that allow them to thrive as well-respected market leaders.
As novelist Stephen King said, "A product is something that is made in a factory; a brand is something that is made by a customer. A product can be copied by a competitor; a brand is unique. A product can be quickly outdated; a successful brand is timeless."
Today more than ever, creating lasting shareholder value requires devising effective strategies to address the needs of shareholders and geographic communities, consumers and various interest groups. This challenge requires business leaders to apply a sound ethical compass together with the clarity and focus needed to make and follow through with difficult judgments.
Leaders set the ethical tone in their businesses. As such, they play the biggest part in helping to gain and hold the public trust. By the same token, a company's failings stem from, by and large, those of its executives. Jeffrey Garten, dean of Yale University's Yale School of Management, New Haven, Connecticut, stated provokingly in the Oct. 30, 2002, issue of Financial Times: "Top business executives, like leaders in any profession, are reflections of what their societies want from them. They come from those societies, exist to serve them and cannot stray too far from public expectations in order to succeed in the long run."
Leveraging the future
The recent propagation of mortgage regulation signifies a bona fide opportunity for innovative organizations to seize leadership roles and create sustained value. Strict compliance with the law does not by itself equate to acting responsibly. Compliance merely sets the minimum requirement for doing business. Focusing too narrowly on cost-effective compliance and not enough on broader public expectations constitutes an inefficient market strategy. Notably, the proliferation of consumer credit regulation indicates changing public expectations and signals an opportunity for the savvy business leader to move an organization to a higher level in the hierarchy of public opinion.
Washington, D.C.-based AARP has been one of the most active voices pushing for anti-predatory lending legislation. Nina Simon, a senior attorney with AARP Foundation Litigation, offers a perspective on the changed public expectations for lender behavior.
"Good faith and fair dealing should be the standard for all customers," she says. "Outreach and special affordable-lending programs should be the icing on the cake of responsible lender behavior. It is not enough to simply get families into homes. The lender should be focused on a family's ability to stay in their home in the long run," Simon adds.
In Georgia, where AARP and others were successful in pushing through one of the most restrictive anti-predatory lending laws (later amended to correct concerns raised by the secondary market), a former elected official sums up his perspective on the legislation: "The predatory lending bill that came before us caught fire because of a coordinated effort between the NAACP [National Association for the Advancement of Colored People] and AARP. If you want to scare almost any public official, have these two groups marching outside your office, stirring up the public against you," observed former Georgia State Senator Robert Lamutt.
"I was one of two senators who stood up against this terrible law with a simple message: Economics 101 says that if you limit price or increase cost (and overregulation is an additional cost), you limit supply," he says.
A growing patchwork of anti-predatory lending laws has emerged as one of the most obvious compliance risks facing the mortgage industry. Under many such laws, mortgage lenders are given the burden of determining whether a loan benefits the borrower through provisions known as "net tangible benefit." These types of provisions imply that the public expects lenders to consider the consumer's best interest throughout the mortgage process.
Without a doubt, the ongoing debate among consumer advocates, mortgage businesses and government entities suggests that regulation entails high economic stakes for all parties.
This raises some intriguing questions regarding value creation, risk allocation and mitigation, risk-reward trade-offs, regulatory intervention, desired market behavior and the proper role for the lending community. Lenders will have to think imaginatively and act decisively in order to build consistent and sustainable shareholder value and preserve customer loyalty. Most important, they must take the lead in defining and establishing the long-term role of the mortgage industry before others put their weight behind a less-compelling future.
Five far-from-easy steps
In the December 2004 issue of Harvard Business Review, Simon Zadek, a senior fellow at Harvard University's John F. Kennedy School of Government, Cambridge, Massachusetts, identifies five discernable stages in how businesses respond to social expectations (see sidebar). According to Zadek, companies initially react defensively to unexpected criticisms or unforeseen social expectations. In time, the first, defensive stage yields to a second, compliance stage, at which point the company establishes a formal policy that it recognizes as a cost of doing business. At this point, securing the company's reputation and reducing litigation risk provides the only perceived value for complying with social expectations. At the third, managerial stage, the company accepts as permanent the change in societal expectations and recognizes that compliance requires delegating responsibility downstream to business managers for operational implementation.
Arguably, in the case of anti-predatory lending legislation, most mortgage businesses are presently situated somewhere between the compliance and managerial stages. They have concluded that adhering to anti-predatory lending laws requires enhancing centralized controls, thus necessitating marginal investments in management, operations, legal expertise and technology.
Yet surprisingly few mortgage businesses view the changing regulatory environment as offering an opportunity for growth through competitive differentiation. Again, according to Zadek, leading companies recognize and seize the opportunities that result from changing public expectations.
At Zadek's fourth, strategic stage, the company learns how to create and institutionalize competitive advantages by integrating social objectives into core business practices in a fashion consistent with company goals. In the final, civil stage, leading companies promote collective action to safeguard their increased market share.
As an example of the strategic stage manifesting itself in action presently, consider the National Community Reinvestment Coalition (NCRC), Washington, D.C., which represents hundreds of community-based organizations across the United States. NCRC operates by the philosophy that working with lenders is good business.
Lenders such as Citigroup, HSBC and Bank of America have responded by joining NCRC's Banker/Community Collaborative Council to take advantage of the conduit that NCRC provides to community organizations and emerging markets. "Providing new services in new areas is good business. It is both profitable and the right thing to do," says David Berenbaum, NCRC's executive vice president for programs. "We work toward creating an environment that is helpful to all lenders and allows them to conduct business so that equal access to credit and consumer choice abound."
Zadek's argument may seem unconventional, but it provides a reasonable assessment of a rapidly changing situation. Surely the first three stages bear a remarkable resemblance to the recent experience of most mortgage businesses, and naturally lead to questions on how best to manage a company to the fourth and fifth stages in Zadek's paradigm.
Subprime to sublime
Many mortgage companies expend significant resources in an effort to comply with regulatory and legal requirements. Yet most view these expenditures as an essential cost of doing business, not as a source of growth with a meaningful return on investment. However, if a mortgage business understands, engages and responds to the concerns of all constituents involved, it can gain the support and insight needed to convert opportunity into a sustainable and profitable market advantage.
While no easy solutions exist for creating strategic advantage in response to anti-predatory lending pressures, some common principles can be employed to help generate value while aligning business and public interests.
* Listen, learn and innovate. Successfully engaging controversial market segments requires lenders to understand the concerns of consumer and community advocates, some of whom may distrust the mortgage industry. Too often, lenders react to consumer complaints with empty gestures and marketing campaigns designed to neutralize critics. Such responses are interpreted cynically.
Mortgage entities can find more constructive solutions by regarding these consumer groups not as a threat, but as a source of information about particular market segments' needs and misgivings. Given such information, mortgage businesses can develop profitable strategies consistent with public objectives to make housing more affordable for underserved markets.
* Bring into play untapped corporate assets. Individual lenders have had difficulty changing perceptions that certain mortgage products, in general, harm underserved market segments. Some borrowers in these segments generally do not understand or appreciate risk-based pricing of mortgage products and simply conclude they are being discriminated against. On the positive side, many lenders contribute meaningfully to these same communities in ways not readily recognized by critics. Identifying and publicizing those contributions could help such companies build additional trust.
* Be an active participant in designing the market. Controversial markets, such as the nonprime market, are almost be definition in flux. Generally, the conditions that promote a well-functioning market either do not yet exist or are in dislocation. Consequently, a new market structure must be developed by participants and regulators.
In the case of the modern mortgage market, the confluence of interstate banking, product proliferation, a robust secondary market, rising house prices and a historically benign rate environment has yielded a rapidly changing industry. Lenders, through involvement with organizations like the Mortgage Bankers Association (MBA), must actively participate in shaping the market by engaging industry critics and setting the bar high on industry practices.
* Reach beyond the law. Business interests do not necessarily have to conflict with the public good. In a sense, mortgage businesses unduly focused on regulatory compliance are, to some degree, missing the point. Lawmakers tend to look for social results--e.g., more affordable access to credit, eliminating discrimination, protecting homeownership--with regulation seen as an enforcement tool for achieving those goals.
Consequently, simply complying with the law undermines the benefits of proactive responsible behavior and distracts lenders from creating competitive advantages through market differentiation. For this reason, regulatory compliance should be a key element and not the end goal of acting responsibly.
* Rethink incentive-based compensation. Some of the current incentive-based compensation structures do not readily correlate with responsible behavior, particularly when high-turnover production personnel or brokers are the primary contact points with the customer. Compensation structures should promote responsible employee- and vendor-retention plans; stronger corporate reputations; brand value; customer loyalty and quality loans through more appropriately designed reward systems.
* Rationalize the fee set. Few issues infuriate customers and their advocates more than a lack of transparency for loan-related fees. The absence of a standard, rationalized fee set increases the probability of loan compliance errors and unplanned liabilities. Being right on compliance issues matters all of the time, not just some of the time. Use of a standard, rational fee set will simplify and clarify the origination experience for customers while reducing the chance of compliance violations for lenders.
The bottom line
Industry leaders must take it upon themselves to devise and implement strategies responsive to the needs of both shareholders and the public. The mortgage industry should function in a manner that balances the interests of all stakeholders in order to enhance credit availability, improve customer satisfaction and provide an attractive return on investment.
In the future, true market leaders will focus their efforts on nurturing reputations of trust, building brand value, engendering customer loyalty and increasing long-term shareholder value by consistently doing the right thing. Those organizations that exhibit strong leadership, innovative thinking, decisive action and nearly flawless execution will be the most admired companies in the industry.
The Five Stages of Organizational Learning Stage What Organizations Do Why They Do it Defensive Deny practices, outcomes To defend against attacks to or responsibilities their reputation that, in the short term, could affect sales, recruitment, productivity and the brand Compliance Adopt a policy-based To mitigate the erosion of compliance approach as economic value in the medium a cost of doing business term because of ongoing reputation and litigation risk Managerial Embed the societal issue To mitigate the erosion of in their core management economic value in the medium processes term and to achieve longer-term gains by integrating responsible business practices into their daily operations Strategic Integrate the societal To enhance economic value in the issue into their core long term and to gain first-move business strategies advantage by aligning strategy and process innovations with the societal issue Civil Promote broad industry To enhance long-term economic participation in corporate value by overcoming any responsibility first-move disadvantages and to realize gains through collective action SOURCE: Simon Zadek, Harvard Business Review, December 2004
Tim Green is chief executive officer of Mavent Inc. in Irvine, California. He can be reached at email@example.com.…