History repeats itself. But so soon?
Imagine: The subprime mortgage disaster might have been averted, or at least lessened, had bankers done some homework.
According to a new article in the Harvard Business Review, the lessons of risky betting on newfangled securities that ride on the swell of a housing bubble were there to be learned had the people running Bear Stearns, Lehman Brothers and Merrill Lynch looked back to the savings and loan debacle of the early 1990s.
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Those leaders "had no fundamental experience in the risk," says Chunka Mui, who, with co-author Paul C. Carroll, distills the essence of business disasters at 750 companies in the last 25 years in "7 Ways to Fail Big."
The common thread is misjudgment of risk. The mistakes that qualify for a study like this are always costly, whether they result in massive layoffs, cutbacks or bankruptcy.
While the classic failures listed in this report are in no particular sequence, one jumps to the top. It is as if it were a blueprint of the root cause of the current credit crisis.
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In the 1990s, Green Tree Financial, a mortgage lender, saw a boom in mobile-home mortgages. The company made a fortune selling 30-year loans on these trailers. The mobile homes, however, had average life spans of 10 years. The company also ignored how rapidly the resale value of a trailer home tumbles after its first sale.
All of that left owners--who often weren't the highest credit-worthy borrowers to start with--with a rotting asset that was worth half of what they paid for it and heading for zero value a third of the way through the loan term. Cue defaults. Meanwhile, Green Tree reported profits based on loan origination without accounting for the likely downside--massive defaults
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Like many who were swept up nearly 10 years later, Conseco, an Indiana-based health and life insurance company, saw only dollar signs and an opportunity to expand into financial services. In 1998, it paid $6.5 billion for Green Tree, only to find it had purchased a house of cards. Conseco incurred $3 billion in write-offs and charges for its mortgage-lending division, which led to bankruptcy in 2002.
All of this might give Bank of America, which bought mortgage banker Countrywide earlier this year and has agreed to buy investment bank Merrill Lynch, cause for concern.
"If you're going to make a very large transformation in your core business, understand that you can't just be lured by great stories of other people," Mui says. "You have to understand what that new business means down to an operational level. You have to understand the downside."
Mui and Carroll's list goes on. The authors review Eastman Kodak's stubbornness toward digital photography in the early 1980s. The New York-based business was so late to embrace the new technology, which would disrupt its old business, that the stock price has lost 75 per cent of its value in the last 10 years.
They also look at companies such as Motorola, which bet on the wrong technology and the myth of merger synergies. There is also school bus operator Laidlaw, which moved into ambulance services without realizing it was leaving the transportation business for the highly regulated world of health care.
Acid spitting directed at those in charge usually follows these blunders. Boards of directors, shareholders and lawmakers cry for new rules and regulations, and they want heads to roll. The fall guy is usually the chief executive.
At least five chiefs from the U.S.'s largest publicly traded firms have lost their jobs this year because of subprime-related mistakes. More will follow. As Mui says, people are "hardwired to make mistakes."
One trick to counterbalance their nature is to institute a formal review. The authors call it a "devil's advocate," and these extra eyes should be weighing the company risks in order to keep the decision makers in check.
Had this occurred at Conseco while it was still afloat, the captain might have not sunk the ship.
