Rowland Hayler examines how the subprime mortgage crisis has been party affected by breakdowns in management processes.
The current global credit environment, generated partly by the US subprime mortgage market, has highlighted a significant breakdown in management processes, where a lack of control has weakened management systems and in some cases completely undermined them.
Some of the fundamental requirements for financial stability in any money market are confidence and trust, and the global market’s confidence has been significantly undermined by the inability of senior figures at some of the world’s leading banks to demonstrate or quantify the extent of their institution’s true exposure to this downturn.
FINANCIAL COMPLEXITY
One of the blocks to quantifying exposure was that many organisations were using extremely complex financial products, such as structured investment vehicles, which were repeatedly sold, broken down and repackaged. In conducting their operations in this way, the banks lost control of the end-to-end risk management process.
This loss of control began when banks started selling low, fixed-rate mortgage products to the subprime sector, creating a high risk of default once that rate period expired.
As the crisis unfolds, central banks are now trying to avoid similar situations by strengthening the regulatory framework. While this may ultimately achieve greater transparency across the money markets, it seems that individual business leaders should be looking to establish a much stronger end-to-end process view of how their organisation’s assets, liabilities and risks are tracked and reported.
OUTSOURCED RISK
Another contributing factor issue is the onward selling of debt to other institutions. This can be viewed as a form of outsourcing, providing clear advantages as an operational model. However, outsourcing – whether it be back-office HR administration activity or the sharing of a debt portfolio – needs to be carefully managed. The value of outsourcing should not be based on exporting an organisation’s existing process defects to a cheaper provider.
In 2003, BAI's Banking Strategies reported that banks were becoming increasingly selective in their outsourcing activities. At the time, Bank of America was spending about $7bn annually on outsourced vendors, with about 80% of the cost spent on 280 suppliers. However, the bank has now written-off $3bn due to US subprime and leveraged loans.
Such losses highlight the need of end-to-end processes to improve risk management and illustrate the true extent of its portfolio across its own internal and outsourced operations. For example, it would provide clarity between the mortgages sold at the front end, with debt packages sold to institutions at the back end.
CREATING VALUE
Improvements to end-to-end process extend beyond risk management, but into the creation of value.
Jack Welch, former CEO of General Electric, used the term "boundaryless collaboration" to describe breaking down the functional barriers and silos that prevent value being created on an end-to-end process basis. This view should be applied across the entire process, including internal functions (marketing, sales, operations) and external companies and partners involved in the supply chain.
Establishing a cross-functional perspective of where value is won and lost across an entire process will require a significantly different leadership mindset than is often evidenced today, especially in investment banking where the emphasis is typically on product rather than process.
When trading environments are strong, the ability to deliver profits sometimes leads to a disregard for process. In tighter business environments, this lack of transparency can lead to major problems. Where work has been weakly supervised, such as with outsourcing, the breakdown can be huge.
If business leaders want to maximise value for their customers, shareholders and employees, and minimise the chances of attracting negative headlines, it’s probably time they placed a stronger focus on how they manage value creation across their entire end-to-end processes.
