smallchou.com/blog

The New York Times has an intriguing look at the widespread attitude of ‘lending at all costs’ that drove Washington Mutual to incredible growth and, subsequently, disastrous failure.

My favorite quote from the piece:

Yet even by WaMu’s relaxed standards, one mortgage four years ago raised eyebrows. The borrower was claiming a six-figure income and an unusual profession: mariachi singer.

Mr. Parsons could not verify the singer’s income, so he had him photographed in front of his home dressed in his mariachi outfit. The photo went into a WaMu file. Approved.

While in retrospect WaMu’s behavior as an organization was greedy and short-sighted, there is actually very little unique about the seemingly systematic misbehavior at the bank. As I was reading about WaMu, I was struck by how the pattern of increasingly dysfunctional behavior within the organization was, in reality, remarkably similar to other organizational failures.

As Diane Vaughan wrote in The Challenger Launch Decision, there are often very logical progressions within organizations that result in corner-cutting and risk-taking. In the case of Challenger, external pressures and internal culture/politicking led to systematic deviations from procedural norms. In other words, the organization made risky trade-offs to meet its goals.

In WaMu’s case, the motivating factor was even simpler: getting paid. Considering that financial incentive was introduced both at the organizational and personal levels within the company, it’s really not unexpected that WaMu would willingly (or naively) accept unreasonable risk for seemingly greater reward.

The truth is that organizations make fundamental decisions about their own risk profiles on a continuous basis. In the cases of both WaMu and the Challenger launch, clear-headed people would argue that the risk/reward structures were measured incorrectly at an organizational level. WaMu as a company, with all of its risks, was so unlikely to succeed over time that “the bet” was clearly a bad one. In poker, we would say that it was a dramatically ‘Negative Expected Value play’.

And that leaves the question of whether WaMu executives were stupid or just personally greedy. If they made such lax decisions for the organization believing that they would be successful long-term, then we could simply label them as stupid (and incompetent at recognizing risk/reward). Case closed. If, however, they made such lax decisions knowing full well that they could likely result in significant disaster, then the only rational reason for continuing on that path would be their own personal financial gain.

Fundamentally, the issue is proper alignment of incentives – would WaMu executives have operated in the same way if their own personal financial stability was completely tied to the long-term success of the company? One would hope not.

But then again, maybe they were just actually stupid, in which case they probably wouldn’t have changed a thing.