Musings from the CU Suite

Written by Anthony Demangone

The duty of loyalty is a powerful thing.  In a nutshell, it says this: When you walk through those doors in the morning and begin work, you must put aside your personal interests.  Focus on what is best for your organization.

Usually, we think of board members when we discuss the duty of loyalty. But recently, the Delaware Supreme court held that officers have the same duties as directors.  While just one state, and a small one at that, Delaware generally leads the way in corporate law.  Other jurisdictions will look to Delaware when considering similar facts.  (And I'm sure every plaintiff attorney on this side of the Atlantic Ocean has that case memorized.)

But the idea shouldn't be shocking.  Corporate officers should make decisions that are in the organization's best interests. 

Today's posting really is the result of some weekend reading.  Specifically, this article in the Atlantic Magazine.  William Cohan makes an interesting argument...

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While most people welcome leverage limits as the just consequence of Wall Street’s greed, and conclude that we will be safer if these businesses are run more prosaically, there is a real danger that we have focused on the wrong problem, and will condemn our once enviable capital markets to a period of bland ineffectiveness. While lower leverage would certainly provide more of a margin against the inevitable future errors of Wall Street executives, hard limits on risk-taking might also lead to stifled innovation and slow economic growth. Would Michael Milken, at Drexel Burnham, still have created the junk-bond market—or Lewis Ranieri, at Salomon Brothers, the securitization market—if the Dodd-Frank law or the Volcker Rule had been around to curb their firms’ ability to take risk?

The problem on Wall Street has never been about the absolute amount of leverage, but rather about whether financiers have the right incentives to properly manage the risks they are taking. During Wall Street’s heyday, when these firms were private partnerships and each partner’s entire net worth was on the line every day, shared risk ensured a modicum of prudence even though leverage was often higher than 30-to-1. Not surprisingly, that prudence gave way to pure greed when, starting in 1970 and continuing through 2006, one Wall Street partnership after another became a public corporation—and the partnership culture gave way to a bonus culture, in which employees felt free to take huge risks with other people’s money in order to generate revenue and big bonuses.

People are pretty simple: they do what they are rewarded for doing. If they get multimillion-dollar bonuses by taking huge risks with other people’s money—as they still do—then they will continue to take those huge risks, and not give it another thought. To prevent another crisis, Wall Street’s top executives, bankers, and traders should once again have something close to their full net worth on the line every day—not just the portion represented by company stock or options—so that they will collectively take risk management more seriously. That’s a solution that has nothing to do with the amount of leverage on Wall Street’s balance sheets.

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A few thoughts, if I may.

1. This article is another reminder of how our credit union corporate governance model generally serves consumers well.  With a volunteer board and no stock, it is hard to make a quick buck in credit union land.  There are exceptions, of course.  I'll highlight one below.
2. Aligning the interests of individuals with the organization is key.  While people generally look out for their own interests, some are better team players than others.  Again, the more team-oriented people you can accumulate, the better.  
3. Incentives work.  If you are a CEO, do you have a clear understanding of all incentive-based compensation agreements inside your credit union?  An employee within NCUA's Office of Inspector General said that one failed credit union employed a lending manager who earned a bonus based purely on loan volume.  Not quality.  Simply volume.  As you can imagine, that credit union churned out loans. Subprime, indirect loans, mind you.  But those counted under the agreement. Again, incentives work. 

So, I'll leave you with these questions.

• How do you support teamwork and the duty of loyalty within your credit union?
• Do you have a firm understanding of your credit union's incentives that are tied to compensation? Are they in your credit union's best interests?
• Do you try to measure teamwork and loyalty in the hiring process?  If so, how?

Have a great weekend, guys.

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While we love our fellow man in the credit union industry, it is better to follow President Reagan's advice of "trust, but verify."  This article, also in this month's Atlantic Magazine, should be required reading for all loan officers. Here's a snippet:

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Alpan works through lunch most days, reading files over food from the deli downstairs. Right now, he’s reviewing the case of a grocery-store manager in New Jersey who paid $120,000 for a home whose value then jumped to $220,000. Over the course of a single day, the manager took out five home-equity lines of credit. A week later, with half a million dollars in his pocket, he walked. The scheme is called shotgunning, and Alpan sometimes wishes he was unscrupulous enough to have done it. “I could have been a millionaire,” he says, snapping his fingers, “just like that.”

One of every four files Alpan reviews contains a hardship letter. Such letters are meant to win the bank’s sympathy, but more often than not, they end up highlighting the lies the borrower once told. “I was selling cars … making $2,100 a month, and they cut my hours,” explained one borrower, though his mortgage-loan application had said he earned $350,000 a year as a regional manager for a Big Three automaker. One hardship letter that went viral around the office began, “I did a lot of coke, and now I can’t afford my mortgage.”

Alpan scowls as he plows through the files. The infinite variety, as well as the sheer tonnage, of bad behavior has clearly affected him. Among the thousands of fraudulent loans he has audited, the only common denominator is deceit. “It’s not just lawyers and pastors and CEOs who lie and scheme. It’s nurses and schoolteachers, too,” he says. “Everybody’s guilty; no one’s up to any good.”