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Bankers Still Oblivious to the Concept of Risk

Five years after Countrywide, one of the nation's largest subprime lenders, hemorrhaged losses and was fire-sold to Bank of America (NYSE: BAC  ) , former CEO Angelo Mozilo remains charismatic, confident, and mostly clueless. 

"I have no regrets about how Countrywide was run ... we were a world-class company in every respect," Mozilo allegedly stated under oath last year, according to Bloomberg. He went on (quoting from Bloomberg): The crisis was "not caused by an act of Countrywide," said Mozilo, 73, according to a transcript of the deposition.

This is all about an unprecedented, cataclysmic situation, unprecedented in the history of this country. Values in this country dropped by 50 percent.

Angelo, buddy. Can we talk about risk for a second?

You're right that we experienced an event "unprecedented in the history of this country." But that applies to more than the collapse in housing prices. It also describes the absurdity of housing prices during the bubble, when Countrywide was lending money hand over fist.

Yale economist Robert Shiller began tracking nationwide home prices years before the housing bubble burst. Better yet, he created an index of inflation-adjusted home prices going back to the 19th century, which he included in his 2004 book Irrational Exuberance. Here's how that index looked up until 2006:

How curious it is, Angelo, that you are so attuned to the historic significance of the housing crash, but didn't seem to notice the equally historic housing bubble last decade. Funny how perspective and insight tends to be different when your paycheck is attached to loan growth.

Now, let's assume the housing bubble wasn't obvious. (It was, but let's assume). How does that change your culpability as a lender who made loans to people who couldn't pay them back?

Not one bit.

There are two elements to risk: The odds of an event occurring, and the consequences of that event. If an event is very rare but extremely destructive, you have to multiply those two forces together so that the risk is still taken seriously, even if you think it's unlikely to occur. If I offered you $1 million to play Russian Roulette with a gun that had nine empty chambers and one bullet, you would probably refuse to play. Even though the odds of death are just 10 percent, death is such a serious event that it's not worth the risk.

It's the same with banking risk. Even if the odds of a 50% slide in home prices were low, the impact on your business -- failure -- was so severe, that you couldn't ignore it. Yet, you did.

There's a long history of this ignorance of tail risks. Nassim Taleb recently told The Motley Fool:

All of these people end up blowing up. They say, "Oh, I only lost money once!" Like CitiBank in 1982. They blew up, lost everything made in the history of banking, but they said "You know, we only had one down quarter!" And it happens to them again, of course, in 2007 and 2008.

Or, as Robert Rubin put it in his 2003 memoir:

There is one type of financial risk, the risk of remote contingencies -- which, if they occur, can be devastating -- that market participants of all kinds almost always systematically underestimate. The list of firms and individuals who have gone broke by failing to focus on remote risks is a long one.

Angelo, you've been added to that list. (Rubin was, as well, coincidentally.) That you continue to deny it only proves your tendency toward willful blindness to reality. Which actually explains a lot about Countrywide's fate. 

Read/Post Comments (8) | Recommend This Article (14)

Comments from our Foolish Readers

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  • Report this Comment On January 21, 2013, at 3:26 PM, SkepikI wrote:

    Morgan: Maybe its because I read this article in sequence with your two on the debt ceiling, but I find it curious you don't recognize the same attributes and attitude in the US government (yes both parties, congress and administration, civil servants) about risk. You need not say so in your article, but just as clearly the misapprehension about risk carries over into behavior, particularly in frugality and hanging on to unproductive assets. I doubt Countrywide could have been saved, but it MIGHT not have been fire sale fodder and left "knock-on" landmines for BAC had it judiciously managed assets and risk by selling some early and regularly. Of course, it would have to have been populated by people who understood and recognized risks, good management and respect for capital, which was not the case, as you point out.

    The same holds true for our US Government and its debt ceiling, and I suggest you might think about that and revisit your article on Feb 15. As noted in a previous comment on that one, debt and revenue are not the only ways to raise cash contrary to many opinions offered. The US has lots of assets it could sell, some quite quickly at a premium. Just think it over, that's all I ask.

  • Report this Comment On January 21, 2013, at 3:43 PM, TMFMorgan wrote:

    <<The US has lots of assets it could sell, some quite quickly at a premium. >>

    Two responses:

    1. "Quickly" and "premium" are two words that can almost never be used in the same sentence when talking about sales. The more desperate you are to get rid of something the lower the price you're going to get for it.

    2. Are there enough buyers out there for the US gov to sell to in meaningful amounts? You can find a buyer for a $1 billion office building, but $1 billion rounds to zero in the context of the budget. You'd need to sell hundreds of billions a year to make a difference, and I highly doubt a market like that exists for specific illiquid assets like land or buildings (as opposed to Treasuries)

  • Report this Comment On January 21, 2013, at 3:46 PM, TMFMorgan wrote:

    And let me state for the record: People who buy long-term Treasuries at current prices will very, very likely lose a tremendous amount of money over the coming years, and in real terms over the coming decades. They are just as oblivious to the concept of risk.

  • Report this Comment On January 21, 2013, at 3:59 PM, devoish wrote:

    I am not selling my US assets. I am going to visit them and make use of them - one of the current owners.

  • Report this Comment On January 21, 2013, at 4:51 PM, SkepikI wrote:

    Morgan, you are not thinking here.... I can name at least two very liquid assets the US government owns billions worth just off the top of my head. Gold and Oil. Maybe they are not at premium prices now, but I think so and only time will tell. I bet if you think hard you can name a few more... oh, platinum, palladium....artwork etc

  • Report this Comment On January 21, 2013, at 5:18 PM, Sotograndeman wrote:


    The connection between your title and the content of the article is tenuous at best. You're digging up irrelevant skeletons for the sake of something to say.

    But little does it matter since Buffett was on only a week ago proclaiming that US banks have never in better shape than now and that they will not get the country into trouble again. Quite a statement from the world's greatest investor and investing mind.

    An article elaborating on the basis for his optimism and statement would have been one worth reading.

  • Report this Comment On January 21, 2013, at 6:13 PM, gtymascpa wrote:

    This same consideration of "Risk" should also be applied to banks for purposes of their size.

    The risk, is the potential devastation to the US economy when a TBTF (to big to fail) bank does, in fact "fail", or implode, etc, as we recently experienced. With all of the regulations and regulators that existed, they still managed to find a way to go into meltdown.

    This is unacceptable for the US.

    The only effective way to mitigate the risk of a bank failure to damage the US is to make sure that its size is not so large, as to be TBTF.

    Managers, accountants, auditors, will always find a way around any rules enacted, or will just plain not understand some of these highbred gadgets that the financial cowboys dream up. (supposedly to mitigate risk or enhance liquidity)

    As a CPA, I am appalled at the crap that goes on.

  • Report this Comment On January 21, 2013, at 9:06 PM, dbtheonly wrote:

    Mr. Housel,

    The concept of "selling assets" is often (usually?) joined with selling off the national parks or allowing lumbering or drilling in restricted lands.

    Equally, selling off the Strategic Petroleum Reserve ignores the very reason it was created.

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