The causes of the mortgage meltdown are diverse and complex, and anyone who points to a single cause is almost certainly wrong. But there is also little doubt that perverse incentives, as economists like to call them, played a role in creating the mess. I've written about how bad incentives can, over the long haul, drive people to do things that are ultimately destructive to themselves and their organizations -- with a little help from a great Dilbert cartoon -- and see this great list of examples on Wikipedia. I love this one:
"19th century palaeontologists traveling to China used to pay peasants for each fragment of dinosaur bone (dinosaur fossils) that they produced. They later discovered that peasants dug up the bones and then smashed them into multiple pieces to maximise their payments"
I am not among those psychologists who argues that money is a weak motivator of human behavior. Rather, as Jeff Pfeffer and I argue in Hard Facts, the problem with using money as a motivator is that it is very difficult to get the incentive system designed so it motivates the right kind of behavior and discourages the wrong kind. You could argue that the problem with using financial incentives is that they work too well rather than not well enough -- causing people to focus their attention narrowly on a small number of things and to forget more subtle and long-term issues. This is especially true with individual incentive systems -- which have been shown to lead to everything from garbage collectors in Albuquerque driving too fast, driving broken trucks, and missing many collections so they could finish their routes more quickly to schoolteachers in Chicago cheating on standardized tests -- giving students the right answers to tests or changing the answers themselves -- to get performance bonuses linked to student test scores.
Alas, the once great Washington Mutual bank seems to have fallen, in part, because so much emphasis was placed on writing as many mortgages as possible, fitness of the borrower be damned. Check out this story in the Sunday New York Times. Here is a excerpt that shows how their reward system -- and misguided culture to supported it -- helped bring down this once great bank:
MS. COOPER started at WaMu in 2003 and lasted three and a half years. At first, she was allowed to do her job, she says. In February 2007, though, the pressure became intense. WaMu executives told employees they were not making enough loans and had to get their numbers up, she says.
“They started giving loan officers free trips if they closed so many loans, fly them to Hawaii for a month,” Ms. Cooper recalls. “One of my account reps went to Jamaica for a month because he closed $3.5 million in loans that month.”
Although Ms. Cooper couldn’t see it, the wheels were already coming off the subprime bus.
“If a loan came from a top loan officer, they didn’t care what the situation was, you had to make that loan work,” she says. “You were like a bad person if you declined a loan.”
One loan file was filled with so many discrepancies that she felt certain it involved mortgage fraud. She turned the loan down, she says, only to be scolded by her supervisor.
“She told me, ‘This broker has closed over $1 million with us and there is no reason you cannot make this loan work,’ ” Ms. Cooper says. “I explained to her the loan was not good at all, but she said I had to sign it.”
The argument did not end there, however. Ms. Cooper says her immediate boss complained to the team manager about the loan rejection and asked that Ms. Cooper be “written up,” with a formal letter of complaint placed in her personnel file.
Ms. Cooper said the team manager told her to “restructure” the loan to make it work. “I said, how can you restructure fraud? This is a fraudulent loan,” she recalls.
Ms. Cooper says that her bosses placed her on probation for 30 days for refusing to approve the loan and that her team manager signed off on the loan.
Four months later, the loan was in default, she says. The borrower had not made a single payment. “They tried to hang it on me,” Ms. Cooper said, “but I said, ‘No, I put in the system that I am not approving this loan.’ ”
My question: Problems like this crop up over and over again. What can we do to stop them? Should we stop using individual incentives? I think that is too extreme, but how do we design individual incentive systems that avert a narrow and misguided focus? I think part of the answer is supplementing them with other motivators, interesting work, a system that encourages pride and praise, and leaders who set the right example -- all that press people to move in the right direction rather than the wrong direction. But when the money becomes so vivid, people don't even seem to notice long-term dysfunctions, let alone potential ethical lapses. The Enron story was much the same.
I have no magic wand and don't believe that anyone else does. There are cultures -- I think of P&G and Google -- that seem to have avoided such evils. But it isn't easy.
I once heard a group of CEOs argue that there would be far fewer ethical lapses and they would be much better at doing the right thing in the long-term if the system was changed so that they reported earnings once a year rather than four times a year. The world is pretty much going in the opposite direction, of course, with people wanting updated information constantly -- but I think it is an interesting thought experiment.