Why Smart People Do Dumb Things—Personal Lessons from the Financial Meltdown

Posted by Bill - September 15th, 2008

How do you keep your head when all those around you are losing theirs? This has become the question for executives managing companies and people managing their careers in an age of technology bubbles, private-equity overreach, and, now, the meltdown in the mortgage market.

Failure, we like to tell ourselves, is an opportunity to learn. If that’s the case, there must be lots of executives learning some valuable lessons these days—as investment bankers make the transition from Masters of the Universe to the Gang that Couldn’t Shoot Straight.

What can the rest of us learn from the heartache and misery on Wall Street and in financial capitals around the world? To me, the most valuable insights come from those few leaders who, while tremendously creative in much of how they did business, decided that when it came to the “financial engineering,” they would sit on the sidelines.

One case in point is Hudson City Bancorp, a 140-year-old company based in Paramus, New Jersey that has managed to avoid the mortgage meltdown and continues to post tremendous results. Business journalists have discovered this quiet little outfit and marveled at its strategic insights. Its shares are up 50 percent since last August, when the credit crisis really kicked in. (A leading index of bank stocks is down 40 percent over the same period.) “Hudson City banks the old-fashioned way,” Newsweek marveled. “It takes deposits and makes mortgages to people who buy homes in which they plan to live. And then it hangs on to” the mortgages, rather than sell them in the secondary market.

Imagine the brilliance! Take deposits. Make sensible loans. Repeat over and over again, until your market cap approaches $10 billion.

The New York Times tried to unpack the secrets of Hudson’s success and offered this analysis: “The bank carefully screened loan applicants to ensure they would be able both to afford a new house and reside there, rather than flip it. And the bank demanded hefty down payments…as a cushion against any sharp drop in home prices, because it planned to hang on to the loans.”

What a formula! Make sure borrowers can afford their loans. Insist that they make a big down payment. Favor owners over speculators.

Hudson City’s mindful approach to banking only looks remarkable because so many established banks lost their minds. ING Direct, a cutting-edge banking innovator that was featured in Mavericks at Work, also managed to avoid the march of folly in its industry. The bank avoided the subprime meltdown because it stuck to simple, plain-vanilla mortgages rather than exotic instruments that sounded too good to be true (and were). The bank has written 100,000 mortgages worth $26 billion and has a grand total of 15 foreclosures. Not 15 percent, just 15 mortgages out of 100,000.

Arkadi Kuhlmann, ING Direct’s founder and CEO, is one of the most creative business leaders I’ve ever met. But he was able to distinguish between get-rich-quick industry fads and real innovation. “Every person who tries to do real innovation is going to be tempted by money, greed, acceptance, being in the middle of the action,” Kuhlmann says. “But at the core there is one fundamental difference: I know why I’m here. I want to make a difference. If I was into this just for making money, being a big accepted banker, I would have been tempted. But that’s not why I’m here. I am trying to build something that changes the business, that allows me to stay on the right side of the discussion.”

Kuhlmann’s skepticism about mortgage fads speaks to one of the unappreciated elements of strategy and creativity. Sometimes, the most important form of leadership is resisting an innovation that takes hold in your field when that innovation, no matter how popular with your rivals, is at odds with your long-term point of view. The most determined innovators are as conservative as they are unique. They make big strategic bets for the long term and don’t hedge their bets when strategic fashions change.

“We as individual leaders operate inside a cultural context,” Kuhlmann explains. “The question is, Do you want to try to influence the culture that you’re in, or do you want the culture that you’re in to overwhelm you?”

That insight applies to careers as well as companies. This past week, as the financial markets were melting down, I finished a new book called Ahead of the Curve. The British journalist Philip Delves Broughton, a one-time bureau chief for The Daily Telegraph, has published a warts-and-all account of his two years at Harvard Business School. The most riveting sections of the book describe the desperate efforts of HBS students to land jobs with the most elite hedge funds and private-equity firms—the very firms suffering today from the credit meltdown.

It’s amazing, really. The 900 students in Broughton’s class could do just about anything—and yet most of them, for reasons they can’t really explain, are all desperate to do the same thing. A student named Cedric described it this way: “We have so many choices, and yet so few people seem happy about that. It just makes them anxious. And then they make terrible decisions about their lives.”

I don’t have any fail-safe advice to help you avoid making terrible decisions about your life. But as we deal with the fallout from so many executives making such terrible decisions, the simplest advice seems the most appropriate. Figure out what you care about and devote yourself to that purpose. Stay the course, even when your colleagues wander off course. And never forget that if something sounds too good to be true—from no-money-down-mortgages to instant riches with a hedge fund—it probably is.

“When you run with the pack, what you generally see are other people’s backsides,” Arkadi Kuhlmann says. “We know why we’re here, and it’s not to copy other people’s bad ideas.”

Words to live by—in your company and in your career.

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