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A Political Note February 4, 2008

Posted by robzel in Business, Democrats, Election, Politics, Politics & Elections, Republicans.
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I have purposely avoided addressing overtly political issues in this blog. While many political issues obviously have a huge impact on business, I feel there are also too many political issues that are of a deeply personal nature that I did not want to address in this type of forum. However, after observing the current drive for our next president I felt I needed to provide at least a brief comment.

This is the first time since I was of voting age where I feel good about the pool of candidates. Regardless of party affiliation, each of the remaining candidates is intelligent, accomplished, well spoken, and for the most part has a well considered and viable platform. At this point, I really don’t know who I want to vote for. That is a good thing; the choice right now is too difficult.

What I think is interesting is that during what are very difficult times, there is what seems a renewed interest in the political process in America. What is emerging from a state of fear caused by the war on terror is a renewed optimism. Each of the candidates represents a new path and a new way forward that people are ready to rally around. Each of the candidates also seem to have the capability to channel this hope and optimism into actions to help propel the US to new heights.

While there are economic storms to yet weather in the US, there is a bright light on the horizon. Now, to figure out who I want to vote for….


FICO Score and the Downfall of the Subprime Industry February 1, 2008

Posted by robzel in Business, Housing, Mortgage, Risk Management, Uncategorized.
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Chances are if you ever applied for credit, you have come across your FICO score. It may have been called your credit score or even more simply your score. With very few exceptions these are one and the same. When used the right way, FICO score is a very useful tool for helping a lender make a credit decision. However, the score was never designed to support all of the ways that it used today. Not only is the score used for underwriting, but it also used to make decisions about insurance premiums, by employers to make hiring decisions, and investors to determine how to price pools of assets. It is this last use that I want to expand further.

Recently, I did some consulting for an investment firm. Their simple question to me was, “how come FICO score doesn’t work anymore for sub-prime mortgage assets?” The simple answer is that FICO score does work, but the way it has been used to evaluate mortgage-backed assets goes beyond what the score was designed to do as a stand-alone tool. Using any type of scoring tool such as FICO score requires an understanding of what the score is designed to do, what limitations exist on the scores usage and above all careful monitoring and vigilance.

Simply put, FICO score is an evaluation tool designed to predict the performance of an individual who applies for a loan or who has an existing loan. While the exact algorithm and development is proprietary, the generic form of the score is designed against the general populations that exist at each of the three national credit bureaus. The score has become the de facto standard that defines whether a person qualifies for a prime loan, sub-prime loan or does not qualify at all. During times of economic stability, the score can provide accurate predictions of future loan performance. During times of economic instability, this same score can seem to stop working.

The reality is FICO score still works. However, a given score no longer has the same performance level. As many investors have found, sub-prime assets with a FICO score of 620 no longer perform at the same level they did a year ago. While the deterioration in performance will vary by portfolio, in general the same score will perform worse; e.g. a 620 might perform more like a 600, a 600 like a 570, etc. In fact performance year over year has gotten worse across all score ranges. The shift is most severe at lower scores, and much less severe at higher score levels. However, it is still true that higher scores perform better than lower scores. So, on a relative basis FICO score still ranks! It is the shakeup in the housing market and the shaky economic times that has caused this shift in performance.

So, FICO score can still be used as it was designed to measure the probability of default, but even for this usage it needs to be calibrated to accurately reflect the current performance of any given portfolio. What FICO score was not designed to do was measure the amount of loss given default. The rapid changes in housing values in almost all markets have caused the severity of losses to climb well above what almost all lenders anticipated. With many years of rising housing prices lenders assumed that even if they were forced to foreclose on a property, they would be able to recoup at least part of their loan because of housing appreciation. This clearly was a bad assumption.

To summarize: Like any tool FICO score (and other similar scoring tools) can be very useful when used properly. FICO score was designed to predict future delinquency levels of groups of individuals on various loan products. When using any score based tool, it is imperative to monitor and calibrate performance by score. This is especially true during times of economic change. Finally, FICO was never designed as a tool to measure asset value or the magnitude of loss. It is only a way to determine the probability that the loss may occur.

To reflect back upon the current mortgage market it is easy to see how simple rules and uninformed decision making led to the current situation. The question, “how come FICO score doesn’t work…” is naïve for anyone who understands how scores work and how to underwrite loans. And yet, billion of dollars were securitized and traded based upon the misuse of this tool and a lack of fundamental understanding of the value of the value of mortgage assets and the sensitivity of these assets to changes in economic decisions. See my blog entries:



What is the solution? Get the right people on board at both the rating agencies and in the securities firms who can properly evaluate and represent the value of these assets. One of the principles of an efficient market is the notion of having the right information to make investment decisions. I can’t help but think that if the right information was available, our current mortgage crisis and subsequent economic slowdown might have been averted.

Not Just My Opinion October 22, 2007

Posted by robzel in Business, financial companies, New York Times.
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Paul Krugman’s editorial in today’s NY Times echos what I wrote about the economy last week (http://www.nytimes.com/2007/10/22/opinion/22krugman.html?_r=1&ref=opinion&oref=slogin). I do admit, I like his explanation better, but he has been writing a lot longer than I have.

On the front page of the Times is a related story about how the lending crisis has created an aggressive real estate auction market. As the article points out, “It’s a symptom of the foreclosure crisis…and it’s cause for concern that …areas that are already hit by investors who are buying up properties to rent them out, which makes neighborhoods less stable than owner-occupied housing”. (http://www.nytimes.com/2007/10/22/us/22auction.html?ref=us)

It seems this mortgage crisis may have some legs.  Of course the contrarian in me has to point out that some buying opportunities may present themselves once the dust settles.

The Future of the US Economy October 17, 2007

Posted by robzel in Business, financial companies, Housing, Mortgage.
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Like ripples in a pond, the downturn in the US mortgage market will have effects that expand into other areas of the US economy.  This holiday season will likely be especially brutal as the ability to use increasing home values and therefore home equity to fuel consumer spending has all but disappeared.  It seems we should have seen this coming; the reality is many people did.  The issue was not that a slump in housing would occur, but rather the timing.  Most economist using tools developed for the analysis of past housing cycles did not anticipate the impact of the secondary and derivative markets in supporting the continued growth in mortgage lending.  There was no way to predict these impacts, because much of these derivative products never existed until recently.

To understand the impacts these secondary markets had on the mortgage industry is illustrative to follow the path of a typical mortgage: The process typically starts with a mortgage broker.  The broker gathers information from the borrower including personal information, income, and property information.  Since the property is used as collateral, an appraisal is typically ordered and is incorporated into the underwriting process.  Based upon the information gathered, loan terms are generated which include not just income and property information, but also includes an evaluation of the applicants credit bureau.  Many lenders choose not to keep these loans on their books, but instead sell them to Wall Street companies.  The advantage to selling these loans is the ability to generate cash more quickly than gathering payments from customers over time.  The amount received for a loan is based upon many factors such as the type of loan (fixed vs. variable rate), duration of the loan, credit quality, etc.   By selling these loans, the selling company frees up more cash and thereby the ability to go out and generate more loans.  As long as a buyer exists for an originated loan, a selling company has almost unlimited potential to continue to generate loans. 

The process still continues on: Firms buying loans strip them into components for sale to investors.  Some examples are selling principle and interest payments as separate products, selling future originations, etc.  Underlying all of this are rating agencies that were supposed to give some estimate of the probability that the derivative products created might default.  If you have been following this story in the press, you know that the rating agencies have missed the mark. 

To summarize, the secondary markets did what they were supposed to do in one sense; they created liquidity which enabled the housing boom to occur.  However, in another very important sense these same markets created an extreme distortion in the mortgage market.  The underlying principle in any efficient market is having good information.  In the case of the derivative mortgage market information was extremely distorted, kind of like smearing Vaseline over some thick coke bottle eyeglasses. In the ‘old days’, when a bank actually underwrote and managed a mortgage loan the credit quality of an applicant and the asset quality of their home were the primary concern.  Secondary markets refocused this view to originating as many saleable loans as possible.  Over time, underwriting became less of a concern as there were buyers in the secondary markets for almost any type of loan originated.  Again these buyers were less concerned about asset values or credit quality but rather returns and income streams which supposedly were factored into the rating of each derivative product.  In this market cycle products began to be created where an applicant did not even have to provide proof of income and other information.  This type of lending was unheard of in previous mortgage cycles.  In latest cycle there were buyers for these ‘no document’ loans and other types of non-traditional mortgage products.

Irrational exuberance was the term used to define the Internet stock bubble.  The lesson from the fall internet stocks was a loss of sight of investment fundamentals. Investors were not interested in whether a company had any real intrinsic value or even much future potential.  Instead a heard mentality prevailed with everyone scrambling to trade on the latest rumor or a tip from a friend.  The fall of the mortgage market has many parallels to the fall of Internet stocks.  The real question is whether lessons will be learned or will history repeat itself. 

The Decipline of Managing Risk October 3, 2007

Posted by robzel in financial companies, New York Times, Risk Management, Zelcom Group.
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There was a recent editorial by Joe Rizzi in American Banker titled the “The Mismanagement of Risk Management” (www.americanbanker.com).  Unfortunately, you need a subscription to view the editorial.  To summarize, the opinion piece describes how risk management has progressed from a judgmental “collection of ad-hoc practitioner rules of thumb into a bona fide discipline”.  I would agree with this statement. However, Mr. Rizzi goes on to say that, “Risk Management has become a hyper-technical, specialist control activity with limited linkage to management or shareholders…A reliance on (statistical) models may encourage us to become lax and to amplify market volatility.”  Mr. Rizzi goes on to argue that over-reliance on risk management techniques can lead to overconfidence by business managers which in turn can cause companies to take on too much risk.

While I think Mr. Rizzi makes some good points, he fails to point out that at least in some cases, business leaders fail to heed the advice given to them by their risk managers.  Any seasoned risk manager knows that models or other statistical tools can start to break down in periods of rapid economic changes such as we are experiencing in the housing market.  Further, these changes are not parallel across the credit spectrum, but tend to impact sub-prime groups more than prime groups.  What tends to drive deaf ears are the high yields of subprime accounts coupled the ease of acquiring these account relative to prime accounts.  The typical business manager is always facing the challenge of getting the most bang for each marketing dollar spent and subprime accounts always seem to be an easy way to boost a revenue number.  In a economic downturn such as we are currently experiencing funding rates can begin to climb which pushes margins down.  This again tends to push business managers to focus more on higher yielding subprime accounts to gain back some margin.  In the end, this only exacerbates to problem.

There have been regulatory efforts such as Sorbanes-Oxley and Basel II that require better reporting and analysis of risk.  While these regulations may have some mitigating effect, they do not necessarily prevent some of the blow ups that have occurred recently.  I agree with Mr. Rizzi that, “…regulatory requirements can become a ceiling rather than a floor, which slows the development of risk management”.

Finally, Mr Rizzi argues that there should be less focus on quantitative risk management and more focus on including risk in “strategic planning, capital management, and performance measurement.”  While I disagree that there should be less focus on quantitative risk management, I do agree that risk management should be viewed not as single cost avoidance strategy, but as a holistic quantitative way to evaluate business opportunities. 

Many companies have moved in the direction of creating enterprise risk management type functions that focus not just on loss avoidance, but rather on creating profit.  Unlike Mr. Rizzi, I do believe that while all employees should be focused on maximizing profit, it is necessary to create an organization with the proper checks and balances.  In this regard, risk management or enterprise risk management functions need to have the ability to say “no”.  At the same time, successful risk managers will also recognize they need to develop creative solutions that solve the collective business goals and objectives rather than just preventing business from happening.  It is this constructive tension that tends to lead to effective business decisions and ultimately successful companies.

Mac vs. PC: The Real Story! August 23, 2007

Posted by robzel in Apple, Apple Computer, PC, Personal Computer.

iMac with Keyboard

There are few things that drive people’s passions as much as the discussions involving Macs vs. PCs. In reviewing discussion forums, you can see the venom in some of the discussions. Each camp vehemently defends its camp touting the virtues of their favorite platform. Where is the truth? Perhaps it is the eye of the beholder. However, this author has a definite opinion. Read on if you care to know.

I am one of the few folks out there that actually owns both a Mac and PC. I have been using a PC for years and I continue to use a PC for business. When my home PC was getting long in the tooth, I did some research comparing the virtues and pitfalls of each platform. Based upon my research I decided the Mac was a better platform for my home needs. Here was my thinking:

Look and Feel: Have you seen the new iMac? Need I say more? The PC is a box and a monitor, plus a keyboard and a mouse. In all these years the basic PC box looks like… a box. The Mac keyboard looks cool and is comfortable to use, although I must admit the mouse is a bit clunky. Mac wins this comparison.

Hardware: Mac and PCs both use similar hardware. However, if you buy and iMac there is almost nothing you can upgrade save the memory. With the available upgradeability the PC has more choices and therefore configurations available. PC wins this comparison.

Software: Where the Mac really excels is in the integration of hardware and software; it seems that Apple has created an almost organic combination. While Vista is nice, it is still a generation behind the current Mac operating system. It will be two generations behind once Leopard (the new OS) is released. While there are fewer choices for software compared to the PC, Mac software if more stable and seems to be more intuitive. Also, the preloaded iLife software is great right out of the box. The same software is not available on the PC. Advantage Mac.

Performance: Admittedly, I have not been able to perform scientific tests comparing PCs and Macs. However, the two machines I own are both recent purchases with dual core chips, 1Gig of ram and large hard drives. The PC is in an office environment and the Mac is used at home. Turning on the PC is a long process, waiting for Vista to initialize, and then boot up. I have time in the morning to get my cup of coffee before the PC is fully up and running. In contrast, the Mac takes less than a minute to boot up. The Mac advantage continues in running applications. Office 2007 runs much slower than Mac Office 2004. Then of course there are the bugs in Vista and seemingly constant Vista updates. With similar hardware configurations, Mac is just faster.

As you can probably tell, I really think the Mac is a better product. If I could I would use a Mac for my business needs as well. Unfortunately, the PC seems to have the advantage in the business environment, with more choices for hardware, software, integration, and support. I do think if Apple wanted to, they could make great inroads into the business market especially for small businesses.

If you are in the market for a PC, I would strongly advise you to check out the new iMac http://www.apple.com/mac/ before buying a PC.

Welcome To Zelcom Central March 26, 2007

Posted by robzel in Business, Consulting, small business, Zelcom Group.
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Dear blog,

Foregive me, but it has been some time since I have had a chance to write.  Since my last entry I have been very busy! On January 31, my business partner and I sold our company Zelcom Group to a company called Edentify.  We continue to manage the company and now have the capital to grow.  I have been focused on setting up our new office which is more work than I ever thought it would be. 

This is an exciting time for Zelcom Group.  We now have the resources to grow our business.  You can feel the pulse as the business grows and begins to take shape.  I shall continue to document our progress as we acheive new milestones.  Stay tuned!

Corporate Expenses: A David vs. Goliath Story January 27, 2007

Posted by robzel in Banks, Business, Expense, financial companies, growth, small business.

Corporate ExpensesIf you work in a large corporation, chances are you have come across systems for expense administration. Now, I have a lot of years of experience working in the corporate world and more recently running my own business. What I am about write below is not to refute the importance of expense management. In order to run a successful business, one must keep are careful eye on unnecessary expenses (although this lesson seems to be forgotten when it comes to executive compensation; think Home Depot). What I am going to illustrate through my personal experience is how the creation of corporate bureaucracy can sometimes cloud what are good intentions. By creating inflexible systems with non-thinking bureaucratic employees the goals of any corporate project can be defeated by negative externalities created. In this story I am cast as David. Goliath is played by a senior finance department employee. The setting is one of the world’s largest diversified financial institutions (one of my past employers).

One day the King (the head of the large diversified financial institution) says to his most senior and trusted financial adviser named Goliath, “Expenses are getting out of control. We are spending millions of dollars worldwide on travel, entertainment and other frivolous expenses. I need you to do something about this!” Goliath goes back to his lush office (no cube for Goliath) and thinks about how he can solve this vexing problem. “I know!” he declares, “We will build a new expense system.”

Goliath gathers all the best systems folks from throughout the organization. Never mind that they were engaged in projects that had huge revenue potential. After all, expenses are real right now not possibilities for revenue in the future. Of course since Goliath was so senior in the organization, project prioritization was not necessary. Goliath did not care that his project bumped countless other projects out of contention. That was a small price to pay for saving expenses! Little did he know (or care) about the hundreds of employees who had toiled on their projects over countless hours. Little did he consider the impact on morale or the opportunities lost for future revenue. Goliath was only focused on one thing, saving expenses.

After only 9 months Goliath sat down with the King and exclaimed, “We are done!” Goliath went on to describe the system to the King. “We have built the best expense tracking system in the world as would only befit the world’s best financial institution. I am so proud of the system and the way we built in measures and controls. Let me give you some examples.” Goliath goes on to explain how every item on the expense report needs to be itemized and entered into the system. Each travel and entertainment item has set limits where if the employee exceed the limit the excess comes out of their own pocket, unless of course the employee gains permission from two levels above them in the organization for the excess expense. All receipts get faxed over to a central processing center (newly set up of course) where the receipts are reconciled against the expense report. All reports need to be electronically approved by the employee’s boss and will not be processed until then. And the kicker as Goliath described to the King is that, “I have actually created revenue opportunities for the company from our own employees. Since all expenses are charged on our own corporate credit card, we can collect late fees and interest on unpaid charges. We have actually tracked the amount of time it takes to process expenses on average and it is in excess of 30 days! That means that unless the employee pays the outstanding balance out of their own pocket, we will be able to charge late fees and interest! The King was so pleased with the system and declared, “This is good!”

So the system was rolled out to the corporation. Almost immediately the expense savings were realized (as well as some revenue)! However, unbeknownst to the King the amount of time required to process expenses increased from 30 minutes to 90 minutes. Not only that, but employees got frustrated with the system and morale began to suffer. Important trips were cancelled or never contemplated just because of the hassle of going through the expense process. Overall productivity began to decline and with it so did revenue. Unfortunately, the King had no way to associate the decline in revenue with the new expense system.

About a year after the new system went on-line a new employee named David (aka me) joined the organization. David had never seen such an abominable system during his time in the corporate world. Unfortunately, David was so much lower in the organization than Goliath that there was no way he could change the expense system or make his voice heard. In order to avoid paying interest and fees David used his own money to bridge the gap in time between bills arriving and expenses being processed. The King received no revenue from David!

After two years, David decided to part ways with the company. Unfortunately, in bridging the gap on his credit card for expense processing David had a credit balance on his account. David sent notes to the company explaining the situation and trying to get his money back, but never got any response. After many months David got mad. He thought, “I no longer work for this company and I am no longer afraid to make waves!” In his last correspondence to the company he threatened to contact his State Attorney General.

Well I am happy to report David got a check yesterday for $230 (OK it’s a little victory). The company is in the headlines a lot recently. It seems they can’t seem to organically grow their business. In the latest article the King declared, “We are going to cut expenses by $1B”. It seems the King still has not learned his lesson.

Oops, He Did it Again! January 14, 2007

Posted by robzel in Apple, Business, Innovation, iPhone, Steve Jobs.
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Actually, there is no oops about it, Steve Jobs has another potential hit on its hands. In my post on December 21, I talked about how it can be difficult to innovate in a large company. Apple under the leadership of Steve Jobs has had a string of hits the latest being the new iPhone. They seem to have a solution to the large company problem.


The keys to such continued product success are the true leadership and vision that Steve Jobs instilled upon his company. If you have any doubts, just look at the performance of the company with and without Steve at the helm. Unlike the Microsoft example I used in my previous post, Apple products have a purity of form and function that melds together. Their products do not have the clunkiness of solutions developed by a committee, but rather appear to have been developed by a relatively small group of people with a shared vision of the final product. Apple’s stuff doesn’t just work well, but it also looks cool too!

This latest example of innovation reminds me of two conflicting theories of evolution. In the traditional theory, evolution is a continuous process, with incremental change occurring over a relatively long period of time. A more recent theory is called Punctuated Equilibrium. According to this theory (which best supports the fossil record), rapid changes occur over a relatively short period of time, followed by periods of relatively small change. These rapid changes are caused by disruptive events such as severe climate change. Apple as a company represents such disruptive change. While there was a gradual change in cell phone features and technology over time, Apple’s new iPhone represents the equivalent of a climate change in evolutionary terms. With all theories of evolution, such rapid changes in the environment usually result catastrophic results, with the rapid extinction of many species. The question remains: Will the iPhone represent such a disruptive change in the cell phone market?

Other phone makers have got to be nervous. By all appearances, the iPhone is not just another incremental improvement over the existing phone model, but a leap forward. Of course, this is all wrapped up in a temping package with the traditional Apple intuitive interface. It seems that incremental improvement may not be enough anymore, at least in areas that compete with Apple. Stay tuned and find out what happens. I for one am definitely temped to buy the iPhone when it becomes available.

When is Prime Not Prime? January 9, 2007

Posted by robzel in Business, cloning, cows, New York Times, news, News and politics, prime beef.
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Cloned CowsNo, this is not a post about Prime Numbers but rather a post about cloning. On December 29, The NY Times reported that the FDA declared, “milk and meat from some cloned farm animals are safe to eat”. I don’t know about you, but I am going to run down to the store and buy some cloned animal products. Especially considering the same Times article goes on to describe how some cloned animals, “are born with deformed heads or limbs or problems with their hearts, lungs or other organs”. Yum!

It is only a matter of time before scientists work out the kinks and deformities, and cloning becomes an industry standard. What a great opportunity for dairy and meat producers where every dairy cow is abundantly productive and every beef cow is prime! Or is it? As the saying goes, be careful what you ask for.

I’m sure many of you can remember the first great piece of steak you had, maybe a nice filet at Gibson’s? If you went to one of the upscale steakhouses, chances are you had a very special evening, with great service, great atmosphere and a nice succulent aged prime cut of steak. Because of the price, an event like this was something you would probably do infrequently and so the experience would become something precious.

Now imagine the cloning future: With improvements in technology, cloning becomes relatively inexpensive. ‘Smart’ businessmen run to their nearest cloning lab (these have sprung up all over) to get prime beef cows. These smart businessmen start to pop up everywhere, and so to do the herds of prime beef cattle (of course the scientists already worked out the kinks and deformities). After all, there is no longer any money to be made in non-prime cattle, but lots of money to be made in prime cattle. Or so it seems. In a relatively short period of time, the price of prime beef starts to plummet. Many of the ‘smart’ businessmen go out of business as do many of the cloning labs. For the consumer, prime beef is no longer prime but just everyday beef. Going out for prime beef is no longer a special event and many upscale restaurants go out of business.

Maybe you have heard of the butterfly effect; a butterfly flaps its wings and through a series of events can cause a tornado. In the same vane, who knows what the future will bring with cloning. Will steak taste the same?