The Countrywide Conundrum

The mortgage lender is justifiably under fire for its subprime lending practices. But it should be remembered the flaw was in the execution, not the idea

It's more than a little difficult to imagine Angelo Mozilo, the embattled chief executive of mortgage lending giant Countrywide Financial (CFC), being a Drucker disciple. But just last year he didn't hesitate to paint himself that way and, in at least one sense, he was right.

"As the late Peter Drucker once said, the entrepreneur always searches for change, responds to it, and exploits it as an opportunity," Mozilo told an audience of bond holders, bankers, and others. "This is the essence of Countrywide's culture."

Countrywide, lashed like many other companies by the subprime storm, isn't crowing as much anymore. A few weeks ago, it reported a loss of $1.2 billion (, 10/26/07) for the third quarter. Included in that were charges related to plans to cut as many as 12,000 jobs, or about 20% of Countrywide's workforce.

The First Responsibility

Meanwhile, Mozilo—long a target of critics for his king-size compensation—is under heavy fire from shareholder activists . (Drucker, too, abhorred excessive CEO pay.) And the Securities & Exchange Commission has reportedly been poking around in Mozilo's prearranged sales (, 11/1/07) of company stock.

More broadly, the mortgage mess brings to mind everything Drucker taught businesses not to do. By peddling complex financial instruments to legions of borrowers who couldn't understand what they were getting into and were unequipped to handle the debt they were taking on, unscrupulous mortgage brokers violated what Drucker termed "the first responsibility" of any professional: to "not knowingly do harm."

By devising ever-more-exotic mortgage-backed securities, Wall Street firms made it tough for most investors to properly assess risk and helped fuel a bubble—precisely the kind of unsustainable, short-term-profit-driven model that Drucker loathed. "Pigs gorging themselves at the trough are always a disgusting spectacle, and you know it won't last long," Drucker said during an earlier market shakeout in the late 1980s.

Regulation is Key

And by taking advantage of lax regulatory oversight, subprime lenders sidestepped one of their main obligations: to make sure that sufficient standards and oversight are in place, even if it pushes up their costs. In most cases, Drucker wrote in his 1973 magnum opus, Management: Tasks, Responsibilities, Practices, "regulation is in the interest of business, and especially in the interest of responsible business."

Without it, Drucker added, there is inevitably crisis and scandal. And that "leads to governmental inquisition, to angry editorials, and eventually to loss of confidence in an entire industry, its management, and its products by broad sectors of the public." Which is, of course, where we are today.

But before totally giving up on subprime mortgages, it's worth remembering they also represent something Drucker applauded (and to which Mozilo referred): a genuine social innovation. During the 1990s the U.S. saw its homeownership rate rise more than at any time since the '50s; it now stands at about 68%. Minorities, who'd been systematically locked out of the system for generations, have made strides. The number of blacks owning homes has climbed from about 42% in 1994 to nearly 47%. The rate of Latino homeownership has jumped from 41% to 50%. One big reason for these gains is subprime loans.

Obviously Risky

Yet as the subprime contagion continues to spread—and the ousters of Stan O'Neal at Merrill Lynch (MER) and Charles Prince at Citigroup (C) indicate it's going to for some time—the pressure will only increase to tighten mortgage lending to where it was 20 years ago.

Indeed, many commentators "have suggested that we throw out the whole market and go back to the constricted situation of the early 1990s," Edward Gramlich, a senior fellow at the Urban Institute and the author of Subprime Mortgages: America's Latest Boom and Bust, told those gathered at a Federal Reserve conference last summer. "[But] that seems exactly the wrong message to take from the experience," Gramlich said. "The subprime mortgage market was a valid innovation, and it did enable 12 million households to become homeowners."

Lending large sums to people with scant or shaky credit histories is, obviously, risky. Then again, Drucker noted in his 1985 book Innovation and Entrepreneurship, "All economic activity is by definition 'high risk.'"

Simple Greed

The problem with subprime lending was not the nature of the innovation itself. It was the way it was carried out. Correctly executed, "Innovation is both conceptual and perceptual," Drucker wrote. "Successful innovators use both the right side and the left side of their brains. They look at figures and they look at people. They work out analytically what the innovation has to be to satisfy an opportunity. And then they go out and look at the customers, the users, to see what their expectations, their values, their needs are. Otherwise one runs the risk of having the right innovation in the wrong form."

In a way, that's just what happened here. Because of simple greed, all sorts of subprime loans were sold with reckless disregard for whether these particular products were appropriate for the consumers snapping them up.

The end result, as Drucker might say, is that the crisis has put all the focus on what shops such as Countrywide have done to society. Largely forgotten is what they've done for it.

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