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Anticipating Market Trends and Their Implications

Monday, September 20th, 2010

By Mark P. Dangelo

Innovative Relevance®

There is still much to be gloomy about across many segments within the U.S.A. — economy, housing, and finance to name just a few.  It appears as though many of the ill-conceived ideas and financial innovations that propelled a decade of prosperity are now contributing to high levels of sustained unemployment, regulatory burdens, and historic deficits. 

Looking forward, the next 15 months will still hold a vast amount of uncertainty and risk along with a substantial amount of political theatre.  Yet, does that mean we do nothing or very little to prepare for the market events and consumer dynamics unfolding all around us?  Is the new BAU really a retro BAU as some have projected?

Positively, indications from dozens of industry leaders point to converging themes and series of actions – although the transparency of these trends still has not been fully revealed.  However, as clarity is achieved, nearly every organization can benefit from these solidifying trends during the remainder of 2010 and into 2011. 

Yet, the evolving trends require the selective integration of financial processes across the spectrum of origination, servicing, and capital markets.  No single idea or pure-play event is on the horizon to ensure that market intricacy is wrapped up in a plug-and-play offering or one-stop vendor solution.  Such a rudimentary belief system is what materially contributed to misinterpreting systemic risks and creating unsustainable mortgage and finance models.

But trends are funny things and their advantages often multi-faceted.  Let us examine just three of the most interesting and misunderstood.

Economic Reality

For an industry, now at one-third its 2007 size, is there life after a three year gutting of businesses and skills?  Have we reached the bottom and market capitulation?  Can technology be of any use, in a market that will be stagnant for the next 3 to 5 years, beyond efficiencies or traditional process improvements?

First, and to be very blunt, economic theory and those who practice it have demonstrated that their models, forecasts, and suppositions are not good predictors of future reality and the complexity of today’s financial markets.  Moving forward, the discipline and rigor of economics will be called into question, resulting in organizations increasing their own business intelligence capabilities in an effort to control and predict future outcomes, risks, and liabilities.  As some economists have indicated, economic disciplines need to undergo a rigorous self-examination if they are to regain public trust.

This void of confidence has spawned an unintended consequence.  It has created a demand for internally vetted intelligence and predictive technology across several primary data taxonomies – consumer channels and behaviors, regulatory compliance, and (bespoke) markets directly linked to dependent products.  Analytics will tie many of the interrelated entities and elements together via multi-dimensional or layered dashboards. 

Since data volumes are doubling every 18 months across the enterprise, and supported by increased access to sophisticated mining tools, it is easy to understand why budgets surrounding the need for intelligence needs are projected to grow at over 25% per year. 

The provisioning needed to support these management defined requirements is also changing.  Considering a backdrop of nearly 10% unemployment now projected until 2012, while facing a hostile consumer base, offshore outsourcing for these knowledge process areas may have reached its peak.   The mix of how to deliver intelligence (e.g., operational, competitive, consumer, financial, regulatory, risks, et al) to the organization has likely been permanently altered to concentrate on inward confidence.

Capital Markets

Capital markets are being reformed to deliver sustainable ABS products spurred on by pending SEC revisions, EC Article 122a, Basel III, and the clearing of derivatives with the Dodd-Frank regulations. 

The need for resurgence of the private ABS market, standing at just over 40% or $350 billion of their 2007, size is clear.  Without liquid and transparent private capital markets, lending cannot be sustained simply by increasing deposit base or via government guarantees.  In addition, the demand and importance of straight-through processing (leading directly into the capital instruments themselves) with rigorous data integrity and standards cannot be underestimated. 

Originators who design their loan processing and vetting from the start with private capital markets as the recipient, will benefit with improved basis point margins, reduced risks, and ensured regulatory compliance (e.g., as proposed for updated EDGAR filings surrounding REG AB revisions). 

Why is this important now?  Just ask RBS with their issuance of $4.7 billion in MBS’s last week, or banks across the globe, as they rapidly staff for an anticipated rebirth of the private ABS and MBS markets. 

Yes, the first iteration of securitization is dead – killed by easy money, lax lending, speculation, and complex, derivative injected, layered securities.  A second iteration has already begun for private ABS as demonstrated by the new market leaders like J.P. Morgan. 

This trend will accelerate in 2011 spurred on by pending dispositions of the GSE’s.  Without a functioning private securitization market, the workouts for the struggling GSE’s will never be politically achieved – nor financially sustainable.

Security

As noted by Maslow back in 1943, security and safety is principal to acceptable human behavior.  This need is transferable into the demand by customers and consumers to be confident, absolutely confident, that the most private information, scores, ratings, and profiles are 100% secure. 

Whereas data storage protection has increased markedly over the last three years, it is the vulnerability of the networks that is gaining increased importance and scrutiny.  Examples of this include HP’s recent acquisition of ArcSight and Intel’s acquisition of McAfee – all at very significant premiums to market valuations. 

This increased focus on the network and accessibility has been a direct result of mobile proliferation and sophistication of devices (e.g., iPad, BlackBerry, tablet computers).  This changing technology-induced behavior has resulted in a complex layering of network points of entry and protections not just for consumer applications, but for enterprise offerings which start at the consumer and touching brokers, agents, loan officers, appraisers, vendors, servicers, and loss mitigation specialists. 

To back up this trend is a one-third increase in budgets projected for FSI organizations specifically targeting network and mobile security over the next year alone.  Factor in regulatory and compliance demands for data – from its originating source to its eventual disposal – and the budgetary impacts are even greater. 

Analogous to the securitization markets being reset (i.e., waiting for “Securitization 2.0”), security is about to take a series of new twists and turns that will govern the next decade of IT skills, business offerings, and consumer protection. 

* * * * * * * * * *

What is very clear is the dichotomy of beliefs and value systems that still must be reconciled in the face of polarized consumers and regulatory vigor.  Stated another way, each market participant believes that the “new normal” will be similar to their accepted models of operation. 

Still, trends frequently mutate as a result of market results and consumer behavior, while spinning a story – or a nightmare – regardless of principles and theories put in place to anticipate them or explain them away. 

As noted recently in the Financial Times, the demand for housing by the consumer actually peaked six years before the market correction regarding ownership rates and housing prices.  Yet, transactional technology focused on a need for greater scale and throughput dominated the industry and their back-office operations. 

It is not atypical for market actions to be out-of-phase against the trends.  Frequently trends were left unnoticed or discarded due to the fact they did not meet the expectations of those who needed to listen. 

It is human nature to dismiss contradictory data when it is outside our traditional models.  It is easy to dismiss ideas with foreign words or rebuke the trends as irrelevant because they appear foreign – beyond traditional understanding.  Retrospectively, hasn’t that already been tried, and failed?

Regardless of beliefs – change will happen and retro Luddites will fail.  So, who will be listening or adapting to market, consumer, and financial trends?  Who will fail to recognize the signals too late – when the end is near?  Who will heed the calls and profit from change? 

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Looking Back at the Strategy of Why Some Succeed — and Many Fail

Monday, March 15th, 2010

by Mark P. Dangelo

www.Innovative-Relevance.com

It was a decade ago, at the peak of the NASDAQ Composite, that the world began to truly comprehend the potential of the “nets” (i.e., Internet, intranets, extranets, and more recently the “clouds” and mobile 4G).  As new firms rose to trailblazer prominence (e.g., Amazon, AOL, Atomic Tangerine, Egg, and others), the phrase “brick and mortar” increasingly became linked with traditional, unwieldy, hierarchical, and candidly, resistant to change enterprises “destined to go the path of the dinosaur.” 

Yet, what was once dismissed out-of-hand (i.e., layering[i]) is now set to become a top-5 strategy challenge for every management team, vendor, and outsourcer surviving in this decade.  A critical question remains if organizations have the vision and humility to leverage the past, while innovating for the future.

A Decade for the Record Books

Since 2000, the removal of the old became a classic win-lose corporate context framed by:

·         enterprise solutions (e.g., SAP, Oracle, and PeopleSoft),

·         consultants, outsourcers, and advisors (e.g., Accenture, TCS, ACS, and McKinsey), and

·         channel-specific solution providers (e.g., Cisco, Sun, and IBM). 

Within the finance and mortgage groups (FMG’s), the implementation value chain solutions became inverted with technology ideals frequently trumping business models, as volume, any volume drove people, and processes over sound management judgment. 

Inadvertently, brick and mortar principles were perceived as outdated and discarded as organizations chased the markets – and the most debt-laden homeowner in history.  With 2010 set to produce the largest volume of delinquencies and foreclosures on record perpetuated by a jobless recovery (9%-10% until late 2011), the surface indicators might support the frustration that once again, we need to start over.  Throw out the legacy models and lessons learned in favor of new approaches and technologies.

Today, pundits declare that the FDIC interventions, TARP injections, and Federal Reserve market actions are merely perpetuating the foundational decay long hidden within traditional FMG’s, operating on axioms defined back in the 1930’s. 

The belief remains that the greatest financial meltdown ever (in real USD lost) was just waiting to happen.  It could not be stopped even if we understood what “irrational exuberance” really meant.  All it needed for the traditional firms to fail were vast real estate bubbles spread across developed nations to provide the spark that lead to the vanishing of 10%-12% of global wealth (since 2007).

Learning, Layering, and Looking Forward

Indeed it is time for sustainable change, new ideas, fresh industry blood, and elimination of systems that benefited so few.  So, why reexamine 20th Century principles that have already been cast aside by 21st Century attitudes and doctrines?  In a virtually connected world that never sleeps, who needs brick and mortar dogma when continuous technological innovation is what consumers are demanding?  Why indeed. 

Nevertheless, when examining those “Jurassic” systems with their layers of front and back office control procedures, history has now shown that the brick and mortar strategic operating principles remained very viable and stable.  When glancing backwards, it is the techniques and underlying implementation methods that have been permanently transformed (see Figure 1 for a list of principles, demands, and techniques). 

As portrayed in Figure 1, it is precisely those brick and mortar operations that not only survived (albeit slightly dented), but continue to grow – JPMorgan Chase, Wells Fargo, and Bank of America to name but a few.  Moreover, each FMG holds valuable lessons learned — as well as publically exposed pitfalls.  If the U.S., like the new stress test ordered for the UK banking community, enters a pause or retracing of economic growth in 2010 (i.e., double bottom), the value g leaned from the surviving FMG brick and mortar principles may be the difference between survival – and receivership.

Layering Tackles Strategy, Complexity, and Uncertainty

Layering for 2010-2013 is best defined as the utilization of principle driven models (i.e., process, business, and technology across the mortgage pillars of origination, servicing, and securitization).  This often missed strategic approach allows organizations to employ the “best-in-class” solutions, products, and services even if they might be viewed as competitive (see Figure 2). 

It is the assembly of these “building blocks” that provides the distinction and profitability so badly demanded within struggling FMG’s.  Stated more pointedly, how many of those “pure-play” offerings survive after just five years?  With VC investments now just 30%-35% of 2006 levels, you only have to look at their investment web pages to notice the portfolio rot driven by a failure to anticipate consumer change and uncertainty. 

If truth be told, the deployment of layering is inherent within all viable business models – domestic or global – as their usage surrounds the assembly of strategies, processes, technology, and people.  Analogous to the building of a foundation with stone, cement, and metal, the use of layering for sustainable business resonates with profitable innovators.  It is now fundamental criteria in investor minds as well.

As shown in Figure 2, if the “foundation” of layers cannot be assembled properly (e.g., the laying of brick for a wall meeting industry “building codes”), the ensuing channels, offerings, and markets will collapse onto the basement floor – much like investors in RMBS and CMBS experienced during the last four years.  Yet, are organizations fully equipped with the skills and abilities to critically examine the successes and failures?  What about the performance of partners and channel providers?  Or will it become a situation where teams are sent out to perform “bring me a rock” analysis?

Stated bluntly for those who still fail to see the building block challenge and financial opportunities, if everyone utilizes the same standards and electronic delivery strategies, how come everyone isn’t equally successful?  The aforementioned are merely the vehicles of delivery – not the layering of complex business requirements that if assembled wrong, lead to failure.  In some cases, career ending failure.

In Closing

If you have any doubts on the strategy of business and technology layering, then take a look at the survivors from the companies previously mentioned.  What were the key principles that lead them as pathfinders succeed and adapt, while others failed or were acquired?  Did they lack technology, people or the “right” idea?  Did they shun brick and mortar principles entirely or selectively apply the fundamentals that worked for their business operations and technological implementations?  Did they let their egos drive their actions?

So now, 10 years after the great market corrections of 2000, it is the innovative business leaders who are gleaning safe and sound practices from the old brick and mortar.  For vendors and outsourcers, those operational leaders that can deliver scalable, interoperability layers of processes and technologies will be the household names across the industry.  How many will act?  How many will continue to be froze in place holding on to the ideals misplaced and misrepresented?  We can all think of a few.

Enterprises (i.e., the core business, their vendors, and outsourcing providers) able to rapidly adapt to changing consumer needs, and more recently, radical mutations of homeowner behaviors will be able to weather any downturn or changing market conditions.  It seems the lessons and principles of the past have become the guides of the future.

Funny, sometimes to go positively forward, you must start out in reverse. 


[i] Analogous to a “method of propagating plants by covering a branch or shoot with soil so that it takes root while still attached to the parent plant.”

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In a Word, “GlobalBorderMalevolence”

Tuesday, February 16th, 2010

By Mark P. Dangelo

www.Innovative-Relevance.com

It has been repeatedly said that, “Desperate times call for…,” well you know the rest.  With a weak economic recovery underway, many domestic financial leaders are trying to navigate unchartered territories, while endeavoring to avoid collisions with unique business obstacles – regulators, politicians, depositors, investors, and global capital markets. 

With nearly 7 million domestic jobs lost in 32 months it may be 6 to 12 years before they can be replaced with equal paying positions — if history is any guide.  The embers of technology investment are seducing many to believe the recovery is here – but is it a recovery that includes domestic workforces? 

Moreover, with trillions USD in deficits piling up and an escalating trade war beginning (all but in name) with the U.S.’s largest creditor, can technology investment be sustainable especially for a mortgage market still under duress? 

If origination volume in 2010 is estimated to be one-third of the levels from 2006 and with REO properties held in reserve equaling or surpassing the number of listed ones (another 8 to 10 months of supply), have we reached an equilibrium – or is there more to come? 

Yes, as my mother used to say when I was a child, “You ask a lot of questions.”  But these days, with so many “experts” at every corner, I feel compelled to query even more. 

Perhaps a fable will help frame the concerns I have when it comes to the slippery slope of regulation and the hidden dangers subsequently facing the outsourcing industry over the next 18 months (within finance and mortgage markets (FMM) for onshore and offshore business process and technology outsourcing).  My fable is titled, “GlobalBorderMalevolence.”

“It is often those nasty ‘unintended consequences’ that linger on long after the deeds are done.  For example, with nearly half-a-dozen global regulatory discussions on going and increased taxes or fees nearly certain for financial lenders, won’t that create additional pressures to margins, profits, and an ability to lend? 

If fees cannot be passed on either due to competition or regulation, then the obvious answer is cutting costs.  For the last two decades, institutions have sought cost reduction and avoidance via outsourcing of functions to developing countries with lower wages and educated classes of laborers.

Therefore, will not an implication of cost cutting demand further shifting of knowledge jobs from west to east in an attempt to keep profits stable to meet investor and regulator solvency demands?  Will not that have an impact on FMM domestic employment moving forward?  If employers shift higher-paying functions to cheaper locales, does that not then mean less tax basis to offset rising regulatory costs and a Federal budget? 

So when jobs are lost, now do we need then a ‘jobs bill’ to protect domestic workforces from disenfranchisement indirectly created from the very issues that taxpayers were seeking relief from – unemployment, lack of credit, or foreclosure?   If we need a jobs bill, then don’t we also need protection from those ‘nasty’ outsourcers who are ‘exporting the future of our economy?’ 

So why not put an extra surcharge or tax on outsourcers and the firms they represent to ensure that labor arbitrage cannot be utilized to improve margins from those bankers who seek to reward themselves with huge bonuses?

If the Indian outsourcing industry increases at their projected 2010-2011 rate of growth approaching 15%, while domestic unemployment still exceeds 9.7%, doesn’t this mean that outsourcing is a perfect industry to target by regulators and politicians? 

After all if outsourcers are growing offshore by shifting jobs west to east then are they not taking advantage of global imbalances created by currencies and export-driven state sponsorships?  Aren’t they equally culpable as much as those ‘bad’ bankers who started the whole mess in the first place? 

On the other hand, if outsourcers have let’s say 25% to 35% of their delivery capability taking place onshore in domestic centers of excellence, should they be treated the same as a service or technology provider who has only sales forces within the borders?  Moreover, what should be done to rebalance the labor arbitrage differences for domestic firms who provide outsourcing service offshore but claim U.S. headquarters?

So goes the circular references and the convoluted requirements for even more regulation to determine who and what is being done to whom.  Furthermore, if you start at one point in the value-chain, why not transcend all the way downstream to punish everyone who is making a profit as a result of changes created at the beginning of the chain?  Is this regulation approach really about free-trade and open borders – or retribution and politics?

Besides, why stop there?  What about any third-party partners involved in JV’s?  How about technology solution sets and innovation needed to streamline processes, driving out costs, and displacing workers?  Should anything and anyone that eliminates a domestic job not be ‘punished?’

Taking it to extremes, would market competition that arises between industries and their representatives also not fall under this disguise?  If competing standards disadvantaged or displaced one interest group, should they not seek regulatory protection against the other? 

What if secondary group demands created disintermediation within the origination and servicing institutions?  Should they not be then regulated to stop their impacts on BAU and jobs?”

Whereas the fable may be a little “cheeky,” its intended seriousness is not to be dismissed.  These hidden exothermic consequences are growing increasingly likely not just domestically, but within the EU and even within the Asian provider countries themselves. 

Let’s also be very clear, that each side of the outsourcing equation has responsibilities that they have not lived up to in the past.  The firestorm of criticism from many practicing xenophobia is fueled by those outsourcing firms seeking to “take orders” — playing into simple labor arbitrage needs and continually advocating the business model of moving jobs from west to east.  These players still exist and are easily identified by their token domestic presence. 

Conversely, without outsourcing to provide leverage and scale, not to mention aggregation of highly complex and specialized skills that cannot be efficiently integrated with traditionally organic approaches, industry innovation would not have been as great as we might think. 

Why?  Because the savings achieved by using global workforces would not have facilitated investments in other innovations needed – fraud, automated valuations, analytics, data mining, interoperable standards, and the list goes on.  Stated another way, by using outsourcing for delivering commodity transactions in origination and servicing, investments in more specialized and complex functionalities could be made.  They were made.

Outsourcing has benefited not just lenders, but homeowners, investors, regulators, and those seeking political advantage.  It will continue to be a integral part of our process and technological solutions fabric.  However, its usefulness can no longer be thought of as mere “exports” or “imports” by anyone within FMM’s. 

There are polarizing factions that are escalating the rhetoric – they whisper “GlobalBorderMalevolence.”  Perhaps this feeling of disenfranchisement has best been characterized by the creators of Comedy Central’s South Park, “They took our Jobs!”  True, unchecked outsourcing based on mere arbitrage is not beneficial long-term to either party.  Conversely, so is no outsourcing.

Just like bankers who are “bad,” the outsourcing industry should not be thinking BAU.  Xenophobia has arrived as a new form of nationalism.  Domestic or foreign firms with sizable local, heterogeneous workforces (i.e., not imported H1B’s within domestic borders) will be the best positioned to not only avoid this coming battle, but also profit from it.  Integrated, domestic workforce outsourcers will be the survivors – and some very large international providers are already embracing a new business model. 

* * * * * * * *

Undeniably, Humpty Dumpty has had a great fall.  No amount of regulation, central bankers (i.e., Kings), or TARP bailouts (i.e., the King’s horses and men) will ever remake the fragility of an egg that tempted fate and spurned consequences by ignoring the market risks (i.e., the wall).  The fall the FMM Humpty Dumpty was a “splat heard round the world.”

As a final point, the U.S. Administrations’ position on outsourcing and globalization has also become increasingly intriguing.  For example, much has been read into Larry Summers, White House Chief Economic advisor, recent speech at Davos as he cited, “the case for free trade might not apply when countries were trading with nations that were pursuing mercantilist policies.[i]”  Even if this particular challenge was directed at one particular country, could it not be also used against others within the same region covering both products and services?

So you see the challenge for lenders and their outsourcing providers will be buried across many nouns– xenophobia, jingoism, patriotism, nationalism, protectionism, and even cultural intolerance.  The noun you select depends on your preference in the on-going debate.  So as new regulation sets in motion the need for increased efficiencies, an implication of what they demand will lay the foundation for yet more regulation and national debates – just farther down into the value chain of mortgage and financial delivery. 

As Abraham Lincoln once said, “A house divided against itself cannot stand.  I do not believe that the house will remain divided – it will either cease to be divided,” or its foundations will wither collapsing the entire structure and advancements onto itself.  But will free-market capitalism prevail?  Will outsourcers stumble on their own past success?  Will they seek to empathize with their domestic clients, and the escalating pressures they face?

This debate has only just begun – and it potential consequences are very, very scary.  


[i] “How the Bottom Fell Out of ‘Old’ Davos,” Gideon Richman, Financial Times, February 2, 2010.

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