It’s a funny thing about changing rules. Now that we have had a chance to play the 20-20 hindsight game around the real estate meltdown while observing the ripple effects that bad mortgages have had on the financial markets worldwide, we realize that there are lessons to learn and apply around business rules. It started with changing rules that had been in place for a long time and relaxing them over a period of time driven by a lack of good returns in the securities markets and the great returns in the real estate market. The business rules around mortgage underwriting were so relaxed they went past normal good judgment. The processes worked very well and spit out mortgages in a most efficient manner. These mortgages were packaged and sold as AAA investments while many of these loans were toxic under any other scenario than a rapid growth real estate market.
This should teach us a couple of important lessons. One is that before rules are changed, there should be significant scenario planning as to the effect of their change over time. This means all the good and bad scenarios. Also constraints (a limiting form of a rule) should be set to sense when one these scenarios start playing out. I really hope companies keep tweaking rules for constant improvement, but build disciplines that keep us from hurting ourselves again. Combining rules, complex events, predictive formulas and simulation needs to be considered going forward. Our government leaders need to do better scenario planning instead of relying on strong and smart personalities alone. The dangers are being played out in front of us now. It’s time to do better with rules.
4 responses so far ↓
1 Process for the Enterprise » Blog Archive » Good Presentation on Mixing Rules and Processes // Oct 30, 2008 at 7:52 pm
[...] On a (somewhat) related note, a somewhat humorous post from Jim Sinur on how rules might have initiated the real-estate [...]
2 Look Before You Leap » Smart (Enough) Systems, the blog // Nov 1, 2008 at 1:05 pm
[...] Jim Sinur wrote “Rules Initiated the Real Estate Meltdown” [...]
3 Mark Eastwood // Nov 12, 2008 at 5:25 pm
Jim,
I appreciate the need to scenario test potential rule changes before pushing them to production. Fair Isaac will soon have this capability in the Blaze Advisor suite. We currently have simulation testing components to some of our other offerings.
That said, your article seem to imply that RBMS and their governance is to blame for unreasonable credit origination strategies, lack of oversight to the securitization market, total lack of governance of the credit derivatives market and the compound effects of the mark-to-market account rules. It’s a complex problem that has been brewing for years and compounding itself. I understand there are more mortgage backed securities than actual mortgages and trillions more in other related, complex derivatives.
One strategy for helping organizations understand the impacts of turbulent markets is stress testing. I imagine stress testing for variations in interest rates, unemployment, inflation and other factors can be used in conjunction with simulation testing to more roundly investigate the impact of a policy change.
BRMS (and decision management) is a growing and maturing discipline and definitely needs better governance but, what counts is the business policy not the implementation mechanism for the policy.
mee
4 Jim Sinur // Nov 12, 2008 at 7:34 pm
I don’t think anyone blames the vendors of the rules capabiilites; It is the managers that set the underwriting rules too low creating toxic mortagages. Other managers packaged these toxic mortgages into investments that were AAA(I have no idea how that happened other than there was no oversight).The underwirting rules were set too loose and everybody knows
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