Body Snatchers

Continuing on the Management Frameworks post, I'd like to think that I have a good eye for evaluating employee potential. Of course, in interview situations I side with Google in that I, like most managers, haven't much of a clue how the employee could turn out. However, in the day-to-day grind in a collaborative work environment, I am pretty good at looking past what most consider glaring flaws and evaluating characteristics that drive value. A principal reason for this is that I've been considered at various points in my careers as someone with glaring flaws. For example, two complaints I have received in the past are that I talk too fast and do not possess enough gravitas, Nevertheless, I was able to demonstrate this to others as a strength as I deconstructed a potential decision into the assumptions underpinning the framework. I could then not only make recommendations based on data and assumptions, but also point out critical weaknesses where the decision could come crashing down if certain events did not go as planned. The management decision could be made (make vs. buy, acquire vs. divest, expand vs. contract) together with parallel decisions to contain the risks of taking that action. I am now better at talking slower, assuming the listener is less familiar with the issue than I am, and even, perhaps, letting my dulcet baritone voice lend to my gravitas. Over time I gained a reputation for structured decision making and providing a clear framework for my direct reports. Perhaps because I have gone through an experience like this, I've learned to ignore a little better my natural biases (e.g., He's tall, dark, and handsome; he must be leader!) and look for underlying traits that drive value creation. I have my mental checklist to check off as I'm working with colleagues: understands quickly and asks questions when they do not understand, takes a holistic approach on the impact to the company, does not "write off" colleagues and does not take criticisms as a personal affront, etc.

About two years ago I stole a "low value" employee from another team with little protest. He was performing glorified data entry/adjustments for account reconciliations. He was very young (23) and a bit rough around the edges in some areas, but he definitely possessed nearly all of the primary characteristics of a dream candidate. I would certainly score him as higher potential in the critical attributes than I was at his age. A year later he was considered one of the highest potential employees. Two years later he was rotating through teams, mostly independently of my work, and doing the same restructuring and optimization that I had done for the last two years. He was slated to move into a mid-management position in 2015, with a target of senior management within four years. Then the other shoe drops. A competitor swoops in, based on the recommendation of a former employee who was let go and jumped to the competitor, and makes an offer for a very solid mid-management position at a great salary. He isn't quite ready for the position, but I know that after some missteps and learning, six months from now he will be doing fine. The position accelerates his career and will probably be more entertaining than his current path. All I could say to him was good luck. This was the first time that one of the high value employees that I have grabbed and groomed has jumped ship.

Some would make the argument, "what's the point of developing them if they are only going to head to another company?" I would answer that I had 15 months of stellar performance from an employee, and if I can't develop other employees to perform similarly I am not much of a manager or leader.

Mixed Messages in Housing Policy

In the school of hard knocks, you graduate either through class participation or observation. However, some never seem to graduate.

In 2009 there was a rare moment of consensus between Main Street, Wall Street, K Street, and every street in between: over-leveraged individuals, companies, commercial banks, and investment banks create an unstable system, even if you really really think this time is different and this nifty model says so right here. On the mortgage side of the equation, the Boston Fed released a landmark study:

"The empirical evidence on the role of negative equity in causing foreclosures is overwhelming and incontrovertible. Household-level studies show that the foreclosure hazard for homeowners with positive equity is extremely small but rises rapidly as equity approaches and falls below zero. This estimated relationship holds both over time and across localities, as well as within localities and time-periods, suggesting that it cannot result from the effect of foreclosures on local-level house prices." (emphasis mine)

Two years later, mainstream opinion writers like Felix Salmon (among many others) were still pointing out that, "If you take one group of loans with a 20-25% down payment, and a second group of loans with a 15-20% downpayment, then the second group, on these numbers will have a delinquency rate 56% higher than the first."

But five years later... well, a lot can change in five years. And, if it cannot change, at least it can be forgotten. This past week the director of the Federal Housing Finance Agency (the US agency that regulates Fannie Mae and Freddie Mac) announced:
"As I said earlier, there are creditworthy borrowers in today’s market who have the income to afford monthly mortgage payments but do not have the money to make a large down payment and pay closing costs. Purchase guidelines that allow for 3 percent down payments will provide an opportunity for access to credit for some of these borrowers."

Yes, the majority are creditworthy borrowers, but a large interconnected and securitized financial system cannot be sustained if 20% of the borrowers default during the next downturn. Let us hope that this time truly is different.

Macro Instability - The Ring of Fire

One benefit of aging demographics is that it decreases the percentage of the most volatile demographic of society, 18-30 year old males. Generally, a key ingredient in a country's internal instability is young men that have too much time on their hands. (There is far more controversy over this statement than you might think in terms of which ways the causation go, but here is one place to start if you're interested.) Youth unemployment is a step to understanding instability, which is why this interactive graphic from ILO is intriguing:

To aid the visual, the colors could have been toned down to a maximum of 40%. Upon closer examination, both visually and in the underlying data, there is a clear hot spot. It's what one could call "the ring of fire." Average youth unemployment for the region is over 25%.

Whether it's called Arab Spring, Mediterranean discontent, separatism, or Southern European unrest, this is a factor that a lot of on the ground managers have in the back of their minds, but is rarely explicitly stated. Greater unrest translates into lower tolerance for capital commitments. If "stuff can go south," there's a natural inclination to hedge, and those who commit the most into these situations are either very savvy on local conditions or subject to a series of winner's curses. Whether it's the world of leveraged buyouts or multinational expansions, one should take a good look at local players before making the leap.

Dealing with Certainty

I don't struggle dealing with uncertainty. I can gauge assumptions and risks quite well. Despite this, I also have no problems with a "ready, fire, aim!" mentality when urgency is required. If the train is pulling away from the station and the debate is jump or not, now is the time to make the decision. We move forward confidently knowing that we are acting with the best available information.

However, I do struggle with those that cannot deal with uncertainty, or rather, those that are 100% confident all of the time. Those few moments in which they do change their minds, they flip to 100% certainty the other way and say, "I was so dumb before, because I didn't know everything I know now." These are the "passionate" that show no difference in knowing 10% of the relevant information and 100% of the relevant information. In my experience, this is far more common in large corporations than small companies. One gets found out too quick in the small company.

When collaborating with this type, I've tried an array of strategies, but the vast majority of the time it bounces off like frozen marshmallows on a tank. Eventually I end up simply discounting their opinions and information, but that's not a long-term play at building a coherent team. I don't plan on giving up, and, like many things, the best approach, in most situations, is "one of these twenty approaches might work, because everyone is different." What is under my control is developing the toolkit to handle the situation. Here are a few approaches I've used with varying success:
- Unassuming simple questions: "What are some of the potential outcomes for this decision?"
- Redirect: "I see what you're saying, but there are also a lot of different ways to attack this problem. Let's brainstorm a few different ways we can go at this."
- Backup request: "Send me over the data you have after this meeting so I can combine it with what's already been submitted and distribute. We can finalize the decision on Wednesday."
- Direct feedback: "Good input. Thank you. We still need to make sure we cover all of our bases and have a sure footing if this is the direction we take. How can we further develop these specific points?"
- Buddying up: "What do we have so that we can convince others and defend this decision?"

In my personal experience, the most successful long-term executives are those who maintain a positive attitude and outlook with others, regardless of position and they have a solid understanding of the assumptions that they are making in the thousands of business decisions that they make throughout the year. However, when they were not in a position of direct power, I've seen executives with a solid history of success hit a brick wall attempting to collaborate with the "certain." Those that have succeeded demonstrated Herculean patience, which I know is an attribute that, because of necessity, I have worked to develop further.

When Insurance Fails - Reflecting on AIG

This Planet Money episode on homeowners insurance reminded me of when I first learned about insurance market failures in college. Insurance markets tend to fail when at least one of three factors is present:

• Moral hazard The insured takes on more risk or incurs costly activities because the insurer is going to pick up the tab. Phrases that I have heard, half serious and half in jest: "Sure I can go skiing! I have hit my max deductible on my health insurance." "I don't mind if my glasses break. Insurance covers another pair this year anyway." "I need to make sure I get my doctor checkups, eyes checked, and dental cleaning. I don't need it, but I'll pay loads more when I switch plans next month."
• Adverse selection A narrow market emerges because the insured possesses much more information than the insurer. My wife and I learned about this in 2008 while evaluating insurance for pregnancy coverage. When we looked at the cost of coverage we discovered that because of the premiums and caps, on an NPV basis the coverage made sense to purchase only if my wife became pregnant within the next six months. A baby was not in the immediate plan, but the insurers did not know that. While the point of insurance is to transfer the risk for a price, a six month breakeven NPV is far outside the range of most people's risk appetites. This limits the number of people applying for coverage to the truly risk averse and those who plan on getting pregnant in the very near term.
• Correlated risks Large-scale meteor strikes, war, and 1918 Spanish flu-style outbreaks do not have insurance products. Either the event never occurs and the insurer walks away with the money or the event occurs and the insurer must pays off everyone at the same time and the insurer does not have sufficient assets to pay out. Accordingly, neither a rational buyer nor the rational seller should enter into the contract.

As I reflected on the podcast and some long ago college lectures, I couldn't help but see the parallels with this and AIG's Financial Products division. AIG wrote credit default swaps to insure collateralized debt obligations. In layman's terms, if a pool of mortgages started to default above a certain rate, AIG would be forced to pay the losses. Companies would approach AIG and offer to pay premiums if AIG were willing to assume the risk. To some degree I see all three forms:

• Moral hazard Anything that could make it through the AIG filters would be pushed through. If the price is identical, the first CDOs in line for credit default swap are the lowest quality relative to the perceived risk. 
• Adverse selection In late 2006, I spoke with a regional mortgage broker who referred to a section of his loan portfolio as "hot potatoes." All the due diligence boxes were checked, but because he was closer to the market, he was more familiar with the underlying risk than the standard scoring mechanisms would show. He was in a hot market, and he knew that the buyers who purchased, rebundled, and securitized would be none the wiser. One fascinating fact here according to a comprehensive FDIC report is that while it is true that, "the loans small lenders sold into the secondary market had both higher default risk and higher prepayment risk," the same was not true for the larger banks. Fortunately for AIG, the larger banks kept the loans with higher default risk, but lower prepayment risk. The data on adverse selection in the collateralized debt obligation market is a mixed bag and AIG ended up lucking out as it could have been much worse.
• Correlated risks While I recognize that many believed that real estate movements were not correlated on a national level because historically that was not the case in the United States, nationally correlated real estate prices had occurred at different intervals across many countries over the last fifty years. A friend once told me of a financial risk conference he attended in 2006, and while "across the board decline in real estate prices" was on the board of one of the primary presentations, it was listed in the "very low probability" bucket. While hindsight is 20-20, this was considered a known risk, and insuring it on this scale is like betting all-in against a pop star becoming addicted to cocaine. Sure, it hasn't happened yet to this person, but are you ready to bet the company, the largest insurer in the world, on it not happening?

While adverse selection and moral hazard can run losses for a company, if there are no correlated risks and the ramp up in underwriting volume is not large, the losses will start to pile up and corrections will be made before it gets too bad. Correlated risks, however, were the doozy that sank the company.

Leadership - Leading

Continuing on a previous post, there is a difference between management and leadership. Unfortunately, this phrase has been an overused cliché and become a blank canvas to project whatever one wishes into the paradigm. With that enormous caveat, below is a description of my experience of when I have felt that I have been led versus when I have been managed.

When I am led, I feel that the leader and I have the same goal. It isn't a single word like "Vision" or "Passion," Of my own volition, I choose to want the same thing that my leader wants. Since individuals want different things at different points in their life, depending on the situation, leading can be incredibly difficult. Consider some of the potential objectives for each employee or team member:
1) Avoid work
2) Positioning for outside company move
3) Job security
4) Maximize compensation 
5) Positioning for advancement inside company
6) Praise and recognition
7) Feel superior
8) Winning
9) Team survival
10) Creation

When I'm being managed, I feel like my manager is appealing to any of the first seven items in the list. "Hit your target and get your bonus." "If we do this well, senior management will recognize it." "We can outdo the sales of those B-listers in the other division." "This will look good on your résumé."

When I'm being led, I feel like my leader is using one of the last three items in the list. "We are this close to the best customer experience in the industry." "We have come a long way, and if we can see this result come May, the bankers will give us the green light." "Pulling this off will forever change the industry. I believe that you can do this."

Because individuals are unique, and some are more difficult than others to lead, leadership will always be difficult, a unique attribute, and contrary to what many believe, an inconsistent attribute. People and circumstances will always change. However, recognizing that the appeals to the first group as primary motivators does not feel like leadership is a good step at rising above hum-drum management and taking a shot at the next level.

Leadership - Management Frameworks

One of my favorite analogies is the fire triangle. It's simple, familiar, and applies well in a variety of situations.

(Image from the peer reviewed journal, Wikipedia)

Anything with three primary elements that breaks if any one part is missing is fire triangable. Learning? Existing knowledge, transmission, and retention. Body building? Calories, muscle exhaustion, and repetition. Fire triangle created. Since it seems nearly every framework comes in threes, and a large percentages of these frameworks are co-dependent, the fire triangle becomes ubiquitous.

Take one fire triangle for leadership and team management:
Knowledge - What is the plan? Does the employee know what (not know how) they are supposed to do? What are the priorities, KPIs, process, routine?
Ability - Is the employee presently capable of achieving the objective?
Motivation - To what level is the employee committed to achieving the goal? How much oversight and followup is needed to keep the employee on task and giving all of their effort?

When all three are present, I see a functioning team. Everyone knows their place, is capable of doing their job, and is committed to following through to the goal. What I find most interesting, however, are diagnostic failures. I have often talked over plans of what to do with "underperformers" with managers. There are cases in which the environment has no direction or plan, but the manager believes the employee is incapable. At other times the employee simply does not have the skills to perform a function, yet the manager still believes that one more pep talk just might do the trick. Finally there are those employees who "just aren't capable," yet they switch managers and become a rising star. Misidentification is a mistake we all make, but once you recognize it, testing the hypothesis before throwing the employee out can yield surprising results.