Solution strategy for the financial crisis

SAS blogger rides down the trail to the root causes

Our current economic crisis is so large and its consequences so great that they demand a comprehensive and sustainable solution for all concerned. Before we ride off in any particular direction, we must first formulate a plan of attack. Fortunately, my co-author Mingyuan Zhang and I just completed a book that does precisely that by:

[one] Thinking outside the box to identify what lies at the heart of the problem.

[two] Analyzing what is needed to bring about the necessary changes in business practices, regulations and the way in which the markets operate.

[three] Recommending appropriate methods and systems that will enable us to work through the current crisis while improving the effectiveness and efficiency of our current credit system and guarding against similar crises in the future.

Relative to the first point, a fresh look at how loans are approved is necessary. We need to forget about how it is done today and consider how it would be done in a perfect world. Relative to the second point, we must consider changes that would be necessary in order to implement the new lending system. This would include a business case and associated timelines. On the third point, it is critical that we identify who qualifies for a loan going forward and who needs, and is entitled to, assistance before any bailout money is used to spur further lending or to help financially strained property owners. To do otherwise risks reinforcement of the very lending and borrowing habits over decades that led up to this financial mess.

In particular, we challenge the notion that you have to use credit in order to prove you are worthy of getting a loan. The past and current credit bureau scoring models reward spenders, while penalizing savers and cash payers. We encourage students and those new to credit to borrow, even when they do not need to, in order to establish a credit history. By doing so, we are encouraging them to get used to buying on credit, instead of saving up for what they want. Once they get accustomed to that behavior, it can get out of control, and then they find themselves in financial trouble before they realize it because they purchased goods on easy credit terms they thought they could pay off using future income that may not have materialized for one reason or another.

We need a system that does not encourage people to borrow when they do not have to and that rewards, rather than penalizes, consumers who save and pay cash. A Comprehensive Credit Assessment Framework (CCAF – pronounced “see-kaf”) will bring about more responsible borrowing and lending and, as a result, more stability to our credit system, financial markets and our national economy. My next five blog posts will highlight five important properties that any proposed solution to a business problem should satisfy.