Thursday, October 31, 2013

Triangle Arrangement

The standard principle agent model is bilateral; however, more often an agent deals with a secondary principle.  I personally have not associated with any strong examples of a triangle arrangement regarding an agent and two other parties.  However, I know that one of the main reasons why the housing crisis of 2008 was such a big deal was because of this triangle structure of cooperation. Essentially, many mortgage associations such as the Federal National Mortgage Association, which is commonly known as Fannie Mae, were involved in sub-prime lending.  Sub-prime lending is essentially the act of providing loans to people who have trouble repaying the loans in small increments.  This process eventually caused many Americans to drown in debt as they were unable to complete their mortgage payments and eventually many houses were foreclosed upon as collateral due to the initial loan being unable to be returned in full.

Essentially, this process was a triangle arrangement as many employees working for mortgage associations felt that they could appease their customers by providing loans despite the lack of qualifications of many borrowers.  Additionally, many employees may have believed that the more loans that they were able to issue to customers, the greater the likelihood of success in the workplace.  They believed they had an increased chance of attaining carrots such as a promotion or a monetary bonus from their employers or superiors.  Ultimately, the practice of sub-prime lending seemed to benefit both the employer and the borrower from the employees point of view at least initially.  However, the problem occurred when the borrower did not make adequate repayments of the loan and thus, the consequences were felt by all parties in the triangle arrangement.

Fundamentally, in this situation, the employer had a different view on good performance than both the borrower and the employee.  Of course, the employer wanted to provide more loans to borrowers just as the employee did; however, the main difference was that the employer wanted to adhere to the standards of lending practices and discouraged sub-prime lending.  However, the employees felt that they could get away with this and unfortunately, it was not the case.  Now the borrowers obviously felt good performance was based on whether or not they received the loan, so essentially, the employees were getting away with good performance from both the employer and borrowers perspective until the practices of sub-prime lending were revealed and then everyone suffered.

In order to resolve this tension and avoid this problem, one might conclude that it necessary to follow the strict lending procedures and avoid loaning to those who does not meet the adequate credit qualifications.  Although this may appease the employer, many borrowers may personally feel that this is not good performance from the employee as they believe that they are entitled to a loan, yet still denied.   Ultimately, it is hard to believe that there is another way to resolve the tension in a favorable manner other than following the rules.  The risk associated with breaking the rules is too great and I doubt many want a repeat of the housing crisis of 2008 in the future.

3 comments:

  1. Let's look at this in two different ways to see if it is a good example of the triangle problem or not.

    First, on your characterization of a subprime loan, I would define it somewhat differently. I would call it loans to people who have poor credit ratings.

    Second, on your comment about strict lending procedures, the question is, what does it mean. Doe it mean no loans at all for subprime customers or does it mean smaller loan sizes and mortgages only of a certain type (fixed rate).

    I think the history shows that many of these customers got mortgages for houses that they rightly could not afford, that the mortgages had low teaser rates but then substantial balloon payments, that the borrowers were not very sophisticated about this, and that making such a loan gave higher commissions to the loan officer than would making a safer loan.

    Also, I believe that Fannie Mae and Freddie Mac were relatively late to the game. They assumed risk to the system generated by the more aggressive private lenders, notably Countrywide.

    So to me this was more an example of deception and fraud than an instance fo the triangle issue.

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  2. You suggested that employees made risky loans just to gain carrots from the employer, but many banks pushed hard for these sub-prime mortgages, knowing these people had bad credit. In fact, it could be argued the banks pushed these loans more than customers did.

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  3. I apologize for using an improper example of the triangle issue. Handing out smaller loans and fixed rate mortgages to subprime customers does make sense. I suppose I should have clarified. I did suggest that employees made risky loans to gain carrots; however, it does make sense that employers may have pushed for this as well if they were getting an increased payout.

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