The new normal of consumer behavior

The 2010 Kellogg Risk Summit takes a closer look at the interplay between marketing and risk
management
By Ed Finkel

12/2/2010 - Consumer behavior in the wake of the 2008-09 economic crisis has changed dramatically. Lenders need
to understand and account for these changes as they consider when and how to begin loosening credit, according to
Chisoo Lyons, vice president, analytics, at Minneapolis-based FICO.
Theres no one who has not been impacted. Business models are changing; profit margins are slimmer; consumers
are behaving differently, said Lyons, who gave a keynote address during the conference at the Allen Center, titled
Understanding the U.S. Consumer: Risk Management and Marketing Intertwined. The Oct. 28 conference reflected
Kelloggs tighter focus on risk management since the 2002 founding of the Zell Center for Risk Research, which cosponsored the event.
As lenders figure out how to make their way forward through the massive environmental changes since the crisis,
they need to realize that analyzing data from the past three years does not necessarily help predict the next three,
and that waiting for more data might not be the best option, Lyons said.
The key to determining the best mix of actions is to introduce more narrowly segmented products for certain types of
customers and to think about whether other products remain necessary at all, she said.
What can you do in this room? Make better decisions, one decision at a time, Lyons said to those in attendance.
You need to find the tradeoffs: Is this the right customer to authorize? Are you losing a good customer if you dont?
One noteworthy change in consumer behavior is the rise in strategic delinquencies, particularly on residential
mortgages they have risen from 22 percent of foreclosures in March 2009 to 31 percent a year later. You need to
tease out those walking away from their bills strategically versus those who are just having trouble paying their bills,
she said. This is the new normal of consumer behavior.
People who strategically walk away typically manage their credit well, spend carefully and have lived in their homes
for short periods of time. Lyons said theyre identifiable in the data, and she believes they can be influenced through
written materials and customer service calls detailing the consequences. Some say, Dont bother, their minds are
made up, she said. I like to be a little more optimistic.
An audience member expressed the opposite view, saying that he would prefer to educate those who are slipping
behind without intending to, rather than guarding against the rational actions of those purposefully walking away.
Lyons mentioned that in the Quarterly Survey of Bank Risk Officers conducted
by FICO and PRMIA, which is completed in conjunction with the Zell Center
for Risk Research, the overall outlook toward credit conditions remains
challenging. However, she sees some signs that credit lending is expanding.
The financial crisis has been painful for risk managers but also a learning
opportunity, said Yan Chang 06, vice president, risk management, Discover
Financial Services, who gave another keynote address.

Related Video
Watch a video interview
with Chisoo Lyons, vice
president, analytics,
FICO

As a risk manager, there are two things you need to do, he said. When things are going well, and you know why
theyre going well, tell your managers. The second thing is, when things are not going well, youd better know why,
too.
Discover, which offers bank deposits, loans and debit cards in addition to its better-known credit card business, first
noticed things were not going well in late 2007 when mortgage delinquency rates spiked in Florida, Arizona, Nevada
and California. An analysis showed that high-risk mortgages were the culprit, and the company adjusted its strategy
in those states but before long, the crisis had spread.
What caused this? Borrowing more than what you produce, Chang said. You can blame it on the bubble, all this
stuff. People wanted to believe in this thing. They kept on borrowing.

Risk managers need to get back to basics and ask customers who are building up their balances why, and whether
they have a solid plan to pay them back.
We need to know more about our customers, he said. Youve got to use that
information for risk management.

Read the current

surveyof bank risk
officers, which finds
persistent credit gaps
facing consumers and
small business owners

In the mid-2000s, less scrupulous risk managers almost seemed like they
didnt want to know the truth about their customers, lest it get in the way of
making a loan, Matt Feldman 86, president and CEO, Federal Home Loan
Bank of Chicago.
Supposedly knowledgeable investors find themselves relying on models,
metrics and other investors to make decisions that are comfortable but not
necessarily accurate, or correct, he said. The level of control in protecting
how this market evolved was simply not present, but the illusion of control was.
And the illusion was perfectly acceptable until it was no longer working
properly.

The illusion led to products like no-income-no-asset (NINA) loans, in which lenders did not ask for documentation
and, in some cases, encouraged applicants to falsify information, Feldman said.
They ask, What do you earn? I tell them what I earn, he explained, and the lender responds: Maybe you should
earn more. Lets put down this amount. Feldman added, Dont think that didnt happen. Just as many [applicants]
said, Hes asking me what I earn, but hes not going to check.
Due to these high-risk products, Feldman expects the wave of defaults to continue for a couple more years and he
says the list of people to blame is a long one that only begins with the Bernard Madoffs of the world.
Bubbles create an opportunity for bad actors, but most of the damage is caused by well-meaning people engaging in
crowd behavior caused by greed, folly, or both, he said. You can look at Madoff and point the finger, and talk about
how horrible it was. But the real damage was caused by everyone else.
Read the current survey of bank risk officers, which finds persistent credit gaps facing consumers and small business
owners The conference, presented by FICO, Discover, PRMIA, and the Zell Center, also featured a panel discussion
that included Russell Walker 06, associate director of the Zell Center; William Farrow 79, president and CEO of
Urban Partnership Bank; and William Panak, senior statistician and scoring officer, Capital One Financial.
In an interview (watch video here), Lyons reflected on the impact the crisis has had on the risk management field.
Pre-crisis, we were the people everybody wanted to avoid. Now, were the people invited to all the meetings, and
were in great demand, she said. Its no longer the quirky little function thats ignored. Indeed, risk management is
front and center in the recovery.
The next Kellogg Risk Summit will take place Feb. 23, 2011 and will continue the dialogue on risk, with a focus on
global risk.