Legal Commentary

Skin In The Game: It Causes Behavior To Change

By Patrick J. Lamb

The President's proposed solution to the economic problems created by the easy loans made during the housing bubble requires banks and other lenders to keep 5% of the loans they package and sell.  The belief is that if lenders have "skin in the game," they will refrain from making bad loans since doing so will cost them money.  All this is according to an NPR story:

Banking industry consultant Bert Ely, 67, remembers when sitting down to apply for a home loan was like going before a judge. "You sat down with a sober banker," he says. Today, "these mortgages are made with the intent of selling, not keeping."

Ely explains that over the years, banks and mortgage lenders started making loans and then selling them off to investors, and when that happened, lenders became more like salespeople. Mortgage brokers and loan officers got their commission regardless of whether a loan was good, and it was somebody else's problem if the loans went bad.

"The lender doesn't care as much about the riskiness of the loan or the eventual likelihood of default if he's going to sell it and not retain any risk," Ely says.

So basically, lenders often don't have skin in the game the way they used to because they're not lending out their own money any more.

Listen to the full story here.

All this is interesting if you're into following the economy, of course.  But it's also interesting to those who follow issues relating to the billable hour.  Isn't the problem identified in the story essentially the same issue raised in indictments of the billable hour model?  When you are economically divorced from the outcome, when your profit is guaranteed regardless of what happens, you behave differently than when you have skin in the game.

There are those who take exception to this claim, who believe they are just as efficient using the billable hour method.  There may be the exception that proves the rule, but in this case, I find the claim that "I am just as efficient as I would be if I had skin in the game" to be like Woodstock, which everyone above a certain age claims to have attended even though most didn't. 

Skin in the game on legal fees drives efficiency.  And results.

Full post as published by In Search of Perfect Client Service on June 18, 2009 (boomark / email).