Financial Mess Root Cause Analysis

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2008-2009 Financial Mess - Cause Map                                                                                                                Overview: One house in foreclosure doesn’t cripple the U.S.
                                                                                                                                                    financial system, but thousands of houses in foreclosure is one of

     Using Root Cause Analysis to Explain a Complex Economic Issue                                                                                  the causes in a "chain of events" that negatively compounds
                                                                                                                                                    throughout the economy.
     Basic Cause Map
    Read the cause-and-effect relationships from left to right by saying "because" in place of each arrow.                                          Preliminary reports from the National Bureau of Economic Research
                                                                                                                                                    indicates that in 4Q 2008 the United States GDP declined at an annual
         Economic                                               Bank / financial       Foreclosures                                                 rate of 6.3%, the worst decline since 1982. In 2008, foreclosure rates
                                        U.S.                                                                    Housing bubble                      increased 81% from the previous year, 25 banks failed, and the
           Goals                                                  institution             increase
                                      Recession                                                                     bursts                          national unemployment rate reached 7.2% and continues to rise. The
         Impacted                                                   failures            significantly
                                                                                                                                                    root cause analysis below shows some of the causes of the current
                                                                                                                                                    financial predicament and focuses specifically on a few of the vicious
    This simple analysis shows that the Economic Goals of the U.S. (its financial security) are affected because
                                                                                                                                                    cycles that continue to fuel the problem.
    the recession The recession is because of the bank and financial institution failures, which were because of
    the significant increase in foreclosures when the "Housing bubble" burst.
                                                                                                                                                    Any feedback to improve the accuracy of this page is appreciated.

          The Cause Mapping method of root cause
      analysis shows how individual cause-and-effect
       relationships connect to create a bigger issue.                                                                                                                                                                                                                                             Supply of
                                                                                                                                                                                                                                                                                                 houses is too               ?
                                                                                                               Downward Spiral of Housing Prices
                                Solution:                                                                                                                                                                                                                                                            high
                                                                                                               Once the "Housing bubble" burst in 2005-2006, housing prices began to decline. The initial
                                                                                                                                                                                                                                        Housing prices              Housing bubble
               Effect            Cause                                                                         decline, along with other components listed, caused homeowner equity to decline. Once
                                                                                         SELF                                                                                                                                           Housing prices
                                                                                                                                                                                                                                        d li      idl                                                            to be
                                                                                                               equity in a house is negative, a homeowner is generally unable to sell or refinance. If a                                                                bursts                      AND
                                                                                       FEEDING                                                                                                                                             decline                                                            continued...
                                Evidence:                                                                      homeowner is also unable to make their mortgage payments, foreclosure is inevitable.                                                                  (2005 - 2006)
                                                                                        CYCLE                  Rising foreclosures increases the supply of houses available which causes further downward                            Evidence: By Sept 2008,       Evidence: See Chart
  For a free copy of our root cause analysis template in                                                       pressure on housing prices. This cycle continues to repeat, feeding itself, producing a                               average U.S. housing price    of the day, above.             Demand for
 Microsoft Excel, used to create this page or to learn more                                                                                                                                                                          declined over 20% from                                      houses is too               ?
                                                                                                               downward spiral with significant consequences.
           about our method, visit our web site at                                                                                                                                                                                   mid 2006 peak.
                                                                                                                                     Increase in
                                                                                                                                      supply of                                                                                                                         Little or no
                                                                                                                                                                                                             Homeowner                     Little or no                                               Housing bubble:
Detailed Cause Map - Starting with the Basic Cause Map above,                                                                          homes                                        Unable to sell or                                                                 down payment
                                                                                                                                                                                                            equity declines               equity when                                               the increase in real
more detail can be added in between each of the cause-and-effect                                                     Evidence: Housing inventory
                                                                                                                                                                                    refinance home                                                                         when                       estate prices to
                                                                                                                                                                                                           (some negative)                 purchased
                                                                                                                     levels reached a record high in                                                                                                                    purchased                  unsustainable levels,
relationships to reveal a more thorough analysis.
                                                                                                                     Sept 2007.                                                                          Evidence: Mar 2008, 8.8                                  Evidence: In 2005, the             where the bubble
                                                                                                                                                                                                         million borrowers                     AND                median down payment for            bursts and prices
                                                                                                                                                                                                         (10.8%) had negative                                     first-time home buyers was              decline.
    Economic                                                                                                                                                                                             equity in their homes.                                   2%. 43% of those buyers
                                 U.S.                                                                                                                                                                                                    Lines of credit          made no down payment.
      Goals                                                                         Business                                                                 Foreclosures
                               Recession                                                                Banks restrict             Bank capital                                                                                          taken against
    Impacted                                                                        spending                                                                    increase                                  Negative Equity:
                                                                                                          Banks                     declines                                            AND
                                                                                                                                                                                                                                          home equity
                                                                                   decreases                                                                  significantly                               Owing more on your
                                                                                                          restrict                                                                                        house than it's worth.     Evidence: 2006 study, 1
                                                                                                                                                           Evidence: 2008                                                            of 5 homeowners held a              Consumerism,
                                                              Business                                                                                     Foreclosure rate up                                                       home equity loan or                 "spending too
                                                              slowdown               AND
                                                                                                                                                           81% from 2007.                                                            second mortgage.
                                                                                                                              Possible Solution:                                                                                                                            much"                     Adjustable-rate
                            Unemployment                                                                                      Federal support of failing                                                                                                                                                  mortgage
                                                                                                                              institutions                                                                                                                                                            (ARM) used to
                             Unemploy                                                                       AND                                                                                                                                                                 AND
                                                                                   Consumer                                                                                                                                                                                                            finance home
                            Evidence: Up to 8.1% (Feb                               spending                                      Bank / financial                                                                                          Household                                                       AND
                            2009) Highest in 25 years.                             decreases                                        institution                                                                                                                             Mortgage
                                                                                                                                                                                     No longer able                                          spending
                                                                                                                                      failures                                                               Household                                                      payments
                                                                                                                                                                                        to make                                             increases                                                  Low interest /
                                                                                                                                                                                                              spending                                                       increase
                                                                                                                                                                                       mortgage                                             (> $OUT)                                                  "teaser" period
                                                                                                                                                                                                           exceeds income                                                                             ended on ARM
                                                                                                           Loss of                       AND                                           payments                                                                                 AND
                                                                                                                                                                                                        Evidence: Americans spent
                               SELF                                                                      consumer
                                                                                                                                                                                                        more than their disposable
                                                                                                                                                                                                                                               AND/OR                                             Evidence: Estimated 1/2
                                                                                                                                                                                                                                                                                                  of ARMs originated
                             FEEDING                                                                     confidence              Possible Solution: Tax                                                 income every year starting
                                                                                                                                                                                                                                                                                                  between 2004 and 2006
                              CYCLE                                                               Evidence: Consumer
                                                                                                                                 rebates, Tax reductions                                                in 1999 (134% in 2008).                                          Higher prices            had "teaser" rates below
                                                                                                  confidence is at record
                                                                                                                                         Less                                                                                            Monthly income
                                                                                                                                                                                                                                            Household                      for food,              4%.
                                                                                                  lows.                                                                                                                                     Household                    energy, goods
                                                                                                                                     disposable                                                                                          income reduced
                                                                                                                                       income                                                                                                (< $IN)
                   Unemployment Causes Loss of Consumer Confidence
                   As business slowsdown, companies are forced to reduce costs which causes lay-                                         AND
                                                                                                                                                                      High Unemployment Reduces Income
                   offs. This causes a loss of consumer confidence as people become concerned
                   about their own employment situation. And the cycle feeds upon itself.                                                                             As business slows, companies are forced to lay off employees to                                                                                        TM
                                                                                                                                     Concern of                       survive. This feeds back into the cycle by reducing income levels
                                                                                                                                     losing job                       causing more foreclosures and less disposable income, both of
                                                                                                                                                                      which feed the downward spiral.
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