Small enough to matter

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[Image source: Grassroots Economic Organizing]

A familiar seed grows amidst the ‘too big to fail’ trees in our financial forest:

After months of anticipation, the East River Development Alliance (ERDA), a non-profit organization established in 2004 to help public housing residents by expanding their economic opportunities, [has] finally opened its Federal Credit Union (FCU) – the first to be chartered in New York City in 10 years.

According to ERDA, three out of 10 people in the Ravenswood, Queensbridge, Astoria and Woodside Houses – which will be served by the new credit union – currently lack bank accounts.  [The credit union] will help change that, ERDA says, by providing public housing residents with a means to build capital, manage their money and achieve their financial goals. Proponents also believe the FCU’s presence will spark economic development in the area.

A credit union is a cooperative financial institutions that is owned and controlled by its members and operated for the purposes of promoting thrift, providing credit at reasonable rates, and providing other financial services to its members.  I call them familiar because they’ve existed for quite some time – the first credit union in the U.S. was founded in 1909 and they’ve been under federal supervision since 1934, backed by the full faith and credit of the FDIC.

The ERDA credit union launch ties in quite nicely with my recent thoughts on microfinance, particularly with respect to its lack of freshness. Here is a centuries-old system of community-based finance, owned by its depositors – sounds an awful lot like a Grameen Bank.  Yet for all the fanfare that has surrounded microfinance, people often overlook the credit union as a tested tool for financial reform in this country.  ERDA’s is the first credit union chartered under the Obama administration, and the first established in New York City in over 10 years.

So props to ERDA for reminding us of the tools we have!  As we contemplate how to regulate institutions that are too big to fail, it’s quite reassuring to know that we might also promote those that are small enough to matter.

* on a related note, check out Raghuram Rajan’s radically provocative thoughts on why deposit insurance should only exist for community-based financial institutions, via Ezra.  It’ll make you go ‘hmmm.’

Posted on April 29th 2010 in news, OrgWatch

On Microfinance

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I worked for a microfinance organization, so it’s a little strange that I have not come around to talking about it yet, but a recent New York Times article touched on all of issues surrounding microfinance that I have been pondering.  So I guess its time for me to confront my opinions.

Microfinance has been hailed by Muhammad Yunus and many others as the elusive formula to improving the lot of the world’s poor.  It is thought that providing small loans to poor people will allow them to pull themselves out of poverty by virtue of no longer having working capital constraints on their entrepreneurial ventures.

One must first consider that lending to poor people is not, in and of itself, a novel idea.  People with capital have always been there to lend it to those who don’t have access to it, and to take profits off the top.  We called these people loan sharks, and have long stigmatized them in film.  They sit in dimly lit rooms and finance a protagonist at a time of desperation. Later, when the loan goes sour, they use violent methods of collection.

There are certainly these sorts of loan sharks out there, but that is not the whole story.  Some are just moneylenders, respected members of their communities, attempting to fill a capital gap because banks, the “formal” arbiters of small business finance, refused to lend in these communities.  The banks considered it too costly to reach these borrowers, and the interest to be earned off of their small balances, has not traditionally been worth the effort.

Enter microfinance.  It has always been an attempt to “formalize” the practice of small-scale lending, to provide safe and affordable access to capital to the segments of society forced to rely on predatory lenders.  And formalize they did.  MFIs simply institutionalized the practice of community lending that existed, which is why many people remain so skeptical.  The interest rates still appear predatory and there are still rumors of abusive collection practices.

The question of whether or not small loans, in and of themselves, can eradicate poverty is hotly debated.  After much internal debate, I have come to the conclusion that, financially speaking, it is simply not feasible.  Even the cheapest microfinance organization is lending at well above 20% APR and thus for this sort of small-scale entrepreneurship to be sustainable, microborrowers would have to be earning above that.  Now, imagine what Compartamos borrowers would have to earn.

But not even the largest, most efficient corporations in the world are capable of consistently earning returns like that – the market average is, at best, 10%.  If it were indeed the case that microentrepreneurs could consistently earn 30-130% on borrowed capital, we’d all be hawking handmade goods on the street and selling fish out of the back our cars, and you can be damn sure that banks would be lending to us.  This is why the interest rate question is so important, because if you can’t earn above the cost of borrowing, the only options are then deeper indebtedness (i.e. more microlending) or bankruptcy.

But I am still a huge proponent of microfinance.

The way I see it, microfinance is the stepping stone between the bottom of the pyramid and the true engine of wealth building, savings.  Microfinance has introduced millions to formal financial services, and as MFIs struggling to become self-sufficient have turned to collecting deposits, they are introducing people to the real consumer benefits of banking, saving.

In the future, we will see that MFIs simply laid down the distribution channels, proving that the poor demanded financial services and that they could be reached affordably – that was the true innovation. And as mobile technology and other innovations bring down the cost of banking to the poor, the logical conclusion of the story, like it or not, will be the transformation or consolidation of MFIs into the traditional banks.  MFIs may survive as full-time distributors, selling loans and receivables between banks and borrowers, but the net effect will be the same, JP Morgan and co. trolling around the bottom of the pyramid.

The reason this scares people is that they think banks will profiteer off of the poor.  But one should remember that banks are heavily regulated with respect to the interest rates they can charge; the same cannot be said for all MFIs, especially non-profit ones.  If there is any reason that banks and MFIs can get away with charging exhorbitant interest rates, it is because the local usury laws permit it.

This is not a question of greed and profit margins.  It is a question of democracy, the will of the people and the rule of law.  It is about what interest rates we as a society are willing to accept.

At the end of the day, if we get the laws right, we will have expanded access to financial services to all corners of the globe, with regulated lending and the opportunity to save open to all.

And isn’t that what we truly want?  Because think about it: if the end of this story is not about savings, are we not just creating another generation of debt-addicted citizens?  Are we not just blowing up another lending bubble?

[The caveat of all this, of course, is financial literacy and how  well we educate ourselves on the responsible use of financial services.  This is not limited to the poor.  It should be a mandated part of high school curriculum for all]

Posted on April 14th 2010 in ideas, news

Responsibility? It’s called insurance.

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Obama comes out swinging at the banks in 2010, just in time to divert attention from the Massachusetts debacle and the behind-the-scenes wrangling that health care will now face.

Scene 1 of Obama vs. the banks: The Responsibility Fee

In his January 14th Weekly Address, the President detailed his plan to recover the TARP funds and hopefully stave off taxpayer liability for future financial collapses.  All financial institutions with more than $50 billion in assets would pay the fee, based on their debt levels, until the TARP money is recovered.  This will include those that did not receive any taxpayer money during the recent crisis.  It is expected to affect about 50 banks and raise an estimated $90 billion over 10 years.

Obama has dubbed it the “responsibility fee” and is marketing it as 1) a chance to recoup all TARP funds, and 2) a way to discourage excessive risk-taking.  Faux News and the Michelle Malkins of the world have predictably called it a tax.

You can spin it from either side, but I simply call it insurance.

Recently, JP Morgan CEO Jamie Dimon dropped this gem in front of Congress:

“Not to be funny about it, but my daughter asked me when she came home from school ‘what’s the financial crisis,’ and I said, ‘Well it’s something that happens every five to seven years,”’ Dimon said. “We shouldn’t be surprised, but we need to do a better job.”

But it is funny.  Tragically funny, because it is true.  It is the business cycle, the inevitable path that the market collectively follows.  It is, in a word, predictable.  And what do we do with things that pose catastrophic, yet predictable, risks?  We insure them.

Take car insurance.  We know that there will be car accidents – approximately 6.5 million per year in the US – and that these will impose costs on the victims that they will not have been disciplined enough to have planned for.  Thus, we mandate that drivers carry insurance to help smooth out the cost curve.

Finance, in contrast, gets an implicit guarantee.  Instead of having banks insure themselves against the failures that even Jamie Dimon’s daughter can now predict, we allow for government and the taxpayer to bear that cost.  And we do it in perpetuity.

This is textbook moral hazard and is often a justification for government intervention in insurance markets.  Simply put, the plan will make banks pay into a pool of funds that can be used to bail them out when the next financial crisis hits.  And the premium is risk-adjusted – since it is based on debt ratios – as it should be in insurance markets.

Implicit guarantees are market distorting subsidies that reduce the cost of borrowing and thus hide risk.  The Obama plan is a purely economical way to eliminate the subsidy, raise the price of risk and therefore reduce it.

The simple logic of this is why economists from across the political spectrum, from Krugman to Mankiw, have come out in support of the plan.  It is the smart thing to do and it should remain in perpetuity.

Unfortunately, as Thomas Cooley points out, the administration’s decision to grandstand and market it as a purely punitive measure may undermine the well-reasoned argument that might have allowed it to become effective and sustainable regulation.

Posted on January 26th 2010 in news

Pause & Think: The Corporation as Human

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The Supreme Court lifts limits on corporate spending in electoral campaigns

Meanwhile, Obama wants to place limits on bank size and risk-taking.

What do you think?

[Image Source: Gallup]

Posted on January 21st 2010 in news, Pause & Think
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