THE LAB

I’d like to NAB me some money.

Doesn’t the whole system need a “new arrangement”?

NAB (New Arrangements to Borrow) is an arrangement through the IMF (International Monetary Fund) where member countries lend to the IMF in times of crisis. It is reported (IMF/Reuters , NYTimes) to be a short-term cash infusion via the sale of bonds. Sounds pretty good. The funds go to poorer countries such as Poland, Mexico and Colombia with others expected to line up. The IMF wants China, Brazil and Russia to throw in big time. They have been balking because they want more voting power.

What it does, according to the articles, is to provide cash where credit is unavailable (isn’t that everywhere?). It is providing actual money instead of the promise to pay money. It is supposed to be short-term, one to two years. Then the cash comes back out of the system.

Currently one can NAB up to $50 billion USD. This sale of bonds is supposed to raise $500 billion. Wow. That seems like a lot.

It is a short-term cash infusion and therefore, I think, a short-term fix to a systemic problem. Is this a lesson that the closer banks are up to 100% cash reserves, and the closer we are to a real economy and not a “paper chase” economy, the better off we’ll be?

What is credit anyway?

The root of the word is from the latin credere, to trust, entrust, believe or, simply, “faith and trust” Oddly, these two fine attributes are missing from the banking system of today. If I walked in to a bank and said I was trustworthy and would work faithfully to repay I’d be turned around and marched right out the door. I would have to have….a CREDIT HISTORY. I would have to prove that I could repay the money. But what if I could never get any money in the first place? What do I do? I generally don’t have to worry about that, because I was born into a privileged and powerful existence just by virtue of being white and male and American.

But what about the 70% of the poorest people in the world who are women and children – and who are “unbankable”?  Will any of this money go to them? Not if it gets into the hands of the mainstream banking system.

On the one hand, NAB could be a way for the poorer countries to develop infrastructure and economic development that should create long-term living wage employment for the lower rungs of the economic ladder. Maybe it can work in tandem with microfinance, so that there is a top down and a bottom up economic plan to help the poorest people in the world, those living on $1 US or $2 US a day.

But on the other hand, let’s go back to the faith and trust thing. One big difference between the banking system and microfinance, is that the microfinance loans are largely uncollateralized. The microfinance system is based on “knowing the borrower” and in many cases, on peer pressure as well, since loans can be made to a group of unbankable people.

Perhaps this model should be included in the New Arrangement to Borrow.

Do we have an obligation to lead effectively?

I don’t know… what if all the people in the world who make less than $2 US a day started buying tvs and bottled water? There would be so much garbage that landfill would be real estate. How can we create an egalitarian economic system that treats everyone fairly and doesn’t degrade the planet? The reason the US accounts for 25% of all the greenhouse gas emissions in the world is because we have so much damn stuff. That is one challenge we face with the economies of China and India, the rising middle class of the “developing world”. The Western model of consumption economics is the aspirations of hundreds of millions of people around the world. What do we need to do? Show a little restraint perhaps?

It is kind of like parenting. I am relatively new to this parenting thing. I have a 5 year old and another one on the way…like…the call could come while I’m writing this. But what I mean is that I can lecture my kid about this and that but it is what I DO that she will do. Not what I tell her to do. Trust me. OK, we recycle, duh, I think it is on the admissions exam for living in Seattle. I showed my little one the difference between the garbage and the recycling ONE TIME. Now, if she thinks the thing I am throwing away can be recycled, boy do I hear about it. That’s because she sees us doing it every day, not because I sat her down and discussed post-consumer waste and #5 plastics.

A better alternative?

Some poverty alleviation metrics from Grameen Foundation and Oikocredit include having a house with a roof that doesn’t leak, sending your kids to school, and seeing a doctor every year or two. It seems to me to be a long hard road, but one that has begun with the existence of some 10,000 microfinance institutions across the world.

So maybe NAB should be turned around for the poorest people in the world, and instead of the over-leveraged financial systems that created our current problem, the future should be not NAB but its palindrome BAN – Borrow Against Nothing….but Faith and Trust.

And by the way, the poor pay back! The average Microfinance payback rate is 95 – 99%, vs. the average credit card payback rate of 91%. And the default rate on all commercial loans has grown steadily for the past 16 quarters.

Business Week wrote a provocative story this month on peer-to-peer lending:

It has been a year of setbacks for peer-to-peer lenders such as Prosper, Lending Club, and Zopa, which use the Web to connect those who need a loan with individuals willing to act as lenders. Once positioned to become an alternative financing spigot for entrepreneurs, the nascent industry has been hit by regulatory issues, a slow economy, and a slew of defaults.

The biggest player, Prosper, stopped making new loans in October. It will resume after it completes its registration with the Securities & Exchange Commission. That has left the field to smaller rivals such as Lending Club, which completed its filing last fall. Zopa, a British company, pulled out of the U.S. market in November after deciding that its business model, which relied on credit unions, simply wasn’t attractive. As Prosper prepares to reopen this spring, one question looms: Can the industry attract enough lenders to be a viable source of funding for entrepreneurs?

The basic conclusion the article makes is ‘no’:

If peer-to-peer lending does make a comeback, it’s likely to serve only those with sterling credit who are shopping for better rates—and not the majority of entrepreneurs.

This is a dramatically simplified analysis of the model and why it is struggling.

First, peer-to-peer lending is the oldest form of finance and it is rooted in the principles of community.  Its first formal structure stretches back to 600 AD in China, but the basics of peer-to-peer lending were present in the earliest human civilizations.

Banks didn’t come around until much later.  Depending on your definition, the first banks sprouted up in the 1600’s.  And really a bank is basically an institutional formalization of the best of peer-to-peer lending.  A person makes a deposit and the bank uses some of that money to lend to another person; when that person pays the bank back, the bank gives some of that interest back to the person who deposited – and so on.

Remember that scene from It’s a Wonderful Life during the bank run.  George Bailey pretty much nails what a bank is: “You’re thinking of this place all wrong. As if I had the money back in a safe. The money’s not here. Your money’s in Joe’s house; that’s right next to yours. And in the Kennedy house, and Mrs. Macklin’s house, and a hundred others. Why, you’re lending them the money to build, and then, they’re going to pay it back to you as best they can.”

The thing is that banks have a tendency to make this rather simple premise extremely complex, opaque, and inaccessible.  And it’s exactly this complexity and lack of transparency that got us into this massive banking crisis.  Things got out of hand when banks got away from the basic principles of peer-to-peer lending and into the madness of derivatives and trading on invented wealth.

Given this context, I think that peer-to-peer lending is more important than ever.

The modern peer-to-peer lending movement is a revival not an invention.  It is using modern tools to reconnect us with a very old tradition — and the important thing is that it cuts out the institution (the bank) and reestablishes the personal connection.

As the article points out, there are flaws.  But I’d argue that these are flaws in execution not concept.  I’ll get more into that in my next post.