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Microfinance and subprime borrowing

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Thursday, Mar 29, 2007

Microfinance—the provision of basic banking services in places where they otherwise don’t exist—has a pleasing commonsense “teach a man to fish” logic to it which makes it seem like an unequivocal good. It seems to make charity somehow less patronizing after you dress it up with the trappings of a loan; you are theoretically no longer supporting an indigent way of life but supplying the capital to break the chains of poverty. The Economist naturally would like to see microfinance become even more businesslike, subject to the same pressures of competition and profit-taking self-sufficiency; in other words, they would like to see it cease to be a charity altogether and instead become another way of investing in developing economies.


some argue that irresponsible lending by philanthropists is just as harmful. They, too, can crowd out for-profit money and, more importantly, local deposits which provide sustainable funding, and also a safe place for the poor to save. Foreign money, public and private, can provide an “important stop-gap”, says Elizabeth Littlefield, chief executive of CGAP, but “I worry that it is not necessarily catalysing the creation of a sustainable, savings-based financial system in poor countries.”
Still, the transformation is happening in snippets, particularly in Latin America. Pichincha, Ecuador’s largest bank, established a microfinance subsidiary in 1999 with backing from an American development agency. Today the subsidiary contributes 12% of Pichincha’s total profits, with arrears of less than 2%—while providing loans to the poor at competitive rates. Citibank houses its microfinance transactions in its bank, not in its community-development group, as others do.
The turning point will come, according to Ms Littlefield, when microfinance is seen not as a new asset class—which “ghettoises” the poor—but as the newest product line for retail banks. The industry has already transformed itself once, from a financial curiosity to a cause célèbre. In so doing, it has created millions of micro-capitalists in poor countries. Now it needs to attract throngs of big capitalists from rich ones.


If microfinance becomes another asset class, then theoretically the global economic system will have established itself firmly in these destitute regions, overcoming the local tribulations (corruption, etc.) to bring the prosperous market system to stay. Multinational banks would then be functioning to override existing arrangements in a society that control the flow of capital to provide a new supply that doesn’t abide by any traditional scheme of values. It allows the profit motive to supersede any other value system, which, when it supplants entrenched bigotry that prefers to see the human potential of a certain subset of humanity go wasted, seems like a good thing.


So microfinance, in this idealized view, is a trojan horse for introducing secular capitalist values; the charitable gift microfinanciers give is the discipline of profit-seeking, the right to be exploited in a systematic rather than haphazard way, at reasonable interest rates rather than usurious or arbitrary ones. It replaces local middlemen, who exploit local conditions, with transnational ones, which are indifferent to local conditions. It connects them to the international credit system, and its more or less stable rules, and the stability of the system teaches the poor the rewards of discipline by guaranteeing them the eventual fruits of hard work (after extracting its expected percentage).


By the same logic then, we should support the expansion of the subprime lending market, which also expands the population subject to discipline of credit and consequences. Now that it is coming undone, we shouldn’t burden it with regulations that would restrict the manner in which companies lend to high-risk borrowers. Thus, on the Economist’s blog, we find this:


many people look at the high default rates in the subprime markets and sniff that lenders are “abusing” subprime borrowers.  One often hears this case made in reference to credit cards and payday lenders.  But it seems to me that there are two possibilities.  The first is that the poor are spending the money on things they don’t need, and then defaulting, in which case it isn’t clear to me who the abuser is.  And the other is that they really need the money for emergencies, in which case would they really be better off with no payday lenders or credit cards?  After all, the informal credit markets these places have displaced (pawnshops and loan sharks) are even less desirable than the high credit card interest rates.


But really this is an argument against microfinance—this is arguing that usury is better than nothing, that there is no need to protect the poor from whatever financial services institutions deign to offer them; that other kinds of institutions—governmental or nonprofit or otherwise—should basically stay out of it. If people want to take out loans they can’t ever possibly repay and get themselves trapped in never ending cycle of debt, that’s their business. What separates bad credit risks in America from those in poor countries presumably is the opportunity the American poor have to be imprudent—to be tempted into wasteful discretionary purchases that aren’t an option for the truly poor. The underlying implication to this, then, would be that with a thriving consumer society—one that encourages us to buy all sorts of crap we don’t need—must come a usurious credit system to keep people in check, to supply the discipline that the advertising promoting consumerism tends to erode. Consumerism extends the magical promise of something for nothing, of all your dreams for free; the exploitative credit market then develops to capitalize on those who believe in it, and punish them for their gullibility.


In other words, while microfinance meets the demand for credit in places that hardly understand the workings of it in order to further rudimentary production (the classic microfinance example of allowing poor entrepreneurs in a village to buy a cow), consumer society creates demand for credit where it might otherwise be unnecessary, stimulating a malaise of discontent remediable only through novelty consumption. It may be that subprime lending has assimilated real estate speculation to the model of therapeutic shopping. This analysis at the blog Calculated Risk inspired my line of thinking on this:


I am puzzled by the phrase “expanded access to subprime mortgage credit.” This assumes that “access” is a question of borrowers having access to creditors, rather than, perhaps, a question of creditors having access to borrowers. The whole idea of “predatory lending,” which is a subset of subprime lending, is that there are lenders who want to lend going after borrowers who may not have supplied the “demand” until someone fast-talked them into it. Even in the more “respectable” parts of the subprime and Alt-A business, I would argue, the “disintermediation” of “national markets, technology, and securitization,” which rely to a large extent on the “intermediation” of brokers, can function as much as supply creating demand than the other way around.


Those who wish to throw the Econ 101 textbooks at me will have to explain to me just how, exactly, borrower demand for loans they obviously do not understand, and that are not anywhere close to being in their best interest, gets created. Are we talking about a demand for credit or a demand for income-substitutes? And those who want to say that it’s all a matter of borrowers substituting short-term interest for long-term interest need to explain this EPD epidemic to me. Either those EPD loans were 100% fraudulent—borrowers who never intended to own the property or make the payments—or some of them were borrowers who never stood a chance of receiving even short-term benefit from the loan. I’m not sure which case is more comforting, but I surely can’t see here unambiguous evidence for pent-up demand that simmered for years until the “new mortgage market” Braunstein discusses suddenly offered the product everyone had been waiting for. Next thing you know, someone is going to tell me about the invention of advertising.


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