April 17, 2008
It's all we hear about these days: The U.S. subprime mortgage bubble -- created by poor and at times predatory lending practices and lax banking regulation and creative investment products -- has burst. Of the approximately 7.7 million subprime loans outstanding, over 2 million are at risk of foreclosure and 600,000 borrowers are expected to lose their homes this year. The majority of us are left in shock as we watch the devastation unfold, the bubbles aftermath wreaking havoc on the U.S. (and increasingly global) economy, ensuing fears of recession and economic pain to come, and leaving politicians, economists, and regulators all scrambling to pick up the pieces.
However, in the meantime, the 2006 Nobel Peace Prize winner on Tuesday proudly hailed microfinance -- the innovation of providing small loans to poor, traditionally financial excluded individuals, mainly women -- as "sub sub sub subprime" lending. That means that globally, more than 3300 microfinance institutions provide such "super-subprime" loans to over 100 million clients and growing. Just to be clear: I'm a huge fan of microfinance. However, I'm left perplexed by this dichotomy: How can a lending practice that is almost singlehandedly dragging the whole of the U.S. economy in to a hole simultaneously and sustainably end third world poverty?
Well according to Yunus, the answer is simple - the U.S. subprime crisis was fueled by "sloppy business practices" and complex product, which simply don't exist in the microfinance industry. Finding ways to extend access to credit and financial services to those with less than stellar or no credit or financial history, if done properly, can provide asset-building opportunities to those traditionally excluded and economically disadvantaged. In that sense (and this may come as a shock to those who only know of subprime as it related to the current crisis), subprime lending is not inherently a bad thing.
However, when discussing this issue last night at a CGAP cocktail reception, the answer seemed to be about as complicated as a 5/1 balloon ARM disclosure. Expert discussants, considering the similarities and differences between these sub-prime markets, concluded that microfinance products and services are indeed different from the complex mortgages and bundled securities of the U.S. mortgage market. However, they all cautioned the microfinance industry to take a close look at how certain similarities - the perverse incentives for quantity over quality; the potential of similar "irrational exuberance" of both clients and lenders; the growing influx of new players, products and dis-intermediated capital that could lead to predatory products and practices; similarly, competition among providers that could lead to "race to the bottom" practices and products; the risk of information asymmetries and moral hazard created by increase in disintermediation (which creates distance between borrowers and lenders), and finally, the lack of regulation in many markets -- indeed mirrors characteristics of the sub-prime mortgage market in the United States.
So, my original question remains unanswered, but these new insights beg related, and perhaps more pertinent questions. In our haste to extend the power of micro-credit to the millions living in poverty around the world, how much, if at all, should we head the warnings derived from the subprime crisis? Can light-touch regulation and more concerted efforts enhance consumer awareness provide the balance between providing as much access as quickly as possible to as many as possible and quality of products and practices? Would putting such regulatory brakes on this exploding industry help us to avoid the possibility of a global sub-prime bubble or just deprive the needy of access to finance?
If some predictions are right, then the tightening of capital in the global financial markets -- essentially the effect of failing to address these issues U.S. until it was too late - may inadvertently apply those brakes before we get the chance to answer the question. But with others predicting the opposite (even more capital being diverted into more lucrative, global markets (i.e., microfinance investment)) then we may need to look at these issues more closely, ASAP.