Saturday, August 18, 2007

Defending Subprime lending - case for democratic economy

There is not a single day goes by without the media do not report the subprime meltdown unfolding in the US credit market. As much as I admit my ignorance on the intricate details of how my mortgage is split into million little pieces and sold to million little investors around the globe, I want to share my own experience of subprime lending if I could call it that.

Years back, actually 15 years back, I was in charge of a rural financial investment and lending scheme that was setup for the mutual benefit of the rural labor class people who did not have enough means to do transaction with a commercial bank. Here is how it worked.

The setup is a small wooden bench, an accounting book and myself sitting at a public open place between 6:00 PM and 8:00 PM every Saturday. I was in college then and they thought that they could trust me with their hard earned money. The members brought a small share of their weekly earning and I made a proper record of the deposit. The amount varied between Rupees 2 (5 cents in today's rate) and Rupees 100 ($2.5 per week). You must be beginning to wonder what we did with the money. Well, we lend money to people who wont qualify for a loan from the traditional banks especially the then notoriously credit tight nationalized Banks. Remember, this is before Muhammad Yunus's Nobel win and days when many did not know much about the concept of micro credits.

The amount of loan varied too. We loaned as small as 5 cents and as high as few dollars. They come to loan to buy school supplies for their kids, to buy weekly ration or some times to pay for the doctor's fee which ran anywhere from 25 cents to a dollar. Doctors were very mean most of the time. They would prescribe the newest medicine concoction cooked up by the pharma companies and ask them to 'come back in a week after trying this medicine'. The poor men and women would go back next week after 'trying' the medicine for a week only to be given prescription for a new medicine. Medical issues apart, they would come for money to make donations to conduct a marriage in their neighborhood, to buy some glass bangles for their loved ones in the annual village festivals. And some other times to buy the coconut leaves to cover their leaking roofs.

Of course, there was credit risk. Some of the loans were never repaid. But we compensated it by charging higher interest rates to every one who borrowed. We did not know that it is called 'Sub prime' in the economic lexicon. But it was the wisdom prevailed among the villagers for decades if not centuries. Even those who made regular repayments knew about the defaulters name. But they did not mind since they knew about the circumstances that caused the person to default and hoped to hedge that risk with higher rate they charge for their lending. It was a social understanding. Some times, well to do families also put their money into the scheme. They would get higher return on their money through this scheme since we lend money at higher than normal interest rates. We charged higher interest rates than Yunus's Grameen Bank. But like grameen bank, the profits were shared by the members proportionately. The high interest rates went to finance the subprime credits.

So what is the difference between the subprime lending in my tiny village and the subprime lending that created unprecedented real estate wealth in the US in the last half decade? It is the scale and complexity of the enterprise. Apart from that, both represent the same intention. Finance credits that are not credit worthy by mainstream banking standards and potentially benefit from it. The investors benefit from it as well as the person took the loan. Sub prime loan enabled them to put a new thatch roof to their humble abode. It enabled people with less than 600 FICO score own a piece of the south land California who otherwise were told by the glass box bankers in the past that they were not worthy of credit. Credit was the privilege of the few but sub prime made it the passion of the many. Sub prime did what Internet did to information. Information is not the privilege of network TVs and syndicated journalists any more. It is the passion of Matt Drudge and Ariana Huffington and alike. Subprime allowed the free flow of capital and credit across the US landscape that created dreams, hopes and immense wealth. Sure few hiccups and defaults. The melt down may take Countrywide along with it plus many frothy real estate markets. After the bubble burst, a new sub prime lending will emerge. Quite like the Web 2.0, Sub prime 2.0! Never underestimate the power of YOULOAN.
TIME article - Real Estate's Fault Line

1 comment:

Jose Thomas said...