When Muhammad Yunus lends money to some of the poorest people, the world rewards him with the Nobel Prize. But when American banks lend money to other very poor people — referred to as subprime borrowers — the lenders are hated for their predatory practices, the global economy falls to its knees, and we may already be in a meltdown of epic proportions.
What’s going on here? What gives the Grameen Bank model the appearance of success, and why have the masters of the universe, as Tom Wolfe memorably described Wall Street’s testosterone-enhanced titans in The Bonfire of the Vanities, lost their ability to soar above the clouds?
Think of the real limitations of lending to the poor. Grameen’s apparent success and the Wall Street’s cataclysmic failure are intertwined in two simple concepts: viability and transparency.
The Grameen model appears to work in many parts of the world (but not everywhere) because the loan is exceptionally small, it is meant to cover transactions, and with extremely limited capital investment. A Bangladeshi woman is not offered a bungalow on the banks of a river; she gets a loan to pay for a sewing machine, and a bit more, maybe a bicycle, so that she can stitch — or repair — clothes for others faster, and get to her market sooner. It will take a long time for her to buy machinery and employ 10 other women.
Moral peer pressure compels her to continue repaying her debt; the possibility of rolling over debt, or swapping credit cards, simply does not exist. That makes the loans viable, but they are relatively risk-free.
Subprime lending for housing is different. People whose income levels are so low that it might take them decades, if ever, to buy even a modest home, are shown tantalizing images of neat, cookie-cutter houses in a new development in the farther reaches of suburbs. Sometimes, the borrower need not provide proof of income. This is all good in terms of granting access to credit, but seen differently, it is an American loan mela. That loan is cheap at first, but balloons far beyond the family’s ability to pay after the initial honeymoon period is over.
The initial lender disappears, and can’t be around when the time comes to send in the collectors. And because the loan is risky, it is broken up and aggregated with other loans; that bundle is hawked to other people, who mix and blend risky loans with safe ones, betting that all bad loans won’t go bust at the same time. This contaminates a perfectly healthy portfolio. The loans change hands rapidly, many times, and no one can accurately tell where that loan, that time bomb, now sits. The entire portfolio gets sick. Risk management for some; risk multiplication for others.
An American executive asked me recently if I saw any difference in the behaviour of the trader who sells a loan knowing it has toxic elements, and the Chinese dairy which knowingly sells chemically enhanced milk (to boost protein count) to unsuspecting families, even if it risks children’s health.
There is one difference: the Chinese mother is not in a position to know all ingredients in the milk. The poker-playing masters of universe are apparently consenting adults who are expected to know the underlying value of each security. Given the pace of transactions, that’s impossible. And so traders live by trust. Trusting the other trader is a rational economic choice, for otherwise transaction costs would make any trade impossible. That’s why it makes sense to be transparent, to build trust — and not cheat — because you might have to deal with the same trader again, possibly tomorrow. That trust is now broken. Cheating has short-term gains, but even economics tells us (not in those terms) that in the long run, honesty and transparency make sense.
The masters of the universe overlooked that law, which makes sense in markets as in life. There are harder lessons — of living within one’s means; of accepting that if a deal looks too good to be true, it probably is; that instant gratification is no fun unless you can afford it; that fortunes take time to build.
That’s the reality of those seeking fortune at the bottom of the pyramid. Opportunity is indeed limited only by one’s imagination. But the “micro” part of microfinance is not just the net worth of the borrower, but also the loan’s size. Those loans help a person float above absolute poverty, bringing her from an economy of subsistence to an economy fuelled by small transactions.
Grameen is not charity — its interest rates are high — but it is not grass-roots venture capitalism either. And as Vijay Mahajan has shown, it has not always succeeded in moving borrowers from transactions to savings and investment. That’s realistic, though not glamorous: like viability, transparency and trust. Old-fashioned? Perhaps. But those values will help us — and the markets — soar again.
Salil Tripathi is a writer based in London. Comments are welcome at email@example.com