How did it all happen? Just how did the US subprime mortgage market cause this much carnage? The answer, on one level, is very simple. Subprime financing was a strategy perfected in the 1980s by Ugandan fishermen on the shores of Lake Victoria. They called it fishing with dynamite.
As a business model, it was flawless. Step 1: get some dynamite. Step 2: Paddle out and scatter food. Step 3: Drop the explosives – after two long minutes, the fish all floated to the surface – lifeless, on their sides, but intact. Bonus time.
The parallel is of course imperfect. It wasn’t dynamite in the subprime business, it was balloon payments and adjustable-rate mortgages. It wasn’t food they used as a lure; but zero interest, and negative amortisation loans. It wasn’t the reject fish ground up into fish oil, it was the riskiest human slices of the credit tranche – NINAs (no income, no assets) and NINJAs (no income, no job or assets). It is not fish that lie empty of life on the surface. It is people’s houses.
For the financial sector, what we are now witnessing is the same system-wide impact, with the impaired viability of the mortgage owners impacting the wider financial system – from the bonds based on the mortgages, to the insurers of the bonds, to the banks that distributed them, to the pension funds that bought them.
So much for subprime.
Is there a different approach, a way to make this market work long term? One radical idea is emerging. For the developed market banks to learn from emerging market bankers. Technology transfer, in other words, from South to North. Does it make sense? There are three reasons to think it might.
The first is that patterns of immigration are beginning to erode the distinction between developed and emerging markets. Of the 40m unbanked and under-banked in the US, the Chicago based Center for Financial Service Innovation estimates 32 per cent are immigrants.
The second is that plain vanilla banking has an unsuitable methodology – if you don’t have a credit history, it is hard to get credit. For the recent immigrant this means unaffordable products – from subprime offerings with hidden fees to loan sharks with rates of 400 per cent a year.
The third is that these groups have the potential to be economically powerful. The ethnic minority population in the US, according to the Milken Institute, is already the sixth-largest economy in the world, and growing at 169 per cent a year. The combined income of the unbanked and under-banked in the US is estimated by the Federal Deposit Insurance Corporation to be $1,400bn a year.
“Poor people”, comments Elizabeth Littlefield, chief executive of CGAP, the Consultative Group for Assistance to the Poor, “represent a vast untapped market opportunity. Poor people need – and will pay for – a wealth of financial options, solutions and services, just like rich people.”
A paradox has emerged. This bottom of the pyramid market – under-served in developed economies – turns out to have three attractive features: its size, un-met demand, and strong payback potential. For Muhammad Yunus, the Nobel Prize-winning founder of Grameen Bank, the logic is clear – Grameen, set up to distribute micro loans to Bangladeshi women, has opened a branch in New York. Addressing this market poses challenges: “Let us face it,” comments Mr Yunus, “the banking system has been designed to serve the rich. It was never intended to serve the poor.”
Core to broad market success will be three departures from the subprime approach. The first is driving down, instead of transferring, risk – from educating the client, to providing micro-insurance against the health and job events that drive the poor into default. The second is driving down costs, using technological innovations to keep products affordable. The third is creating scale without loss of quality, using financial innovations such as Blue Orchard’s Microfinance Securitization that performs for its purchasers, and allows institutions to access critical capital to grow and provide more loans to entrepreneurs.
What is the goal? Banking that delivers value instead of expropriating it. Banking that is sustainable, delivers economic value to the borrower, social value to the community, and long-term financial value to the shareholder.
