Microfinance: born in the USA? Part 1, birth
Age has few enough consolations, of which one is that things others might have studied in school, you can remember.
Decades hence, who among us will still remember this class?
We think of microfinance as a post-electronic activity, yet some of us can remember a similar small-scale finance that comes from a time before the internet, before the cell phone, before the fax machine, before Fed Ex, before the national bank, before securitization, even before privatized GSEs.
And no Starbucks, either …
Even back then, small loans could be made and were made. They weren’t called microfinance; they were called something else. (For this purpose, let me dub it ’steam-powered microfinance’ both to keep you in suspense and so you can see the phenomenon by attribute, not by its historical name.)
Blogging was slow when you had to pedal-push the electrons
Much is made about the bottom-up promise of microfinance – and rightly so, for it offers a way of stimulating capital velocity of informal neighborhoods. Yet, I wondered to myself, many other capital forms were invented in prior centuries, chiefly in the US, England, and northern Europe, before being superseded by later emerging and more sophisticated, larger-scale ventures.
The
So we have:
The local lending circle evolving into the credit union
The community bank evolving into the savings and loan/ building society model of local banking.
So rooted in common sense, and so independent of technology, are the principles of microfinance – small loans, short tenor (duration), lending to people you know – that there’s no reason why it would necessarily take until nearly the twenty-first century for them to be discovered.
Discoverer or re-discoverer?
And then my memory stirred …
When I was a kid, the National Grand Bank was a yellow sandstone edifice at the corner of Humphrey and
Where money was stamped into the very fabric of the pages
We always went to the bank, and the bank was where you got your mortgage (a word filled with portent of death), but some kids’ parents went to another kind of lender, called Household Finance or Beneficial Finance. Small loans, easy credit, for household goods.
It sounded like microfinance, so I Googled their history. And guess what I found in Funding Universe?
A source of funding when the bank wouldn’t fund
Household International, Inc. is the oldest, as well as the second largest, consumer finance company in the
– the company has grown almost continuously since its inception and has at the same time led the way in educating consumers about an industry that has frequently been misunderstood and mistrusted.
Misunderstood and mistrusted? In today’s microfinance industry, the question of profit is being debated even now.
In addition to still offering consumer loans – the business upon which the company was founded–Household International also specializes in credit cards (including co-branded and private-label cards); credit life, accident, disability, and unemployment insurance; student loans; and auto loans.
Having started in consumer lending, Household has branched out into other consumer-oriented financial products, but its core product sounds an awful lot like … microfinance.
A bond for ten cents, and clutch your child, madam!
Founded on Small Personal Loans
There are microfinance’s basic principles: small loans, short tenor, lend locally.
Mackey’s father died in 1879, leaving him a substantial amount of money.
Thus Household began as, essentially, a private bank fueled by Mr. Mackey’s hard equity.
This, along with loans from several uncles, enabled Mackey to keep up with the blossoming demand for his company’s loans.
As there is no mention of securitization or loan reselling, we can presume that Mr. Mackey was cycling capital of very short duration, so that he always maintained liquidity.
The loan business, neither a bank nor a savings and loan, was one of a handful of such firms in the country during the late 19th century. Loans were approved on a case-by-case basis, and were payable in full after three months.
Short tenor. Person-to-person credit decisions.
That’s an insight they don’t teach you in business school
For a fee, Mackey offered extensions to those he believed were in genuine need. One of Mackey’s first employees, R. L. Read, proposed an “Extension Plan” whereby loans were made for one month only and renewed at the same extension rates that the three month loans had been.
Extending credit is good collection policy – and it can also be profitable.
Under this plan, fees were collected after the principal had been paid off, and actual fees paid often accumulated beyond a borrower’s original understanding, to the distress of many customers.
We’ve seen this phenomenon – once in debt, never out of debt – arise in payday lending.
Nonetheless, demand for loans was so high that the company was able to operate in this way past the turn of the century.
Mr. Mackey had found the killer app of local credit, and his business boomed.
In 1883 Mackey constructed a building in
And its vast pool of typewriters, as these ladies were known
Bring the bank to the neighborhoods.
He also hired a manager named Thomas Hulbert.
Whatever their values, and since they started in good Protestant Minneapolis, they were likely church-going men – Messrs. Mackey and Hulbert were definitely in it for the money.
An aggressive salesman, Hulbert oversaw the company’s expansion, largely through advertising.
The killer app of turn-of-the-century marketing: the Sears catalog
This was one of the first methods the loan company used to set itself apart from its competitors.
Mackey soon appointed Hulbert general manager. Hulbert’s first major responsibility was to move the company’s headquarters to
Donors are rightly obsessed with the problem of ’scalability’ – how to take a successful small experiment and multiply its impact. My personal definition is biological: scale equals self-replicability. And self-replication is predicated on positive cash flow.
Although Hulbert was a strong proponent of this existing monthly extension plan, some branch managers argued in favor of an installment plan. Michael Drennen, manager of the
I love this; an internal entrepreneur who decided his idea was good enough to test, and who deduced, rightly as it seems clear now, that such an innovation was within the scope of his authority … or at least, not prohibited.
His plan included a rebate bonus for early repayment of the loan, correctly anticipating a positive response to such a public relations move.
Often the same transaction economics can be sold through a repackaging of perceptions.
It’s all in how you look at it
Is it a surcharge or interest rate for paying over time, or a discount for paying early? Mathematically, they’re identical, but one is a reward while the other is a punishment.
Hard to get consumers to move
Hulbert was gradually convinced of the merits of the installment system, and all branches were using it by 1905.
Networks learn. Human networks learn faster.
In 1896 a second
Even though people are smart, networks are smarter. They can conduct multiple parallel experiments, and if any one of the experiments hits, the knowledge is transmitted rapidly throughout the whole network.
Bees communicating
By the turn of the century the demand for nonbank loans had created a burgeoning national industry.
In short, steam-powered microfinance had boomed.
Toting around steam-powered laptops
Yet its very success brought new problems.
[Continued tomorrow in Part 2.]
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