[Previous Months In Review here: Aug 09, Jul 09, Jun 09, May 09, Apl 09, Mar 09, Feb 09, Jan 09]

By: David A. Smith

Continuing our review of September’s posts, technology changes interpersonal dynamics and in so doing reveals aspects of human nature, in particular that what matters in crime prevention is not the phenomenon of seeing but that of knowing one is being seen, in The robocop on the beat: Part 1, seen being seen:

Are you clicking on images you shouldn’t?

Some years back I formulated a more general version of this as the law of the observant herd:

The herd observes how sinners are dealt with.  In this case, sinners are noticed.  Not arrested, mind you; curiously, not even threatened.  Just noticed.

Crime doesn’t like being noticed.  So crime relocates.

Hopefully, with as little swag as possible

The occupants moved out soon thereafter.

The armadillo does what the residents can’t: it observes, it witnesses.  And in a metallic Christian way, it turns the other cheek and it takes punishment.

and Part 2, seen as one seeing:

In yesterday’s post, innovative police chief Steven Settingsgaard parked a retired police car conspicuously in front of a suspected drug dealer’s house.  Overnight it was demolished, but then something striking happened:

The dealer left the neighborhood soon after the incident –

Flush a predator from cover and the animal becomes unsettled and nervous; easier to capture.

– he was later arrested and convicted on a gun charge.

Evidently the emotional disruption played a powerful role in the physical disruption.

Find me worrisome?

With the disoriented giddiness of one who has staggered off the rollercoaster without losing wallet, lunch, or life –

That’s a lovely bridge to jump off, isn’t it?

– I examined, with more sympathy than its authors did, our retrospective on how we got through the financial precipice of last, 2008, in The mad experimenters: Part 1, being still breathing is winning and Part 2, I must have known it all along:

Despite Chairman Bernanke’s brave words a while back – in this selfsame Wall Street Journal – we may talk about exit strategy all we want, but there will be no substantial exit any time soon.

President Barack Obama goes to Wall Street Monday [September 14, 2009 – Ed.], the anniversary of Lehman Brothers’ collapse, to deliver a cautious victory speech. 

With Wall Street executives, as well as government officials, in attendance, the president also will admonish “to avoid a return to the practices on Wall Street that led us to the financial crisis and to recognize their obligation to help produce a wider recovery on behalf of the American people.”

Sounds good, I suppose.

If you don’t like “admonish,” how about “chastise”?

With a modicum of hindsight now available, do governments and central banks deserve credit for preventing catastrophe? The early verdict from most scholars, executives and government insiders is yes.  [What are bloggers, chopped liver? – Ed.]

How about bloggers?  I said yes at each stage:

March 24, 2008, the shotgun marriage of Bear Stearns to JP Morgan Chase: Banking on value.

April 22, 2008, explanation: Banking on value: the explanation.

April 28, 2008, how the Bear Stearns transaction went down: Anatomy of a coup

September 22, 2008, explaining the Paulson Doctrine(s): Part 1, prevent the second great depression

September 29, 2008, explaining TARP: Bailout or bonanza?

October 20, 2008, converting TARP into preferred-stock injections: Paying your rescuer: Part 1, you *will* do it

January 21, 2009: The GSE’s future: Part 1, we need the eggs

March 23, 2009: The AIG Hearings: Part 1, “Now that we’ve killed all the bomb-makers …”

What, you think that counts as evidence?

On the question of which of dozens of extraordinary interventions — rock-bottom interest rates, surging government spending, billions of taxpayer dollars injected into banks, sweeping government guarantees — made the biggest difference, there’s less agreement.

Sometimes the answer is, All of them.

An impromptu discussion at AHI led me to write down Three key questions to give your ecosystem a physical: Part 1, follow the critters, Part 2, follow the ownership, and Part 3, follow the money:

In the same way, when we consider a housing finance ecosystem, the blood plasma is money, and its tracing is a time-honored investigative technique.

“Follow the money”

When it comes to housing, the money moves in three dimensions: homes, people, and money:

1. Homes.  Providers and consumers finding each other.

2. People.  Sellers and buyers exchanging money for consumption and use rights.

3. Money.  Capital providers and capital consumers financing a home purchase.

Understand these three dimensions and you go a great ways toward placing an ecosystem in its space.

Thus, if you come new to a housing finance ecosystem, either because you’re visiting a country and want to buy or rent a home, or as a student, researcher, or consultant tasked with designing a new program intervention, you can learn a lot about the ecosystem if you follow the money through each of its three dimensions.

These questions are valuable for two reasons:

They are worth inspecting

1. They are discoverable.  Since everyone who might be an investigator can imagine the sequence of finding an apartment, buying a house, or finding a loan, they create a natural and surprisingly comprehensive line of inquiry for investigators.  More particularly, the questions are non-judgmental – they just ask about what is, rather than what should be or what might be or isn’t.

Question 1: Owner-consumer value chain

If you have housing (to rent or sell) and I need housing (to occupy or buy), how do we find each other and what kind of tenure relationships could we establish?

You’re new in town, and you need a place to live.  Think of all the sub-questions you’ll have.

1.       Can I find plenty of places, or are they scarce?

2.       How much space can I afford?

3.       Can I buy or do I have to rent?

4.       If I want to buy, how far out of downtown do I have to be?

5.       Is there enough good-quality rental?

6.       Is the government in the business of providing housing?

7.       Is the government in the business of subsidizing the supply side (helping create more homes)?

Now I’m going to ask you a simple question – do you feel … lucky?

2. They are measurable.  The results can be quantified – search costs, occupancy costs, closing costs.  Those costs make comparisons possible across ecosystems, and also make possible measuring the ecosystem’s evolution over time.

Question 3: Financing a home purchase

If I need to get a lot of money to buy a home, where do I get the money, and what does it cost (up front and over time)?

In every society, owning urban housing costs many multiples of a normal persona’s disposable housing income; indeed, among my rules of thumb for gauging a housing ecosystem (yes, that’s a blog post to come) is the better the housing ecosystem, the longer the period of time over which a buyer must obligate himself or herself to acquire property ownership. 

How long do I have to keep paying for this house?

Seldom is a month complete without some tale from the cradle of US apartment living, and our second-most-formal city, New York, which despite its reputation puts up with a shocking degree of informal settlements in Temporary permanence?:

You elected me temporarily, but maybe I could be permanent?

In New York City, formalization of sheds is literally just around the corner:

But others have higher ambitions: They want an all-new sidewalk shed — airy and elegant. The talk among architects, in fact, is that the city is about to launch a competition to design one.

Given time, New York’s sheds may become formal arcades – if not rivaling Bologna’s, then maybe New Orleans‘ French Quarter.

Formalizing the pedestrian shed: New Orleans arcades

In this post, I came bury sheds, not to praise them – but when you think about it, making sheds permanent by arcading them solves everyone’s problem.  It claims more city space for pedestrians, and more air space for additional structures.  The city becomes more dense, yet more livable.  The informal leads the formal, and in that lead, it changes the city.

The future of New York City’s sheds?  Torino’s arcades

If you leave them there for fifty years, they’ll be historic and then you can’t tear them down.

They claimed this was historic and had to be preserved

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By: David A. Smith

During September, I published a two-part post so depressing and sober it had taken me a year to take it out of inventory, about Winston Smith’s nightmare: The ultimate future city: 1984, Part 1, the poverty of slums and Part 2, the slums of poverty:

Perhaps the most famous year in fiction begins in the most tactile not-present:

It was a bright cold day in April, and the clocks were striking thirteen.  Winston Smith, his chin nuzzled into his breast in an effort to escape the vile wind, slipped quickly through the glass doors of Victory Mansions, though not quickly enough to prevent a swirl of gritty dust from entering along with him.

In previous posts, I’ve profiled visions of ultimate future cities.  Some of these visions are nightmares – and yet, nightmares that can see around us if we know where to look, in the slums inside.

Victory mansions? Soviet flats

The hallway smelt of boiled cabbage and old rag mats.  At one end of it a colored poster, too large for indoor display, had been tacked to the wall.  It depicted simply an enormous face, more than a meter wide: the face of a man of about forty-five, with a heavy black mustache and ruggedly handsome features. 

Big Brother is checking your mouse clicks

Only slightly more cheerful, albeit substantially closer at hand, was this grim multi-part story of Los Angeles public housing, in Distrust me just this once? Part 1, the need for trust, Part 2, the enemies of trust, and Part 3, how to build trust:

Slums persist in part because they have defenders.  Among those defenders are many slum residents themselves, for whom a lifetime’s experience has taught them, Trust no one, especially any well-dressed or well-spoken newcomer who claims, “I’m from the government and I’m here to help you.”  That makes any slum upgrading program a hard sell, as illustrated by this Los Angeles Times article about the obsolescent and miserable public housing property Jordan Downs:

Fred Smith, left, 37, has lived in the Jordan Downs public housing project in Watts most of his life.

Ronald Perkins and his neighbors were nearly outnumbered by the consultants and architects who showed up at the Jordan Downs community center.

Planning session for Jordan Downs

Resident participation is a cornerstone of HOPE VI, as slumdweller control is a cornerstone of Slum Dwellers International’s Urban Poor Fund.  But as Yogi Berra said, if people don’t wanna come to the ballpark, nobody’s gonna stop ‘em.

“Which is worse, apathy or ignorance?”

“I don’t know and I don’t care.”

– High school joke

The public housing system is structured around dependency.  Just as public housing’s financial schema makes housing authorities dependent on an autocratic HUD and behind that a fickle Congress, its residency policies – in particular, totally mean-tested rents and an allergy to evicting miscreants – promote resident dependency.  It is poverty trap and also an initiative trap, and it engenders passivity:

As mental palate-cleaners after such tough pieces were two bits of fluff.  I had a little fun with a Massachusetts state senator who assured us that in no way was he being at all hypocritical by buying his liquor in no-state New Hampshire rather than in new-tax Massachusetts, even though he had by purest coincidence traveled across the entire state, in Borderline behavior:

The absurdity of this is brought home when those who make the laws they expect others to observe flout their own handiwork, as did unlucky Massachusetts state representative Michael J. Rodrigues, who discovered the damning evidentiary power of a cell phone camera, and didn’t like it.  As gleefully reported by the populist Boston Herald:

State Rep. Michael Rodrigues, inset, a Westport pol, was spotted over the [September 1, 2009 – Ed.] weekend piling booze into his car – emblazoned with his ‘House 29’ Mass. license plate – at a tax-free N.H. liquor store.

A Westport lawmaker who voted to hike the state sales and alcohol taxes was spotted brazenly piling booze in his car – adorned with his State House license plate – in the parking lot of a tax-free New Hampshire liquor store, the Herald has learned.

This is not Michael Rodrigues’ car, and any inference to the contrary is unjustified

Savor the scene: a guardian of the public trust smuggling booze into his home state, caught red-handed violating a law he personally helped make more onerous:

Rodrigues, who was loading booze into his car, snapped “mind your own business,” the witness said.

“Rich, you’re giving smugglers like me a bad name.”

The witness’ account was also posted yesterday on Citizens for Limited Taxation’s Web site.

And it’s a doozy:

As my family and I were driving back from York Beach my wife asked me to pull off at the NH liquor store on 95 south at the Mass border. When I pulled around to get a parking space you can imagine my surprise to see what I could only assume to be a Mass state rep’s car. He also had a Deval Patrick/Tim Murray sticker on his back window – so I assume he’s a Democrat who voted in favor of the recent sales tax hike.

Our citizen journalist is right on both counts.  Mr. Rodrigues is a Democrat, and he voted yes on the tax hike.

The increase pushed the sales tax to 6.25% and slapped that same levy on booze – the first time alcohol has been subject to retail sales tax.

So the guy comes out with a couple of cases of booze in his carriage and loads them into his car. I asked him if this was “official” business or personal. He was surprised by my questioning and asked what business is it of mine as to what he’s doing. I told him I was a Mass citizen. He said it was personal – I pointed out the state car with official plates and he said it was “his”.

“That car is mine, not the state’s”

A far cry from Harry Truman, who smacked a stamp onto any personal correspondence he wrote when he was President.

I didn’t ask him why he was in NH purchasing alcohol instead of supporting Mass businesses and the 6.25% tax they just levied on us common folk…

Observe that Mr. Rodrigues’s district is about as far from New Hampshire as it’s possible to be in Massachusetts.

Place-based taxation is predicated on the assumption that consumers cannot flee the law’s grasping hand.

“Thank you, Thing!”

Later I floated some unmoored speculations in All at sea: waterworlds of the future:

We all live in a yellow submarine
Yellow submarine, yellow submarine

– Richard Starkey

Every one of us has all we need?

Perhaps it’s because, as city dwellers, we seek green space and crave privacy, but few destinations capture our imagination more than the idyllic deserted island.

Societal conventions optional

Yet we’re rational enough to realize that a tiny island will lack creature comforts – unless, that is, we build them, which seems the premise behind The Seasteading Institute, whose press release explains that a few months back:

The Seasteading Instiitute crowned the winners in its first Seasteading Architectural Design Contest to design the floating city of their dreams.

‘Floating city’ inevitably reminds me of Gulliver’s Island of Laputa, which Swift envisioned so he could satirize royal and aristocratic disengagement.

Wobbling along the cost of Balnibarbi

Seasteads are permanent, stationary structures specifically designed for long-term ocean living.

Which sounds good, until you realize that very few if any of these structures exist.

Maximizing our use of space!

Still, they make interesting speculations, so let’s take a look:

Serious sums can swing on metaphysical questions only a lawyer can love, as uncovered in You can check out any time you like:

At one end of the money-store continuum is physical property, which as I’ve often observed, is immovable, and as earth, it abides.  At another is financial property, which is just as ethereal.  Money is paper (or worse, just electronic bits) which have value only if we all believe it does.  Because we cannot physically relocate property, we are forced to use intellectual forms – title deeds, mortgages, loans, P&S’s – to convey ownership, which is a pure intangible.  Beyond the immutable of physical property and the intangible of ownership, we further slice ownership by adding new dimensions:

Two dimensions = land and real property.

Three dimensions (add verticality) = condominium, co-operative

Four dimensions (add time) = rental, time share

Each added dimension slices the occupancy/ use rights into a more discrete bundle, which on the one hand tends to add value (because you buy only as much as you need) and on the other complicates the contractual and financial relationships.  Indeed, by multiply slicing the ownership, an unscrupulous developer could tunnel through zoning regulations via a portable hole:

Nobody can pull a comb over my eyes!

In more serious news, we explored whether the third government housing pipeline, the FHA, will need substantial taxpayer equity like its two siblings, Fannie Mae and Freddie Mac, in Liberally prudent or imprudently liberal? Part 1, how we got here, and Part 2, how we’ll get out of it:

Will these folks …

… follow these folks?

An additional 2.4% delinquency on a $627 billion portfolio represents $15 billion more in delinquencies. 

The [FHA capital] ratio last year was around 3%, down from 6.4% in 2007.

An additional 2.4% delinquency is not the same as losses.  Loss = Default Rates x Principal-Writedown Given Default.

Let’s do some simple arithmetic.  How much of a writedown can FHA afford on those delinquencies?  40% losses on 2.4% delinquency represents 0.96% lost portfolio value.  In short, FHA had better recover 60 cents on the dollar.  Or else what?

If its reserves fall short, the agency is obliged to notify Congress, which could spark a commotion over the extent to which the government is funding losses in the housing market.

The Journal is mightily pumping its bellows; ’spark commotion’ is a far cry from ‘go bankrupt.’ 

Keep reading, we’re sure you’ll get fired up

A senior official at HUD, which oversees the FHA, said there is “no risk” that the FHA would require money from Congress if the ratio falls below 2%.

The Journal knows full well that FHA is the Treasury – it will keep going indefinitely, losses be damned, as long as Congress keeps giving its authority.

[Continued tomorrow in Part 2.]

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The older I get, the less I give credence to future-tense verbs: I’m going to X, I will Y.  I place much more reliance on past-tense verbs and durations – for the last decade I’ve Z’d.  So as I read the following Boston Globe article on a praiseworthy idea, and my eye caught the future-tense verbs (in blue bold italic) I found my initially upbeat assessment steadily turning ever more glum:

You got a problem with my gloom?

The city of Boston plans to purchase foreclosed apartment buildings still occupied by tenants in an effort to stem evictions under a pilot program officials say is the first of its kind in the nation.

Mayor Thomas M. Menino today [October 28, 2009, five days before the Boston mayoral election – Ed.] is expected to unveil the buyback program, which will initially involve 12 apartments in five properties owned by Bank of America Corp. that are located in neighborhoods devastated by foreclosures in recent years.

Twelve apartments in five properties is a drop in the bucket – yet every program starts somewhere.

Menino said that over the next six months he wants to expand the program to include other lenders and buy as many as 100 occupied apartments.

“Here we go, Boston, here we go”

This one could serve a genuine need, because, as I posted two years ago in zombie landlords, foreclosure is a destabilizing event:

We had a handshake deal on the rent

But even having a lease is no protection against a post-foreclosure eviction. Under Massachusetts law, foreclosing owners are not required to honor leases signed by the former owner.

That’s remarkable — not that landlords would want it, but that the legislators deferred to their desires.

The mortgage industry says its members are not equipped to act as landlords.

Hire one. 

There are plenty of management companies.

“Why, yes, we’ll happily evict your tenants for you!”

Buying foreclosed apartments and simultaneously executing a new lease with the sitting resident turns the home into long-term rental … and what’s the harm in that?

“The tenants are the victims. It is not their fault they were foreclosed upon,’’ Menino said. “Not only is this good for the tenants it is also good for the neighborhoods.’’

One of the foreclosures that might be candidates

Is there harm in trumpeting something one has not done?

The city has not yet negotiated a price with Bank of America, but the money to buy the five buildings will come from $8.2 million in federal funds set aside to buy and renovate foreclosed homes.

Here we have an advanced form of political vaporware: a pledge to do something in the future, in exchange for your votes – your political equity – today.  That’s outstanding political calculus, of a type I’ve encountered before, most memorably in Egypt, when as a subcontractor to a USAID prime contractor, I designed and built financial projections for a 500,000-home affordable housing production program that President Hosni Mubarak announced one Pharaonic day on the campaign trail, seeking to keep his winning plurality above 90%.  I designed the program; I wrote the financial model; I highlighted the key decision variables; I sent the proposal forward.  Mubarak got elected overwhelmingly, and I never heard further if the program ever advanced beyond that initial conception.

“What did his models say it would cost?”

The properties will then be resold to homeowners, nonprofit groups, or private developers.

Otherwise known as “people we haven’t located yet.”

City officials said they have also applied for [A deflective version of 'maybe we will get' – Ed.] another $39 million under the federal Neighborhood Stabilization Program.

Otherwise known as “money we haven’t got yet.”

Can we apply for money too?

Renters are increasingly being forced to vacate homes reclaimed by lenders through foreclosure auctions. In Boston, more than 75% of those displaced through foreclosure are tenants with no direct involvement in the owner’s mortgage problems, city officials estimate.

While granting the statistic, it doesn’t prove the hypothesis.  Boston has had very few homeownership foreclosures; they’ve concentrated in investor-owned absentee-landlord properties.  If the rate of eviction is increasing, that’s not because of the high percentage of rental foreclosures, but rather because the lenders have finally got their procedures in place to deal with their foreclosure backlog.

Traditionally, lenders have been reluctant to sell foreclosed apartment buildings that remain occupied because of liability and other issues.

It’s an issue of touch and risk.  Making the decision to keep a resident in an apartment requires ‘touch’ – some granular knowledge that’s specific to the market, property, and resident.  It also requires some risk tolerance because (x) the tenant may have counterclaims (warrant of habitability) against the owner, and (y) many buyers of foreclosed homes would rather use them for ownership or renovation rather than having to deal with the tenant themselves. 

It’s easier to secure if you’re out of it

Tom Lin, a senior vice president at Bank of America, said the program is an innovative way to stabilize neighborhoods as well as to allow lenders to unload properties.

Generally, foreclosed homes “sell much quicker vacant than occupied,’’ he said, but lenders are beginning to consider alternatives.

Compared to the touch costs of making the rental-continuation decision and the risks of keeping the tenant in place, the interim rent isn’t worth it.

Often, [foreclosing lenders] resort to evictions or strike deals known as “cash for keys’’ in which tenants are given money to move out.

You can post all the notices you want, but it’s often easier just to pay a few bucks for the resident to go away

Voluntarily, that is. If there is an oversupply of foreclosed homes, which there may be, the tenants can readily find new housing.  So cash-for-keys may prove a good deal for them.  Nevertheless, there’s a human-interest story in protecting these renters, which means there’s both political capital to be accumulated and a policy case to be made.

Lisa Alberghini, cochairwoman of Coalition for Occupied Homes in Foreclosure, a local housing group, said she is pleased the city has taken the initiative in assisting renters living in foreclosed properties.

A while back I had the singular honor and personal pleasure of being paired with Lisa as the 2009 Vision Award winners from the National Housing & Rehabilitation Association (NH&RA).

A good picture of Lisa, animated as usual

She’s on the side of the angels, and smart to boot.

“The idea that the bank agrees to sell properties with tenants still in them and the city has the opportunity to dispose of them without displacing the tenants, it’s just remarkable,’’ said Alberghini, president of the Planning Office for Urban Affairs, a nonprofit housing development group affiliated with the Catholic Archdiocese of Boston. “I hope it prompts others to step forward and do the same.’’

Agreed.  If it can be worked out – the touch and the risk – it can add value.  For that the city can play a significant role, both in doing the work and in the abating the risk.

Bank of America’s portfolio includes about 330 foreclosed Massachusetts properties, Lin said.

Boston housing chief Evelyn Friedman –

Renovating them one at a time: Evelyn Friedman

We met Evelyn in the blog 4 ½ years ago, in our tour of the Hotel Dartmouth historic rehab, when she was executive director of Nuestra Comunidad CDC.  As so often happens in the housing roundelay, she’s now on the government side, interacting as a resource provider with people just like her former self.

– said tenants of the 12 apartments being bought are unaware of the plan, but that they will soon be contacted.

In fact, therefore, nobody’s actually done anything.  The intentions are praiseworthy, yet the properties are not purchased, nor are the rehab or transfer funds in place.

The program builds on an ongoing campaign to purchase abandoned foreclosed properties in hard-hit areas of Dorchester, Roxbury, and Mattapan, she said. Since last year, the city has bought 10 vacant buildings and is in the process of closing deals on 28 others.

Tenant organizers yesterday praised the fledgling buyback program.

“Praise us, we’re going to grow!”

The scale is small, and the delivery is slow.  By the time the program reaches any meaningful level of activity, most of those who were at risk will have solved their problem one way or another.  Still, it’s a start, and if the volume of foreclosed small rentals does spike, at least there will be a mechanism in place, and people who have an understanding of how to use it.

“This is a good thing for occupied tenant buildings,’’ said Steve Meacham, a community organizer with the Jamaica Plain housing organization City Life/Vida Urbana. “It is certainly a step forward.’’

One step forward?

Although the program is being made public six days before the mayoral election, Menino insisted the timing was not motivated by politics.

Insisted.  Residents have not been notified, properties have not been purchased, resale buyers have not been identified, and transfer funding has not been secured.  We were just so bursting with enthusiasm that we wanted to tell all the voters now, even though we couldn’t tell the twelve lucky households.

Just a happy coincidence.

“Luck favors me, doesn’t it?”

He said the intention is to demonstrate to federal officials that the city is at the forefront of anti-foreclosure initiatives as it seeks more funding.

Let us now praise famous Menino and his praiseworthy intentions.

PS  Like President Mubarak, Mayor Menino won re-election.

“Was it ever in doubt?”

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[Continued from yesterday's Part 1.]

Yesterday’s post opened the topic of payday lending as exploitive microfinance, designed not to maximize the borrower’s well-being but rather to hold that borrower on the razor’s edge of permanent default, as illustrated by this article from the Washington Post:

Meanwhile, big companies are muscling into a sector that has been dominated by independent operators, lured by the promise of a largely untapped $13 billion market. Wal-Mart, the world’s largest retailer, stepped up the competition earlier this year by slashing prices on its most popular financial services, such as check cashing.

Three years ago, I wrote about these ‘industrial loan companies,’ or banks by any other name describing them in favorable terms, although with a caveat:

“That’s caveat, not Cavett, as you know full well”

Pursuit of CRA investment test credit is a principal driver in LIHTC equity investment, leading to very high prices and resulting highly efficient use of government tax expenditures. And however much banks may tout their CRA performance, there’s no question it’s a burden to them, so if banks are competing against non-banks without a CRA obligation, they will be at a competitive disadvantage.

Consider then an entity that:

1. Has an enormous market capitalization.

2. Is active from coast-to-coast.

3. Takes deposits.

4. Makes loans and provides financial services to its depositors.

Is that a bank by any other name?

“O Romeo, that which we call a time-deposit, by any equivalent interest rate would yield as much.”

If it is, should it be subject to the CRA?

Ask Wal-Mart, as shown in this Economist article:

When Wal-Mart rolls into town, small shopkeepers quake. Now that the world’s biggest retailer wants to enter the financial business, America’s bankers are trembling, too. On April 10th the Federal Deposit Insurance Corporation (FDIC), one of America’s bank regulators, held the first day of public hearings on Wal-Mart’s bid to open an industrial loan company (ILC).

Industrial loan companies are a symbiotic species advantage – the ILC symbiotically lives inside the retailer, and provides the retailer’s customers with credit to buy the retailer’s products.  That’s powerful competition, and we’re all for it – if it’s properly regulated (as to capital, transparency, and consumer protection) and provided it bears the same social responsibilities banks do – namely, CRA.

Beyond ILCs, we are seeing a rebirth of American microfinance (a business model that I believe was born in the USA just over a century ago:

Start-ups have emerged to offer lending to niche groups, such as Hispanic immigrants, at dramatically lower rates.

Niche lending is key to establishing a microfinance institution (MFI).  Focusing on the niche gives the lender better touch on the customers, which reduces probability of default.

Even as non-banks are making small American microfinance loans, banks too are finding their way into the space:

Some credit unions offer short-term loans as an alternative to payday lenders. North Side Community Federal Credit Union in Chicago, manager Ed Jacob said, introduced a six-month, $500 loan with 16.5% interest several years ago.

Microfinance, American style, coming to you from the streets of Chicago

Five hundred bucks for six months?  That’s the very definition of a normal microfinance loan worldwide.

Mohammad Yunus would be proud of you, NSCFCU

The credit union has since made 5,000 such loans, and it has become one of the most popular products.

Meanwhile, start-ups such as Progreso Financiero in California are targeting new niches. James Gutierrez founded Progreso in 2005 to make short-term unsecured loans of $250 to $2,500 to Hispanic families lacking credit scores and banking records. The company charges 36% interest, significantly less than other payday lenders charge but still more than double the average consumer credit card interest rate.

While we think of America as exporting financial innovation, here is Gutierrez importing innovation, proven in Mexico and Peru and Brazil, into El Norte. 

With Progreso’s main Web site in Spanish, he probably doesn’t even have to translate the forms.

Financiero has made about 25,000 loans to its customers in California but needs to make 100,000 before it can turn a profit because the loan amounts are so small and the cost of doing business is high, Gutierrez said.

Let’s take him at his word, and return to that ‘usurious’ 36% interest rate.  Convert that into 3% per month, apply it to a $500 loan and a six-month average duration, and you get a princely sum of $90 gross revenue per customer.  Out of that must be paid costs of money, costs of administration, loan loss reserves, cost of collection, cost of marketing and advertising …

Hence the challenge of microfinance, American style.  To make a profit from inception, you have to charge rates that seem very high expressed as a pure percentage.  Then, even if you charge a rate that will take many people aback, you make so little per loan you need 100,000 customers to turn a profit.

To get the rates down, get the customer volume up

Jacob said the credit union doesn’t make any profit from its payday-loan alternatives.

Motivation matters.  If you sell a drug to cure someone of addiction, that is very different from selling a drug to get someone hooked.

Too much payday borrowing

Instead, it hopes to boost members into good financial standing so they can then apply for profitable products such as auto loans.

Moving someone up the bankability pyramid makes the prospect profitable to you because you can lend them a larger sum for a longer interval.  Lending profitability isn’t about interest rate so much as it is about the total ‘loan area’: Amount x Term.

Motivation matters.  So does the lender’s use of profits, since that influences the lender’s orientation on rate compression – something to pursue, or to resist?

Some industry veterans are also moving into the sector. Just this year, Wal-Mart lowered the price of its prepaid debit card to $3 and its fee to cash checks to a maximum of $3.

The more nodes, the lower marginal cost

Finance scales.  Like other network-based businesses, it has a substantial establishment cost of intangible and intellectual infrastructure.  As those costs are shared across an expanding customer base, higher marginal profits ensue, allowing lower fees – which in turn expands the market further.

It also allows shoppers to pay many of their bills in stores. The giant retailer estimates that about 20% of its customers are unbanked.

20% of the people who buy there have no bank

Except on the historical context of microfinance born in the USA, I have yet to post structurally on how retailers are natural entrants into the business of financing.  They have interactions with the unbanked – Wal-Mart’s 20% figure is simply staggering.  They are motivated to extend credit so they can sell more products, and they have a hidden pricing advantage in that the profit component of each object sold is, in effect, marginal first-loss exposure for them.  They develop extensive credit histories on their customers and can use computer analysis to provide credit scoring.  Given these facts, the wonder is not that Wal-Mart is in the banking business, but that more such retailers aren’t.

“Our customers are living paycheck to paycheck and watching every penny,” said Jane Thompson, director of Wal-Mart’s financial services.

Wal-mart may be creating the Model T Bank.

The next global bank?

But perhaps the biggest hurdle the industry faces is improving customers’ financial literacy. Many are afraid of leaving their money in banks, do not have the documentation to open a bank account or have had accounts closed. They also may not understand how loans are structured.

There lies the regulatory and policy challenge – how do you distinguish between Bad and Good microfinanciers, when your prospective customer is unable to do so for himself?

D.C. resident Gregory Warf, 20, said he doesn’t want a bank account. He turns his savings over to people he trusts, like his brother, or hides it.

Familiarity dulls people’s risk sensitivity; we have many examples of unworthy siblings.

Oh, you can trust me, Simba

If he needs to cash a check, he goes to the nearest liquor store, which charges him a fee. And if he needs money – say, $10 to put on his SmarTrip card – he asks a friend.

Not trusting anyone dooms Mr. Warf to high transaction costs and cuts him out of the banking system.

“I’d rather have my money in my possession,” Warf said. “I don’t really trust anybody else.”

Except that those two statements are contradictory over time.

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In business, does motivation matter?  Or are markets sufficiently rational that our apologias are meaningless, and we should be judged exclusively by our actions?  This philosophical question lies submerged under every new lender and loan product, for every action – extending or denying credit, charging too high a rate – can be criticized. 

“In many ways, the job of a WaPo columnist is easy …”

After the fact, we can always criticize:

Lenders who refuse good credit.

Lenders who charge ‘excessive’ or usurious interest.

Lenders who extend ‘teaser’ credit to people who cannot repay.

While bad lenders make bad loans, some bad lenders also make good loans, at least in the sense that the loans are repaid, albeit at ruinous cost to the borrowers.  Who then lends to the unbanked – and what are their motivations for that lending?  This compound question runs through a lengthy profile in the Washington Post showing the perils and surtaxes of being unbanked:

For years, the country’s makeshift network of payday lenders and check cashers has operated with little competition or federal regulation.

If, like me, you’re part of our formal financial system, you need sharp eyes to spot the unbanked.  My downtown 7-11, for instance, in addition to doing a land-office business in Mass Lottery tickets and cigarettes, also sells a stream of money orders, typically at $2 or so apiece.

Check-cashing around the corner and around the world …

… and cheap refills on Grotesque Gulps!

While the marginal profitability of each such transaction cannot be terribly high, it’s a legitimate service – and a much more honorable profession than that of payday lending, about which I posted 2½ years ago in Payday lending: doing well …?

Ev’ry evening you will find him,

Around our neighborhood.

It’s the old dope peddler

Doing well by doing good.

“By do-oo-oo-ing good.”

The lenders’ interest is in the very simple question: can we get our loan repaid? By taking a postdated check, the lender jumps the payment queue, assuring itself Mr. Milford pays his loan first, leaving his Christmas presents for last.

A postdated check is not in and of itself a bad thing, but there is certainly something vampiric in the payday lender’s approach.

But I’m so innocent and small …

In many states, including New Mexico, lenders also make no effort to see if customers have borrowed elsewhere, which is how Mr. Milford could take out so many loans at once. If they repay on time, borrowers pay fees ranging from $15 per $100 borrowed in some states to, in New Mexico, often $20 or more per $100, which translates into an annualized interest rate, for a two-week loan, of 520% or more.

Who takes out a two-week loan? People who have difficulty envisioning the future. People living from paycheck to paycheck. People who lack financial literacy or the habit of saving. Such people are vulnerable:

In September, Congress, responding to complaints that military personnel were the targets of “predatory lenders,” imposed a limit of 36% annual interest on loans to military families.

As I made clear in that post’s second part, Part 2 … by doing good?, I found the whole notion of payday lending barely this side of despicable. 

It’s despic-ic-icable!

For decades we have tolerated the payday lenders, largely unregulated, on the reasonable theory that people are under no compulsion to seek them out.  That is changing now:

But as the financial crisis sparks a new wave of consumer protections, lawmakers and the private sector alike are training their sights on an industry that caters to the most vulnerable of populations: the estimated 40 million households on the margins of the nation’s financial system, with limited, if any, access to banks or credit.

Catastrophe being a precondition to fundamental financial reform, when once the groaning granite blocks of legislative inertia start to move, their grinding weight scrapes all before them.  Regulation advances, turn by turn.

You hope it comes out as sausage!

Congress is debating the creation of a Consumer Financial Protection Agency that would provide federal oversight of the industry for the first time.

If as government you think consumers are being bilked, you can do three things: shine a light on the bilking in hopes of making smarter consumers, cap charges, or ban the business altogether.  Yet lending – providing credit to people who need it – is not illegal per se, and most lending is desirable for everybody, particularly the borrowers.  Thus, throughout Congress’s approach will run two possible structural remedies: (1) greater disclosure/ transparency (as everyone becomes a Bank of Glass), and (2) usury limits.

In addition, several bills have been introduced to cap the often-triple-digit interest rates on payday loans, long considered by many one of the industry’s most abusive practices.

Just the phrase ‘triple-digit interest rates’ sounds usurious.  Framing it that way is easy, because payday lenders generate their revenue not through fees but through interest.  Yet at the same time, those payday lenders normally quote interest not in whirling-odometer percentages but in dollars per period, which brings in the second feature: the small sums advanced.  Introducing our protagonist:

If I could just get rid of these debts

Anthony Jeffers lives in North Carolina, where the unemployment rate is 10.7% –

Only on close reading did I catch that bit of urban-sophisticate snobbery.  North Carolina is a big state, and its unemployment rate varies dramatically between the coastal and rural areas versus (say) Charlotte or the Research Triangle.  But to the Washington Post’s editors, it’s all one big Tobacco Road blur.

Where the smokes are grown …

– and he travels to Washington every other month to hunt for construction work.

We don’t ask why Anthony feels compelled to live in North Carolina, instead of bunking with roommates in Washington. 

The costs are high – he pays for an apartment in both places.

Probably he has a wife/ girlfriend and child/ren.  His circumstances should be relevant to his story

The expenses overwhelmed him last year, so Jeffers turned to a payday lender to get $800 for his rent. When he repaid the loan two weeks later, he owed about $1,100, meaning he paid more than 30% interest, or 975% on an annualized basis.

Even making allowance for risk and processing fees, there’s no question $300 for a two-week loan of $800 is brutally expensive – but one does have to ask, Anthony, what are you doing maintaining two apartments?

It comes in handy, in a Mad Men sort of way

“All you’re thinking of is getting your money to take care of your situation,” said Jeffers, who was standing outside a check casher in the District on a recent afternoon after buying a money order to pay his rent back home. “It just seems like a lot of interest to pay back.”

It is – and Mr. Jeffers should find one of several possible solutions – move to Washington, find a roommate or bunking situation for when he is in Washington, find work in North Carolina (presumably harder), or borrower from family/ friends – but all these things are really easy for me to say.  I’ve spent a lifetime thinking about finance; Mr. Jeffers is just trying to keep body and soul together.

“People are always damaged by these products. . . . This can be the thing that pushes them over the brink,” said Rachel Schneider, innovation director of the nonprofit Center for Financial Services Innovation.

Schneider

“In a recessionary environment, the consequences of using predatory products are more apparent.”

Enter the question of motivation.  Mr. Jeffers and other payday-lending customers find themselves in these pickles because they’re not well capitalized, they’re not financially literate, and they lack the luxury of options.  They are desperate.  Encountering those who are desperate, we who are not have power and that makes our choice of action a moral one: do we help or hurt?

Industry representatives say they provide necessary services for households that have become alienated from traditional financial institutions. Many of their customers have poor credit and may not qualify for basic bank accounts [Meaning loans – Ed.].

Microfinance seeks to help.  Loan sharks and shysters seek to hurt. 

We’re all one big happy predator-prey ecosystem, aren’t we?

Though the number of unbanked is difficult to track, Schneider said anecdotal evidence suggests that their ranks increased as the recession deepened.

One thousand?  One hundred thousand?  Nobody knows. 

How many ice creams does it sell?

[We could probably dimension it by measuring the number of payday lenders; speculating as to how many payday-loan customers each one has; and multiplying out.  – Ed.]

Being unbanked does not necessarily mean falling into the clutches of a payday lender – but I’m sure it correlates.

The center estimates that median household income for the unbanked is $26,390 – about half of the national median – and many have little to no savings.

In other words, the median unbanked customer is Very Low Income as federally defined (50% of Area Median Income, AMI), and eligible for Housing Choice Vouchers – which are unfortunately in short supply.

Three bills in the House and one in the Senate that were submitted this spring seek to curb one of the industry’s most controversial practices: charging triple-digit interest rates for short-term loans to risky customers. The bills would impose caps as low as $15 for every $100 borrowed and, in some cases, require greater transparency of the lending terms.

Transparency absolutely.  Caps are more complex:

The cap’s too tight

The payday-lending industry has opposed capping interest rates, and its trade group, the Community Financial Services Association, is raising $1 million from its members to lobby against the bills. CFSA spokesman Steven Schlein said the group has reserved judgment on the proposed Consumer Financial Protection Agency.

Opposition is not necessarily proof of malevolence:

“It’s all in the details,” he said. “It would be a big change for us.”

Right.  The CFSA’s members’ business model is built around on-the-spot credit decision-making, high interest rates (to cover for default and costs of collection), minimal regulation and minimal paperwork.  Even if we grant them the noblest of motives, to overlay government disclosure and government regulation will drive up their unit costs of originating and servicing a loan.  That will disrupt their business model, and it’s certainly possible that the post-regulation, post-reform “better” loans might be more expensive and less available than the lend-first-collect-later model that the payday lenders now use.

The Financial Service Centers of America, which represents check cashers, said that it supports increasing transparency to customers but that additional federal regulation “is unnecessary and duplicative and will only increase the cost of financial services to consumers without any corresponding benefit.”

The FSCA could well be right.  Check cashing is also a form of credit decision, and if the check is bad, the cashier is out the money with no hope of recovery.  So there are transaction costs, and they can rapidly mount up as a percentage of a $20 or $50 check.  One could so burden the hummingbird that it could never fly.

The trade group for payday lenders said it began requiring members to display their fees on posters in their stores last year.

Good!  Why do I have the feeling the members are doing this only because they are running scared?

Industry advocates argue that innovation – not legislation – is the key to reform.

Why not both?

You may need both

Might the innovative response to payday lending be the emergence of 21st century American microfinance?

[Continued tomorrow in Part 2.]

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