Affordable Housing Institute : US

Did you ever fight with your sibling over who got the ice cream cone, only to see it splatter onto the sidewalk?

 

Who ordered the large?

 

That’s the sinking feeling probably being experienced by the government public-private team trying to recruit developers into their Herculean effort to redevelop Mumbai’s Dharavi slum, as the global credit crunch thins the ranks of potential development consortia.  As reported on Live Mint:

Six consortia opt out of Dharavi project bidding

 

Bangalore: Six of the 14 teams in the fray to bid for a Rs15,000 crore [$3.2 billion – Ed.] Dharavi makeover project have opted out, jeopardizing the scheme.

 

Five consortia have to be chosen to develop one sector each of the 535-acre shanty town in Mumbai, to make it a part of the growing residential and commercial development within Mumbai.

 

It always looks so easy on the maquettes

 

With only eight candidates in the bidding, it will be hard to create the sense of government leverage necessary to extract a favorable deal for each parcel.

 

“I am going to raise this issue with the committee of government secretaries that the number of participants does not give scope for adequate competition,” said Gautam Chatterjee, chief executive of the authority. “The committee will take a final call on what should be done with the bidding process.”

 

When it negotiates with the private sector on a macro project, government is usually out-traded: for several reasons: the talent updraft, government’s slow OODA loop, their information/ analytical disadvantage, and the necessity for government to have a consensus outcome.  [And that's even omitting entirely the possibility of corruption and bribery in the award process – Ed.] 

 

Will Dharavi disappear in favor of high-rises?

 

It’s been a particular challenge at Dharavi, which, as I’ve posted, has been politically contentious from the beginning. 

 

On Friday, the Dharavi Development Authority asked the 14 short-listed groups to submit to it the memoranda of understanding among the team members.

 

A very good idea – it flushes from cover who is actually a team and who is simply a mob hoping to win the beauty contest and then plunder the opportunity.

 

We had fourteen, but six of us were shams

 

This was asked after rumours that many of the international and local companies wanted to opt out of the project in the wake of the global economic downturn.

 

The DDA asked a question, and got an answer it didn’t like to hear, but needed to hear:

 

Lanco’s flame has gone out

 

Some lead members of teams that are not a part of the project any more are Unitech Ltd, K Raheja Universal Pvt. Ltd, Lanco Infrastructure Ltd, RNA-Videocon, Runwal group and Kalpataru group.

 

Videocon tuned out

 

Runwal ran away

 

Kalpataru got lost

 

Normally when you’re negotiating, you assume that any offer the other side makes will be on the table indefinitely.  Public-sector and pro-poor groups conducting such negotiations, who are at an information and analytical disadvantage, tend to play their cards by instinct, judging what they can squeeze more by how the other side behaves than by their own internal analysis.  Most of the time that works, especially when there are multiple private bidders competing for the same business. 

 

When the number of bidders shrinks, the public sector’s disadvantage gets worse.

 

Among the remaining teams are Lodha Developers Pvt. Ltd and DB Realty Pvt. Ltd. The two firms recently filed their draft red herring prospectuses to raise money through initial public offerings.

 

Financing their Dharavi development through an IPO??  You’re kidding, right?

 

That’s a joke, right?

 

Lodha has tied up with a Malaysian construction firm, LBS Bina Group Berhad, as its technical partner, and DB Realty has teamed up with its subsidiary, Conwood Agencies Pvt. Ltd.

 

Slum redevelopment is challenging, because it is so much more than simply large-scale construction.  Further, the public-private negotiations are extensive, time-consuming, and fraught with uncertainty.  The private sector converts uncertainty into cost, and cost reduces profit/ equity potential. 

 

Less profit to work with

 

The value of urban land depends on the net residual profit to be derived from developing it; as a result, land price is the most volatile line item in the total uses of funds.  To that uncertainty, add the uncertainty inherent in dealing with government.

 

Looks yummy but perishable

 

Then put another scoop of uncertainty for the slumdwellers themselves, who have an effective voice and are not shy about using it.

 

“Developing slums in Mumbai needs expertise because such projects have serious socio-political complications,” said an analyst with an international property consultancy, who didn’t want to be identified.

 

At some point it becomes unstable

 

With slums being hard to redevelop, the surprise is less than some opted out, but that that so many have stayed in so long:

 

In March, following a harrowing six months of liquidity crunch and slow property sales, five out of 19 teams had opted out, leaving only 14 in the fray. Some the prominent firms that exited were Housing Development and Infrastructure Ltd (HDIL), and Reliance Engineering Associates Pvt. Ltd and Urban Infrastructure Venture Capital Ltd.

 

Big bids always have big consortia – and if one or two team members get cold feet, the team can disintegrate.

 

 

HDIL, one of the country’s biggest slum redevelopers, was forced to opt out after its US-based partner Lehman Brothers Holdings Inc. went bankrupt in September 2008.

 

Sorry, Lehman

 

“We had been getting a little jittery about the project and don’t want to be a part of the project anymore,” Sandeep Runwal, director of Mumbai-based Runwal group, had said in September.

 

Don’t throw me out with the bath water, okay?

 

Property consultants who have tracked the Dharavi project closely said the biggest problem with the participants now is that none of them really has experience in redeveloping slums.

 

Said an analyst with an international property consultancy, who didn’t want to be identified, “besides DB Realty, no other team is equipped for that.”

 

Dharavi is still the fixable slum.  Still, government may have played its cards too slowly, and there may be much less financial ice cream.  If I were advising government, my advice would be move quickly and designate some developers.  The ice cream cone is melting fast, and you may be contending over nothing.

 

The way to think about development opportunities

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By: David A. Smith

 

[Continued from yesterday's Part 1.]

 

As we saw yesterday, the first new development in the Kibera slum upgrading has finally broken ground, nearly eight years after initial conception.

 

The former is supposed to be replaced by the latter

 

Background: A while ago [Early September – Ed.], Kenya’s newspaper The East African Standard published a great and extensive series on the proposed upgrading of Kibera: Africa’s largest slum, which I visited in 2005.

 

Kibera in 2005: photo taken during my visit

 

The articles covered community resistance in the Standard, Kenya, the indignity of having no toilets, slumlord exploitation, slumdweller fears, an idealist’s critique, the power of savings, the potential to reform building codes, and an editorial endorsing affordable housing (which the Standard mistakenly but understandably calls ‘rent control’).  Woven throughout the series were the main themes that show why slums, though hard to eradicate, are also hard to upgrade. 

 

It takes that long because slum upgrading, in addition to being expensive, complex, and risky for government, faces enemies within, starting with the skeptics, cynics, and fearful:

 

Some slum dwellers say they will not move to new houses constructed a few metres away, despite being charged a modest rent of Sh 1,000.

 

And they are giving all sorts of reasons –– some hilarious and others baffling –– to justify their defiance.

 

Kibera in 2005: Francis Umunde, savings group leader

 

Of the residents’ reasons, fear is uppermost, and fear need not be rational:

 

Some claim their children would contract waterborne diseases once they move to clean houses.

 

Such a fear maybe nonsense, but it comes from somewhere, and as we’ll see in tomorrow’s posts, there are plenty of people willing to encourage others’ fears.

 

Others say they are [so] accustomed to squalor life in Kibera that they would not know how to live differently.

 

Poverty creates a curious kind of dependency – that of the familiar.  Be it ever so humble, there’s no place like home sounds to us a homily, yet it conceals within our belief that we do not ‘deserve’ a better condition, that there must be some trick or hidden test, and we will fail it.  We saw entrenched distrust in American HOPE VI public housing redevelopments; we see it here in Kibera.

 

Kibera in 2005: eco9nomic empowerment, co-op office

 

They also fear they might not find affordable schools for their children since most of those in Kibera are sponsored.

 

Fear of the unknown.  Distrust of anyone in apparent authority who provides reassurance.

 

They say other fuels like kerosene, gas or electricity are out of reach.

 

Fear of hidden increased costs.  This is more rational, so you cannot heat or cook by a wood fire if your apartment is a concrete mid-rise.

 

Traders say they will lose their livelihood.

 

03: Ms Jane Ngoiyo, who has lived in Kibera for 30 years, is worried about her grocery business

 

Fear of disrupting their personal cryptobiotica: the delicate web of their economic lives.

 

Josphat Mondia, 28, calls the decanting site ‘The Hague’. He is jittery about moving because of the uncertainties that lie ahead.

 

“Life in Kibera is cheap. With Sh50 you can eat three meals in a day and sleep. That can’t happen at the location. There, you won’t get sukuma wiki or tomatoes worth Sh5.”

 

Mr. Mondia’s fears are a tangle: some plausible, some unlikely, some paranoid:

 

“Again, I feel the Sh1,000 rental fee is just a bait and will be increased progressively, eventually forcing us out of the houses when we default,” he said.

 

That’s just paranoid.  Why would the government, even a corrupt one, want to give people higher-value houses, only to take them away later?  Unlike Dharavi, it’s not as though the land on which Kibera sits has enormous redevelopment potential. 

 

Mondia, who was born in Soweto East, says he knows no other home and would want to remain at the village all his life.

 

Again the psychological dependency of poverty: it is too painful to imagine a better life that will be snatched from you; psychologically safer is to doubt its existence.  After all, when no one official in your life has ever been trustworthy, it’s understandable that you would not trust the government – especially if a majority of structure owners are civil servants, as they are in Kibera.

 

He said his children might fall ill with waterborne diseases once they move, ‘which is unheard of in Kibera’. “Watapata cholera na watoto wa Kibera huwa hawapati haya magonjwa (our children will be infected with cholera and other diseases unheard of in Kibera),” he says.

 

Kibera in 2005: the main thoroughfare of Soweto East

 

Mondia also says unlike in Kibera where there are many donor-sponsored schools, at the new site, parents will be forced to part with Sh5,000 every term.

 

Fear of the unknown.  Fear of the irreversible.  What makes him think that?  Fear.  Who starts such rumors?

 

“That is like burying me alive,” he says.

 

Mr. Mondia may not have heard the answers, or he may have disbelieved them.  No one can overcome disbelief and doubt in an instant.

 

Kibera in 2005: Warning slum dwellers not to buy illegal spirits

 

Philip Kiliswa, 40, who works as a security guard in the city centre, is opposed to the shifting because it will move him further from his workplace, yet walks there.

 

Compared with the walk Mr. Kiliswa now makes, the distance increase in minimal.

 

He is sceptical that the project might turn out like the Highrise National Housing Corporation project in which Kibera residents had been promised housing units that were later taken up by outsiders.

 

I understand his skepticism.  Given Kenya’s performance to date, I’d be skeptical too.

 

02: Mr Cyrus Kimemia fears outsiders may take over the houses. [PHOTOS: ANN/STANDARD]

 

[Continued next week, on Thursday, Nove 5^th, in Part 3.]

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By: David A. Smith

 

A while ago [Early September – Ed.], Kenya’s newspaper The East African Standard published a great and extensive series on the proposed upgrading of Kibera: Africa’s largest slum, which I visited in 2005.

 

The mud structures (in the foreground) will be replaced by the new housing units (in the background) in Kibera under the Kenya Slum Upgrading Project (Kensup).  [PHOTO: BONIFACE OKENDO/STANDARD]

 

The articles covered community resistance in the Standard, Kenya, the indignity of having no toilets, slumlord exploitation, slumdweller fears, an idealist’s critique, the power of savings, the potential to reform building codes, and an editorial endorsing affordable housing (which the Standard mistakenly but understandably calls ‘rent control’). 

 

Kibera in 2005: Soweto East, with middle-class homes in the distance

All Kibera 2005 photos taken during my visit

 

Woven throughout the series were the main themes that show why slums, though hard to eradicate, are also hard to upgrade. 

 

The journey to the realisation of low-cost houses in Kibera, and the envisaged eradication of slums, has been long and bumpy. And it appears far from over.

 

Slums have enemies within: people who for reasons noble or ignoble will fiercely oppose any major upgrading program.  And every slum upgrading program faces one huge obstacle: the cost.  Affordable housing always costs money, costs that are non-recoverable over any normal private-investment horizon, and that money must come from government:

 

The Government estimates a staggering Sh880 billion will be needed to eradicate slums and informal settlements.

 

To give you a sense of scale, that’s $16 billion – and if that doesn’t seem large enough, figure it as 26% of Kenya’s $62 billion GDP; for America to spend the equivalent amount of our $14.4 trillion GDP would mean an expenditure of $3,700 billion – yes, $3.7 trillion dollars.

 

However, Housing Minister Soita Shitanda has been quoted as saying the Government does not have the money.

 

Minister Shitanda and his official vehicle

 

And that presumes slums will sit still while being eradicated, and that the development of new higher-quality housing will not attract thousands if not millions of new rural-to-urban immigrants.

 

Kibera in 2005: limited only by land area

 

It is, in short, a pipe dream. 

 

When the Kibera-Soweto slum upgrading pilot project was launched on World Habitat Day in 2004, it seemed like far away dream.

 

But we must start somewhere.

 

About 1,500 families from the largest slum in Africa, will in the next two weeks move to modern stone houses as part of the Kenya Slum Upgrading Project.

 

A drop in the ocean?  Or a pilot that shows feasibility and builds political and economic support?

 

The construction of 17 blocks of five-storey high flats totaling 600 three-room units is complete and residents of Kibera’s Soweto-East village would be the first to move.

 

Something has been done. 

 

Once they are moved, the shanties they live in will be demolished and new modern houses built.

 

Perhaps those shanties will be demolished to make way for better housing on their sites.  Slums die by withering; the bulldozer succeeds only when the people no longer need them, because they have moved into better accommodations.

 

Kibera in 2005: Our Dream House

 

Once the tenants are moved to the site, the Government will pull down their current structures and build permanent houses within two and half years.

 

“The people at the site will return to new houses but pay for them by installments. Most have already formed cooperative societies and their savings are impressive” –

 

This is my design!  They’re doing it!

 

Kibera in 2005: savings cooperative members and lists

 

 

The initiative to eradicate slums was mooted in 2000 as the Kenya Slum Upgrading Programme (Kensup) through an agreement between the Government and UN-Habitat.

 

After a detailed situation analysis in 2001, a pilot project began at Soweto village –– with 60,000 people –– in the southeastern sector of Kibera.

 

Progress was slow, and intangible:

 

The agreement was renewed in January 2003 and the slum upgrading initiative kicked off in earnest. The Kibera-Soweto pilot project was launched on World Habitat Day in 2004, with a graphic media presentation of the planned redevelopment of the slum into orderly flats.

 

We love the graphics.  The real work is much harder.

 

Kibera in 2005: plaque commemorating building on communal toilets

 

The Housing ministry says Kensup is a core programme aimed at addressing housing problems affecting the majority of the urban population who live in slums and informal settlements. Statistics show 60% of Kenya’s urban dwellers live in slums.

 

Four years ago, after the Bellagio housing conference, I visited Nairobi at the Kenya government’s invitation, to take further into implementation design the Kibera slum upgrading financing strategy several of us – including Angelo Mozilo, then-CEO of Countrywide, Stewart Paperin of the Open Society Institute, Nic Retsinas of Harvard’s Joint Center for Housing Studies, and various Kenyan government representatives – had brainstormed and recommended. 

 

Building on work that Kensup and UN Habitat’s Slum Upgrading Facility SUF) had begun, I spent an intensive week, hard numerous interviews, took copious notes, then returned to Boston and ‘built out’ the program, both its narrative and the financial model.  It was solid work; I was and am proud of it.

 

Kibera in 2005: vegetable stand

 

In August, 2005, I delivered the report, including an extensive financial model, and heard nothing further.  (It is often thus in Kenya, I find; one makes suggestions, is politely heard, then silence ensues.)  I thought it had gone nowhere. 

 

Now comes the first slum-upgrading development, incorporating principles in that original design.  Even if little of this was our doing, we pushed the boulder in the right direction.

 

– says Walter Hongo, a member of the Soweto East Settlement Executive Committee (SEC).

 

As the article explains elsewhere:

 

SEC’s are mainly comprised of slum dwellers. Their main role is to act as a link between the programme implementation unit and settlement community.

 

Buy-in from slumdwellers is critical; without it, nothing can succeed.

 

Kibera in 2005: checkers with bottle caps

 

The SEC is expected to facilitate community networks, co-operatives, and resource mobilisation processes such as savings and credit schemes among others. It is the forum for advocacy for community rights and ideally ensures participation in decision-making.

 

All this comes from Slumdwellers’ International’s best practice.

 

He says beneficiaries will allocated between one and three rooms in the site. Each room will cost Sh1,000 [Monthly rent – Ed.] according to the initial plan.  

 

Of course, this being Kenya, where there is never a last battlefield, there is dithering:

 

Hongo says the movement of tenants has been put off since President Kibaki and Prime Minister Raila Odinga have been, due to official engagements, unable to attend the first event.

 

We’re taking so much time on grip-n-grins

 

The Lang’ata decanting site was identified as a suitable holding ground.

 

The site is located at across the slum settlement adjacent to the village. It measures two hectares. Construction of 17 blocks of five storey high flats totalling 600 three room self-combined units has now been completed, months after the initial November 2007 deadline. In addition, a 4.26km spine road and associated infrastructure are under construction parallel to the railway line across Kibera. The proposed physical infrastructure on the spine road includes roads and walkways, storm water drainage among others.

 

If it happens – when it happens? – the change will seem as paradise to Kiberans:

 

Zipporah Onyango, Kibera resident.”All I need is change. I have always dreamt of the day I will stop paying to use a toilet and relieving myself in a bucket.”

 

After decades living in squalor, most families in the sprawling Kibera slums cannot wait to move to ‘paradise’.

 

To them, the slum upgrading project is godsend. They see it as an opportunity for a new lease of life from the flying toilets, leaking roofs, stinking and clogged trenches, and all other forms of unhygienic conditions that characterise life in Kibera.

 

‘Flying toilets’ are the colloquialism for defecating in public, usually into a plastic bag, and then throwing the feces … somewhere.

 

Mrs Zipporah Onyango who has lived in Kibera’s Soweto-East village for the past two decades says she cannot wait to board the truck that will take her closer to her dream house.

 

“This will be a miracle as I never imagined getting out of this place. It has been so frustrating that even my relatives have refused to visit me here because they say place is inaccessible and insecure,” says the 39-year-old mother of four.

 

You are what you live in.  Change your housing and you change your life, and your children’s lives

 

Her neighbour, Elemina Indeche, says the new houses will be an equivalent of paradise and will make a difference in her life.

 

“All I need is change. I have always dreamt of the day I will stop paying to use a toilet and relieving myself in a bucket,” says the 49-year-old mother of two.

 

Kibera in 2005: toilet built by the co-op

 

Everyone should have the human right to squat in private, safely and cleanly.

 

And after a 14-year sting in the heart of Kibera, Joseph Onyango, 34, says he has never believed in miracles, but says one is about to happen.

 

“Imagine the agony of being rained on while in your house or the shame and indignity of having to use a flying toilet. That is what my life has been like for 14 years now.  And when I dared report it to the landlord, he would scream at me, saying I should move to a house with toilets.”

 

Hideous.

 

“It was all mockery, but it is now just to happen,” he says.

 

Once the initial money had been found, why did it take so long?  Because of the enemies within.

 

Kibera in 2005: Sign outside the Ministry of Lands and Housing

 

Starting tomorrow, we’ll meet them.

 

[Continued tomorrow in Part 2.]

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By: David A. Smith

 

[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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By: David A. Smith

 

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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