A couple of days ago the NYTimes published an article by Neil MacFarquhar (“Banks Making Big Profits From Tiny Loans”, 2010-04-14) on microloans in undeveloped countries.
It’s written in the typical NYTimes style of understated indignation and offence at what he characterizes as exploitation of the poor. Microloans, you see, were supposed to be “the long elusive formula to propel even the most destitute into better lives.” That’s the setup, anyway, but let’s face it: Liberals don’t actually think that business lending is the solution to poverty, but they do believe that anything that puts more money into the hands of the poor at least has that going for it.
MacFarquhar lets Nobel Peace Price winner Muhammad Yunis, “the economist who pioneered the practice”, state the thrust of the piece:
“We created microcredit to fight the loan sharks; we didn’t create microcredit to encourage new loan sharks,” Mr. Yunus recently said at a gathering of financial officials at the United Nations. “Microcredit should be seen as an opportunity to help people get out of poverty in a business way, but not as an opportunity to make money out of poor people.”… and by that same token I guess you could say that the printing press was invented for making bibles, yet look how the NYTimes has debased it by publishing fishwrap. Having “created” the idea of making very small loans to very small businesses (not quite the Nobel Prizeworthy breakthrough, that), Yunus apparently believes he owns the idea and how it should be used. How dare other people use his unique idea in ways he hasn’t approved! The nerve of some people.
Some banks and financial institutions, ace reporter MacFarquhar informs us, have been charging interest rates of up to 100% - or more! Some of them! Up to 100%! And some of them more than that! … and some of them less than that. The article doesn’t actually provide much by way of numbers, but it does provide a breadcrumb trail by way of reference to the Microfinance Information Exchange (“The Mix”) and in doing so provided what’s probably the most salient piece of information in the whole article. It's contained in a single sentence, orphaned in the middle of the article, and in it is a key fact which is succinctly provided and subsequently completely ignored:
“Adrian Gonzalez, lead researcher at the Mix […] found that much of the money from interest rates was used to cover operating expenses, and argued that tackling costs, as opposed to profits, could prove the most efficient way to lower interest rates.”It’s a forehead slapping revelation which undercuts the whole thrust of the article. The interest rates charged are irrelevant so long as the microloan enterprise is to be considered a self-sustaining business, as opposed to a money-losing charity. Charities can and do throw money at social problems with the expectation that their outlays will not be repaid, whereas for a business to continue as a going concern the balance sheet can’t stay negative for long before it goes tits-up.
The interest rate charged is therefore irrelevant because banks and financial institutions are not charities and can’t expect donors to replenish the institution as they bleed red ink. If progressives are going to ride their hobby horse of outraged indignation over greed in this business sector then the relevant metric is the profit margin, not the interest rate. As revealed in this quote, while the interest rates are high, so are the expenses.
That’s to be expected in a business of this nature. The low interest rates to which we’re accustomed in the developed world are possible in part because of our business environment. For example, we have the infrastructure to make informational contact and money transfers between parties simple and quick. Lenders can phone, send letters, or even dispatch a representative if necessary, and vice versa for borrowers – although, for microloans, the very nature of the small loans makes for small profits to begin with, and every added expense therefore will loom disproportionately large; it's cheaper to make one loan of $10K versus a thousand loans of $100.
Furthermore, we can also rely on our judicial institutions for recourse in the event of a dispute, whereas in the developing world judicial recourse is often not an option. Considering that the risk is borne by the lender. The lack of a venue in which to sue the borrower in the event of default makes it easy for a scammer to simply take the money and run.
That would be the worst-case scenario for the lender, but even excluding those whose sole object is thievery, the majority of the target-market of lenders are going to be poorly-educated and unable to make even simple business calculations. Consider the example provided in the article of Maria Vargas of Mexico City, who “has borrowed larger and larger amounts from Compartamos over 20 years to expand her T-shirt factory to 25 sewing machines from 5. She is hazy about what interest rate she actually pays, though she considers it high.” She considers it high, but the truth is that if there were a more competitive rate she would have taken it. In a competitive market the invisible hand will find the true rate, and it's higher for borrowers like Ms.Vargas than for better credit risks in a market backed by an effective judiciary. Note that it’s her factory, and she’s borrowing the money, but she doesn’t quite know what it’s costing her. I’m not blaming her for her poor education, but consider that she’s probably a typical borrower. She simply does not know how to figure out the costs of this business transaction, so the prospects of her paying back the money she’s borrowed are considerably diminished when neither she nor her bank can say for sure whether the transaction makes business-sense in the first place.
The Mix has a detailed Excel spreadsheet for Y’08 which has some interesting information. Since I’m not a financial analyst it’s a bit difficult for me to make heads or tails of the wealth of information provided in it, but the profit margin for For-Profit lenders had a median of 7.3%, whereas the “profit” for Not-For-Profit lenders was 3.3%. So much for the outrageousness coin these loan sharks are skimming from the poor, eh?
The article also has a cautionary tale for progressives:
"In Nicaragua, President Daniel Ortega, outraged that interest rates there were hovering around 35 percent in 2008, announced that he would back a microfinance institution that would charge 8 to 10 percent, using Venezuelan money.That’s right: when the Leftists encouraged default the private capital took flight. With losses all but guaranteed, no sane businessperson would do that kind of business there. Profits are what motivate people to invest. No profit, no money from private enterprise. One way or another it’s got to pay off or they’ll take a hike and put their money to work elsewhere. Just as importantly, the rewards must be commensurate with the risks or capital will seek equally low returns on investments of comparably lower risk. This isn't opinion: this is basic economics and it's completely lost on these Socialists.
"There were scattered episodes of setting aflame microfinance branches before a national “We’re not paying” campaign erupted, which was widely believed to be mounted secretly by the Sandinista government. After the courts stopped forcing small borrowers to repay, making international financial institutions hesitant to work with Nicaragua, the campaign evaporated.”
Socialists and charities are free to make low-interest loans to poor credit risks but they’ll require a regular influx of capital to replace their inevitable losses. When these social engineers create an untenable business environment, free capital walks – the lenders won’t profit, and (pay attention, you progressives) the entrepreneurial poor don’t get loans. Nobody wins – happy now?
The article continues with this threat:
“The fracas over preserving the field’s saintly aura centers on the question of how much interest and profit is acceptable, and what constitutes exploitation. The noisy interest rate fight has even attracted Congressional scrutiny, with the House Financial Services Committee holding hearings this year focused in part on whether some microcredit institutions are scamming the poor.”Oh, yay! Congress will hold hearings. This will surely end well.
… and finally, the article closes with this:
“You can make money from the poorest people in the world — is that a bad thing, or is that just a business?” asked Mr. Waterfield of mftransparency.org. “At what point do we say we have gone too far?”Answer: Since it’s not your money that’s being loaned out you have no business asking.