“The Big Short” Meets Financial Inclusion: Is There a Flip Side to the Hype Cycle?

The-Big-Short-and-Financial-Inclusion

Steve Carell appears in ‘The Big Short.’

For folks like me, whose passion fuel is a unique kind of end-is-nigh moral indignation paired with a seductive hint of world-improvement possibility, a movie like The Big Short hit its mark. Banks are screwing the American public and the world! Incentives are misaligned, the corporatocracy is out of control, idiocy and greed abound, and only a few wise pariahs are there to save the day – or if not save the day, then at least profit from the destruction (which is more in keeping with the American ideal these days anyway).

But as someone who has dedicated the last 10+ years to “financial inclusion,” I am left also feeling a bit confused and conflicted. At one point in the movie, two of the investors about to make gobs of money by shorting the U.S. mortgage market pause to reflect on the decision to sell their position (and make, with a Dr. Evil sneer, one billion dollars) and the economic and ethical superstructure in which such decision is being made. The character Vinnie says something like (pardon the paraphrase): “Well at least we know that bankers will be going to jail, the system will have to change, things will have to get better.” Steve Carrell’s character, Mark, says, “I have this bad feeling that things will stay the same and the banks will blame this one on the immigrants and poor people.”

Sure enough, that narrative lurks in most accountings offered by apologists, the regulators, the raters, the economists, and so on. Today, we’re back to business as usual – even while few can understand what’s in America’s banks today and banks themselves are back to selling a rebranded collateralized debt obligation eerily similar to the first kind that sunk us.

But back to these pesky “immigrants and poor people.” Clearly I’m an opinionated author writing from an opinionated point of view, firmly believing that immigrants, poor people, and all stripes of underserved and yet worthy customers should be offered financial services to help them improve their lives. That such services by and large not only help disadvantaged households or small businesses manage cash flow needs, mitigate risk, and seize opportunity, but also present a booming (albeit sometimes hidden) profit pool for the world’s financial service providers. In general, I believe these services (when offered responsibly, with dignity, and to customers who know what they’re getting into) are good.

I’m not going to try to square this circle with regard to the 2008 housing crisis; many books have been written on that topic. But I am trying to piece together what, if anything, this means for our current moment: a moment in which a new breed of “fintech” startups and insurgents claim to be reinventing finance, and many of them (particularly the ones in which I invest) do so by offering new or better products to those same “immigrants and poor people” that allegedly got us into trouble last time: companies offering better-faster-cheaper credit, payments, investments, insurance and more to the underbanked masses.

“But this time is different!” we scream – and I honestly believe it is. Mostly. Most of what we see genuinely seems on the right track. Focusing just on the U.S., I’m proud of our companies like LendStreet, which helps over-indebted households consolidate and get out from underneath their credit obligations; RevolutionCredit, which helps thin-file households get access to credit they actually deserve, while also providing useful information about how to budget, manage their credit score, etc.; eMoneyPool which brings savings circles online to help instill the group discipline to save money for a variety of life goals; and the Accion US Network (where I’m proud to sit on the Board) which uses technology to turbocharge their long-standing mission-oriented model to provide loans to small businesses.

But then there are a number of other companies who have emerged under the banner of “democratizing finance” or financial inclusion or helping the underbanked that I’m not so sure about. These are companies that are not overtly “social impact” or “economic development” oriented, but that perhaps get a bit of a free pass by virtue of their apparent support for the underdog. For example, companies like OnDeck Capital and CAN Capital have exploded onto the scene in the last several years with a range of daily debit-based small business loan products, with loan amounts and repayments generally tied to credit card transactions (i.e., merchant cash advance). The new source of capital can be great for small businesses, and companies like OnDeck love to position themselves as the best friend to small businesses everywhere.

At the same time, there’s a darker side to this. More capital doesn’t always mean better outcomes for customers, particularly when implied interest rates cross 60% (close to double most credit card rates), customers often don’t know what they’re paying, and repayments aren’t suited to the cash flow patterns of a particular business. Most small businesses probably just figure out a way to cover the costs and are fine; others refinance their way out of trouble. But some are really left out to dry by these products, and that risk could get worse. (For more on the OnDecks of the world, check out this story.)

Similar practices in other areas—small-ticket consumer loans, tech/data powered collections, auto title finance, and so on—present similar good vs. bad conundrums, and present their own risks of mini-blow-ups or other ways customers might get themselves tangled in a financial mess.

Do I think any of these companies is all bad for customers? Of course not; in fact I am generally a cheerleader for leveraging tech to bring more options to customers, and I’d wager that most of these customers are happy for the attention and the options. (Well, maybe not the ones in collections…) If nothing else, most of these startups present at least a modest and in some cases big improvement over whatever was there before, and all in all, I’m very happy they’ve emerged.

But even if these new players and products are kinder and gentler than existing alternatives, this doesn’t mean they’re always kind or gentle, full stop. A part of my Big Short-spooked brain wonders whether, in pockets, we are gearing up for a handful of mini subprime crises, as tech ups the ante and accelerates the spread of broken banking and both providers’ and customers’ financial habits (Note: it seems to this observer basically impossible that these will be systemic contagion, or world-destroying events like the housing crisis, but it could still be very bad for many customers…) And if we are, these mini-crises may be more nefarious, because both good guys and bad will be speaking the same language of “access for all” under the same we-love-our-customers banner; in this movie, the bad guys won’t all be wearing pocket squares, wingtips and smug grins. (Please invert fashion cliché as appropriate for evil females…) Instead, in this “fintech for the underbanked” sub-sector, folks good and bad are probably going to look pretty much the same from the outside. Decisions about how to look out for customers’ best interests (from transparency to pricing to customer service) and how to share the emerging surplus created by new financial technologies will happen behind closed doors with motives and outcomes discernible only by the narratives and counter-narratives that emerge.

I still believe in the power and potential of financial inclusion and “New Finance” (see here and here), and all the great companies we work with to realize this potential. But I also can’t help but sigh and long for simpler days when we knew who the enemies were (whether Soviets, fat grams, or CDOs) and where the good fight was being waged.

(Visited 251 times, 1 visits today)
Share this post:

6 Responses to ““The Big Short” Meets Financial Inclusion: Is There a Flip Side to the Hype Cycle?

  • Paul, nice post. You probably remember this from your past life with us, but I think you have reason to be worried because of the state of oversight in many emerging markets. The US financial crisis was in part a supervisory (and ratings) failure. What I see in the markets where high cost nano credit is taking off is that most financial sector supervisors are not up to speed with the business models, let alone collecting and analyzing their credit portfolios. I don’t know what the magic trick is to fix this: Budgetary assistance for new DFS supervision units/market conduct units; awareness raising; automated portfolio analysis tools that raise red flags for follow-up? But if we don’t fix the supervisory capacity/will gap I can see things “going boom” in one of these markets.

  • Colin Clark
    2 years ago

    Paul,

    Great writing! Very interesting stuff. Seems like all banks are moving to offering things like free basic mobile banking, and I would hope with benefits for all depositors.

    There is a difference between enabling people to use financial institutions for money they have (depositing income, using checking and savings accounts) versus financial institutions’ loaning money to people with little means to pay it back (the loan shark and sub-prime housing model).

    Where does “financial technology” fit in?

    Poor people in the United States do have access to capital, but it’s disproportionately with loan-shark payday and auto-title lenders. If traditional banks have left a void, it is being filled with a different kind of lender, but to me the problem isn’t who is making the loan; it’s the usury.

    Regarding financial inclusion for poor people, if the new way to get a loan is through a website on your phone, isn’t the important question, “What is the interest rate?” Ideally, the new means of access to capital comes with more transparency, and competition will drive down interest rates.

    But why not bring back caps on interest rates for all basic lending services (going back many millenia) or set high minimum loan requirements for high-interest loans so that poor people don’t get sucked into a new means of paying usury?

    Also interesting to think about the role that credit unions play in the shift to mobile banking, since they exist to benefit their members rather than stock-holders (owners of big banks) or investors (owners of start-ups).

    I look forward to your next post!

  • Alex Cooper
    2 years ago

    Paul. Great Post. What has my neck hair raised is that too many well intentioned people and institutions that are trying to do good for the underserved still see banks as the solution. “We need to get them banks accounts, we need to lower the costs of checking accounts.” Big banks are in for the profit. That is their job. As long as they can make more money with less risk (perceived or real) they will never adequately serve this customer. It is the fintech innovators that create new products and channels for customer acquisition that banks will stand behind and then eventually acquire.

    • Paul Breloff
      2 years ago

      Thanks for reading Alex, and the comment! Couldn’t agree more with this POV, keep up the great work with RezzCard!

  • Jayshree
    2 years ago

    I loved the write up, Paul. I think it is good to be wary, but not so much that we stymie innovation. The one thing that would separate the wheat from the chaff is perhaps the investor profile? If one sees rapid exits by investors, or quick successions of fund raise, then one should put them under a scanner. Short term incentives can distort the market like they did with in the subprime case. What I read is the need for patient capital for innovation. Would you agree?

    • Paul Breloff
      2 years ago

      Completely! I love innovation and certainly want us to keep pursuing these new directions… after all, my job is to invest in these companies pushing out the innovation frontier. But movies like this make me pause and reflect, and you’re right that we need more patient capital and less quick buck-seekers.

Leave a Reply

Your email address will not be published.