Archive for June, 2009

I attended a one-day conference on Microfinance at SPU where they had a nice recommended reading list I picked up a book called “What’s Wrong with Microfinance?” This has turned out to be a fascinating and inspiring book – even though it’s ostensibly about international microfinance, many of the issues and lessons resonate with my own ponderings. It’s a series of essays by folks with 10-30 years of experience each in the field. The first essay, by Thomas Dichter, opens the discussion by reminding us that while microfinance is a fancy term what we’re mostly talking about is debt. Debt involves all kinds of symbolic social and moral perceptions that affect not just how the parties feel about themselves and each other but how obligated they feel to perform. The essay notes this is particularly important in countries with poor contract enforcement, but I found myself thinking about P2P lending models like Prosper.

He thrills me with his closing by naming (ah, in German!) a cultural split that I have observed most strongly in economic class differentiation, and that he observes with the spread of microfinance – a shift from gemeinschaft to gesellschaft. Those terms come from sociology and are apparently so classic that not just Wikipedia but Encyclopedia Britannica explains them! For Dichter, gemeinschaft represents a community built on reciprocity, exchange and mutual trust, whereas gesellschaft represents a community based on formal contractual relationships. He sees the spread of microcredit possibly hastening a transition from one to the other, and he particularly draws a distinction between the impact of credit used for consumption (to which he attributes the majority of microcredit) vs credit used for investment.

At BGI we talked about the gift economy vs the financially intermediated economy. I found myself thinking about that recently after a visit to Casa Latina. They’re a non-profit (scratch that, Leno Rose-Avila of Social Justice Fund inspired me to start calling them Social Profits) finding economic opportunity for Latino immigrants. They occupy a socially complex space between the gift economics of a social profit: using volunteers and giving services for free, and the financial economics of a for profit by coordinating marketing and distribution for paid employment services. Like all social-profits they’re under pressure to look for earned revenue opportunities and match revenues to costs.

With their women’s group they have an elegant example of blending the two economies: there’s an internal snack shop they run basically at cost, to provide low-cost snacks for workers. Since its run to be low-cost, it’s run by volunteers. Women from the women’s group staff it, but they get points for volunteering, which combine with other ways they can earn points, all of which move them towards the head of the queue for the next job referral, which rewards them personally with a paying job opportunity. This system has worked and is an interesting interplay between the individual and the community in a combination of non-financial and (ultimately) financial exchange.

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Earlier this year I listened to a really interesting This American Life episode (from May 2008) on “the giant pool of money”. It seeks to understand the sources of the mortgage meltdown. My takeaway from that episode is: there was more money looking for secure income-generating investments than there were high-quality income-generating investments, of which mortgage-backed securities were the favorite. Market pressure caused standards to be lowered. That standards could be lowered in a way that was not entirely transparent to the end-purchaser, IE that people were still able to buy AAA rated crap, is clearly a system failure, but more interesting to me is the problem that there was too much money chasing too little return.

What I remember of Kantian ethics from college philosophy is essentially this: an act is immoral if it causes a system breakdown when everybody does it. As a computer scientist I automatically think of the tragedy of the commons – I can get away with grazing my goat in the commons, but if we all do it the commons is done for, ergo even though I can get away with it, it’s an immoral act even for just me to do it. If I acquire a fortune and live only off the generated income of my fortune I’m doing quite well by the moral standards of my time. But… what if we were all trying to live off fixed-income investments in other people’s work? Like the Giant Pool of Money… perhaps too many of us have made it good. Somebody has to be generating real value.

This was in the back of my mind when a friend forwarded me a look at Common Good Bank, an effort to start a bank that would not have equity owners but be owned by its depositors. In grad school we talked about other banks like that, most famous is JAK bank of Sweden. Browsing around to see who is behind this effort I found the blog of the founder and eventually figured out he is William Spademen. He wrote a post with the provocative title “Unearned Income is the Root Cause of Poverty”. I thought that was a bit of a broad statement, but given the context already simmering in my brain, it caught my attention. Unearned income… we can’t all live off it and if we’re all trying to, where does it come from? Out of the pockets of others? Making them poor?

On his blog someone commented and said “I rent out a house, is that unearned income?” Spademan replied and hedges a bit but does say “In general, owning land is not a productive activity”. This is very accepted in our society that giving others access to our capital IS providing a value, for which they justifiably pay us interest. Yet how is it that we have that capital in the first place and they don’t? Often it’s what resources or business infrastructure you were born to (Bill Gates, Sr likes to point this out), or what great opportunities you stumble in to so that your hard work actually does pay off as opposed to the hard work of many others which doesn’t. We tell ourselves people who are renting instead of owning are choosing a different risk/reward distribution. But is it really their choice, or their lack of choice?

On an email list I received a link to an animated video called “Money as Debt”. (Warning – this link plays music: http://www.moneyasdebt.net/ ) It’s 45 minutes long and talks about the fractional reserve banking system and how money is created in the system when banks are approved and allowed to write loans at a 9:1 ratio against their equity, and a 1:9 ratio against their deposits since those deposits are assumed to be originated somewhere upstream as debt. It keeps the system in balance, except for the problem of interest. If we’re all circulating capital out of the same pool, the pool needs to keep continually expanding to account for the interest we’re all charging each other. That made sense to me, and what really caught my attention starts at about minute 23, that we can’t simultaneously pay off all our debt because Money IS debt – otherwise we’re back to bartering and time banking. But more intriguing for me was the assertion that this kind of closed system of principal circulating to pay off principal + interest has an inevitable math: (Interest)/(principle + interest) = foreclosure rate. That’s a bit of an oversimplification of all debt to mortgages, but I did a little research and turned up that mortgage debt is about 78% of all debt and consumer debt is less than 10%. Constant economic expansion, and support of that expansion through the creation of new debt is what keeps us ahead of the curve – this year’s circulating principal is more than last year’s.

This has been very tricky for, interestingly, men I know to understand. Women don’t seem to have as much trouble. There’s a difference between creating new value (inventing something, discovering something) and creating additional money (by opening a new bank or changing reserves through open market operations). Perhaps substituting the word “currency” for the word “money” will help keep it straight. I find myself thinking that problems must come when the pace of those two creations gets out of wack: value is created faster than currency or currency is created faster than value. Aha, the Fed validates me: “Inflation is caused by excess growth of money and credit relative to the supply of goods and services in the economy” (via another noisy link!) No wonder monetary policy and managing inflation is so complex – how can we really tell how much value is being generated year to year? Also several papers have demonstrated that the velocity of money – how quickly it changes hands, has changed considerably over the last few decades and also impacts how much total money can be said to be in circulation. And finally, how much control does the Fed really have over the amount of money in circulation when investment banks can invent entire new private debt vehicles (CDOs) and loan back and forth to each other?

With this thread, I don’t have any answers yet, still trying to formulate clear questions. It does seem that built into our monetary system is a need to balance the accumulation of interest, through some combination of expansion or bankruptcy. If we’re unknowingly in a game of musical chairs to avoid the short straw, it seems likely the less educated and well connected will more often end up with the short straw, but I can’t show that connection yet.

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