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Lending--the Answer or the Problem for Low-Income Americans?

Session 1: November 2, 4:00-5:30 pm, Belfer 503 (M-RCBG conference room)
Guest Speaker: Susan Weinstock, Director of the Office of Consumer Policy, US Department of the Treasury

Session 2: November 14, 4:00-5:30 pm: Discussion with Nick Bourke of Pew Charitable Trusts;  Belfer 503 (M-RCBG conference room)

For many years, policymakers and advocacy groups of all political stripes have agreed that increasing the access of low-income Americans (“LIAs”) to consumer credit is critical to economic development and social mobility and, therefore, should be a core goal of public policy. 

Historically, advocates for the goal of increased lending to LIAs expressed either egalitarian or libertarian reasons for their views.  Egalitarians generally focused on eliminating lending discrimination through legislation and regulation and the benefits of “financial inclusion”, while libertarians posited that private loan markets, by efficiently distributing credit to all comers, could solve the problem of access to credit best.

Since the 1990s, the latter view has gained more traction, partly as a result of a series of developments which significantly changed consumer credit markets in the US. 

  • A revolution occurred in data analytics--due largely to computerization of borrower data and the creation of large databases of consumer credit information--which greatly expanded the number of potential borrowers who could be considered for credit.  New mathematical consumer credit scoring and advanced data management techniques permitted the analysis of consumer credit and risk on a portfolio basis and the extension of credit to many more borrowers with a higher propensity to default.
  • Long-standing usury laws were sidestepped and consumer interest rates were largely deregulated as policymakers with a “pro-market” bias came to believe that the introduction of “risk-based pricing” of loans to higher risk customers was an effective way to increase access to credit and enhance economic growth.
  • An increase in the data available on individuals permitted collections efforts by lenders to be handled centrally, thereby permitting nationwide lending activities.
  • The bankruptcy laws were changed to significantly reduce the benefits of bankruptcy protection to consumers.
  • Pooled consumer credit structures became a major part of the fixed income capital markets, providing an active outlet for the “risk-priced” consumer loans being originated and increased liquidity for bank and non-bank lenders to subprime borrowers.

These changes led to a vast expansion of lending to LIA borrowers and the establishment of a large, highly profitable and politically influential industry of lenders focused on “subprime,” high cost lending to LIAs. While the high-cost LIA consumer credit industry was damaged by the subprime mortgage crisis in the late 2000s, it quickly rebounded in other areas and today there are hundreds of lenders—fewer banks but many so-called “marketplace” or P2P lenders--providing subprime auto, personal, small business, payday and other loan products to LIAs. 

Interestingly, the view that universal “access to lending” might not be helpful to LIAs as a general matter has not gained any real traction in the political or economic sphere.

I have been a senior executive at companies which engaged in subprime lending as part of their business and have seen at first hand the impact on LIA customers.   My personal view is that, in the majority of cases, the provision of high cost consumer credit damages LIAs financially and personally, and impedes their economic development and social mobility.  High-cost credit is almost always a bad solution to the problem facing an LIA consumer, frequently leading to an ever-worsening debt trap and eventual default with highly adverse personal consequences.   This is a function of the structure of subprime lending products, the perverse economic incentives imbedded in the subprime lending model and the lack of a coherent policy framework for regulating subprime lending to LIAs.  While this lending may sometimes increase economic activity in the short term, I believe that any benefit is offset by the consequences of high default rates.

In our study group we will explore some of the issues raised by lending to LIAs, including:

  1. What financial life is like for LIAs and what really happens when a borrower defaults
  2. Are subprime lending’s incentive structures the problem?
  3. Price and demand inelasticity in high-cost lending
  4. “Cohorting” and lending costs
  5. FinTech—capabilities and impact of innovative business models to replace subprime borrowing

I’m looking for lively discussion and challenging questions.  Guest speakers are likely.

Todd H. Baker is currently the Managing Principal at Broadmoor Consulting, LLC, which provides strategic consulting services to boards of directors, management and shareholders of domestic and international financial services and financial technology companies at all stages of development.  Mr. Baker is best known for driving strategic change in financial services organizations and his long history of leading high-profile financial services M&A and capital-raising transactions.  He is also a prolific writer and speaker on financial services and FinTech topics, with a special interest in alternatives to high-cost borrowing for low-income consumers and strengthening the business models of non-bank mobile and online lenders. Before founding Broadmoor, Mr. Baker was the Managing Director and Head of Americas Corporate Development for MUFG Americas Holdings, the Americas banking operations of Mitsubishi UFJ Financial Group (MUFG) and Executive Vice President of Corporate Strategy & Development for Union Bank NA, the U.S. commercial banking operation of MUFG, where at various times he led the company’s strategic planning, corporate development and performance management activities in the US and the Americas. Prior to joining Union Bank, Mr. Baker served as Executive Director of Corporate Development for TD Bank, N.A., where he was a member of the Managing Committee and had responsibility for leading Toronto-based TD Bank Financial Group’s acquisition activities in the U.S. market, and Executive Vice President of Corporate Strategy & Development at Washington Mutual, Inc. where, at various times, he served on the Executive Committee and had responsibility for acquisitions & divestitures, strategic planning, investor relations, venture investing and competitive intelligence.  Prior to his executive roles, Baker was a partner with the international law firms Gibson, Dunn & Crutcher LLP and Morrison & Foerster LLP, where he represented bank, non-bank financial services, technology, corporate and investment banking clients in corporate and board governance matters, mergers and acquisitions, public and private securities offerings, securitizations and compliance issues and was recognized as the leading financial services M&A and securities attorney on the West Coast. As a Senior Fellow at M-RCBG, Baker will explore alternatives to high-cost borrowing for low-income consumers with faculty sponsor Howell E. Jackson, James S. Reid, Jr. Professor of Law at Harvard Law School.  Email: todd_baker@hks.harvard.edu

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M-RCBG Senior Fellow Todd Baker