BACK TO THE FUTURE
A Look to the Past Provides a View Into the Future
These are tumultuous days for consumer credit, the bloodline that has pumped life into two-thirds of the US economy for the more than 30 years of MicroBilt's existence. There's no escaping it, the American economy is in sad shape right now. Some economists are predicting a prolonged recession. Others say a depression is imminent while still others claim that the worst will be over by the spring of 2009. One way or another, something's got to change for the economy to heal.
To {see} the solutions we must first understand the roots of the problem. Since the first half of the 20th Century, the United States has carefully developed a system of compiling consumer credit histories that were amazingly predictive of a consumer's future credit activity. This consumer credit data system is the envy of third world and emerging economies and has been replicated through the developed economies of the world. So how did we get into such dire straits?
Things weren't always this way. It was not until after the end of World War II that banks and other lenders began to extend credit to the growing US middle class. When Johnny came marching home in victory from Europe and Asia, he brought with him sad memories of lives cut short by war and a determination to live life to the fullest. That meant a wave of consumer spending and credit, one primed by the GI Bill that provided college tuition and new home mortgages. The nation's credit reporting industry swelled to 2,250 credit bureaus, maintaining and providing credit histories on local citizens. Almost all credit granted in the 50s and 60s was local, thus enabling the local credit bureaus to provide valuable and predictable credit histories for future credit experiences.
Consumer credit in the United States continued to grow rapidly through the second half of the 20th Century aided greatly by availability of consumer credit data and technology. While individual and family credit indebtedness increased well past anything their Depression Era parents and grandparents would approve, delinquency rates were tolerable and commerce boomed.
So what has gone wrong? Why has consumer credit dried up so dramatically? A simple answer is that those managing credit moved so far away from the fundamentals of extending credit and are now unwilling or unable to take even good credit risks. Risk-based lending supported by an insatiable worldwide secondary market for loans and their derivatives resulted in many consumers spending beyond their means. When the music stopped and consumer defaults started to escalate, the house of cards came tumbling down.
So does the credit crisis mean that we'll start again - local merchants and local banks providing the credit to the local consumer to allow commerce to flow again? Certainly that will be part of it, but no one really believes that the answer is to turn back the clock completely. The fact is that when lenders and investors make good credit decisions based on a sound purpose to consumers with good payment history, everyone will be a winner.
As we begin to mend the wounds from the excess of the past, where are the new frontiers and what are some of the new innovations that will restore consumer credit and fuel our growth. Here are a few we can {see}:
Alternative Data
It is estimated that between 50-70 million Americans have insufficient credit information to qualify for mainstream credit. There is significant research to suggest that the inclusion of "Alternative Data" in an individual's credit history would bring many of these individuals in to the mainstream of traditional credit. Alternative Data is positive payment information, like rents or utility payments, which can give enough information in order to rate previously unscorable individuals. These newly-scored individuals have risk profiles similar to those already in the mainstream credit system.
Furthermore, loans become smarter. Including alternative data has little effect on the credit mainstream (those already scorable in the current system). Furthermore, this increase in data actually decreases the number of bad loans.
Credit data gets personal
Peer-to-peer (social lending) is a new breed of credit transaction that occurs directly between individuals ("peers") without the intermediation/participation of a traditional financial institution. An enabling technology for person-to-person lending has been the Internet, where person-to-person lending appears in two primary variations: an "online marketplace" model and a "family and friend" model.
The online marketplace model enables individual lenders to locate individual borrowers and vice-versa. This model connects borrowers with lenders through an auction-like process in which the lender willing to provide the lowest interest rate "wins" the borrower's loan. The marketplace process may include other intermediaries who package and resell the loans, but the loans are ultimately sold to individuals or pools of individuals.
Traditionally, lending institutions have benefited from scale and diversification. By pooling the available money supply and lending it out again, the impact of any one default is made trivial in light of the timely payment of the vast majority of the notes outstanding. The downside to the traditional model is that it has introduced greater transaction overhead and removed community loyalty from the equation.
Peer-to-Peer Lending attempts to reintroduce the social components that are lost in traditional centralized banking models, while maintaining a mixed quantitative/qualitative balance of diversification - as opposed to the purely quantitative diversification available through institutional lending. They also attempt to take advantage of the lack of overhead implicit in being primarily online ventures, thereby reducing the infrastructure costs (such as physical branches) inherent in traditional bank lending models.
Peer-to-Peer Lending attempts to correct this inefficiency and create a "virtuous cycle" which would allow those who have funds to lend to garner a better return, while, at the same time, providing a more favorable interest rate to those who need to borrow, by removing the bank from the equation.
In 2005, there were $118 million of outstanding peer-to-peer loans. In 2006, there were $269 million, and, in 2007, a total of $647 million. The projected amount for 2010 is $5.8 billion.
View Our Other Articles From This Issue of {see} Magazine