As Wall Street continues its slow-motion hari kari, tens of millions of people on the lower-end of the income spectrum are finding that their access to credit is becoming all but nonexistent. As banks set aside ever more cash to cover themselves against potential future losses, the credit spigot that flowed so promiscuously to riskier customers is now not flowing at all.
Even with the promising plan of the federal government to take the more toxic loans off of bank balance sheets and fold them into the so-called "bad bank," loans to the lower-end of the income spectrum are likely to be hard to come by and inordinately expensive. That is a problem that none of the current plans address and it is real one.
Just because people making under $30,000 a year tend to be at higher risk of defaulting doesn't mean that they should be denied access to vital credit. People at that income level represent as much as 40 percent of the country according to census data, and while granting someone with that income a $300,000 mortgage is absurd, so is granting them zero credit or credit at rates that would make a loan shark blush.
The experience of Grameen Bank, founded by Noble prize winner Muhammad Yunus in Bangladesh and now operates one branch in Queens, New York. A pioneer in microfinance, Grameen lends mostly to women, and in small amounts, but has a repayment rate that any commercial bank would envy. By maintaining close community ties and an on-going relationship between borrowers and lenders, the bank never forgets that one of the best risk controls is making sure that those who lend money have some direct relationship with those who borrow.
The experience of Grameen should be a reminder that credit is a vital source of economic activity and growth, especially for the less affluent. Demonizing credit creation because of prior lax standards risks an excessive caution against further debt, and that is exactly the wrong path. Debt is a powerful tool that can help generate robust activity is used and created wisely, just as it can be immensely destructive if allowed to spin out of control.
Technology can be used to create better risk controls, just as it was used to fashion quantitative models that would have made Pollyanna look like a sourpuss. Robert Shiller, the Yale economist has some novel ideas about how to use derivatives as a risk-management tool for the individual home-owner (for more on Shiller, see my piece on him here). Not all will agree with his ideas, but financial innovation can be a tool for greater prosperity - after all, once upon a time a mortgage was a new and untested innovation, and on the whole has been of more societal benefit than not, current morass notwithstanding.
Debt can be good, bad or indifferent. Denying it to a wide swath of society that can and does use it constructively is as distorted as the profligate dispersion of debt that we have just witnessed, and it will make it that much harder for millions of people who are determined to improve their lot in life. Finding the right balance between too much and too little is never easy, but replacing one extreme with another is no solution.