Want the 'Underserved' to Borrow More? Really? Here's How

Recent columns in these pages, notably Kevin Villani's, show that though we may prefer to blame Ben Bernanke or even the Chinese, the housing bubble was inflated largely by government policies pushing lenders to render homeownership "affordable" for people with weaker or unreliable income or credit. 

These policies gave us affordable-housing goals, Community Reinvestment Act requirements, and incompetent misdirection of Fannie Mae and Freddie Mac by their then-regulator.

Despite this not-yet-forgettable history, there's continuing vigorous public advocacy for getting people with scanty or uncertain income or credit to borrow more—this time, unsecured.  "This is like déjà vu all over again," in Yogi Berra's phrase. 

Ah, for the good old days, when the late lamented Acorn picketed the homes of finance company managers, supposedly to persuade them to approve more loans at lower rates, but actually with a much more rational goal: extortion. Now we have the Federal Deposit Insurance Corp. asserting, preposterously, that its low-rate bank loan program targeting the "underserved" was a success, though it was a foreordained and total flop. 

Pushing the price of these loans down would make their volume go up—elementary economics. Is that a goal?

If this campaign has some purpose beyond broadcasting political correctness and attracting nonprofit funding, that purpose must be to increase borrowing by the financially underprivileged.  Should we examine the evidence, if any, that these consumers would actually benefit rather than suffer if they borrowed more?  After all, it didn't turn out that way for the home loans.  We force-fed the geese, and they laid rotten eggs.

But, no time to worry about that, right?  Here we have a beast that any midget can mount. Example: The National Credit Union Administration's recent initiative to encourage credit unions with many low-income members to lend larger sums to businesses. Before I could stop laughing, the American Bankers Association made me laugh even harder with its outraged and irrelevant reaction. 

If bad-credit consumers should be borrowing and leveraging more, then, shelving the shabby shibboleth of "consumer education," there are two routes to this goal. I'll arbitrarily label one of them "the Democrat approach." Subsidize the lending and confer valuable benefits (via CRA, Camels ratings, or whatever) on those who lend. As with mortgages. Terrible idea. 

The alternative, Republican, approach would be to remove obstacles that prevent the market from competing to serve these customers—while strengthening protection for borrowers, primarily through the CFPB.  

What are the obstacles preventing lenders from competing to lend to the nonaffluent?

One is the perceived reputational risk, higher capital requirements, lower valuation of earnings, and more intense regulatory scrutiny now associated with "subprime." That's one reason top credit card issuers that dominate the consumer market have stopped advertising subprime cards. 

There's a reason to focus here on cards. Ignoring the incessant howls for "innovation," let's use proven products. Most innovations fail.

Cards are the preferred, most flexible and economical unsecured lending medium. So, widespread opposition to letting consumers overdraw on prepaid cards (as they are allowed to overdraw, at much greater cost, on checking accounts) is stupid, counterproductive. 

The subprime unsecured card was highly developed and widely available before the crisis, and performed well throughout. In other countries, such as Russia, moderate-income consumers use such cards to borrow money at ATMs and repay in weeks to stop incurring interest. Overwhelmingly, they do pay on time.  Expensive face-to-face service is entirely avoided.       

There is a more insidious reason why U.S. lenders, almost all banks, will send 3 billion credit card solicitations in 2012, but few if any to nonprime households, the majority of consumers: The oligopolistic price-setting for interchange rates (commonly confused with "merchant discount") imposed by MasterCard and Visa on behalf of banks (referred to by MasterCard as "customers"!) makes prime card transactor accounts so profitable, especially given today's super-low losses and funds costs, that big issuers see no need to serve the nonaffluent. They'd rather spend $150 to get a new prime account. 

The pending litigation settlement aims to make this absurd, "only in America" distortion of interchange rates permanent. Congress should intervene, restore fair competition, and help nonprime cards come alive again.

Add resources. Nonbanks, particularly consumer finance companies, were a primary loan source for the less affluent for decades. Even now, according to last week's FDIC report, many consumers find nonbank credit "easier or faster to obtain than bank credit"—which isn't saying much. If you want these people to borrow more, give nonbank lenders equal market access by according them regulatory parity with banks.

Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of First Deposit, later known as Providian.