Alternative Lenders

I found an interesting article in the Wall Street Journal on Alternative Lenders to small businesses.  Some highlights with comments.

With Credit for Businesses Tight, Nonbank Lenders Offer Financing at a Price

When Khien Nguyen needed $180,000 to open his 13th nail salon near Philadelphia in November, he didn’t go to a bank. Mr. Nguyen’s credit score had dropped during the recession, so he figured a bank would put him through weeks of aggravation, then reject him.

He turned instead to one of the nonbank, short-term lenders that have been gaining traction since the financial crisis. The lenders cater to small businesses, often at high cost.


Delaware-based Swift Capital reviewed his financial records and social-media sites such as Yelp and Facebook for reviews, then dispatched someone to one of his salons to pose as a customer. Swift wired him the money a few days later….

About two dozen such nonbank lenders—including OnDeck Capital Inc., Kabbage Inc. and CAN Capital Inc.—lent about $3 billion collectively last year, double the 2012 total…

Banks generally require solid credit scores and spend weeks reviewing financial statements, tax returns and business plans.

This is one interesting theme of the article – use of social media and other internet data mining to develop information about credit worthiness and move quickly.

Biz2Credit, an online loan broker for small businesses, says an analysis of loan applications made in December through its website showed big banks approved 18% of loan applications by its customers in December, while small banks approved 49%.

Various nontraditional lenders have stepped into the void…

Alternative lending to small businesses expanded during the financial crisis as bank credit dried up….

In 2008, when the financial crisis hit, sales at Robin’s Nest Floral and Garden Center in Easton, Md., dropped by 15%, according to owner Ken Morgan. The 30-year-old company needed $50,000 for a shipment of Christmas decorations. “I went to the bank, where I’d always done business on a handshake, and they were scared and having their belts tightened,” he says. He was turned down. …

It is so heartwarming as an economist to see, even if slowly, all the adjustments we expect. Banks not lending (or forced not to lend)? Someone will start a new business model to fill in the void. 

But there is nothing that stops a bank from using new sources of information, streamlining loan approvals and so forth. So if regular banks are not doing it, and if new businesses that want to serve this market  are organizing as something other than new “banks,” it raises the interesting question, what’s wrong with regulation or competition in banking?

Mr. Nguyen is paying 14.9% interest over the loan’s six-month term—the equivalent of about 30% annually …

Interest rates on such loans can run in excess of 50%, on an annualized basis, much higher than on conventional bank loans. Usury laws limiting interest rates generally don’t apply to the short-term lenders. Some of the loans are originated in states that don’t cap interest rates on commercial loans. Others are structured as private contracts between two businesses. …

Ah, usury, predatory lending consumer protection and all that. That gives us a hint here of the regulatory roadblocks. Now we know why the loans are short term. Wouldn’t it be nice if Mr. Nguyen could get a long term loan?

For small and very short loans, quoting the price as an annualized interest rate doesn’t really make much sense. The fixed cost of the transaction and the fixed, non-time dependent, probability of repayment seems much more important.

Speaking at a recent Small Business Administration conference, Treasury Secretary Jack Lew said the government wants to “do more to knock down barriers to financing,” …

Hmm. I’m curious which barriers he has in mind, and how many are erected by the self-same government. Isn’t the same government behind tightening bank lending standards, limits on bank entry causing these new businesses to have to spring up, interest rate caps, “consumer protection” and more?

Peer-to-peer online-lending platforms channel funds from ordinary investors to borrowers. Private investment partnerships, including hedge funds, make direct loans to struggling businesses, often with costly strings attached. …

Unlike banks, the short-term lenders don’t take deposits, so they need other sources of capital to fund the loans. OnDeck has an $80 million credit facility from a syndicate that includes Goldman Sachs Group Inc.“They have a successful business model that we like,” says a Goldman spokesman.

This fall, OnDeck secured another $130 million from, among others, KeyCorp.  Adam Warner, president of Key Equipment Finance, says loans to OnDeck and to CAN Capital are “a way to diversify our small-business lending.”

I found this especially interesting. It’s often said that banks just must “transform” deposits to loans, that there is something eternal and magical about deposit funding for risky business lending. Not true apparently, and that gives me heart for my view that real banks could support lending just fine if they had to raise money as equity or long term, non-runnable debt. I wish the article had more about the capital structure of these “banks.”

Richmond Fed Interview

The Richmond Fed published a long interview with me in their Econ Focus, shorter pdf (print) version here and longer web version here. Some of the questions:

• Does the 2010 Dodd-Frank regulatory reform act meaningfully address runs on shadow banking?
• So what do you think is the most promising way to meaningfully end “too big to fail”?
• Do you think there’s any reason to believe recessions following financial crises should necessarily be longer and more severe, as Carmen Reinhart and Kenneth Rogoff have famously suggested?
• Many people have asked whether the finance industry has gotten too big. How should we think about that?
• What are your thoughts on quantitative easing (QE) — the Fed’s massive purchases of Treasuries and other assets to push down long-term interest rates — both on its effectiveness and on the fear that it’s going to lead to hyperinflation?
• Both fiscal and monetary policies have been on extreme courses recently. What are your thoughts on how they might affect each other as they move back to normal levels?
• Switching gears to finance specifically, what do you think are some of the big unanswered questions for research?
• You wrote an op-ed on an “alternative maximum tax.” What’s the idea there?
• Can transfers really help the bottom half of the income distribution?
• Which economists have influenced you the most?

You’ll have to click to the interview for answers!

Thanks to Aaron Steelman, Lisa Kenney and especially  Renee Haltom, who helped a lot with the editing. I’m a lot less coherent in person!

What to do when Obamacare unravels

Wall Street Journal Oped December 26 2013.

The unraveling of the Affordable Care Act presents a historic opportunity for change. Its proponents call it “settled law,” but as Prohibition taught us, not even a constitutional amendment is settled law—if it is dysfunctional enough, and if Americans can see a clear alternative.

Source: David Gothard, Wall Street Journal

This fall’s website fiasco and policy cancellations are only the beginning. Next spring the individual mandate is likely to unravel when we see how sick the people are who signed up on exchanges, and if our government really is going to penalize voters for not buying health insurance. The employer mandate and “accountable care organizations” will take their turns in the news. There will be scandals. There will be fraud. This will go on for years.

Yet opponents should not sit back and revel in dysfunction. The Affordable Care Act was enacted in response to genuine problems. Without a clear alternative, we will simply patch more, subsidize more, and ignore frauds and scandals, as we do in Medicare and other programs.

There is an alternative. A much freer market in health care and health insurance can work, can deliver high quality, technically innovative care at much lower cost, and solve the pathologies of the pre-existing system.

The U.S. health-care market is dysfunctional. Obscure prices and $500 Band-Aids are legendary. The reason is simple: Health care and health insurance are strongly protected from competition. There are explicit barriers to entry, for example the laws in many states that require a “certificate of need” before one can build a new hospital. Regulatory compliance costs, approvals, nonprofit status, restrictions on foreign doctors and nurses, limits on medical residencies, and many more barriers keep prices up and competitors out. Hospitals whose main clients are uncompetitive insurers and the government cannot innovate and provide efficient cash service.

We need to permit the Southwest Airlines, Wal-Mart, Amazon.com and Apples of the world to bring to health care the same dramatic improvements in price, quality, variety, technology and efficiency that they brought to air travel, retail and electronics. We’ll know we are there when prices are on hospital websites, cash customers get discounts, and new hospitals and insurers swamp your inbox with attractive offers and great service.

The Affordable Care Act bets instead that more regulation, price controls, effectiveness panels, and “accountable care” organizations will force efficiency, innovation, quality and service from the top down. Has this ever worked? Did we get smartphones by government pressure on the 1960s AT&T phone monopoly? Did effectiveness panels force United Airlines and American Airlines to cut costs, and push TWA and Pan Am out of business? Did the post office invent FedEx, UPS and email? How about public schools or the last 20 or more health-care “cost control” ideas?

Only deregulation can unleash competition. And only disruptive competition, where new businesses drive out old ones, will bring efficiency, lower costs and innovation.

Health insurance should be individual, portable across jobs, states and providers; lifelong and guaranteed-renewable, meaning you have the right to continue with no unexpected increase in premiums if you get sick. Insurance should protect wealth against large, unforeseen, necessary expenses, rather than be a wildly inefficient payment plan for routine expenses.

People want to buy this insurance, and companies want to sell it. It would be far cheaper, and would solve the pre-existing conditions problem. We do not have such health insurance only because it was regulated out of existence. Businesses cannot establish or contribute to portable individual policies, or employees would have to pay taxes. So businesses only offer group plans. Knowing they will abandon individual insurance when they get a job, and without cross-state portability, there is little reason for young people to invest in lifelong, portable health insurance. Mandated coverage, pressure against full risk rating, and a dysfunctional cash market did the rest.

Rather than a mandate for employer-based groups, we should transition to fully individual-based health insurance. Allow national individual insurance offered and sold to anyone, anywhere, without the tangled mess of state mandates and regulations. Allow employers to contribute to individual insurance at least on an even basis with group plans. Current group plans can convert to individual plans, at once or as people leave. Since all members in a group convert, there is no adverse selection of sicker people.

ObamaCare defenders say we must suffer the dysfunction and patch the law, because there is no alternative. They are wrong. On Nov. 2, for example, New York Times NYT columnist Nicholas Kristof wrote movingly about his friend who lost employer-based insurance and died of colon cancer. Mr. Kristof concluded, “This is why we need Obamacare.” No, this is why we need individual, portable, guaranteed-renewable, inexpensive, catastrophic-coverage insurance.

On Nov. 15, MIT’s Jonathan Gruber, an ObamaCare architect, argued on Realclearpolitics that “we currently have a highly discriminatory system where if you’re sick, if you’ve been sick or you’re going to get sick, you cannot get health insurance.” We do. He concluded that the Affordable Care Act is “the only way to end that discriminatory system.” It is not.

On Dec. 3, President Obama himself said that “the only alternative that Obamacare’s critics have, is, well, let’s just go back to the status quo.” Not so.

What about the homeless guy who has a heart attack? Yes, there must be private and government-provided charity care for the very poor. What if people don’t get enough checkups? Send them vouchers. To solve these problems we do not need a federal takeover of health care and insurance for you, me, and every American.

No other country has a free health market, you may object. The rest of the world is closer to single payer, and spends less.

Sure. We can have a single government-run airline too. We can ban FedEx and UPS, and have a single-payer post office. We can have government-run telephones and TV. Thirty years ago every other country had all of these, and worthies said that markets couldn’t work for travel, package delivery, the “natural monopoly” of telephones and TV. Until we tried it. That the rest of the world spends less just shows how dysfunctional our current system is, not how a free market would work.

While economically straightforward, liberalization is always politically hard. Innovation and cost reduction require new businesses to displace familiar, well-connected incumbents. Protected businesses spawn “good jobs” for protected workers, dues for their unions, easy lives for their managers, political support for their regulators and politicians, and cushy jobs for health-policy wonks. Protection from competition allows private insurance to cross-subsidize Medicare, Medicaid, and emergency rooms.

But it can happen. The first step is, the American public must understand that there is an alternative. Stand up and demand it.

Comments

Thanks as usual to my superb editor at the WSJ, Howard Dickman.

This is the Oped version of my essay, After the ACA; go there for more details. In case I have to hit you over the head with the point, we need to focus on the supply of health care as well as health insurance. For guaranteed renewable insurance and solving preexisting conditions read “Health Status Insurance” etc. here.

The comments on Hope for Healthcare and some followup correspondence paint an intriguing picture. Take a look at goodrx.com, www.oration.com and also at the health technology review in last Saturday’s WSJ, “5 high tech fixes.” The internet undermined un-competitive behavior and non-transparent prices in cars, electronics, life insurance, and many other fields. Maybe, just maybe, it can undermine the hospital-insurer-government complex too. I ran out of space to write about that, but there is hope.

I was thinking a little bit about the exchanges and the latest latest deadline chaos, and the following occurred to me: They are restructuring an entire market, basically substituting website exchanges for insurance brokers and company marketing. They are redefining an entire product space–individual health insurance. And then announcing that an entire country has to sign up in about a month.

Think how any other new product or marketplace is introduced, especially a complex one like health insurance. There is a whole spread of word of mouth, magazine and internet reviews, company marketing efforts, friends and relatives pass on what they learned, which plans are good, which are bad, which networks have good doctors in your area, and so on.  They ignored this entire new-product process. And then wonder that it’s not working so great.

Well I guess it’s appropriate for the season. Augustus Obama decreed that each must be registered with healthcare.gov. So Joseph and Mary, lacking a computer, went to a public library to register. But she was with child, and the website crashed while Joseph was entering their income history, so there among the books a child was born…

Hope for healthcare?

“Can this Man Save Health care?” is another nice article about Dr. Keith Smith, founder of the Surgery Center of Oklahoma (SCO) in Oklahoma City. (Previous blog post here.)  He is trying the audacious, running a low-price hospital with prices posted on the web – the Southwest Airlines of hospitals that I’ve been hoping for.

Smith knew that putting his prices online had been a great idea when Canadians began flying down to the SCO for treatment…

In addition to targeting the uninsured and Canadians, Smith has also had success in appealing to people with high deductibles…

Smith’s transparent pricing has already had a significant impact on the healthcare market in Oklahoma City. Smith says, “What we’ve done by putting these prices online is created a price war, and it’s really going on in Oklahoma City.” With the SCO as an option for residents, the big nonprofit hospitals in the city are having difficulty continuing to charge their inflated rates. “The big hospitals,” Smith says, “have been thrust into a market economy whether they like it or not.” Consumers finally have the option to shop around for the best medical care. 

The effects have been felt throughout the region. The Oklahoma Heart Hospital and the nearby McBride Orthopedic Hospital have both followed the SCO’s lead in publishing their prices in an effort to attract consumers. Worried that they were losing heart patients to the Oklahoma Heart Hospital, Galichia Heart Hospital in nearby Wichita has also published its rates, creating the first semblance of the price war Smith has been trying to start.

He believes that his model can cut into the profits of big healthcare: “The big hospital’s nightmare has arrived.”  

This is an interesting observation. The established hospitals, working with the established insurers were not competing with each other. It took an upstart with a new business model to provoke competition. It is ever thus, but this is not the model our regulators use when they think of competition.

Another interesting observation. The existing insurers were not at all anxious to save money through him. He had to go around them to cash customers, Canadians, and directly to companies.

Smith has also had success in appealing to people with high deductibles and to mid-sized companies in Oklahoma and North Texas.

He has directly courted companies that feel that they are overpaying for their HMOs…

Smith admits that his strategy hasn’t won him any friends in the healthcare establishment or, as he refers to it, the healthcare cartel: “I don’t get invited to any big hospital garden parties.” In fact, he claims that “giant hospital chains and insurance companies were lined up arm-in-arm” to prevent the SCO from succeeding. Following its opening, business suffered for several years because it was locked out of insurance plans that would rather pay the higher in-network amounts at the bigger hospitals across town. The SCO only became profitable when it went over insurers’ heads and pursued corporate clients directly. “The big hospitals and insurance companies hurt us for a while,” Smith says, “but we stayed with it; now they’re sucking wind. 

Sometimes people say I am foaming at the mouth too much when I refer to our current system as crony-capitalist, captured-regulator and so on, and getting worse. Perhaps I’m not exaggerating after all.

There is a ray of hope. The large deductibles  on many exchange policies leave people some incentive to shop. Not as much as you’d think – there still is the in network and out of network business, and once you hit the deductible the sky is the limit. But some. Can a mass of patients who care about money stimulate a competitive supply market?

The big question on my mind, is, will our government allow this ray of hope to emerge?  As Smith found out, there are powerful forces in the local hospitals and large insurers that want to stop him. Now they have a powerful friend in the ACA.

Will the employer mandate allow companies to go around big insurers in this way? Or will they be forced to participate in cross-subsidies through the established insurers? Will these side deals be deemed “ACA-Compliant” employer-provided insurance? Will ACA-approved high-deductible plans be allowed to use him? Will he be allowed to give cash customers a discount? He so undermines the whole structure I can’t see how they can let it happen.

Smith hopes, however, that he and a handful of other transparent fee-for-service providers will be the vanguard of a free-market movement that runs parallel to the ACA.

That would be wonderful. A free-market system could emerge alongside the ACA, and then people like me will not have to prove that there is indeed a promised land on the other side of the waters, the promised land will appear on its own.

If the ACA will allow it. Competition undermines cross-subsidies, and competition undercuts powerful lobbies to a very powerful regulator.

Calomiris and Haber on the politics of bank regulation

Foreign Affairs has a very nice article “Why Banking Systems Succeed – And Fail: The Politics Behind Financial Institutions” by Charles Calomiris and Stephen Haber.

This is a healthy tonic for all us economists who seem to specialize in clever complex advice for the benevolent monarch sort of policy. It’s a good reminder of just how counterproductive our bank regulation is for economic ends, and how it serves well political ends.

They cover English vs. Scottish banking, US vs. Canada, and the roots of the dysfunctional US system that crashed in 2008. They are light on the current situation, but it isn’t hard to see the same groups feeding at the public trough before receiving tribute now.

Public choice often seems depressing, as if ideas don’t matter at all. But they do, and the last few paragraphs are thoughtful.

Within a democracy, effective reforms in banking require more than good ideas or brief windows of opportunity. What is crucial is persistent popular support for good ideas.

It does no good to assume that all the alternative feasible political bargains have already been considered and rejected.As George Bernard Shaw wrote, “The reasonable man adapts himself to the world: the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.” Meaningful banking reform in a democracy depends on informed and stubborn unreasonableness.

“Informed and stubborn unreasonableness.” I like that a lot better than “tilting at windmills!”

After the ACA -- Crafting an Alternative to Obamacare

I gave a talk at Hoover, encouraging those of us who are less than fans to speak up and outline the alternative to Obamacare. Podcast here.

Repeal and status quo is not enough. We need to listen, and point out how a radically freed and competitive system will address the genuine concerns that motivate many to support the law despite its flaws – preexisting conditions, health care for the poor, outrageous cost and so forth.

The essay “After the ACA” lays it out in some detail.  The talk is a lighter discussion of where we are, but emphasizes how sitting back and letting the ACA unravel will just lead to an even more expensive and incorherent system. Stand up and state the alternative.