How to Avert A Great Depression Through the Hungry 2010s? 

Answer, By Making All Banking Very Much Cheaper, By Norman Macrae

If banks in rich democracies had been truly competitive institutions, at least one of them somewhere would have seized the main opportunity created by the computer. This main opportunity was to make all deposit-banking vastly cheaper than ever before. By this cheapening it should make such banking hugely more profitable. Then further competition would search for the cheapest ways to guide all the world’s saving into the most profitable (or otherwise most desirable) forms of capital investment, thus enriching all mankind.

Instead, during 2008 the total losses of banks in rich democracies – in North America, West Europe and Japan – soared into trillions of dollars. Fearful for their solvency, these banks virtually stopped lending. The issuance of corporate bonds, commercial paper, and many other financial products largely ceased. Hedge and insurance firms also crashed. Mankind is thus threatened in the 2010s with its longest great depression since the hungry 1930s.

Why? The strange answer seems to be that other happy consequences of modern technology promised to make this cheapening even faster. Call centres in Bangalore vastly undercut the middle class salaries of Midland bank clerk who until the 1950s expensively answered clients’ questions in their branches in the City of London. Cheap mobile phones kept village ladies in once miserable Bangladesh as fully in touch with market prices as is the chief research officer of the First National Bank of Somewhere in California. His weekly salary is still 1000 times greater than the previous annual earnings of that village lady. The cost-effective way of running the old Midland or First National then seemed to be to cut its total salary cost by something like 99%. This did not please Western welfare governments, or the decent chief executives of the old Midland or First National bank.

Western welfare governments have long preferred to run their banks in high cost cartels, and even invented reasons why this seems to be moral.  Their deposit-banks have usually kept in cash only 10% of the total amount deposited with them. If 11% of depositors suddenly feared that their banks might go bust, this could accelerate a run that would send them bust indeed. Governments therefore thought that depositors would be less fearful if they were assured that the banks were officially and tightly regulated. Actually, this mainly meant that the banks had to hire ever more expensive lawyers so as to escape any crippling consequences from this regulation. The attached quote shows that Samuel Pepys understood this fact of life in his Diaries of July 21, 1662.

The decent bosses of the deposit banks felt that the best way of avoiding sacking nine tenths of their staffs was by competing with a very different sort of financing called merchant banking whose earnings and bonuses were far more generous than those given to their own staff. These merchant banks were of peculiarly differing pedigree. In London, it was assumed that they could best be run by families like Barings who had done the job for over 200 years. In the 1990s, Barings went totally bust because one of its hired traders bet much of its money on a hunch that a bad earthquake in Japan meant that the shares of Japanese banks and insurance companies would become more profitable. In Zurich, merchant banks felt it most moral to keep the accounts of their depositors totally secret, especially if these accounts were being used to defraud their own countries’ tax authorities. In 2008 those secretive banks were then defrauded. In Wall Street, Goldman Sachs and Lehman Bros bid up their annual bonuses to millions of dollars for each partner. In 2008 even Goldman Sachs made a loss and Lehman Bros went bust.

A former chairman of the Federal Reserve argues that “fearful investors clearly require a far larger capital cushion to lend unsecured to any financial intermediary now”. He therefore thinks that taxpayers money should be ladled into them to make those investors less fearful. This seems far more likely to make depositors intermittently more terrified and cause any depression into the 2010s to linger on and on.

One of the few big banks to make a profit in 2008 was the Grameen Bank (which means Village Bank) in that once basket-case country called Bangladesh. The sole staff in a branch serving several villages was once a woman student. It is now more usually someone who has learnt to use the computer in the right way.

The rest of this report will examine how this marvellously cost-cutting operation works. Perhaps the most relevant and terrifying analogy is to commercial airlines. In 1945, there were only a tiny number of passenger airmiles flown on them. In each successive year these increased hugely and in this slumptime 2009 there will be billions of passenger airmiles flown. In the late 1940s most governments therefore created national airlines and were confident they would flourish in this boom industry, with official regulation assuring they would be safe. Instead all proceeded to lose money, and later privatised but large airlines also did. The present trend is to cost cutting airlines like Ryan Air.

The same will happen to banks. Large banks mislending to the rich have run into losses that have created the slump. Politicians, thinking they are saving the world, are mislending huge sums to these mislenders and will eventually make the slump worst.

How to create cost-cutting banks? Begin the story with the crosshead below, peculiar as it may seem.

START IN A STARVING VILLAGE

The Nobel peace prize for 2006 was controversially awarded, in Oslo, to a “banker for the poor” in usually unfashionable Bangladesh. Since the microcredit system pioneered by this Dr Muhammad Yunus really has lifted record millions of Bangladeshi women from the world’s direst poverty, some of the world’s toughest tycoons have thrilled to his stated aim to “harness the powers of the free market to solve the problems of poverty”.

To his fans’ delight and astonishment, he is achieving exactly that. In the past quarter of a century, his Grameen Bank has lent (without collateral or lawyers) increasing billions of dollars to millions of poor women in the previously starving villages of Bangladesh, and got an extraordinary 99% repayment back. His often illiterate customers have started millions of successful small businesses in unimagined fields like mobile telephone ladies and saleswomen of the world’s cheapest yogurt. All these successes have been won by keeping costs incredibly low. A banking operation that would cost Goldman Sachs $100 in New York or London would cost Grameen in Bangladesh well under 100 cents.

This is a huge development in human history. Money can now be directly channelled into productive use by the world’s poorest people, while unsuccessful lending to the rich has caused a world slump. How do we switch custom to cost-cutting banks?

During Bangladeshi’s terrible famine year of 1974, Dr Yunus ( who had won his doctorate in economics in a free market American university, which most founders of banks have not done)  came back to his 1940 birthplace of Chittagong, as professor of economics at the university there. He started lecturing on his republic’s 5 year plan, which like most 5 year plans was economic nonsense. In search of reality he took a field party of his students to one of the nearby famine threatened villages. His group analysed that all 42 of the village’s small businesses (such as tiny farm plots and market stalls) were  indeed going bust unless they could borrow a tiny total $27 on reasonable terms.

The first thought was to give the $27 as charity. But Yunus lectured that a social business dollar, which had to be paid back after careful use in an income generating activity was much more effective than a charity dollar, which might be used only once and frittered away.  The careful use of loans in very small quantities, says Yunus “means that you bring in a business model, you become concerned about the costs, the revenue, how to bring more efficiency, new technology, how to redesign, every year you review the whole thing. Charity doesn’t bring that whole package”.

Mercifully, all those first 42 tiny loans were fully repaid, and lent back. After 9 years of further experiments, Yunus in 1983 founded his Grameen Bank. Its priority was to make loans that were desperately needed by those of the poor that did repay them. Indeed, he argues that “access to credit is a human right so long as that credit is repaid”. This is the reverse of the usual banking priority, which is first (and in credit crunches only) to make the safest loans those to the rich that can provide collateral.

In these last 25 years, Grameen has provided increasing $billions of loans to poor people with that astonishing 99% repayment rate. In 2006, it had 7 million borrowing customers, 97% of them women, in 140,000 villages of Bangladesh. Microcredit had by then reached 80% of Bangladesh’s poorest rural families. Over half of  Grameen’s own borrowers had successful small businesses. The women borrowers predominated because they usually are the poorest people in rural Islam and proved best in paying back.

When a Grameen bank manager goes to a new village, he has entrepreneurially to seek for poor but viable borrowers. He earns a star if he achieves 100% repayment of loans, and other stars if his customers are fulfilling most of the 16 guarantees that all customers are asked to pledge, ranging from intensive vegetable growing, through sending all their children to school, to renouncing dowries. A branch with no stars would be in danger of closing, so borrowers rally round with suggestions, such as which unreliable repayers to exclude. Borrowers from the bank who do repay are called owners of the bank and receive incentives such as opportunities for insurance, and for winning university scholarships for their children.

An early income generator was the profession of telephone ladies. They borrowed enough to buy a cheap mobile phone from a Grameen subsidiary. They draw fees for phoning to see if more profitable prices for crops are available in a neighbouring village, and from anybody who wants to hire the phone to contact the outside world. This is a job that could only become important in a microcredit setting. The owner of a mobile phone in richer suburbia would not find many customers to hire her set.

One special desire of Yunus  was to improve the nutrition of poor children in Bangladesh , and he formed a social business with the largest French food multinational. This Grameen-Danone test marketed to find what sorts of fortified yogurt Bangladeshi children would like.  Although Danone at first wanted large plants with refrigerated systems, Grameen won the debate to make them small plants which bought local milk. It hired very cheap local distributors who knew which families had children who might buy the yogurt at a few cents a cup. To keep the price that low, Danone had to agree not to pay any dividend from the sales of the yogurt in Bangladesh. but its $1 million investment remains returnable and it has learnt a lot about sales of a new product in poor countries.

A French water company is forming a similar social business with Grameen to remove arsenic from Bangladesh’s rural water supply. Some American computer tycoons (including Bill Gates) may help to find the best way to establish computer centres in remote villages. The telephone ladies will then face competition, but constant competition in new technology is one name of this game.

Nobody is suggesting that Goldman Sachs, when it recovers, should operate precisely in Yunus’ mode. But some competition in sharply cutting costs in most banks will have to be part of the world’s new banking system.

Microcredit will play a part in solving some problems that statesmen won’t yet believe. http://bankabillion.org

Bangladesh’s Social Business system design, thankfully made famous worldwide by Dr Yunus, is the closest I have seen since our 1976 survey of Entrepreneurial Revolution (The Economist , 25 December) launched the search for sustainability’s missing system. That one needed for hi-trust microeconomics mapmakers to free global markets to value sustainability’s exponentials rising.

-------------------------------------------------------

Some References From Microeconomics History

Will NetFutures Empower Yes We Can Economics http://www.normanmacrae.com/netfuture.html