David R. Henderson  

The Uberization of Banking

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But isn't SoFi cherry-picking loans? Absolutely. Why can't banks do this? Because if you use depositor money for loans, as all banks do, you fall under the jurisdiction of the Federal Deposit Insurance Corp. and the Community Reinvestment Act, which bans discriminatory credit practices against low-income areas, known as redlining. In exchange, banks use leverage, but that's courting trouble.
This is from Andy Kessler, "The Uberization of Banking," Wall Street Journal, April 29, 2016 (the Saturday/Sunday issue of the WSJ for those who get the print version.)

The whole thing is worth reading, as is John Cochrane's "Equity-Financed Banking," which called my attention to the WSJ piece.

Cochrane summarizes succinctly:

Yes, bank "safety" regulations demand that banks purposely lend to people that one can pretty clearly see will not pay it back, and demand that they do not lend money to people that one can pretty clearly see will pay it back.

Back to Kessler:
SoFi doesn't take deposits, so it's FDIC-free. The firm isn't a bank, at least in that sense of the word. Instead, SoFi raises money for its loans, most recently $1 billion from SoftBank and the hedge fund Third Point, in exchange for about a quarter of the company. SoFi uses this expanded balance sheet to make loans and then securitize many of them to sell them off to investors so it can make more loans.

Yes, this sounds like what was happening before the subprime meltdown. But with a highly tuned algorithm and a carefully selected book of loans, instead of the "No Doc" free-for-all that caused the financial crisis.


But watch out for the regulators:
Rather than by the FDIC, SoFi is monitored by the Consumer Financial Protection Bureau. The overbearing regulator that was Elizabeth Warren's brainchild thus far hasn't come down on SoFi--the CFPB is perhaps too preoccupied with using "disparate impact" analysis of old-school auto-loan businesses to focus on a relatively exotic, app-based form of banking. But Mr. Cagney should watch his back.

Cochrane points out one huge systemic advantage of this form of banking:
Since it makes no fixed-value promises, this structure is essentially run free and can't cause or contribute to a financial crisis.

In 2012, candidate Mitt Romney said that starting banks in garages was a bad idea. I challenged him on John Stossel's show. SoFi is coming awfully close.

BTW, I can't find the Stossel show on line any more. If someone can find a link, I would be most grateful, to the tune of $40. (First one who comes through with something I can download gets the money.)


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CATEGORIES: Competition , Finance




COMMENTS (9 to date)
Foseti writes:

These guys need to double check their knowledge of banking regulations.

SoFi almost certainly has to partner with a bank that will actually make the loans and then instantly sell them on. The bank-partner is still subject to CRA and fair lending regs. You can't just use a third party to avoid all consumer regs. Regulators may be dumb, but not that dumb.

That means whoever their bank partner is, should be ensuring compliance with fair lending and CRA, and that reviews will be under the supervision of the CFPB and the OCC, FDIC, or Fed.

Admitting to not following these rules in the press is a bad idea.

Kevin Erdmann writes:

Really great. This sort of thing is the only way we will find economic growth again. It is clearly housing that is holding back the economy, and not only is everyone fighting the last war - they are fighting hobgoblins from the last war that had little or no bearing on the crisis. Recovery has been slow because there are a lot of organizational frictions to overcome and we have made an emergent policy choice, really starting as early as 2004, to severely cut back on the traditional way we have funded housing. Astoundingly, this tectonic shift has happened mostly because of unintended consequences and false premises.

William Bruntrager writes:

I believe this is the link you are looking for:

https://youtu.be/saeIvyggJrk?t=32m45s

There are definitely ways to download videos from YouTube...

Mark Barbieri writes:

Couldn't find the episode, but if it helps, it was called Disaster and Election Myths. You can see more about it here: https://thetvdb.com/?tab=episode&seriesid=173691&seasonid=489989&id=4436893&lid=7

It seems that people are getting increasingly good at finding ways to work around regulations to improve markets. I suppose it has always been a race between regulators and innovators, but the increased pace of technological change may have tilted the table a little in freedom's favor.

It would be interesting to put together a list of areas where regulations most distort markets and where they are most susceptible to circumvention. For example, land use regulations are probably among the most harmful, but most difficult to work around.

David R. Henderson writes:

@William Bruntrager,
Thanks. I will contact you for your address so I can send the check.
@Mark Barbieri,
Thanks.

Thank you for this news of a shining spot of hope.

I've been wondering how Uber has become so successful in the face of what I had assumed was a lethal blanket of regulations. That will make a good book-length story, a movie even. Also, who were the people who founded Uber and where did they get their values and education? I am amazed.

Turn them loose on the housing industry!

Roger McKinney writes:

I would check with Julien Noizet at spontaneousfinance.com first. He has written multiple times about the ridiculous ignorance of economists about banking.

The banking crisis did not cause the latest recession but instead banking was a victim of the recession. The value of real estate collapsed first, because of the recession, which made the value of mortgage backed bonds collapse. See Gorton's "Slapped by the invisible hand."

Sofi cannot escape the problem of recessions. It will do far worse at lending because their arrogance will cause them to make a lot of bad loans. Most of those loans will go bad in recessions and make the bonds based on them collapse in value. A little humility would help them a great deal.

Roger McKinney writes:

SoFi’s model isn’t that different from what the investment banks were doing through mortgages. The default rate on even the subprime mortgages wasn’t that high. The really bad loans got concentrated in certain tranches that paid high interest rates so only those bonds would have gone bad because of defaults. However, all MBSs tanked, not just those with subprime in them. How did that happen? Again, read Gorton.

When the recession of 2008 hit, the value of real estate plummeted that backed the MBSs. As a result, the buyers of MBSs, usually money market funds (MMF), wanted higher more security for their loans to investment banks (IB). The MMF bought the MBSs from the IB in order to get higher rates on their money to pay their investors. When the value of the real estate behind the MBSs collapsed, so did confidence in the security of the MBSs. The IB couldn’t sell the MBSs except at a much higher discount. The spreads for the IB collapsed and the snowball rolled downhill. The same will happen to SoFi when the recession hits, the defaults increase, and the loans funding the securities lose value.

SoFi can survive a recession only if it foregoes the securitization process for money and relies exclusively on equity. Then when the recession hits their investors will lose money and some will pull out, but they need not go bankrupt. Debt is what causes bankruptcies and bank failures. Any business can survive a downturn in the economy, even a bank, if they don’t have too much debt. A lot of bankers, especially regional banks, saw the recession coming and never got into trouble.

jw writes:

When I first read the first paragraph cited here in the original WSJ article on SoFi I broke out laughing and loudly exclaimed "Brilliant!". My wife thought I was nuts.

Hopefully, their unique model can withstand the scrutiny of Warren's devil child, we shall see.

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