esotericvoyage.com

From the NY Times article “Turning Around the Idea of Student Loans“:

LAS VEGAS — Over sandwiches and pizza, a group of high school students here debated the pros and cons of combating poverty in five desperate nations. They scrolled through Web sites, analyzed statistics and considered how much they knew about the economy, language and culture of each country.

This was no mere academic exercise. The students, at the Meadows School, have real decisions to make and, they hope, real people to rescue. By the time they scattered after their lunch period, the group had deferred until next month the decision on where to spend the $25,000 they had raised, but seemed to be leaning toward Peru.

That may seem like a lot of money for a student group, but it was the entry fee for the school to become investors in Pro Mujer, a nonprofit lending institution based in New York that issues small loans to poor women in foreign countries to use for buying tools to start or expand small businesses.

In raising the money and investing it with Pro Mujer, the Meadows School is by all accounts the first high school to operate a microbank. “In all the contacts I have had, I’ve never seen a school do this in that particular way, so it’s definitely something extraordinary,” said Brad Hales, assistant director of the Economic Self-Reliance Center at Brigham Young University, widely seen as the academic backbone of the microfinance movement. “At most schools, a club may start and raise a couple of hundred of dollars and the larger microbanks will take their money as a donation, but it’s not enough money to have much say.”

The founder of the Meadows Microcredit Action Group, Justin Blau, 17, and its faculty adviser, Kirk Knutsen, have bigger plans for their endeavor.

Pro Mujer will mete out the $25,000 to recipients in the country the students select and return to the school both regular status reports as well as a modest amount of earned interest. The group plans to use that interest and other money raised locally to invest in smaller, more specific projects through Kiva, another microfinance lender, with no minimum entry requirement.

“We wanted to have a much larger impact and establish ourselves as the first high school microbank so we could make sure that it continues in an ongoing basis and so we could encourage other schools to do it,” said Justin, a senior who recently worked as a Congressional page for Representative Shelley Berkley, Democrat of Nevada. “This is a five-year loan, and that helps ensure a certain amount of longevity for this project.”

Justin said he first became interested in poverty issues while researching a debate team speech on problems in sub-Saharan Africa. His debate teacher, Mr. Knutsen, had recently become intrigued by what he had read on microfinance and its chief theorist, Muhammad Yunus, the Bangladeshi economist who received the 2006 Nobel Peace Prize for promulgating the view that such lending creates work and income.

Because, as Milton Friedman (1912-2006) wrote in an 1928 essay, “Only a crisis, actual or perceived, produces real change. When the crisis occurs the actions that are taken depend on the ideas that are lying around.” (emphasis added)

The New York Times was already re-evaluating Friedman’s legacy in April, 2008 with a short article titled “A Fresh Look at the Apostle of Free Markets“.

The chief object of their scorn was John Maynard Keynes, and his message that government had to juice the economy with spending during times of duress. That notion dominated policy in the years after the Depression. Mr. Friedman would spend much of his career assailing it: He argued that government should simply manage the supply of money — to keep it growing with the economy — then step aside and let the market do its magic.

So firm was his regard for market forces, so deep his disdain for government, that Mr. Friedman once said: “If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.”

Friedman, in a 1976 essay, claimed “the Great Depression was produced by government mismanagement.”

See also:

My previous post “Blogger Changes A Country” from June 2008.

Wikipedia entry for Milton Friedman.

AlterNet has a good primer on how home loans, banks, investment banks and insurance companies caused our current global financial problems called Financial Meltdown 101.  And it has really good illustrations.

In 1996, the Fed allows regular banks to become heavily involved in investment banking, which opens the door to conflicts of interest in banks pushing sketchy financial products on customers who poorly understood the risks. In 1999, under intense pressure from financial firms, Congress overturns Glass-Steagall, allowing banks to engage in any sort of activity from underwriting insurance to investment banking to commercial banking (such as holding deposits).

Low interest rates make borrowed money cheap for everyone from homebuyers to banks. This ocean of credit was one factor that led to a major shift in the home-lending industry — from originate to own to originate to distribute. Low interest rates also meant that homebuyers could take on larger mortgages, which supported rising prices.

Of all net job growth from 2002 to 2007, up to 40 percent was housing-sector related: mortgage brokers, appraisers, real-estate agents, call-center employees, loan officers, construction and home-improvement store workers, etc.

There was a conflict of interest, however, because the rating services earned huge fees from the investment banks. Moody’s earned nearly $850 million from such structured finance products in 2006 alone.

Furthermore, the banks would hedge the tranches, another way of distributing risk, by purchasing credit default swaps(CDSs) sold by companies like AIG and MBIA. The swaps were a form of insurance… But CDSs started getting brought and sold all over the world based on perceived risk. The market grew so large that the underlying debt being insured was $45 trillion — nearly the same size as the annual global economy!

For instance, Merrill Lynch had a leverage ratio of 45.8 on Sept. 26. That means that if Merrill had $10 billion in the bank, it was playing around with $458 billion. The Federal Reserve is supposed to regulate reserves to limit the growth of credit, but the SIVs were one method to get around this rule. More leverage also meant more risk for the bank, however, because funds could disappear quickly if a few bets went bad.

This system kept the U.S. economy chugging along for years. For some 35 years, real wages have been stagnant for most Americans, but as house values skyrocketed over the last decade, many homeowners refinanced and cashed out the equity — turning their homes into ATMs… By 2004, Americans were using home equity to finance as much $310 billion a year in personal consumption. This debt-driven consumption was the engine of growth.

From 2004 to 2006, nearly 20 percent of all mortgage loans were subprime loans. As the vast majority were adjustable-rate mortgages(ARMs), this created a time bomb. 

When all is said and done I think the root cause of the global financial crisis will come down to two causes.  The first is the approval and implementation of new global financial regulations on collateral called Basel II.  These regulations were designed to decrease the risk of a world wide banking meltdown.  Adoption started in 2005 in the United States and is also happening in many world wide countries.  (Note: Turkey just decided to delay implementation because of the current crisis.) 

Then global insurance company AIG created a financial product (basically insurance) for banks to meet the new regulations with out increasing the amount of cash they need to keep on hand.  Banks did not want to keep more cash on hand because this would lower profitability.  This new financial product was initially extremely profitable for AIG but also very risky.  From the 2007 AIG annual report to shareholders, they created this loan insurance for banks…

“for the purpose of providing them with regulatory capital relief rather than risk mitigation.”

Unfortunately these facts are not yet well known or reported upon.  With billions in government bailouts happening across the world and the US Presidential elections at stake, one has to wonder if we are following the best path to fix the problem.

References:

Forbes, “Why Wasn’t AIG Hegdged?” 9/28/2008

(American Internation Group) AIG 2007 Annual Report to Shareholders

FT Alphaville, “AIG and an overlevered Europe?” 10/01/2008

Wikipedia has a (poor) entry on the Basel II Accords

The Daily Wealth.com, “How AIG’s Collapse Began a Global Run on the Banks“, Porter Stansberry, 10/04/2008