Editor's Note: This new world of the faiV is going out decidedly more idiosyncratically than the prior incarnation. That's mostly to do with my travel schedule, and trying to find a balance on frequency. For now, the plan is for the next faiV to be on the 22nd, and then on May 10th.
I'll link this again below to make sure that people see it, but in the last edition I inadvertently left out a link to an article about tech-driven efficiency in financial services that was central to one of the items.
I didn't realize that the theme of regulation was running through this faiV from beginning-to-end until I got to the end myself.
- Tim Ogden
1. Regulation
How much would you pay to make sure you never sawed off a finger? Probably not the question that you were expecting to kick off a financial inclusion newsletter. But it's a compelling way to talk about consumer protection that we rarely use in the financial services world. How many people would you exclude from the formal system to ensure no money was ever laundered or used for terrorism? How much extra would you pay on a loan to ensure no one was ever charged a predatory rate?
The saw safety debate has lots of relevance to the particulars of financial services consumer protection. The danger is not completely inherent to the product—the alternative safety procedures and behaviors are effective. For the record, I should note that I have a lot of woodworking tools in my basement that could cut off a finger or two, including a table saw without this protection that I bought because it was cheaper than a SawStop (the article meaningfully understates the price gap). Similarly, I have a couple of credit cards that charge very high effective interest rates on balances—and would therefore cost me a lot of money if I didn't use "safe practices" like setting up auto-pay of the full balance. Why do I have them? Because used in this manner they save me money (see the next item). But I know they cost other people who are less "careful" more money.
Then there is the other framing of regulations and consumer protection: regulations simply drive people outside of the formal system and that's worse that the status quo before regulation. You see a good bit of this argument in the US these days in all sorts of domains—for instance state regulations requiring adult sites to use age-verification, and it's always been a part of fights over gun control and abortion regulation—but almost never when it comes to financial services. I'm trying to remember the last time I saw something akin to "If you cap short-term loan rates, people will just go to the mob to borrow money." There's more of this in lower-income countries and concerns about moneylenders, but in general we don't tend to focus on this aspect, and we especially don't focus on the aspect of how many people just don't get served by formal providers because of the costs of complying with regulation, and how much we should paternalistically try to keep people from using products that can be quite harmful to some users. There is some of this happening—the current fights over Section 1071 of the Dodd Frank Act, requiring lenders to collect and report data about ownership of small businesses they lend to, and the ongoing revision of the Basel III Endgame implementation. But even there, arguments are often proxies for a weird amalgam of all sorts of other policy goals.
Consumer protection in financial services is hard. Balancing the interests of protection, gaining needed data to understand the landscape, and inclusion are never easy choices—it's a trilemma! I guess I'm just hoping that every now and then we have a bit more clarity in the discussions similar to "how much would you pay to not cut off your finger?" (and then factor in the reality that the answer after you cut off your finger is much higher than before you do).
Extra credit: Check out the first two items in this Money Stuff column, the first of which is about nominally well-informed consumers making crazy decisions that are likely harmful, and the second of which is about an alternative regulatory scheme where individual participants can choose to be in the highly regulated vs. lightly regulated sectors—and then tell me if those affect how you think about the questions above.
2. Consumer Finance, Part I
Regulation is a big part of consumer finance, and business models are a big part of how regulation actually works (or doesn't, see below). Apologies if I'm beating a dead horse here, but well, I think this horse is still very much alive and needs attention—for instance because of pieces like the one I forgot to link last week about how the future of financial services is tech-driven efficiency gained from connecting all sorts of systems together.
To better understand some of those business models, here's a post about the business model of rewards credit cards from one of my favorite explainers of how the financial system actually works. But keep in mind that those business models are subject to dramatic change based on the proposed settlement to the Visa and Mastercard antitrust suit brought by US merchants.
I think that in part is why we are seeing a different kind of innovation in the financial services space than we typically talk about around here. For instance Chase is now in the advertising business. Merchants can now get targeted ads to Chase customers based on those customers' transactions. Intuit is in this business now as well, with a few innocuous questions designed to get users' permission to mine their tax data to sell to advertisers. I don't think the Next Billion writer was thinking of this as the frontier on which efficiency was the future of financial services, but here we are: it is definitely super-efficient to mine highly detailed data about consumers' finances to advertise.
3. Consumer Finance, Part II
A common discussion in consumer finance which plays into what and how to regulate is the behavior of consumers with regard to their money. For instance, regulations creating pensions and or private retirement accounts (and what those accounts are and aren't allowed to do) are based in the reality that most humans have a very hard time saving for the long term.
That's historically been a relatively simple conversation from the government regulator side of things: should we ban/require this or that thing? But what happens to regulatory conversations when the governments which do a lot of the regulating are dependent on the things that need regulation for income?
We've long known that governments make something of a devil's bargain on lotteries. People like to play the lottery; people will play the lottery even if you ban it; why not offer some measure of protection of the integrity of the lottery, and collect some of the income that would go into it anyway by having the government run the lottery?; let's mumble past the part where the vast majority of people playing the lottery are low-income who we are spending more than we earn from the lottery to provide services to.
There is a whole new part of this devil's bargain that seems to me to be headed for disaster in the mid-term if not sooner: sports gambling.
For a long time the approach to sports gambling regulation in the US laughed in the face of the argument that "if you ban it, people will just go to shady underground dens to do it and that will be worse." Sports gambling was banned basically everywhere except Las Vegas. And—to inform how you feel about such arguments—sports gambling was difficult and rare. Over the last 10 years, there has been a tidal wave of change. Sports gambling, and specifically online sports gambling, has become legal in most of the United States (with age verification laws, hmmm....). Why? Because state governments saw huge potential revenue from taxing sports gambling. That was clearly right: sports gambling has exploded. The other parts of how and whether to regulate are quickly becoming apparent, but still to my mind not getting enough attention.
I haven't linked to any data above, because I want to focus on the visceral issues here. Online sports gambling has expanded so fast it is already changing the experience of participating in sports. And not just the experience of professionals, or even just of stars. Some states have started re-banning some types of sports gambling. While we have known for a long-time that the poor spend a lot more on lotteries, it's becoming clear that the young—especially young men—are driving sports gambling growth. And not just for adults. The most visceral thing for me was this week when my high school senior came home from his AP Economics class last week to tell me that he and his teacher had spent an entire class session arguing with the boys in the class about the (negative expected) returns from sports gambling.
There is big trouble brewing here, and it's going to get harder and harder to deal with the longer governments "enjoy" the revenues that come from it.
I think it's likely the next great uphill financial services regulation/consumer protection battle is going to be over drastically cutting back sports gambling again. In the meantime, think about the efficiencies that are going to come along in the meantime: using transaction data to identify the people who are very bad at evaluating risk, are compulsive spenders, and selling them financial services that capitalize on those features.
4. Small Firm Finance
One of the primary ways that we do financial services regulation is not by banning things but putting guardrails on: interest rate caps, or required disclosures of costs, for instance. There's a long history of the shadier parts of the financial services industry finding "creative" ways around these regulations. And then there are the really shady operators who don't find particularly creative ways around these regulations. One of those is an organization called Yellowstone Capital which offered a product that was definitely not a loan at 800% interest—because that would be illegal—and instead offered cash advances on future income. Again, totally not a loan! And after regulators acted against Yellowstone, it shut down operations, and didn't just rebrand itself as Delta Bridge Funding and continue the same practices. The folks involved are now being sued by the state of New York for $1.4 Billion. Just a drop in the bucket for sports gambling revenues by the way.
The existence of such operators are a testament to the need that many small firms have for working capital, one of the key findings of the Small Firm Diaries. Of course, the firms that turn to organizations like Yellowstone/Delta Bridge are doing so not just because they are unaware, but because they can't get the funding anywhere else. On Deck, a non-bank short-term lender to small firms, recently released their first "Small Business Cash Flow Report" based on surveys, but most interesting based on analysis of the bank statements that borrowers provide when applying for a loan. The On Deck summary is notably positive: small firms are optimistic about growth and revenue has been growing! I got the report from someone I know in this area who had a somewhat different take on the underlying data (which to their credit, they make available). With his permission, here's his take: "the majority of [On Deck's] small business loan applicants...have no positive net cashflow and fewer than 3 months of cash coverage. And they are seeking capital not for investment but to cover business expenses." That does sound a lot like what we see in the Small Firm Diaries data. And it seems like the same is true in Australia, where according to government data, 43% of small firms are not profitable. It's another illustration of both the need for, and the challenge of, offering a working capital credit product.
In other small firm finance news, the JP Morgan Chase Institute has a new report on the trajectory of the small firms in their data set, specifically the pathway for these firms from start-up to $1 Million in revenue. Less than 9% of firms reach $1M in revenue in their first five years, and nearly half of the ones that do, do so in their first year of operations: "most do not grow beyond the general realm of their initial revenues within five years of starting." There are also key differences in the likelihood of reaching $1M by industry and by race and gender of the founder, with some interactions between the two.
5. Our AI Overlords
We've been talking about the cost of complying with regulations for financial services providers, but small firms (and indeed all formal firms) have regulations they have to comply with, and figuring out what those regulations are can be a struggle in itself. If only there were an AI chatbot that small firm owners could consult to get advice on how to comply with regulations, and perhaps even increase their profit margins. That could be very helpful, unless it, for instance, tells the business owners to do things that are illegal. Perhaps those microenterprise owners who stopped paying attention to the business advice texts sent to their phones were making the right choice.
Far be it from me to not give our AI overlords credit when credit is due. It turns out that my snarky rants might not be the best way to change anyone's mind. It could be that chatting with an AI overlord is more likely to change minds, especially if the AI overlord has access to personal information about the person it is chatting with. Remarkably, that's even true if the subject of the chat is a conspiracy theory that the human believes. Of course, the AI overlords would want us to believe that.
Chart of the Day
Back to Consumer Finance, there's a lot of advice out there on how to manage money, with very uncertain grounding in lived reality, and much of that advice is at least a bit confused. The chart above is grounded in real world data, but to understand what it's saying you really have to read the article, and then you'll probably still be a bit confused. Good luck consumers! Via Axios analysis of data from Acorns.
The faiV is written by Timothy Ogden and produced by the Financial Access Initiative at NYU's Wagner Graduate School of Public Service
Email: fai-wagner@nyu.edu
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