As Canadians brace themselves for a government announcement Monday onthe gross domestic product’s shrinkage in the last quarter of 2008,Americans speculate on the extent to which their government willnationalize major banks.
Since the economic troubles of the pastyear were caused mainly by bad loans, it raises questions about therole of the banks as intermediaries between lenders and buyers. Couldthe Internet make it easier people loan money to one another withoutrelying on banks as middle-men?
First, let’s take a look at the major economic problems of the last 18 months.
InCanada, the market for asset backed commercial paper suddenly dried upin mid 2007, meaning owners of the securities were unable to sell them.Much of these securities were “backed,” indirectly, by Americanmortgages.
As millions of Americans defaulted on theirmortgages, financial institutions worldwide were forced to write downdebt, which devalued other people’s investments. Basically, the banksthat agreed to provide these mortgages loaned money to people who, inthe end, were unable to pay it back. The whole raison d’etre of a bankis to take people’s money, loan it to others and assess the creditworthiness of debtors on behalf of investors, who supposedly do nothave the resources to do this.
But the Internet should be ableto change all of that. In the same way that Craiglist and eBay connectbuyers and sellers directly, the Internet should be able to connectinvestors and borrowers directly. Consider this scenario. Jane Smith, a35-year-old renter, wants to buy a house for $200,000. She posts an adlooking for loans. Meanwhile, Bill Jones, a surgeon with $2 million insavings, wants to invest them in something secure. What’s preventingJones and ten other potential investors from finding a pool, comprisedof Smith and other homeowner wannabees, on the Web, and coming up withan agreement to loan them the money for their homes, using the homes ascollateral?
Jones could invest $1 million of his savings bylending $20,000 each to 50 home buyers, one of whom is Smith. Smith hasonly borrowed $20,000 from Jones, and the other $180,000 she hasborrowed from nine other investors. All of the data related to creditchecks in on a secure server somewhere, accessible only by those whoneed to know.
Arrangements like these would require lawyers andother professionals and would certainly carry some risks. But theywould not necessarily need huge banks and investment houses, withexecutives making multi-million dollar bonuses. Detractors would pointout that without using banks as middlemen, you would not have expertsin credit to assess the ability of borrowers to pay off their debts.They would also point out that if a borrower defaulted, it would causea massive paper chase and repaying the debt would not be easy tosettle. But as we’ve seen over the past 18 months, using the banks asmiddlemen didn’t work any better.