Swimming Against the Tide; Robert Shiller’s Solution to the Credit Crisis

The Man Who Saw it Coming (Click on image to read article)

Robert Shiller is part of a handful of economists who had made dire predictions of the impending economic downfall that we are dealing with today. What differentiates him from the crowd is the fact that he had predicted the economic downfall for the right reasons.

“Long before the extent of the subprime-mortgage crisis was evident, Shiller predicted that home prices would fall more rapidly than any models had predicted and that financial markets globally would be upended as a result.”

Shiller is an expert in the management of risk; and in this capacity, “he recognized that the real-estate bubble in the United States and parts of Europe represented, above all, a failure to manage risk.”

Unlike the U.S. administration and the federal reserve who are in a mad rush to saturate failing banks and many other failing companies with billions upon billions of “rescue plan” funds, Shiller believes this is the wrong approach. “He argues that unless the central issue of risk is addressed, all the money that governments are pouring into financial rescues won’t prevent another, potentially worse financial crisis down the line.”

“In Shiller’s view, derivatives “are a risk management tool much the same way insurance is. You pay a premium and if an event happens, you get a payment.” His radical answer to our problems is that trying to leash financial innovation is hopeless, and that we should instead push forward into a brave new world where derivatives become as common as cash.”

Another quality that separates Shiller from the majority of economists is his lack of faith in the “efficient-market hypothesis.” Shiller instead believes, “that market prices reflect ‘animal spirits’ and popular passions, not perfect information.” This is why he is a strong believer in financial innovation and calculated government regulation. His ultimate solition is to, “use derivatives to allow home-owners—and, by extension, lenders—to insure themselves against falling prices.” In supporting his solution of using derivatives as a means of insuring themselves from falling prices, he makes the following argument.

“For stocks, because of the use of derivatives and options, money can be made when markets fall, which significantly increases the potential number of buyers and sellers at any given point. And more buyers and sellers—according not just to Shiller but to most finance scholars and traders—means that markets stay liquid and functional even under pressure.” This is truly a novel solution and one that should be boldly pursued, despite the opposition it may face due to the bitter taste derivatives have already left for a many investors.

Weak Bank Regulation to Blame for the Credit Crisis?

OECD Blames Weak Bank Regulation for Financial Crisis (Click on image to read article)

The Organization for Economic Co-operation and Development (OECD), “blasted the regulatory framework as “very poor” because not only did it fail to prevent the crisis but also contributed to it”. According to the OECD, the source of this financial crisis can be traced back to 2004, presaged by four events.

The first event was President Bush’s proposals to make it easier for poor Americans to obtain mortgages.

“Second was the tougher capital requirements imposed on the mortgage finance groups Freddie Mac and Fannie Mae, which triggered an invasion of banks into their territory.”

“Third was the transition towards Basle II, which made mortgage lending more attractive and fostered the creation of off-balance sheet vehicles.”

“The final element was a policy shift by the Securities and Exchange Commission, which allowed investment banks to increase their leverage from about 15 to one to as much as 40 to one.”

Ultimately this set of relaxed regulatory frameworks paved the way for risky lending policies and less than secure investment vehicles that were flooded into the market. The sub-prime mortgage lending and mortgage backed securities were the sum total of these two practices that have led the global financial market into the state that it is in now.

“The OECD also blamed “a massive failure in corporate governance”, the bank bonus culture, the credit-rating agencies and the lack of due diligence by institutional investors for exacerbating the crisis.” This illustrates the fact that the banks are not the only culprits responsible for this financial mess. For instance, if the credit-rating agencies actually followed the 5 C’s of credit (Capacity, Capital, Collateral, Character, Conditions), then a lot these risky mortgages would not have been issued. Ultimately, what is needed is a return to a more conservative banking sector with a new strategic regulatory environment.

Kiva to Help Out U.S. Entrepreneurs

Kiva to feed cash-starved US small businesses (Click on imgage to read article)

Kiva is an online microfinance service whereby loans are made available from individuals wanting to provide the necessary funds to aspiring enterpreneurs in the developing world. However, what makes this article interesting about Kiva is that for the first time, they have decided to provide loans to small businesses in the US.

As was mentioned in a previous post, one of the major problems small businesses face in securing credit is the reluctance of banks to provide credit to those borrowers with little to no assets to secure. According to Premal Shah, Kiva’s President, “Kiva didn’t intend to raise money for aspiring businesses in the world’s largest economy. But the reluctance of U.S. banks to lend during the past nine months caused the San Francisco-based nonprofit to reconsider”.

This is truly a novel approach by Kiva and one that is sure to stir some controversy since it is widely accepted by the international community that it was the U.S. financial meltdown that has caused the global recession. Even Kiva staffers have their doubts about this approach. According to Shah, some of Kiva’s staffers remain convinced the loans are needed more in poorer countries. Despite their objections, Kiva is not giving U.S. borrowers any special treatment. According to Shah, “Kiva will let needy U.S. small businesses vie for funding alongside a melting pot of cash-starved entrepreneurs that includes everything from a Cambodian fisherwoman to a Moldovan butcher to a Bolivian taxi driver. At any rate, this is a much needed novel solution that will hopefully make a dent into the frozen credti markets.

Bank Lending Policy is a Problem in Need of a Solution

Why Tough Bank Lending Policies are Boosting Default Rates, Write-offs (Click on image to read the article)

This article from FinCriAdvisor makes a case for the banks hand in fueling further bankruptcies as a result of their tight lending policies. These strict lending policies have lead and will continue to lead to businesses, and in the case of the article, contractors to go belly-up as they cannot secure financing to ensure their companies are going concerns. Not only are bankruptcies expensive for the company filing for them, they also take quite a long time to reach a suitable resolution through restructuring

According to Bob Regnier, chairman, president and CEO of Bank of Blue Valley in Overland Park, “Bankruptcy can be a formidable obstacle that pushes out resolution by 6 to 9 months”. If banks were to ease-up on their lending policies and free up much needed credit for struggling businesses, the financial restructuring process for these businesses could be completed in a much shorter time, and result in further economic activity.

The banks are aware that all these bankruptcies are having a detrimental impact on their business, but they have their own problems to deal with. According to attorney Chet Cobb, a partner at Phillips Lytle LLP in New York, “Financial institutions calling in loans have little choice because their own debt obligations are coming due, and there may be insufficient cash available”.

So what is the solution to this seemingly catch-22 scenario? Refer to the “Solutions” section for some novel ideas.

“Bankruptcy can be a

formidable obstacle that pushes out resolution by 6 to 9

months

Training Entrepreneurs to Save Communities

Training Entrepreneurs to Save Cities (Click on the image to read the article)

The Emerging 200 program, or more commonly known as the E200 program is a social program by the U.S. based Small Business Administration to help out struggling small businesses in this tough economic climate. According to the article, “The project’s goal is to provide talented entrepreneurs with the skills and contacts they need to grow their companies and create more jobs in their communities”. I believe that this initiative will help the U.S. economy, which in turn will lead the way for a global economic recovery, more so than the trillions of dollars that is being pumped into the very institutions that were the root cause of this financial market melt-down.

The more communities become self-sufficient, community-minded in the business decisions they make, and innovative in their approach to securing new business, the sooner the current state of the economy will improve. One thing that intrigued me about the E200 initiative is what is provided to the participants of this program. According to the Small Business Administration, “At the end of the six-month program, E200 participants walk away with a written, three-year growth plan – a helpful document to have handy for entrepreneurs looking for business loans or investors”. Again, drawing on my own experience when making decisions whether to extend credit to small business owners, if the business owner has a clear growth plan with realistic goals, I would be more enticed to extend the credit as I could see the potential of the business.

Why this Social Problem Matters to Me?

The reason I chose the inaccessibility of credit and challenges of entrepreneurship as the social issue to focus on can be attributed to a few reasons. First of all, I am a firm believer in small business and building a robust local business community. I also recognize that this goal cannot be achieved without the availability of affordable credit, and a local entrepreneurial spirit that leads to entrepreneurial endeavors.

Second, I am very interested to get as many points of view on this worthy topic as it would help me when I am making decisions on whether to extend credit to small business loan applicants. I find sometimes that the decision of whether to extend credit has to do more with how the would-be borrower presents his/her business plan. Therefore, by striving to learn more about the plight of entrepreneurs in starting their ventures, I will be able to make a more informed decision based on the presentation of the business plan and the insights that I will gain through the postings in reply to the information found on my blog.

Finally, as a soon to be business student graduate, I have my sights set on starting a business consulting firm with some talented friends whose experience’s span the IT, Project Management, and Finance sectors. In order to maximize the chances of success of this lofty business venture, I recognize that taking into consideration others thoughts and ideas on securing credit and best entrepreneurial practice will be indispensable in my own entrepreneurial effort. Don’t forget, knowledge is power, and collective knowledge is the most powerful business tool any aspiring entrepreneur can possess as it will help them with all aspects of starting their business and securing the best financing options.

Share Your Thoughts

I am a true believer of collective knowledge. As stated on the Welcome page, one of my goals for this blog is to generate a forum whereby varied ideas and thoughtful insights about how to address the social problem of inaccessible and unaffordable credit can be shared.

To help get your creative juices flowing, maybe start off by answering a few of the following questions:

– If you were in a position to offer one major inatiative that will potentially pull the world out of this recession, what would your inatiative be and how would you go about implementing it?

– In your opinion, what can the world economy do to avoid such a recession the next time around? How about Canada?

– Can you provide any reason why a recession could help spur entrepreneurial endevours?

– If you made a decsion right now to start your own business, what would it be? How do you think the current recession would affect your ability to secure credit for your business venture?

– If you had a choice to start your business domestically or internationally, which would you choose and why? What would be some of the benefits in each scenario?

– How do you think entrepreneurship and social innovation relate?

Top 10 Reasons Why Entrepreneurs Fail

It is common knowledge that the majority of new business ventures fail within their first year of operation. There are literaly hundreds of reasons why these business ventures fail, and it is simple enough to search the Web for the most common reasons. Luckily I came about a great site that lists the top 10 reasons for the failure of businesses better than any other site that I researched. The site can be visited by clicking on this link: http://www.sparkplugging.com/freelance-parent/ten-reasons-businesses-fail/

1. Money: Whether you don’t have enough to adequetly fund a business, or you just do a poor job of managing it, money issues are one of the biggest downfalls of a small business.

2. Planning: Lack of planning is only second to proper money management with new businesses. Business owners need to plan for where, when, and how much to spend in order to ensure that the doors stay open.

3. Competion: Not only should you research your competition in the planning phase, but you also need to keep current once you’re up and running.

4. Pricing: One of the hardest parts of starting your own business is knowing how to set the best prices.

5. Marketing: Marketing is a complicated beast, and most of us are fumbling about in the dark when it comes to marketing our small businesses. If you aren’t able to hire a marketing professional, build some basic skills through your local library and online resources.

6. Inexperience: This is one problem that can bite the entrepreneur in so many ways. Perhaps you don’t have any experience in your chosen field. Obviously, this can hurt when you’re competing against businesses that have been around for years.

7. Sales: Many entrepreneurs are great with ideas but somewhat lacking in sales abilities. In your excitement, you may also have overestimated how much business you were really going to get in the early stages of operation.

8. Business Records: Not only do business records help you stay compliant with government regulations, but they can also help direct the future of your business by creating a clear picture of where you’ve been and where you are.

9. Dependence: Too often, a small business will become reliant on one or two customers. While having a steady customer is a great place to start your endeavor (it beats not having any customers, after all), it’s not enough to sustain you for long. It is vital that you continue reaching out to grow your customer base.

10. Burnout: Once you get to the point of engaging in your business, you may find yourself working ridiculously long hours in order to build momentum. In some cases, the burnout leads to “entrepreneur fatigue,” and you end up procrastinating or just not getting things done. Both mean the death of your small business.

Defying the Recession to Launch a Biz

Defying the recession to launch a biz (Click on image to read article)

I really like this article because it starts out by accurately listing some of the most prominent problems a would-be entrepreneur would face in this incredibly tough economic climate. But it emphasizes a point that I couldn’t agree with more; the need to be bold and make the first move towards self-employment in a tough economic climate. A poor economic environment with high levels of layoffs has a tendency to spark new life into once novel and risky business ideas, as the desperation for income generation becomes ever more prevalent.

But according to Tim Kane, who is an economist who studies entrepreneurship at the Kauffman Institute, “Self-employment rises in recessions, but entrepreneurship doesn’t necessarily rise”. This distinction between self-employment and entrepreneurship is one that I had never given much thought to, as I, just like many others had always made the assumption that entrepreneurship and self-employment went hand-in-hand. The article corrects this erroneous assumption by stating, “Entrepreneurship, in the classic sense, means starting a venture that eventually grows into a bigger company. Many of those going solo now will never expand their business beyond a sole proprietorship”.

In my humble opinion, one of the greatest business related advice that you can ever receive can be found in this article. According to Sloan of the StartupNation, “You need to be conservative with spending, and aggressive as hell with marketing.” According to him, this will have the end result of building your business on a solid foundation, which can only help you further as the state of the faltering economy takes a turn for the better.

Ultimately, this article emphasizes the importance of sticking to the fundamentals of business: minimize spending and costs, maximize profits through extensive marketing and sales activity, and staying vigilant, no matter how tough the economic situation may be.

The Credit Crunch and Small Business

The Credit Crunch and Small Business (Click on image to read article)

The Credit Crunch and Small Business” by John Tozzi is a relatively current article that accurately and concisely conveys the current state of the credit crunch and its effects on small businesses. According to Dayton bankruptcy and workout attorney John Rieser, “In Ohio, banks are refusing to renew lines of credit and calling in loans made to decades-old family businesses that are current on payments”. Working in the banking industry myself, I can understand where the banks are coming from. It is just so unfortunate that well established family businesses who are keeping their credit products current are losing their hard-earned credit due to the mistakes of the big banks.

The article raises an interesting point. According to the president of Sterling National Bank, John Millman, he sees “the current crisis for banking giants as an opportunity for regional banks like his.” Sterling National Bank deals in small business lending. He goes on to state, “When there’s disruption in the marketplace, that creates opportunity for banks like ours who have lots of liquidity”. The irony of this statement is in the fact that the failure of some of the major American banks, which has forced many small business to close down, has at the same time created lucrative opportunities for smaller entrepreneurial banks such as Sterling. It just goes to show you that the over-used economic statement, “wealth is transferred, not lost” holds true in this case.