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Over the last few months, the subprime mortgage crisis has grown to become one of the biggest problems in our economy. As we look over this crisis, its short-term impact is apparent: massive write-downs in the banking industry, a drop in home values and a slowdown in new construction, just to begin with. And as we look down the road, it is clear that this crisis will be with us for some time to come.

What went wrong? We’ve read about unscrupulous mortgage brokers and kickback schemes. A cry for new controls has gone up, and no doubt our elected officials will get to work closing loopholes and toughening up rules. Conventional wisdom leads us to believe that a little more legislation will do the trick.

But legislation isn’t always effective, and sometimes it even has an effect opposite to what is intended. Take campaign reform, for example. As soon as one kind of donation is outlawed, another questionable form of campaign support appears. Why is that? We live in a world where people determine their actions by what they can do instead of what they should do.

Subprime loans are a good example. Were they a good idea? No. But subprime loans were legal, and brokers offered them because they could. Of course, subprime loans allowed a lot of people to obtain housing, including many first-time homebuyers, but many of these same people are losing their homes because of the way these loans were structured.

Had the mortgage industry been driven by a different set of values – had financial institutions been thinking in terms of should instead of could — the story might have turned out differently.

Take microfinancing, for example. Does it make sense to loan money to poor people with no collateral? Muhammad Yunus thought so. He and his Bangladesh-based Grameen Bank received the 2006 Nobel Peace Prize for their work providing low-interest loans to poor entrepreneurs. The bank is now one of the largest in Bangladesh, with 2500 branches, and it has loaned $6.38 billion since it opened its doors in 1976, mostly to women who make less than $1 a day.

This is the sort of success possible when a lender extends trust, reaching out to customers with a set of values that reach beyond profit taking – should instead of could.

In an interview with the Wall Street Journal, Yunus described his approach: “Microcredit… must be for income-generating activity, without collateral and without any legal instruments that could land the borrower in court. It must focus on poor people. And the interest must be low: The cost of the loan — the expense of the employees of the bank, the overhead and so forth — plus 10% is acceptable… (Microcredit is) a protest against conventional banking systems, because two-thirds of the world doesn’t have access to banking, and poor people are the ones who need it the most.”

This is innovation with a difference, informed by a higher standard.

There are plenty of other examples of banking practices rethought along the lines of should. Consider the ways in which some small lending institutions are trying to make room for Muslim customers. Since Islamic law prohibits the paying or charging of interest, Muslims find it difficult to buy a house through traditional avenues. So companies like the Guidance Financial Group are designing “Sharia-compliant” ways to allow Muslims to purchase homes without paying interest, or technically speaking, without borrowing money at all. There are even mutual funds designed around these principles – funds that have done quite well during the subprime crisis, in part because they do not invest in mortgage-related securities. Aiming for a higher standard – rethinking banking practice by what should be done for customers – has helped keep these institutions out of the reach of the crisis.

Here’s one more example. According to the Wall Street Journal, “about a third of the 40 million Hispanics in the U.S. don’t have an account at a federally-insured financial institution.” Some of these people are legal immigrants who simply don’t feel comfortable at English-only banking institutions. Others are illegal immigrants, who, for obvious reasons, prefer cash, and who end up paying high transaction fees at local check cashing services. Whatever your position on immigration, it is important to point out that it is not against the law to provide banking services to illegal immigrants. There is even a home loan available to such immigrants — the ITIN mortgage. Applicants for this mortgage do not need a Social Security number, only an individual taxpayer identification number, which the IRS provides to foreign workers so that they can file tax returns.

And again, here is opportunity. Small alternative banks like California’s Banco Buena Ventura are working to bring Hispanics into the fold, both legal and illegal immigrants, by opening Spanish-language branches that offer non-traditional services, such as advice on how to work with the IRS. They are aided by the FDIC, which has made lending and investing in underserved markets a priority. It should be said that lenders have seen almost no defaults on ITIN mortgages during the subprime crisis.

How would the economy look right now if banks had designed mortgages with the real needs of lower-income people in mind? What would the housing industry be like if financial institutions had approached things from a higher set of values, extending trust to their customers, instead of simply trying to make a fast buck? How would things look if people thought in terms of should instead of could? We would, no doubt, have a healthier housing market, and a healthier economy. Innovation backed up by the right values creates more economic productivity, not less. It is a lesson financial institutions and government should consider as we move forward to fix this crisis.

Last 5 posts by Dov Seidman
• The Certainty Gap - June 26th, 2008
• Of Doughnuts, Aristotle and Children... - May 28th, 2008
• Southwest Flies Into Crisis - April 3rd, 2008
• Even the Boss Has Stupid Rules - March 6th, 2008
• What's Next? - February 27th, 2008

Dov Seidman  posted January 26, 2008 3:31 pm