Bank Bailouts

I wish I could be so sanguine. Mervyn King’s speech is great (not least because of some apt quotations from Sir Walter Scott, which remind us that nearly 200 years ago, “prosperity” was also threatened by the “over-speculating undertakings” of “capitalists who sought gain not by the encouragement of fair trade and honest industry, but by affording temporary fuel to rashness or avarice”). King’s main message, echoed by Volcker, that commercial and investment banking activities need to be separated once again — in the U.S. this would require a repeal of the repeal of Glass-Steagal — is spot on. Tighter regulation is likely not to be strong enough medicine to keep the banks from repeating the mistakes that precipitated the financial crisis.

It is important that banks in receipt of public support are not encouraged to try to earn their way out of that support by resuming the very activities that got them into trouble in the first place. The sheer creative imagination of the financial sector to think up new ways of taking risk will in the end, I believe, force us to confront the “too important to fail” question. The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion.

It’s good stuff. But in the U.K., the government of Gordon Brown is rejecting King’s advice, and in the U.S., per the New York Times, Volcker, while supporting 80 percent of the Obama administration’s economic policy efforts, is making no headway with the president on the banking reform front.

My question is: What difference would it make if Obama was listening to Volcker? What if he were out on the stump preaching that JPMorganChase and Bank of America should be broken up and that Glass-Steagal should be brought back from the dead? The bitter truth is that nothing would change, even if progressives might be inclined to look a little more fondly on the White House.

At least, that’s what the sorry state of progress vis a vis financial regulatory reform so far tells us. Being bold isn’t likely to get anywhere, if even cautious, incremental steps die stillborn. On every front: derivatives regulation, the proposed Consumer Financial Product Agency, new limits on commodities trading, the administration’s initial proposals have encountered overwhelming opposition from lobbyists and been eviscerated as they inch through Congress. As Felix Salmon moaned yesterday, while noting that even the proposed rules for tightening regulation on the ratings industry were in the process of being emasculated, “it’s clear which way the wind is blowing, it’s clear that we’ve wasted our crisis, and it’s clear that… lawmakers [have]… lost any and all fire in the belly when it comes to trying to ensure we never have another one like it.”

This is not 1933, when Congress — including both Democrats and Republicans — and the new President shared a commitment to radically remake government to cope with the disaster of the Great Depression. This is 2009, when one party is resisting any effort at reform, in any context, and the other is still largely beholden to the interests that require regulation. Progress in this context, as we are witnessing with healthcare reform and will no doubt witness when the fight begins in earnest on climate change, is extraordinarily hard to achieve. At this point, one can only conclude that it will require an even bigger disaster than the recent crisis to bring real change to Wall Street.

Great challenges face us — on climate change, energy, healthcare, the economy — but Washington has proven itself incapable of coping with any of them. An entire generation of voters who believed President Barack Obama’s election would usher in a new era has every right to be disappointed and disillusioned: Gridlock has never seemed so entrenched.

But even as our sense of powerlessness at the impotence of Washington and the resurgence of Wall Street feeds anger and despair, fueling grass-roots insurgencies on both the right and the left, beneath the surface a paradox lurks: As individuals, we’ve never been so empowered to make change on our own, to network and organize with like-minded individuals and to put our own money to work for our own dreams. The ascendance of the Internet, combined with the rise of social networks and the ubiquity of smartphones, has opened up a new frontier where the old rules of Washington and Wall Street don’t necessarily apply. Our present challenge is to figure out how to occupy this new frontier, to stop looking to Washington for answers, and start learning what we can do on our own.

We’ve seen this coming for a long time. The Internet fundamentally disrupted the mainstream media’s gatekeeping influence over news and information. The ease with which data can be copied and distributed drastically upended long-standing entertainment industry models. Digital campaign fundraising has proven extraordinarily powerful, allowing candidates to tap huge sums through the amalgamation of small contributions from millions of people.

But we’re only just beginning to understand the ramifications of our point, click and copy world — and some of the biggest Titans have yet to fall.

Here’s looking at you, Wall Street. If we apply the new power of social media networks and digital computing to the world of finance, we can retake control of our own money and reinvigorate our local communities. The day is not far off when we can wave our smartphone at the local business storefront of our choice and start steering investment capital directly to it. Since Washington cannot rein in the runaway power of the financial sector, we’re going to have to do it ourselves.

The first step is obvious: taking our savings out of the big banks and putting them into smaller, independent institutions. If the Occupy Wall Street movement has achieved anything, it has most certainly breathed new life into the two-year-old “Move Your Money” campaign, as well as spawned numerous imitators. Nov. 5′s “Bank Transfer Day” will be a major test of the power of anti-Wall Street sentiment. We already know that consumer opinion can change the operating behavior of even the mightiest financial institutions. The abrupt decision by nearly all the biggest banks to bow to public outcry and withdraw plans to impose new fees for debit card use offers us just one recent, potent example.

It is simple enough to find a highly rated local bank or credit union in your own community and there is nothing inherently difficult about getting your money out of a Chase or Bank of America, but the overall process is also not quite as carefree as some parties like to suggest. Switching over online bill-paying and changing your direct deposit and direct withdrawal arrangements can be a hassle. It’s a mess that calls out for “one-click” disintermediation — it should be as easy to switch banks as it is to take your phone number from one carrier to another. Legislation has been proposed that would accelerate the process, but right now we’re still in the banking dark ages.

But just moving your money from one bank to another, while symbolically important, is still only a tiptoe dip into the new sea of possibility. A far more important step is to do something interesting with that money — to make your money work for your values. Wall Street won’t lend out the trillions of cash it’s sitting on, so we’re going to have to do it ourselves.

Ever since the San Francisco start-up Kiva began facilitating the donations of small sums of money to struggling entrepreneurs in countries all over the world, the notion of peer-to-peer lending or “crowd-funding” has attracted increasing attention and hype. So-called peer-to-peer lending or crowd-funding is a classic way to leverage the power of the Internet — as easy to master and participate in as your run-of-the-mill online dating site. You’ve got transparency: You decide whom you want to help, and you can track the progress of your cash. You can leverage your social networks. Instead of inviting your Facebook friends to a party, you can invite them to an organic farm virtual barn-raising. There is point-and-click ease of use — just a few twitches of your mouse, and your money has suddenly been transferred from your credit card or bank account to a seamstress in Djibouti or solar-power start-up in Fresno. Kiva’s example has been accompanied by scores of others in the U.S. alone: Prosper.com, the Lending Club, Indie GoGo,, Microplace and Kickstarter are some of the most famous.

In the process, the focus has shifted from the dramatic power of globe-spanning connections between the developed and developing world to the potential for encouraging development in one’s own community — what author Amy Cortese has dubbed “locavesting” — with a tip of the hat to the food and farming activists who have championed sustainable, locally focused agriculture. Just as Internet-enabled campaign fundraising facilitated the aggregation of millions of dollars into the coffers of politicians like Barack Obama and Ron Paul and Herman Cain, so too can small flows of cash from ordinary citizens be aggregated in support of the entrepreneurial efforts of other ordinary citizens. Maybe you’d like to steer your funds toward public transportation-friendly urban renewal instead of a faceless office park in the suburbs, or help a local farm with its expansion plans instead of fueling some giant grocery store chain’s metastasizing growth. You can do it.

There have been some bumps in the roads, but the peer-to-peer lending world is growing quickly, says Cortese.

“When social networking meets finance, it make it easier for companies to reach out to their supporters,” says Cortese, who also credits the slow economy, the jobs crisis and “public dissatisfaction with Wall Street and government” as factors that are fueling interest in crowd-funding.

The bandwagon is growing. On Nov. 1, Starbucks launched a massive crowd-funding project in collaboration with a network of community-lending institutions to steer cash to community businesses. Kiva is using some of those same institutions — technically referred to as Community Development Financial Institutions — to vet targets for donations from its donors.

One of the great attractions of crowd-funding is that local investors tend to operate according to values that go beyond mere maximization of the rate of return. As we saw so clearly in the run-up to the financial crisis, global capital doesn’t care a whit about local conditions. It just wants to move cash in and out as quickly as possible while accumulating the highest payback. If the fastest way to generate a profit is to build a bunch of McMansions and finance their sale with dodgy mortgages that get securitized and flipped to the next speculator, so be it. Never mind what that kind of development means for the environment or the local culture or whether the homeowners who move in can actually afford such monstrosities.

But when we start looking around at what we might want to invest in, in our own hometowns, we may think a little differently; we’ll accept lower returns over longer periods, in exchange for a more vibrant downtown or the nurturing of independently operated businesses. We’ll valorize quality over hit-and-run greed.

There are encouraging signs as to how the increased access to information enabled by the Internet and smartphones is already helping break down the influence of big corporations on our consumption habits. A recently published study on the impact of online consumer reviews by Harvard Business School researcher Michael Luca delivers a nugget of information with breathtaking implications. Luca looked at recommendation aggregators like Yelp and concluded that online consumer reviews increased the profitability of independent restaurants while decreasing the relative share of revenue enjoyed by chain restaurants.

It’s easy to see how this works. Picture yourself in a strange town, looking for a place to eat. You pull out your GPS-enabled smartphone and check for highly rated local restaurants. Given the choice, an independent eatery with great reviews is always going to win out over the Olive Garden. As consumers, we crave authenticity and lust after worthwhile options. We want to support Mom and Pop, if we know that their enchiladas are going to be killer.

The same principle can work for investment. Ian Galloway, a senior associate specializing in community development at the Federal Reserve Bank of San Francisco, envisions a compelling future.

“I can imagine a world not too far down the road,” says Galloway, “where you can walk down the street and pass a blighted piece of property, take a photo of it with your smartphone, click your CDFI [Community Development Financial Institution] app and have that photo geo-coded and sent to the local CDFI with your 25-dollar investment in the predevelopment loan that would cause that property to be redeveloped.”

However, there is still one big roadblock obstructing that future, warn both Galloway and Cortese. As currently constituted, the regulatory environment doesn’t make it easy for peer-to-peer lending to flourish. If you promise investors a return on their investment, federal law regards that loan as a “security” and that triggers an avalanche of legal and fiduciary hoops to jump through. Getting into compliance with federal and state law can be a very expensive proposition, as both Prosper and the Lending Club, which do offer a return on investment, have discovered.

But if you don’t promise a return on your investment, you’re asking for charity. So far, the charity model has worked for Kiva and Kickstarter, but there are obviously limitations to how far that can scale up. We’re not going to break Wall Street’s power over the American economy by encouraging charitable donations. There needs to be a market incentive.

The laws date back to New Deal regulations aimed at protecting ordinary investors from unscrupulous market players. They have their place, but they probably need to be tweaked to fit the Internet era. The power imbalances that used to skew the relationship between a small investor and a company seeking investment are ameliorated by the transparency facilitated by the Internet. And when a bunch of people are trying to invest small sums of money in a local business, it’s not at all clear that they need a high level of protection.

The result of the current regulatory framework, says Cortese, “is a terrible injustice.”

“If you are a wealthy individual you can invest in anything you want — private companies, hedge funds, venture capital. But the large majority of Americans are basically relegated to public companies and bonds.”

Crowd-funding won’t take off, says Cortese, unless restrictions on earning a return from peer-to-peer lending investments are lifted.

Which leads us, unfortunately, back to where we started. The fact that the future of peer-to-peer lending and the democratization of finance may depend on congressional action on the regulatory environment is an invitation to slip right back into the same black pit of despair that has inspired so many Americans to seek ways to outflank Washington and Wall Street. If Washington is broken, how will we ever be able to move forward.

But all may not be lost. In this particular case, there might actually be some room for bipartisan agreement. President Obama proposed a relaxation of the rules that would cover crowd-funding in the American Jobs Act. That package failed to get out of the Senate, but a measure specifically focused on crowd-funding has been introduced in the House by a conservative Republican, and may be up for a vote as early as next week.

Whether the Senate will follow the House’s lead, should the bill pass, is, of course, uncertain. Which means, after all, that Americans still can’t completely turn their backs on Washington. Even as we move our money, and look for better places to invest our money, we can’t let up our pressure on our representatives in Congress, no matter how incapable of doing their jobs they appear to be. We need to get our new rules for our new economy, so we can use our smartphones and social networks to change the world, as we see fit.