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September 15, 2009

Is Credit Irresistable?

Posted by David Roodman in Uncategorized Tags: ,

A basic point I feel I have not pondered enough is that people who are financially cornered may borrow unwisely—at least sometimes. A Microfinance Insights article by Lilian Simbaqueba and Vitalie Bumacov of the Colombian credit-scoring company LiSim made me think of this now:

With limited access to mainstream credit services, the availability of an opportunity to borrow is overwhelmingly attractive to microcredit borrowers. A “good” opportunity, meaning availability of the right amount of loan at the right time, is a driving factor for microfinance clients to borrow, often without deliberate consideration of the potential risks involved.
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Even in a mature market like Peru, microfinance institutions have to “think for both” themselves and their clients. Easy availability of credit offers a bigger temptation for clients to borrow simultaneously from different sources. Competition among credit institutions may ease the approval or renewal of policies. If the MFI is not aware that the borrower has other current loans, it cannot asses the over-indebtedness of the applicant and, by consequence, can disburse a “low-risk” credit, which in reality is very risky for the client and for the institution. Microborrowers tend to hide this information while MFIs strive to obtain it. In the absence of a credit bureau, this task is nearly impossible.

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August 26, 2009

Beat the Market in Your Spare Time with My Proven Strategy

Posted by David Roodman in Uncategorized Tags: , ,

[Honest subtitle: Ten-year Report on My Experiment in Measured Contrarianism in Personal Finance]

A decade ago this summer, my wife and I returned from nine months in Saigon. We flew back to the States with more cargo than we left with: Mai, a Vietnamese-American, was expecting our first child. (Also packed on the plane were matching T-shirts for mother and son with “Made in Vietnam” embroidered in both English and Vietnamese.) Needless to say, that summer was a time of great change. We moved to a new city, Baltimore. Mai started a new phase in her medical training. We bought our first car, an old Corolla from her brother. We prepared for the baby. According to the division of labor between us, managing the financial consequences of our transitions fell to me. I opened a checking account at a local bank and found renter’s insurance for our new place. I bought auto insurance and—another first—life insurance for us both. I also confronted the question of what to do with the small amount of money Mai had accumulated in a retirement fund in her previous job.

Earlier, my father had introduced me to the writings of John Bogle. Creator of the first index mutual fund for individual investors, founder of the Vanguard Group (now the largest mutual fund company in the world, or at least right up there), and author of several clear and responsible investment books, no one has done more for the ordinary investor. Bogle famously advocates a simple strategy: put all your money in index funds and chose your stock-bond split based on your age and general risk tolerance. A rough rule of thumb is that the % of your portfolio in bonds should equal your age, and the rest should be stocks. A minority of your stock portfolio should be overseas. Bogle argues that it is foolish to try to beat the market, so you should just buy the whole market through low-fee index funds, thus ensuring that you are not ripped off by slick brokers and Wall Street types who claim they can beat the market.

This all made sense to me. But I wondered: why does Bogle second-guess the market when it comes to the stock-bond split and the foreign-domestic split? Why not buy a single index fund of all traded securities in the world, each weighted according to their total market value? If the total value of foreign stocks is twice that of domestic ones, then your portfolio would hold these two assets types in the same ratio. Ditto for stocks vs. bonds. Or conversely, if it is wise to second-guess with regard to stocks vs. bonds and foreign vs. domestic, why not go further and second-guess the market more finely? How did Bogle decide where to draw the line?
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August 5, 2009

My Brain Made Me Do It (Again)

Posted by David Roodman in Uncategorized Tags: , , , ,

Piggy bank from cover of Mike Dixon, ippr, Rethinking Financial CapabilityA month ago I blogged some reflections on transparency. Transparency is the motherhood and apple pie of microfinance, I wrote, if not in those words. Microfinance institutions (MFIs) should make it easy for clients to understand the full costs of services, not hide fees in fine print or no print at all. And they shouldn’t introduce charges through the back door such as by overcharging for life insurance bundled with loans. But accepting the necessity for transparency, I wondered about the means. Are annualized percentage rates (APRs) the best way to summarize expenses? There, my reflections stopped.

Writing about this for the book just now forced me to push the analysis farther. I realized that transparency is in a way a distorting metaphor for disclosure. After all, pages of fine print are “transparent”: all the information is right there. Accepting that MFIs should give clients a clear window onto costs, there remains the question of how to describe those costs. The window must be framed. One of the most important ongoing developments in economics is the subfield called behavioral economics. The famous duo of Daniel Kahneman and Amos Tversky demonstrated through experiments that how information is presented (framed) often matters at least as much as the information itself for how human beings act. I’ll show you an example below.
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March 6, 2009

My Brain Made Me Do It

Posted by David Roodman in Uncategorized Tags:

Sendhil MullainathanSendhil Mullainathan, the second MacArthur Fellow here blogged, writes in Seed Magazine about how human psychological foibles influence how we borrow and save:

“This perspective will eventually alter the way we fight poverty. It should affect the way in which governments in developing countries set their policies, donor agencies like the World Bank provide aid, and foundations and others give support.”

For example, a poor woman might borrow at usurious rates to pay for a safe hospital delivery of her baby even when it would have been cheaper to save up in advance.

Strikes me that the psychological perspective has implications for the moral one. If because of our genes we predictably borrow more than we should, that puts an onus on lenders to prevent over-borrowing. The sanctity of consumer autonomy–the ethical stance that borrowers are entirely responsible for their own actions–doesn’t suffice. OK, so maybe that’s not a new idea.

Hat tip to Jonathan Morduch at the Innovations for Poverty Action blog.

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