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Subprime loan goes to India, a new bubble in microfinance

From WSJ:

A Global Surge in Tiny Loans Spurs Credit Bubble in a Slum

RAMANAGARAM, India — A credit crisis is brewing in "microfinance," the business of making the tiniest loans in the world.

Microlending fights poverty by helping poor people finance small businesses — snack stalls, fruit trees, milk-producing buffaloes — in slums and other places where it's tough to get a normal loan. But what began as a social experiment to aid the world's poorest has also shown it can turn a profit.

That has attracted private-equity funds and other foreign investors, who've poured billions of dollars over the past few years into microfinance world-wide.

The result: Today in India, some poor neighborhoods are being "carpet-bombed" with loans, says Rajalaxmi Kamath, a researcher at the Indian Institute of Management Bangalore who studies the issue. In India, microloans outstanding grew 72% in the year ended March 31, 2008, totaling $1.24 billion, according to Sa-Dhan, an industry association in New Delhi.

"We fear a bubble," says Jacques Grivel of the Luxembourg-based Finethic, a $100 million investment fund that focuses on Latin America, Eastern Europe and Asia, though it has no exposure to India. "Too much money is chasing too few good candidates."

Here in Ramanagaram, a silk-making city in southern India, Zahreen Taj noticed the change. Suddenly, in the shantytown where she lives, lots of people wanted to loan her money. She borrowed $125 to invest in her husband's vegetable cart. Then she borrowed more.

"I took from one bank to pay the previous one. And I did it again," says Ms. Taj, 46 years old. In four years, she took a total of four loans from two microlenders in progressively larger amounts — two for $209, another for $293, and then $356.

At the height of her borrowing binge, she says, she bought a television set. The arrival of microfinance "increased our desires for things we didn't have," Ms. Taj says. "We all have dreams."

Today her house is bare except for a floor mat and a pile of kitchen utensils. By selling her TV, appliances and jewelry, she cut her debt to $94. That's equal to about a fourth of her annual income.

Around Ramanagaram, the silk-making city where Ms. Taj lives, the debt overload is stirring up social tension. Many borrowers complain that the loans' effective interest rates — which can vary from 24% to 39% annually — fuel a cycle of indebtedness.

In July, town authorities asked India's central bank to either cap those rates or revoke lenders' licenses. "Otherwise, the present situation may lead to a law-and-order problem in the district," wrote K.G. Jagdeesh, deputy commissioner for the city of Ramanagaram, in a letter to the central bank.

Alpana Killawala, a spokeswoman for the Reserve Bank of India, said in an email that the central bank doesn't as a practice cap interest rates for microlenders but does press them not to charge "excessive" rates.

Meanwhile, local mosque leaders have started telling people in the predominantly Muslim community to stop paying their loans. Borrowers have complied en masse.

The mosque leaders are also demanding that lenders give them an accounting of their finances. The lenders say they're not about to comply with that.

The repayment revolt has spread to other communities, including the nearby city of Channapatna, and could reach further across India, observers say.

"We are very worried about this," says Vijayalakshmi Das of FWWB India, a company that connects microlenders with financing from mainstream banks. "Risk management is not a strong point for the majority" of local microfinance providers, she adds. "Microfinance needs to learn a lesson."

Nationwide, average Indian household debt from microfinance lenders almost quintupled between 2004 and 2009, to about $135 from $27 or so, according to a survey by Sa-Dhan, the industry association. These sums are obviously tiny by global standards. But in rural India, the poorest often subsist on just a few dollars a week.

Some observers blame a fundamental shift in the microfinance business for feeding the problem. Traditionally, microlenders were nonprofits focused on community service. In recent years, however, many of the larger microlending firms have registered with the Indian central bank as a type of for-profit finance company. That places them under greater regulatory scrutiny, but also gives them wider access to funding.

This change opened the door to more private-equity money. Of the 54 private-equity deals (totaling $1.19 billion) in India's banking and finance sector in the past 18 months, microfinance accounted for 16 deals worth at least $245 million, according to Venture Intelligence, a Chennai-based private-equity research service.

The influx of private-equity cash is the latest sign of the global rise of microfinance, pioneered by Bangladeshi economist Muhammad Yunus decades ago. On Wednesday, Mr. Yunus, a 2006 Nobel Peace Prize winner, was one of 16 people honored by President Barack Obama with the Medal of Freedom.

"We've seen a major mission drift in microfinance, from being a social agency first," says Arnab Mukherji, a researcher at the Indian Institute of Management in Bangalore, to being "primarily a lending agency that wants to maximize its profit."

Making loans in poorest India sounds inherently risky. But investors argue that the rural developing world has remained largely insulated from the global economic slump.

International private-equity funds started taking notice of Indian microfinance in March 2007. That's when Sequoia Capital, a venture-capital firm in Silicon Valley, participated in a $11.5 million share offering by SKS Microfinance Ltd. of Hyderabad, India, one of the world's largest microlenders.

"SKS showed the industry how to tap private equity to scale up," said Arun Natarajan of Venture Intelligence.

Numerous deals followed with investors including Boston-based Sandstone Capital, San Francisco-based Valiant Capital, and SVB India Capital Partners, an affiliate of Silicon Valley Bank.

As of last December, there were over 100 microfinance-investment funds globally with total estimated assets under management of $6.5 billion, according to the Consultative Group to Assist the Poor, or CGAP, a research institute hosted at the World Bank.

Over the past year, investors have poured more than $1 billion into the largest microfinance funds managed by companies, a 30% increase. The extra financing will allow the industry to loan out 20% more this year than last, much of it to countries such as the Ukraine, Cambodia and Bosnia, CGAP says.

Here in Ramanagaram, Lalitha Sharma recalls when the first microfinance firm arrived seven years ago. Those were heady times for her fellow slum-dwellers: Money flowed freely. Field agents offered loans to people earning as little as $9 a month.

They came to Ms. Sharma's door, too. She borrowed $126. Under the loan's terms, she said she would use it to finance a small business — a snack stand she runs with her husband. Many microfinance providers require loans to be used to fund a business.

But Ms. Sharma, a 29-year-old mother of three, acknowledges she lied. "You have to mention a business to get a loan," she says. "There was no other way to get the money." She used it to pay overdue bills and to buy food for her family. Ms. Sharma earns $8 a week, on average, in a factory where she extracts silk thread from cocoons.

Over the next four years, she took nine more loans from three different lenders, in progressively larger sums of $209, $272, $335 and $390, according to lending records reviewed by The Wall Street Journal. A spokesman for BSS Microfinance Private Ltd. of Bangalore, another of her lenders, declined to comment on her borrowing history, citing central-bank privacy rules.

This year, she took another $314 loan to pay for her brother-in-law's wedding, again saying the money would be used for business purposes. She also juggled loans from two other microlenders — $115, $167 and $251 from the Bangalore lender Ujjivan, and $230 from Asmitha Microfin Ltd.

Ujjivan confirmed it issued three loans. An Asmitha official said he had a record of a loan to a Ramanagaram resident named Lalitha, but at a different address.

"I understand that it is credit, that you have to pay interest, and your debt grows," Ms. Sharma says. "But sometimes the problems we have seem like they can only be solved by taking another loan. One problem solved, another created."

Many of the problems in Indian microlending might sound familiar to students of the U.S. mortgage crisis, which was worsened by so-called "no-documentation" loans and by commission-paid brokers. Similarly in India, microlenders' field officers are often paid on commission, giving them financial incentive to issue more loans, according to Ms. Kamath.

Lenders are aware that applicants often lie on their paperwork, says Ujjivan's founder, Samit Ghosh. In fact, he says, Ujjivan's field staffers often know the real story. But his organization maintained a policy of "relying on the information from the customer, rather than our own market intelligence."

He says that policy will now change because of the trouble in Ramanagaram. The lender will "learn from the situation, so it won't happen again," he says.

It's tough to monitor how borrowers spend their money. Ujjivan used to perform regular "loan utilization checks," but stopped because it was so costly. Now it only checks in with people borrowing more than $310, Mr. Ghosh says.

BSS checks how loans are being spent a week after disbursing the money, and makes random house visits, according to S. Panchakshari, its operations manager. The company doesn't have the power to insist that borrowers not take loans from multiple lenders, he said in an email.

Lenders also tend to set up shop where others have already paved the way, causing saturation. There is a "follow-the-herd mentality," says Mr. Ghosh at Ujjivan. Microlenders "often go into towns where they see one or two others operating. That leaves vast chunks of India underserved, "and then a huge concentration of microfinance in a few areas."

[where credit is due]

In Ramanagaram district, seven microfinance lenders serve 22,500 women (most microloans go to women because lenders consider them less likely to default than men). Loans outstanding here total $4.4 million, according to the Association of Karnataka Microfinance Institutions, a group of lenders.

Lenders in Ramanagaram say the loan-repayment revolt was instigated in part by Muslim clerics who oppose the empowerment of women through microfinance. Most lenders are still servicing loans to Hindu borrowers, but have stopped issuing fresh loans to Muslims. "We can't do business with Muslims there right now," says Mr. Ghosh. "Nobody wants to take that kind of risk."

The irony is that, for years, Indian microlenders have touted themselves as bankers to the nation's impoverished minority Muslim community, which has long been excluded from the formal banking sector.

A 2006 report commissioned by India's prime minister found that while Muslims represented 13% of India's population, they accounted for only 4.6% of total loans outstanding from public-sector banks.

Islam prohibits the paying of interest, but mosque officials don't cite that as the reason for the loan-payment strike. They stressed the overindebtedness of the community, and the strains it's putting on family life.

Ramanagaram's period of wild borrowing irks some residents, both Hindu and Muslim. Alamelamma, a 28-year-old vegetable seller, says that she has benefited from microfinancing and that the profligate borrowers "have ruined it for the rest of us."

One gully away, Ms. Sharma, the heavy debtor, has a different view: She would like to see the microlenders kicked out of the community entirely. "Not just for now, but forever," she says.

Will China suffer double-dip too?

Worries that China will suffer double-dip in economic growth once the effect of government's stimulus wanes, from WSJ:

Ten months after China unleashed a massive economic-stimulus program, worries are building about what happens to the world's third-biggest economy when the government money runs out.

China's stock markets have plunged this month on concerns Beijing might tighten the reins on lending and abruptly end the party. Even if the speculation is overblown, the economy still looks unready to motor on after the four trillion yuan ($585 billion) in stimulus starts to fade later this year.

The authorities haven't weaned the economy from its dependence on exports, so with demand for Chinese goods in key markets like the U.S. likely to remain weak, the letup in public spending and loans later this year could leave China in a bind.

While the country might shift benignly to stable levels of economic growth, it faces the risk of a renewed slowdown — or worse — next year, asset bubbles, overcapacity in basic industries or a burst of inflation from all the money the authorities have injected into the economy.

"China is not changing its growth model," says prominent China-watcher Andy Xie. "It is pumping up demand in ad hoc ways."

Instead of steering the economy toward growth based on domestic demand, Beijing is using stimulus as a stopgap until exports rev up again, says the Shanghai-based economist. But if developed economies don't rebound as expected, "we will have a second dip by around the middle of next year and we will be talking about a second stimulus" in China, Mr. Xie said.

Worries like this partly explain why Chinese shares sank 15% from Aug. 4 through Friday after jumping about 90% since the start of the year. The Shanghai Composite Index closed 1.7% higher Friday at 2960.77.

China is likely to hit the government's official growth target of 8% if for no other reason than the authorities have the power to make that happen, at least for a time. Money supply is growing at its fastest in 13 years and fixed-asset investment is running at growth levels not seen since the height of the last inflationary cycle in 2004.

Economic growth picked up to 7.9% on year in the second quarter from 6.1% in the first as the stimulus kicked in and the global economy began to stabilize.

If China doesn't find a substitute for exports as the stimulus wanes, however, it will have to live with slower growth, although Subir Gokarn, chief Asia-Pacific economist for Standard & Poor's says that "may not be such a bad thing."

S&P forecasts China's growth will slow to 7.5%-8.0% this year from 9% last year, then edge up to 8.0%-8.5% next year. On the bullish end of the spectrum, Goldman Sachs expects China to zoom to 11.9% growth in 2010.

There is always an outside risk, though, that with the massive amounts of cash China has pumped into the economy and questions about the country's published data, things could take a turn for the worse, potentially spelling another rough period for global markets and even economies.

China opens up to private equity

China starts to allow foreign private equity firms to raise money in local currency, reports WSJ:

China is opening up to foreign private equity firms — but the promised land is no paradise yet.

For the first time, foreign firms have the green light to raise yuan-denominated funds. It's a significant, but qualified, breakthrough for the likes of Blackstone Group, Carlyle Group, and the private equity arms of CLSA and Macquarie Group — all of which have announced, or will soon announce, new funds.

Raising funds in yuan means being able to tap wealthy Chinese investors, as well as state-backed institutions like China's national pension fund.

And using local currency should mean the funds can more speedily take advantage of investment opportunities in China.


But this isn't going to be easy — both when it comes to raising money and deploying it.

For starters, the foreign firms face competition in raising funds from China-based private equity groups that have a purely Chinese focus — and better local knowledge.

It's unclear, also, whether the foreign firms will be allowed to bring their own money into China, convert it into yuan and take equity stakes in mainland companies, says William Liu, a partner at law firm Linklaters.

That's important if the firms are to follow the model of investing alongside their limited partners — ensuring some of their own money is on the line too.

A regulatory uncertainty applies to investment opportunities as well — whether or not the foreign firms setting up local currency funds will be treated as foreign or domestic investors. The difference being a heap of approval procedures for investments, as well as restrictions on sectors to invest in.

It's questionable, too, whether local governments and regulators will want to give foreign firms access to China's best investment opportunities. For now, with Chinese banks offering so much credit to companies, turning to private equity is anyway less of priority for China Inc.

In a smart move, foreigners setting up yuan funds are aligning their strategies with government priorities. Hong Kong-based First Eastern Investment Group will set up three funds, investing in small and medium sized enterprises, green companies and infrastructure firms respectively.

First Eastern is typical in that it's scaled back its ambitions: The three funds, worth $850 million together, will be smaller in total than initial plans for two funds raising $1.5 billion.

Keeping the funds small, for now, is reasonable. Plenty of uncertainty remains over private equity's freedom to maneuver in a country that is still some way from having capital allocation guided purely by market forces.

Lessons from 1937’s double-dip

With economic recovery looking on track, what lessons can be learned from the 1937-stalled recovery — the double-dip contraction? (source: WSJ). This is a followup to my previous post “The lessons of 1937“.

WASHINGTON — A few months ago, Obama administration officials were sounding the alarm about another 1929. These days, it’s 1937 that has them in a sweat.

The Great Depression was W-shaped. The stock-market collapse led to a steep economic decline. But by 1933, the economy had rebounded. Then a series of monetary and fiscal blunders drove the country back into a deep recession at the end of 1937.

[history lessons]

That episode is at the heart of the debate over how quickly the government and the U.S. Federal Reserve should unwind the emergency measures they have taken to fend off a Depression-like contraction.

For the administration, the answer is clear: Err on the side of continued expansionary policies. “What you learned from that episode in 1937 is that it’s not enough to be recovering,” says Christina Romer, chairman of the president’s Council of Economic Advisers and an expert on the Great Depression. “You don’t want to do anything when you start recovering that nips it off too soon.”

For fiscal conservatives, the answer is equally clear: Start cutting the federal deficit and slowing the growth in the money supply now, before the binge generates a burst of inflation.

Ms. Romer is “sending the absolutely wrong message — that we can’t do anything to worry about inflation until the recovery is locked in because of concern for unemployment,” says Allan H. Meltzer, a political economist at Carnegie Mellon University. “The reason economists and central bankers have two eyes is so they can do two things at once.”

The economy was recovering briskly during Franklin D. Roosevelt’s first term in the White House. The jobless rate, which had peaked at 25% in 1933, fell to 14% in 1937 — not exactly cause for celebration but a relief nonetheless.

The comeback stalled in 1937. Banks, nervous about the fragile recovery, were holding huge amounts of cash in reserve at the Fed. Fearing an inflationary surge should the banks decide to lend that money out to businesses and individuals, the Fed — which had made the mistake of tightening monetary policy soon after the 1929 stock-market crash — miscalculated again. The Fed ratcheted up banks’ reserve requirements three times, starting in 1936. The banks reacted by cutting lending even further.

“There’s no doubt that [Fed Chairman Ben] Bernanke is heavily influenced by these two mistakes of the Fed during the Depression and is absolutely intent on not repeating them,” says Alex J. Pollock of the American Enterprise Institute, a free-market think tank in Washington.

Compounding the Fed’s errors, the federal government tightened fiscal policy. Congress approved a big bonus for World War I veterans in 1936, providing a spark of consumer spending. But lawmakers allowed the subsidy to lapse in 1937. At the same time, the government began collecting the first Social Security taxes, on top of income and capital-gains tax increases that Mr. Roosevelt approved in 1934-35.

Tightening the monetary and fiscal screws sent the economy into free fall again — the second trough of the W. Unemployment shot up to 19%, prolonging the nation’s suffering.

Fast-forward to 2009. Most economists surveyed by The Wall Street Journal this month believe that the recession is over. On average, they expect to see a 2.4% increase in output in the third quarter, at a seasonally adjusted annual rate. Construction of new single-family homes has started to climb. Auto sales are up.

But administration officials and their allies fear a second dip if the government pulls back the $787 billion stimulus or if the Fed clamps down too soon.

“I think it’s a fringe view to say we should get rid of the stimulus,” says Ms. Romer. Economists who say the economy is on the upswing do so because they assume a continued fiscal boost through 2010, she says.

“Even though the Fed is talking about and obviously doing internal planning for the exit strategy, nobody should think it’s imminent,” says Princeton University economist Alan Blinder, a former Fed vice chairman and economic adviser to the Clinton White House. “And it shouldn’t be imminent; the Fed has got to have its pedal to the metal for some time yet.”

Mr. Meltzer says the risk lies not in pulling back too soon but dithering too long. And he would scrap the stimulus program immediately and replace it with cuts in marginal tax rates for individuals and businesses. “It’s certainly not a bad idea to get rid of a policy that isn’t working,” he says. “It takes courage, but that’s what we pay these people to do.” And, he says, the Fed should now slow the growth of the money supply.

Conservative voices in Congress are sending the same message. Last week, Sen. Jon Kyl, an Arizona Republican, reiterated his view that the rebounding economy renders further stimulus spending superfluous.

This week the Obama administration and Congressional Budget Office are to release new federal deficit forecasts. The White House projection is expected to be a record $1.58 trillion for the year ending Sept. 30, and the congressional forecast could be even larger. Expect the news to prompt an outcry from those who believe that the inflation of the 1970s is now a bigger risk than the deflation of the 1930s.


The danger of data mining

Data mining and stock predictions. Some wise words.

Reports from Jackson Hole, WY

Series of interviews at Jackson Hole, WY, where the Fed’s annual summer policy conference takes place. Fed watchers should not miss.

Fred Mishkin interview:

Ken Rogoff interview:

Glen Hubbard interview:

Time to rethink investment model in US college endowment?

Traditional view is that college endowment investment should focus on long term; short term ups and downs should not be major concern. But with most big college endowments down over 25% last year, question arises as to how to reconcile the long-term investment goal with short term liquidity problem: pay for student’s tuition, for example. (source: WSJ, 08/21/2009)

College endowments, reeling from their worst annual performance in decades, are questioning their faith in investments that fueled huge returns before backfiring last year.

The crisis of confidence has been playing out at the University of Chicago, in a previously unreported battle that divided the overseers of the nation’s 10th-largest university endowment, a committee that included hedge-fund managers Sanford “Sandy” Grossman and Cliff Asness. Amid last fall’s market turmoil, the committee argued over whether their portfolio’s assets, $6.6 billion in June 2008 but falling fast, were too risky and volatile.

[The University of Chicago, shown this week, had a $6.6 billion fund.]

The endowment’s managers staged a $600 million share selloff to buy safer instruments, an unusually abrupt no-confidence vote in its portfolio model. In a late October email to committee members, Kathryn Gould, a venture capitalist who heads the college’s endowment committee, and Chief Investment Officer Peter Stein, wrote: “We will no doubt look like heroes AND idiots in the next couple of months.”

More such judgments will be passed beginning later this month, when colleges begin disclosing how their portfolios fared over the fiscal year that ended June 30. Northern Trust Corp. estimates that, over the period, the average U.S. college endowment has a 20% decline.

Harvard University has predicted the asset value of its endowment, the nation’s largest, would drop as much as 30%. Yale University and Princeton University have projected declines of about 25% each. The University of Chicago has predicted a 25% decline in its portfolio value for the fiscal year.

Though loath to discuss their money-management strategies, many universities appear to have considered moving to more conservative investments. Harvard tried last year to sell a chunk of its private-equity portfolio but didn’t receive an acceptable offer; it has been cashing out some of its hedge-fund investments, say people with knowledge of the situation.

Most college endowments used to favor stocks and bonds. David Swensen, hired in 1985 as Yale chief investment officer, argued that endowments — long-term investors that were unconcerned about redemptions or short-term market fluctuations — were ideal for the likes of real estate, leveraged buyouts and distressed debt. Yale beat markets by a wide margin.

But the stock market’s nosedive last year showed what some see as flaws in the model. “The endowment model contained a colossal intellectual error in thinking — that long-term investors don’t need short-term liquidity,” says Robert Jaeger of BNY Mellon Asset Management, a unit of Bank of New York Mellon, who advises endowments on how to structure their portfolios.

Some endowments maintain that, despite steep losses, they aren’t second-guessing themselves. “That would require moving away from equity-oriented investments that have served institutions with long time-horizons well,” Mr. Swensen said in an interview earlier this year.

In 2005, the University of Chicago hired Mr. Stein from Princeton, where he had worked under a protégé of Mr. Swensen. In June 2008, the university’s endowment had 77% of assets in “equity-like investments” — foreign and domestic stocks, private equity and hedge funds — according to the 2008 annual report.

That September, around the time that Lehman Brothers collapsed, members of the investment committee took a hard look at their mix.

“We had underestimated the value of liquidity and overestimated our degree of diversification,” said Andrew Alper, chairman of the university’s board of trustees and a committee member. He says the committee hoped to change the portfolio’s long-term exposure to risk and volatility, and would have preferred to unload its stakes in private-equity firms.

But with the market in these illiquid assets essentially frozen and hedge-fund redemptions coming slowly, they began to talk about selling stock.

In early October, the Dow tumbled 18% in one week. In an Oct. 28 email viewed by The Wall Street Journal, Ms. Gould and Mr. Stein told committee members they were considering “an outright sale” of $500 million in stocks — “virtually all the immediately saleable equities.”

By early November, according to people familiar with the matter, Ms. Gould had instructed Mr. Stein to sell $200 million of equities.

James Crown, a trustee and a general partner at Henry Crown & Co., a Chicago investment firm, expressed confusion. “Where are we going with the endowment and why?” he wrote to committee members in a Nov. 2 email viewed by the Journal.

A force behind the sales push was Mr. Grossman, a Greenwich, Conn., hedge-fund manager and economist, say those familiar with the situation. On Nov. 6, during a three-hour committee meeting at university’s business school, Mr. Grossman sketched out formulas on an easel to explain the portfolio’s relationship to market risk. Other times he referred to the 2008 returns at his own hedge fund, QFS Asset Management — some were ahead double-digits that year — to make a case for selling, these people say.

They say some of Mr. Grossman’s points were challenged by Martin Leibowitz, a managing director at Morgan Stanley, and by top trustee Mr. Alper.

Mr. Grossman says he advocated reducing risk and volatility but doesn’t remember whether he pushed to sell stocks.

The night of the committee meeting, Ms. Gould wrote several members that Mr. Stein was preparing to sell $300 million in stocks. A sale of another $100 million followed. Some proceeds went into fixed-income funds.

Mr. Asness, co-founder of Greenwich, Conn., hedge-fund firm AQR Capital Management, expressed dismay at the response to Mr. Grossman’s presentation. “Was Sandy that convincing?” he wrote in an email the next day. “I felt a consensus was building not to be so short-term.”

University of Chicago officials won’t say when they sold their stock, so it is impossible to calculate returns. Mr. Alper says the proceeds weren’t invested into other stocks but that the endowment continues to hold equities.

Fallout continues. “We cannot time the market to this degree and should not be trying,” Mr. Asness wrote in a January email to members of the committee.

Last year, the university changed its policy so only trustees could serve on its investment committee. That led three nontrustee members, including Messrs. Asness and Leibowitz, to step down in June.

Endowment CIO Mr. Stein announced his resignation in January. Mr. Stein said in a statement at the time that he left for family reasons.

Will Ben Bernnanke be reappointed? Part 3

Did Ben save the world?