Fintech Looks Like the Achilles Heel of Global Corruption

[According to one Harvard professor, the world is getting better. Perhaps this is partly driven by the impact of fintech on global corruption.]

[3 min. read]

pablo escobar corruption fintech

The world can be a tough place.

In my courses on International marketing, I spend an entire class period talking about corruption around the world. What’s the difference between a full-on bribe and slipping someone $20 as a lubricating payment to expedite your application?

I talk about how different cultures perceive these with varying degrees of acceptance. What is blatantly dishonest to one is just the way things are done (and really NBD) to another.

How does corruption impact humanity?

In the course, I introduce the class to the Global Corruption Perceptions Index released by Transparency International.

Global Corruption Perceptions Index 2017 for Fintech Article

This world map illustrates how countries are perceived in terms of their tolerance and support of corruption.

I heard Utah-based VC, Paul Ahlstrom on the Sales Founders podcast discussing the impact of fintech especially in the developing world (which you may notice also tends to have a high perception of corruption).

Paul drew the interesting correlation between global corruption and global poverty. By comparing these two maps, it isn’t hard to distinguish a rough correlation between corruption and poverty.

2007 World Poverty Map

Paul makes the case that graft and the flow of money fueled by corruption is thwarted by the adoption of fintech tools for moving money around electronically.

This makes sense to me. If I was pulled over in Mexico, for example, I would not expect the officer to whip out an iPad with a Square Reader attached so he could take my pay-off via credit card.

I’d love to see the memo on my statement for that transaction.

Nor would I expect to get shaken down for ransom payments in bitcoin (although that’s not unheard of).

What do the trends for poverty and corruption look like?

I’m not suggesting that big fintech startups have these aims explicitly in mind.

Maybe they do.

But I expect they are out to make a buck by solving problems for people just like any other company. Messing up the financial infrastructure for corruption is just an unintended bonus.

In fact there is some evidence that rapidly emerging fintech is a challenge for regulators and watchdogs to keep up with. And corruption seems alive and well (here are two notable examples from Mexico and Argentina).

Maybe there’s an argument to be made that these examples of corruption would be unknown to the public if not for the rise of technology.

Whether intentional, related, influenced, or coincidental to the growth of fintech in regions with a history of corruption, the status of poverty in the world is improving significantly.

Harvard professor and author of Enlightenment Now: The Case for Reason, Science, Humanism, and ProgressSteven Pinker gave a TED talk in which he shared that today fewer than 10% of the world’s population still live in abject poverty.

Which seems like a very good thing.

Since my time as a fintech CEO, I’ve been very bullish on the fintech space and today that seems more sensical than ever. I’m excited for the changes we will see in the coming years as these developments among others alleviate suffering caused by corruption (however unintended).

Author Bio: @chadjardine is the CMO @goreact, an associate professor at @uutah and sometimes blogs about marketing on Medium.

Education Bubble Part 2

More of this is hitting the news. This video gives more details of the education bubble. To me the big question is this, is the free market being prevented from equalizing the student loan debt situation because student loans are not bankruptable? If bankruptcy is the great “do-over” allowing citizens to recover from untenable financial situations and return to society in a productive role, then are we just crippling students by not allowing them to participate in this mechanism available to the rest of society? Maybe the OWS crowd wouldn’t be so angry if they had the ability to recover from the fateful decision of picking a major with no economic prospects. In any case, I think there is a reasonable argument to be made that if we are willing to forgive debt to countries in Africa, we ought to consider giving at least the bakruptcy option (which is not without consequences) to our own young people.


Bailout Gets to Banks, Not to Customers

bankI was recently discussing a recent Business Week article about U.S. banks.  I have to say that this burns me up a little. Here the banking industry is supposedly in big trouble. Seventy seven banks have failed so far this year and many claim that the national bank of the U.S., the Federal Reserve, wouldn’t pass the stress-test audits it has just forced the nation’s banks to go through. But the sector as a whole seems to be riding high. Banks at large are generally profitable, thanks to a generous bailout on the backs of taxpayers (and I suppose the greed and financial savvy of China).

So, what’s the big deal?

The big deal to me is that the taxpayers have bailed out the banks, but banks have not returned the favor! The Business Week article makes a pretty strong claim that banks are not shying away from risky derivatives, they are just firing up their creative engines and looking at ways to stick consumers with the risk.  Now, part of the article cites banks diving into the payday loan industry. In the interest of disclosure, I am in the payday loan industry myself, but one of the reasons that payday advance financial products are both in tremendously high demand and that this type of high-interest credit is useful and necessary in the economy (as outlined in this report from the NY Fed) is, ironically enough, because the banking industry is not serving the consumer.  Credit is tightening for small businesses, home buyers, and credit card users. A slew of articles today, including this one from USA Today, illustrate how banks are taking the kicking they got from new legislation and passing it right along to consumers.

Because they were not allowed to fail, banks were clearly not allowed to learn their lesson.  This is what happens when government tinkers with the operation of free market economic principles.  You get banks, who normally would be accountable to their customers by virtue of their mandate to earn a profit for shareholders, serving a new master—the legislative hand that feeds them (and in some cases owns them). So they preserve their profits at the expense of customers rather than by serving them. With Congress as their rainmaker, this is an industry that has stopped believing in any form of accountability … except the kind they enforce on you and me as customers. And that’s the big deal to me.  I would love to see someone call these guys on the mat for taking a bailout funded by taxpayers and then turning around and sticking it to those same taxpayers in the form of fees, tighter credit, and inflexibility on loan mods for borrowers facing financial crises.

Who Stole More Futures, Madoff or FDR?

twothievesIt’s official, Bernie Madoff is going to the big house. They are tossing him in the slammer and throwing away the key. What else do you call it when a white-collar criminal gets 150 years? He is now the poster child for scam artists—the man who brought the term ponzi scheme into every American household the way President Clinton did oral sex.

Okay, so I know comparing FDR to Madoff is inflammatory and a little over the top. My point is that the much ballyhooed Madoff scandal is a drop in the ocean when compared to the number of people who are going to lose their future because of Social Security. The government is on Madoff like stink on a turd, the SEC is increasing its oversight and scrutiny, and the people trading in the capital markets who haven’t missed a beat in years are walking on eggshells minding their Ps and Qs (or 10-Ks as the case may be). However, nobody is scrutinizing the broken promise that is Social Security. It isn’t on the news, it isn’t in Obama’s rhetoric, it’s tired and absent from the national conversation.Picture 1

I am not an apologist for Madoff. From what I can tell, the guy deserves whatever they give him. But, the comparison is there for anyone to see. Madoff screwed around 13,000 people out of around $13 billion. Social Security has overpromised benefits to the tune of $17.5 trillion at last count! 80 percent of Americans pay more in Social Security taxes than they do in Federal Income Tax. Yet, imagine the outcry there would have been if Madoff’s victims had comprised 80 percent of Americans.

I’m going to update this with some more stats in the future, but for now, just think about who is responsible for more lost futures, the biggest Wall Street scammer ever, or the guy who gave us Social Security as part of a New Deal. As the New Deal ages, it’s looking more like a Raw Deal for people looking to their future. Until then, here is an interesting site for polling details on how Americans feel about Social Security.

Customers, Shareholders, Stakeholders, Oh my!

bankBanks and automakers who accepted bailout stimulus money are living the truth behind the proverb, “when you pick up a stick, you get both ends.” Banks are realizing that dipping their hand in the taxpayer till may turn out to be a honey pot that they should run—not walk—away from. Stories like this, this, and this, begin to paint the picture of banks looking to escape the strings attached to bailout money. It looks like at least some of these firms are shaking their heads asking, “what have we done?”

Banks, however, seemed a little quicker on the uptake than the automakers, who may still not fully realize their plight. In Stakeholder Capitalism and Chrysler, Harvard Business Review editor, John T. Landry exposes two significant trends fueled by the Administration’s approach with Chrysler. First, there’s a new precedent of legal priority caves to political expediency. Second, there is an underlying movement to supplant shareholder value as the primary goal and purpose of a business with the similar-sounding, but very different meaning stakeholder value.

What do I mean about the legal stuff? I’m talking about U.S. bankruptcy law. (For a more apologetic and detailed angle, read Who is Screwing With Bankruptcy Law? It isn’t my purpose to delve into the nitty gritty of the Chrysler deal, just to hold it up as an example of a shifting macro-opinion.) Typically, companies raise money by issuing various types of debt and equity. Each of these exchanges represents a promise of repayment, and that promise is called a security. In a bankruptcy liquidation, there is often not enough money available to pay everyone back, so these various securities represent the priority of who gets paid back first. Bonds are debt securities, while shares of stock are equity securities. Typically the pecking order from first to last is, bondholders > preferred stockholders > common stockholders.

chryslerHowever, in Chrysler’s case, the President’s offer gave a better deal to the UAW than it did to bondholders. Bondholders made a statement that to the effect that they felt they had an obligation to their shareholders to defend the rights of their more senior position. The President’s opinion is clearly that workers (read stakeholders) are more important than shareholders. President Obama‘s words (abridged) were:

Now, while many stakeholders made sacrifices and worked constructively, I have to tell you, some did not. In particular, a group of investment firms and hedge funds decided to hold out for the prospect of an unjustified taxpayer-funded bailout.

They were hoping that everybody else would make sacrifices and they would have to make none. Some demanded twice the return that other lenders were getting.

I don’t stand with them. I stand with Chrysler’s employees and their families and communities. I don’t stand with those who held out when everybody else is making sacrifices.
Because of the fact that the UAW and many of the banks, the biggest stakeholders in this whole process have already aligned, have already agreed, this process will be quick, it will be efficient. It’s designed to deal with those last few holdouts, and it will be controlled.

It’s a process that has the full support of Chrysler’s key stakeholders and the full backing of the United States government.

What about the second point, that Obama’s opinion represents a more widespread and significant trend shift toward stakeholder value supplanting shareholder value as the corporate mandate. A more overt treatise is available from Harvard Business Review editor Michael Yaziji in his frightening article, Time to Rethink Capitalism.

My intention is that with the recent surge in popularity of anti-capitalist sentiment both in the U.S. and abroad, I think it’s time capitalism received a defense, however inadequate in the context of the shareholder/stakeholder question.

I contend that companies exist to create value for two groups: customers and shareholders, both of whom voluntarily fund the company with cash in exchange for the value the company creates for them. When the company is successful creating value for these two groups, it is able to use the cash they provide to pay employees and value chain partners in order to grow and increase its capacity to create even more value. Without this funding, companies have no resources to allocate to community reinvestment, corporate giving, philanthropy, and corporate citizenship.

Mr. Yaziji contends that between employees and shareholders, employees take greater risk. His logic is that the scope of individual risk represents the ethical grounds for earning a return. He concludes that since the economics of today’s capital markets produce shareholders that individually have a very small stake in the company, in fact may not even know that they own the stock if the purchase was part of a manged fund, that shareholders individually carry much less risk than do individual employees and that laborism, the notion that employees should make most of the decisions and be the primary recipients of returns, is justified.

What!?! Let’s consider a few problems with this argument. For starters, the individual scope of participation by shareholders does not change the essential nature of the function they provide, or the relationship they have with the company. In other words, just because the capital markets have evolved a mechanism that allows more investors to participate (in line with their risk tolerance), and thereby more money to be made available for companies seeking to raise it, doesn’t mean that the function of their investment is different than if it were a single “deep pockets” investor. Just because an employee’s compensation package may constitute a larger dollar amount than the size of the average shareholder’s investment, doesn’t change the fact that employees have one relationship and shareholders another.

Looking at the relationship in investment terms, we see that employees invest “sweat equity”, they deliver their labor. Although the potential for value exists within that labor, it does not automatically translate directly into value for the company.* It is possible for any amount of labor to end up wasted and worthless. (For instance the labor invested in producing Chrylser automobiles that customers are not willing to buy.) In exchange for that labor, employees receive a paycheck every pay period. As investors, we might say that the risk employees face of losing their original invested capital only lasts as long as the time between paychecks. The only thing at risk for employees is potential returns in the future—employees risk only Return on Invested Capital (ROIC), but practically never risk Return of Capital.

Investors on the other hand risk both their invested capital and their potential returns. But, some say, employee compensation represents much more than simply a paycheck. What about benefits like health insurance, retirement accounts, and options?

Well, the employer portion of insurance is typically paid each pay period, so employees receive that benefit immediately. Retirement accounts and options typically vest over time, so there is the potential for employees to lose some of that value which could be considered part of their invested capital. However, these instruments typically create an opportunity for employees to participate as investors. To the extent that these benefits function as investments, the participants should really be regarded as shareholders and not employees.

As Kirby Cochran argued in What About Those Pesky Shareholders?, when companies focus on shareholder value, all other stakeholders are taken care of. It’s a win-win. However, the opposite is not true. A scenario where stakeholder value is preferred over shareholder value, the cart is before the horse and a win-lose scenario results.

*Note that Karl Marx’s notion that the value of a product was equal to the sum total of all the labor that went into its production is undeniably false. Just look at the current housing market. The labor value could be summed up as the “replacement cost.” Houses are selling below replacement cost. That’s because value is established by the customer, not the worker.