Common Currency: Community Development Corporation may be wise option for Park Rapids
I recently came across this sentence in a 1996 paper published by the Wharton Financial Institutions Center: "The key value added of intermediaries is that they provide the function of allowing risk to be allocated efficiently at minimum cost.... intermediaries can transact at near zero cost while individuals have high trading costs. This means that intermediaries can create a large number of synthetic assets through dynamic trading strategies."
This paper, published a decade before the cataclysmic financial collapse that is now leaving its mark on an entire generation, made note that almost all of the financial innovation of the 1970s and 1980s resulted in a radical departure from the traditional role financial institutions historically played as intermediaries between individuals and firms.
The authors of this paper observed that the explosion of innovative financial products, such as mortgage backed securities, credit default swaps, derivatives, securitized loans, etc., was overwhelmingly becoming used by financial intermediaries to swap, hedge, trade and make bets among and against each other, rather than provide any real value or service to a real individual, or a real corporation that actually owned assets, or had real business risks that needed management expertise.
I suppose hindsight is 20-20, but creating "synthetic assets" for allocating risk through "dynamic trading strategies" sounds like something you might have found in the 2001 balance sheet footnotes at Enron. That one didn't end so well either.
Today, it seems financial institutions have forgotten how to perform basic financial intermediation in the old school way: Providing a real service to real businesses.
Forgotten might be too strong a statement. But there certainly is something of an "Alice-in Wonderland" quality to an economy where banks have more money than they know what to do with and can't find qualified borrowers to lend it to; the federal government is desperately trying to "incentivize" businesses to expand and make new hires to bring down the unemployment rate, yet at the same time regulators are punishing banks with onerous restrictions on any risk taking at all, which is where the new ventures that hire new employees is going to generate the greatest gains.
The traditional model for financial intermediation between risk taking entrepreneurs and risk managing bankers has broken down, and the bank examiners are only making it worse by forcing write- downs not only on bad loans, but on loans that are current and performing, just because they might go bad.
See? Alice-in-Wonder-land: "First the verdict, then the trial!"
This could be particularly troubling for a small local economy like Park Rapids on the verge of recovery: Now that we have made the hard decision to reinvest several million dollars in essential public infrastructure, we need to complete the task of revitalizing the business climate here in Park Rapids so we can build on that investment.
Considering the disconnection between bankers and entrepreneurs these days, I think we might just need a new business model to get it done: Park Rapids needs its own Community Development Corporation.
Here is a telling statistic for you: More than 80 percent of the businesses in Park Rapids employ 10 people or less. Almost two- thirds employ four people or less. This indicates that business formation and job growth is primarily dependent upon the success of small entrepreneurs with limited capital and resources.
And that also means without some way of bridging the gap between entrepreneurs, government, and financial institutions, full economic recovery will be prolonged longer than it should. It all comes down to attitudes and capacities to deal with risk, which is what financial intermediation is all about.
For an entrepreneur, risk represents an opportunity to be embraced. For a financial institution, risk is a variable that requires assessment, for a governmental entity, risk is something that is inherently bad and should be avoided or eliminated wherever possible.
All three - entrepreneurship, financial management and public governance - are necessary components of an energetic business climate, yet these days, we all might as well be on separate continents. No one is speaking the same language, and the talking is mostly past each other. A community development corporation could bridge the gap.
A community development corporation is a special creature of Minnesota statutes that allows a non-profit public charity to operate as a business corporation.
A CDC typically operates as a 501(c)(3) tax-exempt entity to address the social costs of redevelopment and business formation where barriers are high due to low incomes, high unemployment or a chronic lack of investment.
Larger cities have had them for years to revitalize older neighborhoods. Maybe it is time we had one too.
"The key value added of intermediaries is that they provide the function of allowing risk to be allocated efficiently at minimum cost."
Instead of creating "synthetic assets" maybe it is time for a CDC to do it "old school" and create an intermediary for Park Rapids that creates real assets and real opportunities for the community.
Alan J. Zemek is a Park Rapids area developer and author of "Generation Busted: How America Went Broke in the Age of Prosperity." You can follow his blog, or comment on this article on his website, www.generation busted.com.