But isn't SoFi cherry-picking loans? Absolutely. Why can't banks do this? Because if you use depositor money for loans, as all banks do, you fall under the jurisdiction of the Federal Deposit Insurance Corp. and the Community Reinvestment Act, which bans discriminatory credit practices against low-income areas, known as redlining. In exchange, banks use leverage, but that's courting trouble.
This is from Andy Kessler, "The Uberization of Banking," Wall Street Journal, April 29, 2016 (the Saturday/Sunday issue of the WSJ for those who get the print version). The whole thing is worth reading, as is John Cochrane's "Equity-Financed Banking," which called my attention to the WSJ piece.
Cochrane summarizes succinctly:
Yes, bank "safety" regulations demand that banks purposely lend to people that one can pretty clearly see will not pay it back, and demand that they do not lend money to people that one can pretty clearly see will pay it back.
Back to Kessler:
SoFi doesn't take deposits, so it's FDIC-free. The firm isn't a bank, at least in that sense of the word. Instead, SoFi raises money for its loans, most recently $1 billion from SoftBank and the hedge fund Third Point, in exchange for about a quarter of the company. SoFi uses this expanded balance sheet to make loans and then securitize many of them to sell them off to investors so it can make more loans.
Yes, this sounds like what was happening before the subprime meltdown. But with a highly tuned algorithm and a carefully selected book of loans, instead of the "No Doc" free-for-all that caused the financial crisis.
But watch out for the regulators:
Rather than by the FDIC, SoFi is monitored by the Consumer Financial Protection Bureau. The overbearing regulator that was Elizabeth Warren's brainchild thus far hasn't come down on SoFi--the CFPB is perhaps too preoccupied with using "disparate impact" analysis of old-school auto-loan businesses to focus on a relatively exotic, app-based form of banking.
But Mr. Cagney should watch his back.
Cochrane points out one huge systemic advantage of this form of banking:
Since it makes no fixed-value promises, this structure is essentially run free and can't cause or contribute to a financial crisis.
In 2012, candidate Mitt Romney said that starting banks in garages was a bad idea. I challenged him on John Stossel's show. SoFi is coming awfully close.