Grassroots Credit

Walking into town on Sunday to pick up my car after a night of severe intoxication, I strolled past Tartu's office of Parex Bank. No, I didn't know we had one either; but apparently we do, and what's more, it's still operating - and what's even funnier, they are advertising 9.5% return on deposits in Estonian kroons.

Now, obviously, very few people would be foolhardy enough to place their savings in Parex these days, but it is the vanguard of an interesting phenomenon. Russian economic blogger Artyom Eyskov of Superinvestor.ru mentions today that a bank in Russia is offering a savings deposit plan at 20% per annum. Furthermore, Artyom took the time to check out that plan's terms, and it appears legit - which motivated him to do a little investigating and come to the conclusion that the bank in question is gathering up cash wherever it can find it, in order to pull off an investment so lucrative that even significant interest payouts are worth the bother. (The bank's offer is not an investment plan, but a deposit, so it is guaranteed by the Russian government.)

And then there is Vabakapital.ee: a company that seeks investment, promising payouts of between 16% and 28% - even at the bottom end, that's a very big reward. They're not a venture capital or an investment fund, but rather an intermediary - providing the connections between people with cash to spare, and entrepreneurs in need of loans. They advertise to both sides and, presumably, charge both sides a fee.

Of course there are some caveats, the most obvious one being that the company does not actually assume any risk. It's not a financial institution; if the deal goes sour, Vabakapital is not liable. However, it is a very good idea, and a highly curious phenomenon.

The problem of the credit crunch is not a lack of capital, but a lack of faith, as exercised by institutional creditors. The nature of business in a time of industry and globalization is that business deals are conducted against lines of credit; if you need raw materials, you're not actually going to hand over a bag of cash to a guy in China once a freighter docks at Muuga. Instead you're going to give your supplier a letter from your bank, saying that the bank is confident you're good for it. Hell, more often than not, if you and the supplier have an established relationship, he's just going to trust you. Sure, there are legal papers saying you have to pay, but that's not the same as cash on delivery.

So business runs on credit, and yes, banks are a large part of it (many companies use short-term bank loans to smooth out cash flow, and most have borrowed from the bank to grow the business anyway). Now, the banks put a lot of their money into really stupid deals that naturally fell through. I'm not going to go into detail on that, suffice it to say that banks are left with not just huge losses, but no real idea of how much they lost - the assets they got for the deals are worth something, and nobody has a clue how much exactly (but not a lot). So banks are afraid they have too little, and won't give out loans.

Without loans, businesses can't produce and deliver. The demand is actually still there - at least until all the workers get laid off - but without lubricant, the machine grinds to a halt.

And here's the important bit: just because a business can't function, doesn't mean it's not a good business.

So in the global economic crisis, somebody with some spare cash can actually make a very good investment - buy a functional, profitable, well-structured business that has simply been tripped up by the act of globalization shutting down for a year. The machinery is still there, the people, the business contacts, and most importantly - the paying customers. Just needs a bit of liquidity to get it moving again.

And if the banks won't help, then there is an opportunity for individuals and groups. The crisis has lowered barriers to entry and made a lot of business owners desperate; and let's face it, if you're looking to get a return on your money today, you really have no good reason to trust investment bankers and other professionals. They've shown themselves to be utterly worthless as a class of humanity. But if you're dealing directly with the owner of a business, and are giving him a loan backed by his real assets - or better yet, buying a stake in the company - you're in a position to exercise your own best judgement. The very fact that you still have money to invest means your judgement is a hell of a lot more sound than that of hedge fund managers.

There are companies elsewhere doing this already, sort of, but the Vabakapital thing seems like a lot more simple, and likely to work. Mind you, it could still be either a massive scam or an epic failure, and I haven't given them any of my own money yet.

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Ah! you say. But who has spare cash to lend these days? Well, there's a good probability that a lot of people do, they just don't feel comfortable doing it. There's a crisis on; we might all lose our jobs; let's not spend, and definitely let's not be frivolous with our savings. The upshot is that everyone keeps their money in the bank, where it's safe, guaranteed by the state. Funnily enough, there is already some evidence of the banks - at least here in Estonia - seeking to make use out of all those deposits and pushing consumer credit again. At high rates, certainly, but still.