Lending

We love that scene in It’s a Wonderful Life where Jimmy Stewart explains, during a run on his Savings & Loan, that one person’s money was loaned out to another person, and isn’t sitting in the vault. We have believed for awhile that lending should be based on more knowledge than mathematically calculated credit scores. After all Freddie and Fannie both used their expert algorithms to only buy “safe” loans and how did that work out? You would think that others might reexamine this too in light of where our mathematical models led us recently. Well, someone has. Tufts University economist Amar Bhidé argues in a recent book that especially small business lending should be based on a deep understanding of the borrower’s situation, not on rules and algorithms. He argues that an academic argument that all risk can be quantified was embraced and all non-quantifiable stuff was called marginal and unimportant. So whether you had known the borrower for 15 years or whether he had just showed up in town didn't matter. We once met a sharpie who claimed a credit score of 900 (the actual highest is 850) as if that was all we needed to know about him. Maybe getting to know the borrower isn’t such a bad idea and Bhidé is on to something.

-- Paul Marotta