Four financial innovations for a new generation
While financial innovation is often associated with nearly toppling the international economic system, some entrepreneurs are preparing a different breed of financial tools.
Sarah Beth Glicksteen/The Christian Science Monitor
Then, in 2000, federal officials, academics, and a local nonprofit group stepped in with a solution: Homeowners could purchase what amounted to insurance against future price declines for a one-time fee of 1.5 percent of their home‚Äôs value.
Then prices stabilized ‚Äď probably because of some slight improvement in the local economy.
The insurance might have kept some Salt City residents from panicking, too. Of the more than 130 homeowners who purchased the protection, no one has yet filed a claim.
‚ÄúIt‚Äôs one of the few cases out there where providing the insurance makes the insurance less expensive,‚ÄĚ says Barry Nalebuff, a professor of management at Yale University in New Haven, Conn., who helped design the program.
In the aftermath of subprime mortgages and credit default swaps, investors might be excused for equating financial innovation with Wall Street shenanigans. Yet it is precisely those highly destructive missteps that are causing a new generation of innovators to find opportunities to give investors more ways to protect their portfolios, more oversight over the stocks they own, and more socially responsible avenues for their money.
‚ÄúWhat we are looking for are products that are simple enough to be understood by average people,‚ÄĚ says Rama Cont, director of the Center for Financial Engineering at Columbia University in New York. ‚ÄúEven people who sit in their bedroom and look at television all day ‚Ä¶ are exposed to financial risk because they have a mortgage,‚ÄĚ he says.
Once individuals understand that they are exposed to such risks, they become more receptive to new instruments that can help them hedge, Mr. Cont adds.
A handful of new products are now being advanced by innovators in the financial-services sector. Whether any or all will take off remains to be seen. Such innovations need broad buy-in from the financial industry to get lift and become widely available. Still, in the shadow of the longest recession in the postwar era, they keep coming.
1. Home-value insurance
Syracuse‚Äôs home-equity insurance is one method to protect homeowners. There are others. Yale economist Robert Shiller has proposed income-linked mortgages, in which the buyer‚Äôs monthly mortgage payment would drop if the average salary of his or her profession fell, regardless of what happened to the individual‚Äôs salary.
In a relationship account, the mortgage essentially becomes like a consumer‚Äôs checking account. When a homeowner deposits money into the account, it reduces the principal of the mortgage and thus lowers the interest cost and that month‚Äôs mortgage payment.
When the owner withdraws money for, say, the purchase of a car, the interest costs rise, as does the monthly payment.
‚ÄúInstead of borrowing [as you do with] a credit card, you‚Äôre borrowing against a secured asset on which the interest rate is significantly lower,‚ÄĚ says Mr. Landry, who works for information-technology services firm CGI, which is headquartered in Canada. ‚ÄúIt‚Äôs like giving yourself little home
equity lines all the time.‚ÄĚ
Relationship accounts are in use in various forms in Australia and Britain, Landry says. Banks Wells Fargo and SunTrust are already offering products akin to relationship accounts, offering home equity lines of credit in lieu of first mortgages.
Only the wealthy ‚Äď those who meet certain criteria, such as a net worth of $1 million or more ‚Äď can invest in firms privately owned by someone else.
Depression-era rules restrict everyone else to publicly traded companies, where there‚Äôs government-mandated disclosure and oversight. That protects average investors from the staff accountant who cooks the books ‚Äď but it also prevents them from putting money into the well-run hardware store that donates heavily to local causes or even larger, privately held entities like TOMS Shoes, a retailer in Venice, Calif., known for such programs as One for One, through which it donates shoes to children in need.
Enter innovators like Rick Wynn, founding partner of Inspire Capital Partners in Boston. His vision is to knock down barriers facing the average investor‚Äôs path to ethical investing while generating a solid profit.
First, Mr. Wynn is devoting his energy to finding ‚Äúfirms of endearment,‚ÄĚ a term coined by a trio of academics in a 2007 book by the same name. Wynn is betting that firms with a strong moral purpose, ethical leadership, and a stakeholder (versus shareholder) focus will replicate the success found in the firms of endearment study: Between 1996 and 2006, such firms outpaced a group of 11 ‚Äúgood to great‚ÄĚ companies known for outstanding returns by more than 3 to 1, according to the academics‚Äô research.
‚ÄúIf you take a long-term view, you can actually do better by investing in companies like this,‚ÄĚ says Wynn. He says he believes he can give access to middle-income investors by creating a public holding company that would, in the long run, post solid gains. ‚ÄúA lot of individual investors are looking for a long-term solution and that‚Äôs exactly what I can give them,‚ÄĚ he says.
With a minimum of $1,000 to open an account in RSF Social Finance‚Äôs ‚Äúsocial investment fund,‚ÄĚ investors get what amounts to a 90-day bank certificate of deposit. But instead of reinvesting the money as a standard mutual fund would, RSF, a San Francisco firm, uses it for loans to for-profit and nonprofit businesses with a social mission. Investors are paid dividends on the interest rate that RSF charges businesses.
The relationship that RSF has developed with its loan beneficiaries may even allow it greater resilience than standard mutual funds would during times of uncertainty. If RSF is hearing pushback from investors on rates being too low in down economic times, ‚Äúthen our borrowers might be able to say, ‚ÄėWell, we could handle 50 basis points in order to ensure that RSF can retain its investor base,‚Äô ‚ÄĚ said Gary Sprague, RSF‚Äôs communications manager. ‚ÄúIt can work in both directions, and that‚Äôs what we‚Äôre after, a two-way dialogue there where the borrower‚Äôs needs are always clear.‚ÄĚ
To get his clients up close and personal with their portfolio, wealth-management adviser Josh Silverman steers them toward an approach he calls ‚Äú100-mile investing.‚ÄĚ
By putting money in firms within 100 miles of Charleston, S.C., ‚Äúit allows us better oversight into those companies, to formally interact by going to annual meetings, for example,‚ÄĚ Mr. Silverman says. ‚ÄúYou‚Äôre going to read about the CEOs in the local paper and maybe it‚Äôs somebody you know at the local country club.‚Ä¶ My clients were feeling distance from their investments and 100-mile investing will allow them the touch-and-feel factor.‚ÄĚ
The development of local investment schemes takes a lot of work, Silverman acknowledges. ‚ÄúThis type of approach not only needs folks with a sensibility for [the] communal aspect, but it also means being able to read through and understand those extra reports and sustainability reports, and go visit those companies, and [for] an investment adviser, that‚Äôs an expensive proposition.‚ÄĚ
Financial innovation in the medium term has its fair share of skeptics.
‚ÄúI just don‚Äôt see that there is a great need for innovation for quite a while. It‚Äôs a period for consolidation,‚ÄĚ says George Kaufman, a professor of finance and economics at Loyola University in Chicago. Right now, he says, the financial industry faces a time ‚Äúto make sure we don‚Äôt throw out the baby with the bath water‚ÄĚ as regulators try to cope with the fallout from the bursting of the stock market and housing bubbles.
Some homeowners and investors might not be ready either. Many have been stung by overextending on their home equity.
‚ÄúI think the challenge is that people are going to wait a long time before they start using their homes as ATMs,‚ÄĚ said Jim Eckenrode, a research executive for banking at TowerGroup, a financial-consulting firm in Needham, Mass.
For example: While home-value protection was arguably successful in Syracuse, it hasn‚Äôt been adopted anywhere else, despite prominent champions like Mr. Shiller and Mr. Nalebuff behind the idea. Even in Syracuse, community reaction was mixed.
Some embraced it, says Karen Schroeder, marketing and research development manager at Home Headquarters Inc., the Syracuse nonprofit that oversees the program. ‚ÄúOn the other hand,‚Äô she says, ‚Äúwe had people who thought that it magnified the problem.‚ÄĚ
Yet there are stirrings of approval from industry leaders for some of these ideas. For example, the Global Impact Investing Network ‚Äď backed by the Rockefeller and Gates foundations and banks like Citigroup, Deutsche Bank, and JPMorgan Chase ‚Äď has big aims: quantitative measures for socially conscious investing and lobbying for regulatory changes to make such investing easier.
‚ÄúCan you invest in the welfare of people?‚ÄĚ asks John Katovich, chief legal officer at the Boston Stock Exchange. ‚ÄúCan you invest in health support of a community ‚Ä¶ in small, local innovations? And can you invest in bringing people, actually, together.‚ÄĚ Mr. Katovich continues: ‚ÄúIf you can maintain a healthy growth in your bank account and support all of [those things] at the same time, which one are you getting a better return on? That or a hedge fund?‚ÄĚ
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