"Loan fairness" as redistribution

I've noticed an interesting desire, especially on the political left, to want to use loans as a means of redistribution. The idea is that lenders should be willing to make loans to poor people when the risk-return tradeoff is worse than for loans to rich people. This could mean, for example, loaning money to high-default-risk poor borrowers at the same interest rate as to low-default-risk rich borrowers. Or it could mean extending loans to poor people whose perceived default risk would previously have prevented them from getting loans. The notion that this is "fair" - or that lenders "owe" it to poor people to give them favorable lending terms - pervades such works as David Graeber's Debt: The First 5000 Years.

A more recent example is Cathy O'Neil's recent post on Big Data and disparate impact in lending:

Did you hear about this recent story whereby Facebook just got a patent to measure someone’s creditworthiness by looking at who their friends are and what their credit scores are? They idea is, you are more likely to be able to pay back your loans if the people you’re friends with pay back their loans... 

[This] sounds like an unfair way to distribute loans... 

[In the neoliberal mindset], why would anyone want to loan money to a poor person? That wouldn’t make economic sense. Or, more relevantly, why would anyone not distinguish between a poor person and a rich person before making a loan? That’s the absolute heart of how the big data movement operates. Changing that would be like throwing away money. 

Since every interaction boils down to game theory and strategies for winning, “fairness” doesn’t come into the equation (note, the more equations the better!) of an individual’s striving for more opportunity and more money. Fairness isn’t even definable unless you give context, and context is exactly what this [neoliberal] mindset ignores. 

Here’s how I talk to someone when this subject comes up. I right away distinguish between the goal of the loaner – namely, accuracy and profit – and the goal of the public at large, namely that we have a reasonable financial system that doesn’t exacerbate the current inequalities or send people into debt spirals. This second goal has a lot to do with fairness and definitely pertains broadly to groups of people.

I don't get the random swipe at "equations", but the rest all seems pretty clear, even if it is couched in vague terms like "context", "reasonable", and "pertains broadly to groups of people". The basic idea is simple: Society is more fair when lenders give poor borrowers favorable terms relative to rich borrowers.

Let's think about this idea.

One problem with the idea would be that following it might force lenders to accept negative expected returns, which would drive them into bankruptcy. But let's assume for the moment that this doesn't happen - that lenders can lend to poor people and make lower, but still positive, profit margins overall. Loan "fairness" would then act as a subsidy from lenders to borrowers - a form of redistribution via a tax on loan-making businesses.

Another problem would be a more subtle version of the first problem - the implicit "fairness tax" on lenders might reduce the amount that they lend overall, and thus hurt the economy. This would be an example of the "leaky bucket" of taxation, in which we trade efficiency losses for welfare gains.

But let's ignore that issue. Let's think not about efficiency concerns, but only about the fairness of this type of redistribution.

Obviously fairness is a a matter of opinion, but there are some things we can clarify. Who are the recipients of "loan fairness" redistribution? Answer: Poor people who ask for loans.

Some poor people ask for loans because they have businesses to start, or for standard consumption-smoothing reasons. If these people are currently subject to borrowing constraints because of asymmetric information - in other words, if they can't get a loan because lenders don't realize they can and will pay it back - then these borrowing constraints will be ameliorated by "loan fairness" redistribution. That seems like a good (and fair) thing to me.

Other poor people ask for loans that they are unlikely to be able to pay back. This might be because they don't realize that their chances of repayment are low. Or it might be because they don't really intend to pay the loans back. Both of these groups of people will benefit from "loan fairness" redistribution.

One effect of implementing "loan fairness" redistribution would be an incentive for more people to join the latter group. Once poor people realize that society's desire for redistribution has given them the opportunity to get loans on more favorable terms, some poor people - it's not clear how many, but more than zero - will certainly take advantage of this by taking out a bunch of loans that they can't or don't intend to pay back.

A final group will be those poor people who don't ask for loans. Some will probably have ideas of morality that tell them to work hard, save money, and "neither a borrower nor a lender be". Others will think it unfair to request loans that they know they are unlikely to pay back. Others will simply not need to borrow that much. These groups of poor people will not benefit from "loan fairness" redistribution, because they will not ask for loans.

This introduces what I see as a source of unfairness. Poor people who are honest, and who refuse to borrow money that they know they can't pay back, will suffer compared to poor people who are dishonest and will just borrow as much as they can without any intention of returning the money. I think one could probably find some evidence of this kind of behavior among poor-country governments that borrow money and then ask for loan "forgiveness".

That seems clearly unfair. But there also seems to be another source of borderline unfairness here. Poor people whose moral values prevent them from asking for loans will be disadvantaged relative to poor people who have no moral problem asking for loans. Morality-based redistribution sounds a little iffy to me in the fairness department.

So purely in terms of the fairness of "loan fairness" redistribution - without even talking about efficiency concerns - I see some big problems with the idea of opportunistically redistributing money to only those poor people who are willing to walk into a lender's office and ask for a loan.

A more intuitively fair method of redistribution might simply be to tax rich people and give the money to poor people. Crazy idea, I know.