SoFi started by making student loans to Stanford MBAs, after figuring out that the default rate on such loans is basically zero. It
has since expanded to student loans more generally and added mortgages, personal loans and wealth management. Mr. Cagney says SoFi has done 150,000 loans totaling $10 billion and is currently at a $1 billion monthly loan-origination rate.
Where does the money come from?
SoFi doesn’t take deposits, so it’s FDIC-free. … 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
He quotes from a WSJ profile of the founder of SoFi. Cochrane sees this as a form of safe banking, because it relies entirely on long-term funds. But it could turn out otherwise. Suppose that an insurance company puts up the long-term funds for these loans, but the insurance company finances its investment with short-term commercial paper. Then this becomes shadow banking. The next step is for the commercial paper to be bought by too-big-to-fail banks.
My point is not that I think that this is how it will play out, or that SoFi ought to be regulated out of existence. My own guess is that it will not turn out to be sufficiently scalable and profitable for its investors, and it will die a natural death.
My point is that when it comes to financial intermediation, be careful what you wish for. What may appear to be a robust form of financing can be readily transformed into something else entirely.
I guess maybe a rejoinder to your argument would be that a TBTF bank isn’t likely to make commercial paper a big part of its balance sheet, is it? Traditional banks need to exploit the difference between short and long term interest rates in order to generate any profits, so they probably won’t be holding tons of commercial paper, outside of providing some liquidity and mitigating interest rate risk. Who primarily buys commercial paper these days? Isn’t it mostly money market funds? I could be wrong about that. My banking days are long gone, at this point.
I recently refinanced my student loans with one of SoFi’s competitors that has a similar business model. They gave me a rate that was a full percentage point lower than the cheapest traditional back I tried, and almost 5 percentage points lower than the government.
If firms don’t care if they go out of business that throws off a lot of assumptions. You are left with diversification, which might not always help in a panic as proliferated frictions may slow adjustments. However, one fringe benefit of small and diversified providers may be that it is logistically difficult to bail them all out as well as added friction to the regulatory capture processes.