Crowdfunding has wide appeal. For libertarians on the political right it demonstrates the power of individual action, free from the constraints of institutions and regulation. For geeks it is a demonstration of the vitality of the internet. Much of the public welcomes the sidelining of traditional financial institutions.
And even cautious policy makers are inclined to offer a guarded welcome. They are concerned about the availability of funds to small and medium-sized enterprises – and, in Europe especially, they are right to be concerned. The problem is not that there is a shortage of savings. Far from it. The flow of intermediation is blocked by the debris of bank failures. Just as dammed water finds new channels of escape, crowdfunding seems to provide a way around the blockage.
But regulators are more cautious. The Securities and Exchange Commission has been dragging its feet over implementation of the section of America’s Jobs Act that would allow companies to sell their shares directly to investors via the internet. Britain’s Financial Conduct Authority recently issued proposals for the regulation of crowdfunding sites. The regulators want to make sure that unsophisticated investors do not end up committing a large portion of their assets, and that people who raise money in this way have some sort of serious business.
Such hesitation attracts the wrath of the enthusiasts. Barry James of the Crowdfunding Centre wondered aloud “whether our FCA is the worst regulator in the western world. The words that spring first to mind are inflexible, stubborn and unimaginative.”
By chance, I have just been reading a history of the disastrous experiment of individual learning accounts. This was a UK scheme to promote adult education; individuals who invested a modest amount of their own savings in training would qualify for government subsidies to meet the full cost. The idea was to bypass Britain’s fusty old further education colleges, which had failed to cater for disadvantaged students or stimulate new forms of learning. Newly empowered consumers, rather than bureaucratic inspectors, would judge the quality of training. By the time the plan was scrapped in 2001, at least a third of the money spent under the scheme had been creamed by fraudsters.
And naivety is as much of a problem as criminality. Most business plans read persuasively. It is only when you have read a few – and seen that even the best conceived and executed ones rarely work out as planned – that you begin to learn how to judge them critically. It is not often sensible to invest in early stage businesses without personal knowledge of the people involved. Providing equity or loan capital to small and medium businesses requires skill, expertise, experience and a good deal of cynicism. Such cynicism is precisely the quality the enthusiasts for crowdfunding do not have.
The costs of financial intermediation are excessive. But dispensing with knowledgeable intermediation completely is not, for most people, a good idea either. Crowdfunding makes some sense for the zany projects of which there are many on Kickstarter. People who share enthusiasm for some creative idea can provide support without real expectation of further reward. But that is very different from regarding peer-to-peer lending as a substitute for a deposit account, or facilitating attempts to get rich quick by subscribing for shares through an internet offering.
There is a seeming inevitability about how this debate will evolve. Over the next few years there will be a series of scandals. Some will be the result of blatant fraud, others will represent the triumph of hope over experience. The regulators who are today denounced for their intervention will then be castigated for their neglect, and governments will come under pressure to compensate the losers, either directly or through the various compensation schemes. New regulations will be introduced that will impose controls similar to those imposed on the rest of the financial services industry.
Some of the new P2P lending and equity crowdfunding services will survive, operating in a more closely regulated environment and developing their own skills in vetting projects and assessing their suitability for their investors. Of course, such institutions once existed. They were called banks.