Posted on November 11, 2008

As the global financial system destroys decades' worth of Americans' savings, the relative calm and stability surrounding community-based financial institutions is striking. Locally owned banks and credit unions, which rarely got involved with predatory loans or resold their loans on global markets, are faring remarkably well. The founders of e3bank, a new ecological bank in Philadelphia, believe that they now will have an easier time raising necessary capital. The Rudolph Steiner Foundation's business loan funds, underwritten by their anthroposophy-minded investors, expect most of their client businesses – all carefully selected for their strong social and community character – to fare reasonably well.

In my last blog posting I suggested the importance of expanding the Community Reinvestment Act (CRA) from banks to all kinds of financial institutions, including bond issuers, mortgage and consumer credit companies, insurers, and mutual, pension, venture, and hedge funds. All these institutions should be required to disclose where their investments are going (to reveal how much, if any, of their capital stays local) and be incentivized to invest more locally (the CRA conditions mergers or expansion on good community performance).

Several weeks of further deterioration of my own pension funds have convinced me that CRA expansion is, ultimately, less important than a total reinvention of the U.S. financial systems. The CRA is about altering the behavior of financial institutions that are not typically locally owned – about pushing, guilt-tripping, even extorting them into slightly better behavior. What we really need is to replace these players altogether.

Microbusiness Securities
Roughly half of the U.S. economy resides in small, local businesses, and yet it's almost impossible to find an American who places any retirement or pension monies into them. Everyone, including locavores like you and me, are overinvesting in Fortune 500 companies we distrust and under-investing in local businesses we know are essential for our well being. The reason is not that small businesses are less profitable – to the contrary, sole proprietorships (the legal structure chosen by most firsts stage small businesses) are seven times more profitable than C-corporations (the structure of choice for global businesses).

What really stands in the way of local investment, frankly, are securities laws enacted during the early Jurassic period. Small investors who are "unaccredited" – a category that, according to the Securities and Exchange Commission (SEC) definitions, includes all but the richest two percent of Americans – are prohibited from placing even tiny amounts of money in small businesses. That is, unless these small businesses spend $50-100,000 on lawyers to prepare private placement memoranda or public offerings, thick documents with microscopic ALL CAPS print that no human being in the wild has ever actually been observed reading. An overhaul is long overdue.

I'd like to propose that SEC carve a new exemption to its securities registration requirements to allow unaccredited investors to make low-risk investments in locally owned microbusinesses. By local ownership, I mean that stock shares can only be bought, held, and sold by residents within a state. By low risk, I mean that no person can hold more than $100 worth of any one stock—basically a risk equivalent to the price of a nice dinner for two. By micro-businesses, I mean any business with a total stock valuation upon issuance of under $250,000.

Sure, some light regulation might make sense to prevent outright fraud, but that can be left to each state for creative experimentation. (Why should the SEC meddle in strictly in-state matters?) A microbusiness could fill in some simple forms that provided basic information about its mission, products, plans, people, and budget – nothing more complicated than the components of a business plan. The CEO and board signs off and is held liable for any misrepresentations. No expensive audits. No absurd legal filings. No restrictions on in-state sales.

Additional Legal Reforms
To this microbusiness exemption let me add a few other suggested reforms:

• Micro-Investment Funds – Let's allow small investors to pool their money (again, up to $100 per person) to invest in funds that, in turn, invest in local stock micro-businesses. (Only the rich can invest in such funds now.)
• Co-op Investment Funds – Let's allow cooperatives to set up investment funds for their members as well. (Currently, co-ops can only invest member capital in businesses they own and operate for the benefit of the cooperative itself.)
• Local Stock Exchanges – Let's allow private companies to facilitate the buying and selling of microbusiness stock electronically, like Prosper.com and Kiva.org do for microloans. (The SEC currently bans small, electronic exchanges like these from dealing with equities.)
• Pension Fund Participation – Let's allow any pension fund that places as much as five percent in local securities, either directly or through microbusiness investment funds, to meet legal standards of "fiduciary responsibility." (ERISA and other pension laws define the term now in a way that virtually demands that investments go to global companies.)

Were these reforms enacted nationally, literally trillions of investment dollars could begin to move into the local business economy. Entrepreneurs hungry for new capital – in part because of the post-meltdown unavailability of commercial credit – will restructure themselves to receive microcapital. Investors terrified about continuing to bet all their money in the global casino will be eager to invest in local businesses that they know and trust, run by local entrepreneurs with whom they can visit and at whom they can fire tough questions.

The real result will be a nation of stronger local economies, with American investors increasingly placing their money into backyard businesses rather than in the untrustworthy hands of distant speculators.

And here are two remarkable features about these ideas. First, the cost is zero. And second, most can be undertaken at the state level. Surely a country that was prepared to spend $700 billion of taxpayers' to prop up dubious nonlocal financial institutions ought to be willing to create an alternative, safer system – for free?

How a state might enact just one modest policy and unleash all these changes will be the subject of my next blog entry.

By Michael H. Shuman