When economist and former U.S. Treasury Secretary Lawrence H. Summers talks, people tend to listen.

And so it was on Wednesday, when small business lending entrepreneurs turned out in droves to hear the man who served as secretary of the Treasury under President Clinton, president of Harvard University, and former chief economist of the World Bank speak. He delivered the keynote address at the Lendit conference in New York, during which he focused on alternative financing--a hot topic for many businesses interested in securing additional cash flow.

To hear Summers speak of things, alternative financing will save the future of the United States and its economy, and will usher in a brave new world of financial stability.

"This is a challenging time for the American economy," Summers said. "The conventional financial sector has, in important respects, let all of its main constituents down over the last generation, and technology-based businesses have the opportunity to transform finance over the next generation."

Never mind that as Treasury secretary in the 1990s, Summers successfully pushed to overturn the Depression-era regulation, known as the Glass-Steagall Act. That law separated the commercial and investment banking arms of traditional banks. Never mind also that he has opposed most recent bank regulations, such as aspects of the Dodd-Frank law, which would prevent banks from making risky bets with customer money, or that he has served as a paid consultant to big banks, hedge funds, and venture capital firms over the years. And perhaps more germane to the audience he was addressing: Summers sits on the boards of both Lending Club and payments company Square, which recently started offering working capital loans to small businesses.

Here's what things look like from Summers's vantage point:

Though the U.S. fended off a recession in 2008, the typical American family and the typical American business are worse off than they were a decade ago. Gross Domestic Product in 2015 is 10 percent less than it was predicted to be in 2007, amounting to a decrease of $1.6 trillion in 2015. That's equal to roughly $20,000 less annually for the average family of four in the years since the low point of the latest recession.

This financial malaise takes place against a backdrop of record low interest rates around the world. In the U.S, real interest rates, adjusted for inflation, have been about 0.2 percent for the last 10 years, which generally speaking should have been great for any business that needs a loan, and any bank that wants to lend.

Only banks haven't been lending, and that's been impeding growth. In this gap lies a huge opportunity for alternative lenders, who have ample room to innovate in an industry that hasn't really innovated since the creation of the ATM, Summers said.

Certainly big banks still control a large pool of lending to small businesses, currently worth about $600 billion, according to a recent Harvard Business School study. But their lending to entrepreneurs has been in serious decline, dropping about 20 percent since 1995. And although alternative lenders make loans whose value is worth about 2 percent of what banks lend, that's likely to change fast.

In the next decade, Summers said, non-bank alternative lenders, using technology that crunches big data in ways that let them lend to borrowers that banks consider too risky, could be responsible for as much as 30 percent to 40 percent of consumer lending, and up to 75 percent of small-business loans.

The new lenders will diversify the lending environment, Summers said. And since alternative lenders don't hold loans on their books, as banks do, there is less danger of them becoming "too big to fail."

Only that's not entirely true. While lenders such as Lending Club and Prosper don't hold loans on their balance sheets, others, such as small-business lender OnDeck and near-prime lender Avant, do.

What's more, the big, unanswered question is, how should new lenders be regulated? As Karen Mills, the former head of the Small Business Administration and a colleague of Summers at Harvard, said following Summers's speech, alternative lenders certainly addressed a small-business lending gap left open by banks during the financial crisis. That, she added, contributed to "an undermining of the whole economy."

Yet greater transparency is necessary for the entire industry, particularly around loan pricing, where annual percentage rates can be 60 percent or higher.

"Nobody's standing up to regulate them and nobody is watching them," Mills said, warning that continued lack of regulation could lead to a new financial crisis equivalent to the one in subprime mortgages.

On that point, Summers did not entirely agree.

"The task of renewal of our financial system is not one for public policy," Summers ended his speech by saying. "It is primarily one for entrepreneurial innovation."

Published on: Apr 16, 2015