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Peer-to-Peer Lending: Will Aggressive Operators Screw Up a Promising Idea?

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Never underestimate the potential of bankers to ruin a good idea by trying to wring too much profit out of it. Subprime lending, mortgage securitizations, microfinance all were products that had merit and were beneficial until industry incumbents pushed for growth and cut corners and/or tried to extend the market well beyond sensible limits.

Peer-to-peer lending may prove to be yet another victim of this propensity. A story in BBC (hat tip Richard Smith) describes the premise and its progress in the UK. The sites take money from individuals and makes loans. Unlike a bank, the lenders’ funds are not guaranteed, but the rates offered are much better, with the site charging a bid-asked spread between the two rates (1% in the case of the UK leader, Zopa). Currently, that means a bit over 7% interest for lender and 8% for the borrower. The lenders are protected by their funds being distributed over many borrowers (the are supposedly allocated pieces of specific loans, £10 each. The 1% retained covers the cost of credit screening, admin, and one assumes, collections. The three major sites have a bit over £250 million among them and claim to average losses of 0.5% (I’d like to see an actual breakdown of repayments, delinquencies, and defaults, to make sure I was comfortable with how that figure was arrived at). The BBC story does no discuss the liquidity of the lenders’ funds, but there are presumably restrictions, like set or minimum terms.

In concept, this is a great idea, and no less than Andrew Haldane of the Bank of England endorses it. There are other versions of this idea that aspire to be alternative money systems, such as Ripple. But while the UK versions have (at least as of now) a bit of an idealistic, New Agey feel, in the US, bankers are eyeing peer-to-peer as a new territory to be conquered. For instance, an April Financial Times story depicted the fact former Morgan Stanley CEO John Mack was joining the board of US peer to peer lender the Lending Club as a sign that the industry was growing up.

Needless to say, a lot of people would happily agree to tie up their money for 2 or 3 years if they thought they would get a 5% to 6% annual return. And my crude sense, based on proliferation of bank branches in Manhattan (displacing all sort of retail stores, just in my ‘hood, a liquor store, a specialty food shop, a Gap) is that banks have overinvested in brick and mortar. But at their current miniscule share of the total lending market, these companies can be stringent about borrower quality and still have plenty of candidates to choose from. What happens when new entrants pressure the incumbents, and when companies like the Lending Club have to keep increasing their total volume of loans to satisfy investors? For instance, the Lending Club looks as if it getting close to an IPO (Kleiner Perkins invested, along with Mack, and Mary Meeker also joined the board).

I’d be happier if these companies were mutualized (as Vanguard is) and management was given back end incentives (say based on the level of timely repayments). The world of finance would work much better if we had operators that would be content building and defending a nice, niche business rather than pushing for growth, which in lending eventually leads to making more and more risky loans. And of course, there is an additional risk of peer-to-peer lending, that of a Ponzi scheme or other frauds on investors. Maybe Occupy should start a peer-to-peer lender and give Mack as well as the big banks something to worry about.

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16 comments

  1. Sunshine

    ms smith i need a micro loan.

    the idea is to set up a network of community based locally sourced gardens in major metropolitan world cities.

    let me buy you lunch at fatburger next time ur in town and ill be glad to fill you in on the details,as to how your micro loan can help kick start this project. email me.

    1. Sunshine

      actually iwant to make clear, this isnt about money, it is about ….well ill elt that go for now.

      i dont want your cash (it’s truly a micro-cost project, which, depending on ur pov can be good or bad)
      what i really want;

      i want your expertise in getting this project off the ground.
      miss smith.

  2. F. Beard

    Needless to say, a lot of people would happily agree to tie up their money for 2 or 3 years … Yves Smith

    The money should be tied up for the length of the loans (matching maturities). Otherwise the “lending club” is lending money it doesn’t really have and is subject to bank runs. For long term loans, resellable bonds would be the way to finance them. That way, if the lender needed cash he could just sell some of his bonds.

  3. Daniel de Paris

    Micro-loans are AT THIS PRESENT MOMENT a fantasy in our so-called rich countries. OECD countries need a more-controlled banking sector. And less loans.

    Check the prices of homes against WORK revenues in most of them. In the UK the bubble has reached such levels that is not even a joke anymore. The Titanic was no joke. Home prices in Spain are no joke either (vs WORK revenues as always).

    Check the prices (and related ability to pay it back with WORK money) for yourselves in most countries. I certainly understand that this may have changed in the US already by the wat.

    For those countries that do not apply check their level of saving/thrift. Full stop. Why full stop? Because you need thrift as well.

    Having people hooked on credit for consumption is not exactly a promising societal feature.

    There will be room for peer-to-peer lending when insane bank lending will have stopped.

    Anyway in view of the idealogy at work in Britain (and here on the continent now as well), one can garantee a full monetary crisis will occur until then. You cannot have a country indebted to the neck and a decent currency.

    “In concept, this is a great idea, and no less than Andrew Haldane of the Bank of England endorses it.”

    Should the views of the members of the BOE be a guide, I certainly feel more vindicated. Check Mr Bean, the othe one, view:

    http://www.dailymail.co.uk/debate/article-1316084/UK-economic-crisis-Id-hide-cash-splurge.html

    PS: That is no right-wing thinking. That is a macro fact by the way. We’ll discuss the practicalities of you “peer-to-peer” after the asset price crash, once the monetary system has settled back to decent cash-return standards. It will be badly need then. Let us be patient.

  4. jake chase

    More money has been lost chasing yield than at the point of a gun. I cannot wait to the the results of this pipe dream. Send your money to a web site that says it is making loans? Didn’t Alan Sanford do something like this?

  5. John L

    An alternative P2P lending network is the local lending idea exemplified by Port Townsend Washington’s Local Investing Opportunities Network https://www.l2020.org/LION. The idea is that lenders and borrowers meet face to face and work out the terms between them. I’ve made a personal loan to a local farmer this way and so far we’re both very happy.

    1. rotter

      people have always done that, and theres not (yet) any law against it. If that could satisfy the need then it already would have. Obviously it cant.

      1. F. Beard

        There’s no competition possible with the government backed/ensured/enforced counterfeiting cartel, the banking system WHEN they are lending.

  6. bhikshuni

    “Maybe Occupy should start a peer-to-peer lender and give Mack as well as the big banks something to worry about.”

    A member-owned and operated credit union/cooperative. Can it can keep funds invested in actual capital equity and block institutional members (or individuals making $250,000 or $1,000,000 a year and up) as an article of incorporation? Where do we go to apply for membership in this credit union?

  7. tyaresun

    One of the places the idea of micro-finance started was in India after 1947 to help women who had no other alternatives and wanted to stay away from rapacious money lenders (watch the movie Mother India if you are a movie buff). The idea has been completely hijacked with the biggest banks getting into the act over the last decade.

    The result is that micro-finance is now just another channel for raping the poor in India.

    1. Ms G

      Yes, and as with Greek Austerity, a cause of suicide due to micro-lending debt.

      http://www.bloomberg.com/news/2010-12-28/suicides-among-borrowers-in-india-show-how-men-made-a-mess-of-microcredit.html

      How is it that “micro lending” even rates as an “interesting concept/solution” in the continuing aftermath of the 2008 crash, and the lively discussions in the alternative blogosphere about how debt peonage is both a deliberate kleptocrat strategy and the cause of the spiraling misery across the globe?

      Was there a time when this industry was NOT hijacked? And in any event, the hijacking has been going on for quite some time — it is not entirely a new development. See, e.g. ACCION (a “microfinance services” firm), headed by a man who was Robert Rubin’s gofer at Treasury and then followed him to plushness at Citi, before becoming the head of . . . ACCION. Chair of the Board? Diana Taylor, roommate of lead Oligarch, Michael Bloomberg (and famous recently in New York for being on the Board of Brookfield Properties — owner of former OWS HQ Zuccotti Park). Taylor is also on the Board of Sotheby’s.

      She had this to say when the Sothebey’s workers protested that their pay was being cut 10% and health benefits being diminished as the CEO’s pay doubled to $6 million:

      “I have one thing to say to you. I have had one conversation with [Sotheby's President] Bill Ruprecht about this, and I told him that if he accedes to any of your demands, I will resign from the board. That’s all I have to say.” http://sylverblaque.wordpress.com/2012/02/11/sothebys-ceo-salary-doubled-as-workers-get-pay-cut/#more-8521

      So Yves is right to argue that when a JPM, or people like Rubin’s proteges at Treasury and Citibank and Diana Taylor get interested in “microfinance” you know there’s more looting, skinning and kleptocracy afoot.

  8. Nathanael

    It’s perfectly straightforward to lend to local businesses if they announce that they want loans. You don’t need a company or intermediary to do it.

  9. Andrew

    I think there may be some confusion about this space. You may find it useful to spend some time looking at Prosper.com. I think that their model of the investors policing the borrowers works pretty well.

  10. Mrs. Alena Mubelga

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    They help me with a loan of 200,000euro to start up my own business. i am now a manager of my own and i have up eight (8)

    workers that work for me in my super market. all thanks go to God almighty for the life of Mr. D.M Crown who help me to

    secure a loan from their company. at first i was afraid to be a victim of scam but i just decided to give it a try and see

    what will happen and to God be the glory every thing comes out peace fully. i promise to share my testimonies with other

    people who are in financial crisis, please do visit them with your financial problem and they will surely help you to

    secure a loan only if you are honest and truthful. here is their contact> loan_finance_taylors_limited@yahoo.com

    regards
    mrs. Alena Mubelga

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