Can Peer-To-Peer Finance Work?

Dotnaught writes "Two companies, Prosper and Zopa, appear to be convinced that social networking can be combined with borrowing and lending. They're intent on using eBay as a model for listing and bidding on loans without the involvement of a bank. Call it peer-to-peer finance. There are already some 800 groups on Prosper ready to loan money to specific causes, such as the Apple User Group, 'a lending group for those wishing to purchase either a Macintosh or Apple iPod.'"

Existing Finance

[foundme]

I can't imagine how this is able to compete with existing financial providers.

First of all, how many bad debts can these peers handle? Large corporations have enough cash to handle bad or delayed debts.

Unlike other successful P2P services, this model is entering a market where existing businesses are making a living out of it.

Welcome Back

[Camel Racer]

With this announcement, we are now officially in an economic bubble.

credit checks?

[chicken_tonight]

Unless there are credit checks people will use this borrow money when they're desperate. Sounds like a recipe for disaster to me.

Re:Existing Finance

[rvw14]

Peer to Peer financing has been around for decades. It is called a Credit Union.

Re:If only you can book those loans as revenue...

[AuMatar]

Unfortunately, step 4 seems to have been skipped.

End-run around anti-discrimination statutes

[Ph33r th3 g(O)at]

Check out the loan requests at prosper.com -- lots of them include the borrower's age, ethnicity, gender, etc. either outright stated or inferable from the accompanying photographs. While Prosper as the lender of record only provides a credit grade based on an objective score from an Equifax report, the individual lenders are no doubt going to make (or not make) loans according to their own personal prejudices. The very fact that this information is available to prospective "loan buyers" (who are the actual lenders in all but name) will very quickly attract the attention of regulators.

Re:Existing Finance

[DragonWriter]

I can't imagine how this is able to compete with existing financial providers.

If you aren't completely risk-intolerant, it looks far better a place to put money than a bank for a small investor.

For a borrower, I don't see much advantage, though the terms may be slightly better. I think the lenders are what will drive its success, since having the money to lend will, itself, make it attractive to borrowers.

First of all, how many bad debts can these peers handle?

Zopa lets you limit your exposure to any given borrower to as little as 10 pounds, Prosper does something similar with a a minimum of US$50. Automated aggregation allows spreading the risk.

Unlike other successful P2P services, this model is entering a market where existing businesses are making a living out of it.

Successful P2P services have done that, too. "Buying and selling goods" is, after all, something business were making a living at (even using auction models) long before eBay.

In a sense this is an eBay system for buying and selling money, which actually can work far better since its a uniform, fungible commodity that allows spreading the risk. (Its a little bit different, since the auction service here also covers fulfillment, which isn't necessarily the case with eBay, but that's better for users, since it offloads much of the risk of dealing with a difficult person at the other end.)

Re:Amazing!

[ornil]

There's good reason why there's so much regulation of banking & finance. It used to be a free-for-all, with rampant fraud on both sides: borrowers and lenders. Do you really feel confident enough not to be fooled by fraudsters of various sorts? It's sort of like phishing, only imagine you are computer-incompetent, because I doubt your (and my, and most people's) understanding of finance is good enough to detect the more sophisticated financial fraud out there. This is like a honeypot for thieves of the worst sort, because there's no tangible goods involved anywhere, it's just money - numbers in people's accounts.

OMG!

[Ph33r th3 g(O)at]

There are already some 800 groups on Prosper ready to loan money to specific causes, such as the Apple User Group, 'a lending group for those wishing to purchase either a Macintosh or Apple iPod.'"

Yes, this is exactly the group I'd lend to -- a bunch of status-seeking wanna-be yuppies who want the cachet of conspicuously consuming an Apple product but need to borrow the money to pay for it. Uh-huh. I'm all over that.

Re:End-run around anti-discrimination statutes

[patio11]

If (and this is a *very big if*) this idea were actually doable, then you wouldn't have to worry about discrimination because peers who were non-discriminatory would be able to make boatloads of cash lending to clients who were not risky but being discriminated against by the marketplace. In the real world, if there are only 3 banks in your neighborhood and you need a home loan, but all 3 lending officers don't like you for whatever reason, you're sort of screwed. If, however, you have zillions of banking providers competing for your business then even if zillion - 1 say "We care more about discrimination than making a profit, neener neener" you only need one profit-maximizer to give you a loan.

In the real world, by the way, you see banks adopting the same strategy -- Bank of America invests boatloads of cash in getting its name out in the various Hispanic communities, which are typically underserved when it comes to banking services.

Re:Adverse Selection

[Ph33r th3 g(O)at]

The fine print on those credit card offers allows the lender to change the terms for various reasons:

• you're late on a payment with a different lender
• your credit score decreases even if you've made no late payments
• you look at funny
• they just feel like it

So while prosper.com is devoid of teaser rates, I can see why someone with good credit would choose a fixed-rate, fixed-term installment loan from there over a teaser 0% offer that could become 30+% for the cost of a lost piece of mail or one two many credit pulls when shopping for a car loan.

Re:look at numbers...

[DragonWriter]

That's kind of an apples-and-oranges comparison. Since you get the money in your account as soon as the payments come in, unless you re-issue new loans, its equivalent to withdrawing part of the interest from a bank savings account every month and letting it sit around as cash.

Yes, CDs feature automatic reinvestment, and with Prosper you have to manually reinvest. But comparing the two without comparing them at full reinvestment is not especially useful.

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[account_deleted]

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Natural evolution of loan sharks

[i am kman]

Seems pretty obvious this will rapidly devolve into supporting primarily folks with bad credit (or can't get loans from banks) who desparately need money FAST. Well, that and look for major identity theft rings.

Banks are highly regulated for a reason and offer strong protection to folks on both sides of the fence (investors and borrowers). New, completely unregulated financing options are really recipes for disaster and abuse - particularly in this day and age.

And, even though pieces of it will be very legitimate and well-intentioned, a few bad apples will bring down the whole scheme. Stay away (unless you want your kneecaps broken).

Re:Amazing!

[AuMatar]

To be honest, I know well I can trust the main banks

Study history. The ONLY reason you can ay that is because of regulations. Look back at the 30s- respected banks went out of buisness as much as anyone else.

I'm not competent to tell what banks are trustworthy. I'm not competent to tell what food won't give me botulism. I'm not competent to tell what products will do what they're supposed to and what won't. I'm not competent to understand cutting edge medicine. I may be able to pick up 1 of these, but there's a limited number of hours in the day- I need to keep up on my primary profession as well. And I'm at the high end of the intelligence curve, I'm far more capable than the average person. The average man would be completely and utterly fucked.

The government regulations are the only thing that enables me to go down to the store and have faith in my purchases. Without that, the economy falls apart. Government regulations are a good thing. Regulations on banks are a damn good thing, they ensure my life savings are safe. There's a reason why prior to regulation most people kept their money under their mattress or someplace similar- they couldn't trust banks. The world is a better place for these changes.

Re:Lock down your mailboxes

[DragonWriter]

Because identity theft is going to SKYROCKET if this catches on.

Er, why? Its certainly no easier to scam money with identity theft from this system than traditional lenders working through the mail or the net; you might convince people to give you better rates this way, but that doesn't matter if you are using identity theft to skip out on payments. I can't see any way this is more vulnerable to identity theft then traditional lending. Its certainly more vulnerable to exploiting gullibility in other ways, though the information providing by the various ratings limits the prospect of that.

I'm a lender on Prosper.com

[atlantageek]

I'm in for $2500 so far and I've had very positive experience. I've already had one loan paid back in full and all but one of 29 (15 of which has had a payment due) loans has not paid. I'm getting an average 14% return.
Prosper does a lot of the credit checks for each loan. Beyond the credit score they track current lates and 90 day lates in the last 7 years on people's credit report.
If the loan does turn out to be a deadbeat the loan gets turned over to a collection agency and Prosper handles the paperwork involved to ding the person's credit.
Prosper also allows you to spread your risk by investing small amounts(no less than $50) into lots of loans.
Why should banks be the only ones getting 10-15% returns on loans.
Lenders are also starting to form informal groups (some are invitation only) where they research the borrowers and score them for the high risk high return loans.
I'm also collecting stats at http://www.savagenumber.com./ [www.savagenumber.com]

Re:This is a disaster

[vidarh]

Yes, it's a good business model. It's called being a bank.

Re:Existing Finance

[ostehaps]

In a sense this is an eBay system for buying and selling money, which actually can work far better since its a uniform, fungible commodity that allows spreading the risk.

While money itself is a uniform commodity, that's not actually what's being bought and sold here. What's really being traded is risk, and that's nothing near a commodity. Essentially with this kind of system it seems it would be exceedingly difficult to assess the risk profile. To the extent that interest rates would be lower here (not sure why that would be the case), it just means that these individual lenders are exposing themselves to the same risk at a lower premium than the bank. In fact, for reasons of adverse selection and moral hazard they're quite likely going to expose themselves to more risk for a lower premium.

I'm really not sure about the intuition that individual lenders should be better or even equally able to assess such deals as compared to bankers, who do it for a living.

Please be careful!

[lorcha]

I checked out the site, and these were my reactions to it:

The borrowers post what they need the money for, and their stories are identical to the stories I hear every day about why a tenant's rent money is unavaiable/late/whatever. There are some people out there who actually will come up with the rent money. There are some who really intend to come up with it, and believe that they can come up with it, but are unable. There are some who never intend to pay for what they consume and are just good at making up stories. Please, please be careful!

Be sure to spread your risk across many borrowers. When (not "if") one defaults, you won't lose your entire investment.

Be careful of people who, within the last few months, just had a major financial hardship (divorce, medical problem, job loss, etc.) I'm not talking about someone who had the problem 2 years ago and has his/her life more or less back on track... but the FICO score isn't up to where it should be yet. I'm talking people who are in he midst of financial turmoil. It's very tempting to take pity on those people because they are in trouble. Just make sure you are playing with money you can afford to lose. Their FICO and D:I may look ok now, but it's possible that their defaults on their obligations haven't caught up with them yet.

Before you lend any money, please become extra familiar with what the various FICO scores mean and what the debt to income ratio means. Those are the only verified pieces of financial info that you're going to get from the site. A good credit score but high D:I is a very risky loan. Be careful.

Make sure you're getting a good rate on your loans! You can get a 10% average return with an S&P 500 Index [yahoo.com] investment. What return are you getting on your money that you're lending out, when you factor in the default rate? Remember, these loans are not FDIC insured. Credit cards are charging these folks a minimum of 18%, and credit cards are not stupid. Make sure you're getting a huge return.

Good luck! I hope it goes well for you!

Re:Similar to Angel investors vs VCs

[narcolepticjim]

Car title loans and payday loan places often get higher interest rates than loan sharks. And while I certainly don't want to hang a smiley face on loan sharks, it isn't unusual for a shark to have a regular, reliable customer for whom a lower rate is given.

The difference: our governments say it's okay for the payday/car title people to fleece people, while loan sharks (rightly) operate illegally.

Oh, and most payday loan shops won't break your hip.

Re:look at numbers...

[DragonWriter]

Assuming the amount of effort in the initial investment is the same between propser and a CD, you get better returns and better security with the CD.

I dunno. Zopa, maybe, given the rates some people have quoted from their. There seems to be little on prosper below 10% and lots up to 20%+. Even adjusting for the expected default rates in the various credit categories and the fees, Prosper allows you to realize far better returns than any CD rates I've seen quoted recently, though your personal risk tolerance may affect whether the risk is worth it. Since you can diversify automatically with no additional effort using the standing order [prosper.com] system on Prosper, I don't see much justification for the claim that "you have to spend more time diversifying with prosper" to get "low returns".

To invest $1000 into either of the above banks, you simply send in a deposit. To invest $1000 into prosper, you have to diversify to spread your risk. So, maybe you break it up into $100 chunks. Now you have to find 10 people who you want to lend the money to.

Or you have to set up a standing order based on credit grade and other criteria, splitting it into as small as $50 chunks without about the same amount of work as making one manual bid. Nothing restricts you to making only manual bids on Prosper.