In Saturday’s New York Times, columnist Ron Lieber penned an article in his regular Your Money column titled, The Gamble of Peer-to-Peer Lending. While in some ways it wasn’t a bad article, it did make assertions that peer to peer lending was akin to “a new type of casino game in Vegas.” But within two days of writing the article Lieber’s chief concerns have been proven to be unfounded.
The Unverified Income Question
One of the key questions that concerned Lieber had already been answered by the end of day Monday by Felix Salmon, the finance blogger for Reuters. Lieber was concerned that Lending Club verifies income on only 60% of the loans on their platform. He wondered about the other 40% and thought the whole thing “doesn’t smell quite right.” But rather than do some digging to find out why he just left the question hanging. Felix Salmon did some digging for him in a follow-up post on Sunday. He pointed out that the underwriting system likely only raised a flag 60% of the time and so those loans were the ones that were investigated. But the big question was this: how do the performance of the 60% income verified loans compare with the 40% unverified loans. He reported his findings in a second blog post on Monday night.
To be fair, it is completely valid for Lieber to question the performance of these unverified loans. I, as well as some of my readers, have wondered that very same thing. Now, it appears we have an unequivocal answer from Lending Club. Loans with unverified income are actually performing slightly better than loans with verified income, according to CEO Renaud Laplanche. Salmon confirms a loss rate of 2.8% versus 2.7% on loans that are at least one year old. How can this be? Laplanche explains that it is only the very best borrowers whose loans are not verified for income; the reason being that you want to make the borrowing process as easy as possible for these people because they can easily obtain funding elsewhere.
Why Peer to Peer Lending Isn’t Gambling
The biggest error in judgment that Lieber had in the article, in my opinion, is equating peer to peer lending with gambling. This was only a small part of the article and it was a shame (and even somewhat misleading) that it made it into the article title. But newspapers like to stir controversy I guess, which was probably the reason for the choice of title.
I think in the early days of peer to peer lending it was a little more like gambling in that more investors lost money than made money. But since both companies reopened after their quiet periods returns have been much better and defaults have gone down dramatically. But don’t take my word for it. Use a third party statistics site like Lendstats.com to investigate. If you compare loans made before 2009 to loans made in 2009 and later you will see a dramatic improvement in loan performance for both Lending Club and Prosper. Lieber is still stuck in in his pre-2009 view of Lending Club and Prosper.
My own experience backs up this data. I have four different accounts total at Lending Club and Prosper. I have one Lending Club account that is now 19 months old and despite several defaults my total investment has increased every month since I started (except for one month that I explained in my Biggest Mistake in Peer to Peer Lending post). Two of my accounts use the automated plans offered by Lending Club, so I am not doing anything special to generate above average returns with these accounts and still they go up in total value every month. I certainly wish I could say the same for my portfolio of stocks and bonds.
The Article Was a Net Positive I Believe
The biggest challenge that p2p lending has is one of overcoming ignorance. If every investor and borrower in America was even partially informed about the concept of p2p lending it would become a multi-billion industry overnight. What this article does is reduce that ignorance (in an imperfect way), and for those people who are inclined to explore alternative investments it provides some interesting tidbits.
Sure Chris Larsen, CEO at Prosper, and Laplanche of Lending Club probably hated the gambling references in the article, but the Lieber article wasn’t all negative. Far from it. He explained the rationale for borrowers paying high interest rates on their credit card seeking out p2p lending. From the investor side he noted the large number of million dollar accounts at Lending Club and he stated that p2p lending now “is precisely the sort of uncertain situation that experienced investors with a high risk tolerance can capitalize on.”
It would have been nice if Lieber had done a little more homework in this article but regardless of that I am happy he published it. It gave the millions of people who read the NY Times, either in print or online, a little taste of p2p lending. With both Lending Club and Prosper looking to grow rapidly this year, an introduction to p2p lending in a widely read publication can only increase awareness for both companies which is certainly needed to help drive that growth.