[Editor’s note: This is a guest post from Michael and Connie Erlanger, co-founders of Marketcore.com. For the full byline see the end of this article.]
Reports of potential systemic vulnerabilities in loan markets are appearing with increasing frequency in both the mainstream and the trade press. These reports do not bode well for the lending industry (or the financial sector) in general. At the same time, speakers at marketplace lending (MPL) industry events have discussed the need for an expanded spectrum of services and an associated increased volume of borrowers and investors. In particular, at every conference we’ve attended, numerous participants have cited the need for a viable secondary market to provide the liquidity of the underlying assets that will power continued growth in MPL.
Sustainable liquidity is a fundamental and complex issue for any marketplace, most particularly a new one. Exit strategies for investors are as critical for continued market growth as are both efficient pricing and execution. The absence of a functioning secondary market directly, and adversely impacts originations.
We have all seen the devastating results of illiquidity in loan markets before. In the 1990’s there was tremendous product demand in the mortgage market but, because of inconsistent process and workflow standards across loan originators, transactions in the secondary market had an extraordinarily high rate of “failure-to-close,” especially in the secondary market for whole loans (as high as 85%).
When principals to transactions did not want to share their underwriting standards or make warranted risk-detailing disclosures, market makers responded by creating novel and often opaque products, such as increasingly complex securitizations, derivatives, alternative loan structures and tools with which lenders and investors could purportedly “bucketize” and/or hedge their risks. However, simply pooling risks (viz. subprime mortgage securitizations) proved faulty, as became apparent with the failure of critical market sectors. The resulting viral loss of confidence led to the ensuing global credit crisis.