Monday, May 22, 2006

Massive multiplayer online lending

Salon has an article (that you might have to watch an ad to read) about a fascinating new trend in money lending -- what it calls "P2P lending". Sites like Prosper and Zopa allow borrowers to post appeals to potential lenders, who group together with individual loans of $100 or so if they trust the borrower to make good. This way, lenders get excellent interest rates and distribute the impact of defaults, which are (so far) surprisingly few.

One thing the article discusses is how Prosper encourages users to form official borrowing groups whose members vouch for each other. Groups compete with catchy names and themes, from volunteer firefighters to Columbia University graduates. The groups do actually improve the economics of the lending system, by pre-screening members and developing reputations based on members' default rates, but I bet their real function is to create mild social networking seems to draw in users and make the site feel like a community where a significant number of other users is always present.

From the article:

Many of the lenders on Prosper, for instance, know almost nothing about BusyLady52, not even her name (which she asked me not to publish). What they do know about her (a middling credit score, a couple of current delinquencies) is the sort of thing that would render her ineligible for a traditional loan. Yet lenders saw in her story some spark of genuine responsibility, a possibility that she'd do well if given a chance. More than 50 people got together to give her a total of $5,000 at a 16 percent rate. She now says she's determined to set her money straight again, if only to prove herself to those who invested in her.
Often, though, borrowers will argue that these numbers don't tell the whole story. Sometimes, they have a point. If I told you about Person X, who had a credit rating of H.R. -- "high risk," the lowest rating -- a string of recent delinquencies, and a 20 percent debt-to-income ratio, you'd probably conclude that she was heading straight to bankruptcy. Lending this person money would be about as profitable as throwing it into a fountain and waiting for your wish to come true. But what if I also told you that this person, Suzy, had accumulated her debt while she was studying at Harvard Law School? And what if I mentioned that she had just graduated with honors, and had accepted a job at a Manhattan firm with a starting salary of $140,000 a year? She only needs a loan to tide her over until she starts work. Now I tell you that she's willing to pay a 20 percent interest rate on your money. Would you take a risk on her now?

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