Capital Markets in the Information Age: P2P Lending

The information age has been bring about changes in the capital markets, I earlier showed crowd funding, now comes a variant, P2P lending

Writes Alex Daley at the Casey Research

It's a new idea but is based on the familiar technologies of the Internet; it's known as peer-to-peer (P2P) lending. The premise is simple: cut the bankers out of the loan market and keep the difference for yourself by making loans directly to other consumers.

I know, that sounds rather risky. When I see my neighbor pull up in his driveway with a shiny new car that I can guarantee costs more than his annual salary, the idea of loaning money directly to other consumers seems a little crazy. However, that's where the real innovation lies. With peer-to-peer lending, an individual investor doesn't make a single $10,000 loan. Instead, he can buy 400 different loans, taking only $25 of risk per loan, for example. Services that offer this option pull together large numbers of investors, who each take a small slice of large numbers of loans, thereby distributing risk much like an index fund. The result is usually a steady and expected rate of return after fees and defaults.

And there are plenty of defaults. Consumer credit is a risky space, after all. With peer-to-peer lending one can choose among unsecured loans only. However, despite what you may have gathered from your last attempts to find a parking space at Home Depot on a Saturday, the majority of people are good. And those good people have a tendency to pay back their loans. As an investor, these P2P services allow you to pick loans by risk category. Credit scores, debt-to-income ratios, income verification, and all the familiar tools of the professional lender are there, allowing you to make decisions about what kind of loans to buy and which to avoid.

This allows individual investors to tailor a portfolio to their own risk tolerance. Whether selecting all the individual loans by hand, or using the bulk investing tools each of the suppliers provide, a portfolio can be built in a variety of ways: from only investing in "A" grade loans with single-digit interest rates and predictably low defaults, to debt-consolidation loans for consumers with much lower credit scores, paying much higher interest but coming with significantly higher defaults as well, and everything in between.

Read more here

The above represents changes in the investment sphere (perhaps some of these companies will be publicly listed someday), as well as, changes in the social dimensions which should impact the political economy: The growth of P2P lending and Crowd Funding will eventually reach a tipping point where it will be seen or becomes a threat to the establishment. And that threat will be met with a feedback mechanism: response-counter response feedback by political authorities and the markets.

Nonetheless the internet has been providing the platform to expedite dramatic and rapid innovation based transformations.