World
Sad consequence of easy money policies

The real problem with present day peer-to-peer or P2P lending is, several times, lenders are clueless about financial health of the borrower. This is because the information used by the P2P lenders comes from the borrowers and can be inaccurate or intentionally false

Peer-to-peer (P2P) lending is the practice of lending money to unrelated individuals directly without the need or expense of a traditional intermediary such as a bank. It is supposed to be one of the newest and most innovated business models of the social network era. Actually, it is nothing of the sort. P2P lending is very old. It is exists in many countries. But there is one major difference. The older variety is far safer for one reason: information.
 

The old names for P2P lending differ by country. In Vietnam they are called hui (associations). The Koreans call them keh (contracts). The Chinese refer to them as biaohui and they have been around for centuries. The Caribbean community in the US calls them su-su (among us or savings). Mexican Americans call them tandas (turns) and they are also widely used in Ghana.
 

They all operate on the same principal: a group of unrelated individuals get together and agree to pool their capital. Then one member of the group gets to borrow a sum agreed upon by the group. How the borrower is chosen varies from country to country. Some do it by lot. Others take turns. Some present business plans.
 

These P2P group lending clubs work for two reasons. First, they are small; all the members know each other. They all have a large incentive to get as much information about the borrower as possible and then keep tabs on them until the loan is paid off. So they have excellent information. Second, they are at some level—social institutions. So like a lot of micro lending programs, the group is collectively responsible. There are enormous social pressures to make sure the loans are repaid. Legal recourse is basically unnecessary. These two factors are not available to the modern online P2P platforms.
 

Nevertheless, these P2P businesses have mushroomed. The largest in the US are LendingClub and Prosper. Both have experienced triple digit growth. In 2013, LendingClub originated $2 billion worth of loans, while Prosper made $350 million. The process is quite simple. Borrowers make loan requests of between $2,000 and $35,000. Lenders, both ordinary retail investors and large institutional lenders can select which requests they want to fulfil. They can take fractional parts of loans or the whole loan.
 

The real problem with P2P lending is the extent to which lenders have information about the financial health of the borrowers. In the US, most borrowing depends on your credit score (called a FICO score). These scores range from a perfect score of 850 down to a miserable 300. Average credit is considered a score of 620 to 679. Scores below 580 mean higher interest rates and a score below 500 mean no credit at all. In addition to FICO scores, the P2P companies have their own proprietary systems for determining credit. Minimum scores for lending on LendingClub are 660 and Prosper is 640. Interest rates vary from 6% to 35%, both quite high in a lending environment where prime is presently at 3.25%. So for lenders it seems ideal way to get double-digit returns in relative safety. Generally FICO scores are a good indicator of credit.
 

But there is a catch. People sometimes lie. The information used by the P2P lenders comes from the borrowers and can be inaccurate or intentionally false. LendingClub states that it cannot verify income for 40% of its sample borrowers. For those borrowers who were asked to verify their incomes only 60% provided satisfactory responses. Of the rest, 10% withdrew their applications and 30% either failed to respond or provided information that failed to prove their stated income.
 

There are other risks that we should have learned from the crash six years ago. Double digit interest rates in a lightly regulated industry should be approached with extreme caution. A 15% interest rate should be a major red flag that you may loose your entire investment. P2P loan rates look good because of their short history during a time of unprecedented easy money. P2P lenders also use proprietary ‘black box’ programs to determine a borrower’s credit. A lender who advertises that they can approve a loan in minutes should be suspect. Lenders do not have any ‘skin in the game’. They just put borrowers and lenders together and then collect fees. Their incentives are quite distinct from investors just like subprime originators before 2008.
 

But just like 2008, Wall Street is now in on the action in a big way. The P2P portfolios are now being securitised. The deals are only in the tens or hundred million range, but if the search for yield continues, they will grow.
 

The business model has become popular all over the world. The UK has three major one, Zopa, Ratesetter and Funding Circle. These sites have expanded despite the fact that two Dutch sites and one UK site failed after they piled up large bad debts. Sites have also struggled in Spain, Italy and Friends Clear in France was forced to close. But the risks have not stopped the creation of sites in countries as different as Estonia, Korea, Japan and India.
 

The risks rise in countries as regulation falls. This is especially true of emerging markets. China is a perfect example. Many of the P2P lenders that started in the last few years as a $4.4 billion part of the massive $6 trillion shadow banking industry have closed. The largest firms are still active, but there is trouble ahead. There are about 1,000 P2P companies in China providing investors with an average return of 19.7%. Obviously too good to be true! Because 58 of those firms, went bankrupt in the final quarter of 2013. It is estimated that 80 to 90% of the firms will go under as the Chinese central bank tightens rates.
 

The reason for the problems in China is obvious, bad information. In game theory, borrower’s incentive is simple. Don’t pay the lender back. In the original P2P lending societies, lenders got around this problem by having a long term and direct relationship with the borrower. It is this type of relationship that also made lending by smaller local US banks so successful. But these close relationships and the local banks are a thing of the past. The knowledge they gained about their borrowers will be sorely missed as the credit cycle turns. The supposed disrupting influence of P2P may only be disrupting to the lenders’ pocketbooks.

 

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first-hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages.)

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COMMENTS

Candace Klein

3 years ago

Thank you for the thoughtful article, William. I'm reposting a blog post about it this week. I fear that this may be a bit too simplistic of a view of P2P underwriting processes, and would love to discuss a potential follow up. Let me know if you'd like to talk! -Candace

Debt investment made easy: Moneylife Foundation Fixed Income Seminar

Moneylife Foundation held an exclusive, in-depth session which delved into different regulated options for fixed income investments. Avoid unregulated schemes even if they offer lucrative returns. More money has been lost chasing higher yield. What are the warning signs?

Moneylife Foundation hosted its 196th seminar with the event titled “Understanding Fixed Income Securities. High Returns, Safe Capital” conducted by Debashis Basu, editor, Moneylife and Raj Pradhan, columnist at Moneylife, who writes on insurance, taxation and fixed income products. Mr Basu explained the different types of fixed income products available and the returns one can expect. He also explained how much should allocate to different investments of equity and debt based on your age. Post retirement investment options were also discussed.
 

Mr Pradhan gave insights to the audience on different investment options to benefit from high rates regime. One can choose from fixed-deposits (FD) of banks, corporate bonds/non-convertible debentures, tax-free bonds, fixed maturity plans (FMP) of mutual funds and G-Secs. Reserve Bank of India’s (RBI) Inflation Index Bonds (IIB) may not have fixed returns, but is a new entrant worth considering for retirement savings instead of relying on bank FD. RBI should consider coming up with non-cumulative IIB as it will help senior citizens who rely on steady income from investments. With IIB, you have an option for getting returns beating inflation without any risk of capital. The taxation is still a sore point. 
 

There finally seems to be some respite in the economy with the retail inflation for the month of December 2013, as measured by the consumer price index (CPI), sliding to 9.87% from its previous level of 11.24% in November. With hopes of RBI cutting repo rate possibly after couple of months, there is possibility of bond yields softening. Will you be able to make capital gains with taxable and tax-free bonds purchased today? If so, what are your options for taxable and tax-free bonds in primary and secondary market? How will you evaluate the different debt investment options you have today?
 

For those in 20% and especially 30% tax bracket, an excellent option is tax-free bonds from government companies. You have an option for long-term investment as the bond terms are 10, 15 and 20 years. It helps with mitigation of reinvestment risks. Getting a near 9% pa tax free returns without reinvestment risk for 20 years from AAA rated government companies should definitely be scooped by savers for their debt instrument portfolio.
 

FMP has a great tax advantage, but you need to choose carefully. Choose FMPs with high-rated securities investment. Make sure you don’t need the money in the interim. Assume that your investment will be illiquid till the FMP matures. G-secs are rarely explored as an investment option by retail investors, due to numerous reasons. The current scenario of the bond market, however, offers a unique opportunity to savers to add G-secs to their portfolio. The good news is that you have the option to buy G-secs and get it added to your regular demat account, which holds other asset classes like equities/bonds.
 

Mr Basu explained how over different age groups from 21 to 60 years, one can invest in a mix of equity and fixed income products. Stocks and equity funds over the long run of 5-10 years have more often than not beaten inflation. Other products like scheduled commercial bank FDs and other fixed income products may not deliver high returns but offer safety of capital.
 

For those who have retired, Mr Basu advised the audience to create a two-part portfolio. One, containing 60% of the total corpus to be invested in fixed income securities such as bank and corporate fixed deposits and bonds to garner safety for the portfolio. And the second, containing 40% of the total corpus should be invested in safe equity mutual funds, which would work towards beating inflation.  
 

For the fixed income part, The different investment options needs to be evaluated for parameters such as safety, ease of investment, returns, liquidity, interest payment options and suitability based on your tax bracket. Each investment option was discussed in detail for its advantages and disadvantages. You can’t get best of everything in one instrument and hence there are good reasons to understand all the options and allocate your money in different options based on your risk appetite.

 

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Sunanda’s death 'sudden, unnatural', say doctors from AIIMS

Injury marks were also found on the body Sunanda Pushkar, who was last night found dead under mysterious circumstances

Doctors, who conducted an autopsy on the body of Sunanda Pushkar at AIIMS, on Saturday said it was a case of 'sudden, unnatural death'. They however, ruled out poisoning even as police investigated various angles into the death of Union Minister Shashi Tharoor’s wife.

 

Injury marks were also found on the body of 52-year-old Pushkar, who was last night found dead under mysterious circumstances in the luxury Leela Palace hotel in South Delhi.

 

The head of the three-member panel of doctors that conducted the autopsy on Pushkar, said, “We have conducted the post-mortem examination... It is a case of sudden, unnatural death” but ruled out poisoning.

 

However, he said the team has preserved certain “biological samples for toxicological analysis as well as visco-pathological examination.”

 

“We have completed the whole procedure. Samples for toxicological analysis means ruling out any poison. Some pathology of the heart has been preserved by us,” he said.

 

Pushkar was found dead in her suite at the hotel and the body was shifted to AIIMS at around 3:30am for post-mortem.

 

The police is also expected to record the statement of Tharoor, who was admitted to AIIMS following complaints of chest pain and was discharged later.

 

Pushkar and Tharoor were at the centre of a raging controversy when reports emerged that she was upset over reported text and tweet messages between her husband and Mehr Tarar, a Pakistani journalist.

 

Gupta, who is Head of the Forensic Sciences Department at AIIMS, said the autopsy report would focus on investigating from a medical angle the sudden unnatural death.

 

He said the final autopsy report will be prepared within the next couple of days after receiving reports of toxicological analysis and visco-pathological examination.

 

“After receiving all these reports in the next couple of days, we will finalise the post-mortem report and we will give our opinion in the case,” he said.

 

When asked about the injuries on the body, he refused to give details saying as police was working on the case, certain issues cannot be revealed.

 

“There were certain injuries on the body. I cannot reveal the details of the injury. Basically in medico-legal cases, the number of injuries does not matter. Whether these injuries were related to fatality or not matters,” he said.

 

Asked whether the injury caused death, he refused to give a direct answer.

 

Pushkar and Tharoor had checked into the hotel on Thursday as their home was being painted.

 

A joint statement from the couple on Thursday said they were “happily married” but distressed by “some unauthorised tweets”.

 

Pushkar had accused Tarar of “stalking” her husband and trying to “break” her marriage when she was away for medical treatment.

 

She had told a couple of newspapers that she was considering divorce from Tharoor in the wake of the alleged extra-marital affair.

 

The Pakistani journalist rubbished the charges of having any relationship with Tharoor.

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COMMENTS

MOHAN

3 years ago

Kairali News:

Suanda's death is similar to the death of Bob Woolmer

Bob Woolmer :

http://en.wikipedia.org/wiki/Bob_Woolmer

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