Welcome to the end of the week! Just sit back, relax, and enjoy this weeks roundup in another edition of Happy Hour.
Bloomberg did a piece on the future of the finance industry that’s worth reading. In it, they interviewed Marc Andreessen on the potential for disruption in the finance industry. I won’t argue against the possibilities. We already see it with low-cost index funds,robo-advisors, and peer-to-peer lending. The finance industry is ripe for change and these are very early days.
Though, I’m not convinced P2P lending is the disruption it was meant to be. Who really wins?
No doubt, the timing of the popularity of peer-to-peer lending is no coincidence. When you lose a ton of money in an investment, lets say stocks, the typical response is to avoid stocks like the plague. Combine that with low interest rates and P2P had a recipe for success.
Success doesn’t equal a good idea especially in an industry with little regulation that’s only been around a few years. I won’t say P2P is wrong. In the wrong hands, like any risky investment, it’s dangerous. Go back to any debt crisis to understand why.
- The interest rates are high for a reason. There’s no collateral – unlike the housing crisis and the S&L crisis before that, at least the lenders got something back with the loan default. And the banks knew the government had their back. Somehow I don’t see the government bailing out P2P lenders.
- Only you, the lender, have everything to lose since there’s no collateral. Your earnings are limited by the interest rate while your losses can be 100%. That’s backwards. It’s also why asset allocations typically view the fixed income (bond) portion of a portfolio as less risky.
- Humans have a history of doing dumb things with debt. If the financial crisis taught us anything it’s that borrowers were part of the problem. People bought too much house, borrowed too much money, and lied on loan forms. This will never change.
- When dumb things happen, selling the loan will be a terrible option. As a lender, your money is tied up for the length of the loan. Your ability to sell out early is entirely based on some other sucker buying it. Nobody will buy a defaulted loan at full price. Yes, you can diversify across hundreds of loans. Except, a basket of very risky loans don’t become less risky because you own more. Again, look at the financial crisis for inspiration on what happens when the buyers dry up.
- The lending intermediaries use the same tactics as payday loan and credit card companies to bring in a steady flow of borrowers. Both types of companies get knocked for taking advantage of borrowers. Yet, credit card and payday companies get a much higher interest rate than any P2P lender ever will. Who’s really being taken advantage of with P2P lending- the borrower or the lender?
- If banks won’t take on the risk of the loan, why should you. What does average joe money-lender know that the banks don’t? Not much. Payday lenders, credit card companies, or loan sharks have a better grasp of the risks and get compensated for it.
Simply, can you trust other people to continue paying all their bills when times get tough? Given the choice between feeding the family, keeping the heat and lights on, credit card bills, mortgage/rent, or paying that P2P loan, which do you think comes first? What happens when the economy slows down or goes south? History tells us default rates increase and lenders lose. Like every other high return investment, it’s great until you lose money.
An argument can be made that it helps the payday loan and credit card industries by weeding out the higher risk borrowers. The worst offenders simply transfer their debt and risk to P2P lenders and pay a lower rate in return. Yes, P2P lending might be a disruption but for who? There’s a reason costs and rates are high for financial companies that lend money. Due diligence pays off.
- The World’s Greatest Stock Picker? Bet You Sold Apple and Google a Long Time Ago – Ritholtz
- Diversification Sucks – BasonAsset
- Global Diversification: Accepting Good Enough to Avoid Terrible – Wealth of Common Sense
- The Problem With Long-Term Thinking – M. Housel
- Real Estate Investing Offers Only One Likely Outcome: a Low Return- NY Times