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Monday
May042009

Counterpoint: Prosper is Back…But is this innovation wise?

As we profiled yesterday, Prosper, the former industry leader of the p2p lending industry, continued to innovate and evolve during its forced “quiet period” in anticipation of its re-launch. In addition to offering traditional p2p loans, Prosper has now introduced its Open Market Initiative, which will allow other financial institutions to place their already funded loans on our site for auction. In his blog post, CEO Chris Larsen makes the argument that more opening up these loans to greater competition will lead to better rates.

That may be so, but I have a number of concerns about this model. First, I’m concerned about these lenders unloading their bad loans on the site. Prosper suffered some early challenges regarding poor repayment rates and I’m surprised to see them immediately target a less-than-prime space right at re-launch. Additionally, are retail investors really prepared to evaluate these loans effectively? Many of Prosper’s early lenders struggled to effectively diversify their p2p loan portfolio, explaining some of the initial losses reported. I see no reason to believe that they will be able to price more complicated small business, car, and consumer loans.

Finally, Prosper seems to be encouraging lenders to make financial decisions from the heart. From Mr. Larsen:

“...auto loans listed on the Open Market will show in which auto plant and city the car was made. That way fellow Americans who put a value on American jobs might make loans to cars made in Ohio, for example, at a better rate than loans to cars made in Germany.”

This structure introduces a level of transparency that we have not seen in loans before and it sounds great from a social entrepreneurship perspective. But is it wise from a personal financial decision-making perspective? Just as it may be dangerous to fund borrowers based on how they look (recall the recent study on how Prosper lenders gave more money to faces that looked “trustworthy”), it is risky to fund companies based on values. If your primary motive is gaining a healthy return, then whether you “like” the individuals or companies’ practices should be a non-factor. If your motive is to provide social value, then perhaps you would be better off funding a loan through Kiva.

I do agree with the sentiments of Mr. Larsen, however, that “the crisis is painful but is also a once in a lifetime opportunity to rewire finance in a way that is fundamentally more transparent, more participatory and more durable.” I’m glad to see Prosper back online and running. I’m really glad that it’s been able to start passing the onerous regulatory hurdles. Best of luck to the site in its second incarnation.

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Reader Comments (2)

re: "it is risky to fund companies based on values". True to the extent that theses values do not generate positive social returns that are externalities not captured in private returns, and to the extent that values-less investment generate negative social returns that are not captured in private returns but socialized to the taxpayers of one or more countries.

If one expects the values he/she invests on to be emerging ones that will grow to the point where legislators will have to modify accounting/tax laws in way that favors these values, it may not be a bad long-term investment.

May 6, 2009 | Unregistered CommenterGuillaume Lebleu

Guillaume,

Very interesting point. I think you're right, but it's a dangerous path to be constantly guessing what the government will choose to value in the future rather than evaluating what has value in its it own right. That may just be a sad reality of the current economic climate.

May 16, 2009 | Registered CommenterMelody
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