It began here with this post at Zopa.

The problem is that unlike so many other far healthier industries, the banks have no effective competition. Microsoft is kept in check by Apple and increasingly Google. Warner, EMI and Sony are battling it out with the digital download phenomena. Tesco has to watch out for Sainsburys, M&S and Waitrose. Even the BBC has to keep something of an eye on ITV and Channel 4.

Banks don’t have the self-righting mechanism of genuine competition. It’s become a cosy club where customers are simply the supplier of money for banks to punt in their casino operations, politely called ‘investment banking’

Then James ex of Lloyds kicked in at Bankervision.

If Zopa were to have a material effect on bank lending, and its competitive differentiation is price, it will not win. It does not have pockets deep enough to win a price war with a major bank, let along the whole market. This much is simple market forces at play. The only reason this isn’t happening now is that, as Martin says, Zopa is not having a material effect on the market at present.

Then ‘always up for an argument’ Chris Skinner ratcheted up the volume here. [disclaimer - I am 100% with Chris on this one]

The real point is that, assuming there is a need for these new businesses which I believe there is, the only thing that undermines their business model is access to ongoing capital to get to the point of success. This is the challenge of any new business, and this is the real challenge to these new entrants: can they fund the business long enough to be successful?

Luckily there are plenty of financers out there who do believe in these new businesses however to fund them through their fledgling beginnings, including Red McCoombs for SmartyPig and Zopa’s investors range from Bessemer Venture Partners and Balderton Capital to the Rowland Family.

Even so, in Zopa’s case where they are creating a new market in P2P lending, the issue and challenge has always been getting enough people placing money into Zopa to enable them to meet the demands of those who want to borrow. Without funders, there is no marketplace.

So the challenge is to maintain investment and manage operating costs long enough during this start-up phase to get to the tipping point of growth. And, based upon a 40% increase in total loans just in the last year, maybe that tipping point has finally arrived.

And now the debate has made the FT blog …

But what we at Money Matters want to know is whether UK individuals who have used Zopa have got a good deal. At the start of the year, Matthew Vincent wrote a piece about a new online auction site for fixed-term deposits – and although he found that online lending exchanges such as Zopa were offering higher rates of interest, he suggested that these rates could come down as the number of lenders using Zopa increased.

… and the House of Commons through Tom Watson MP blog.

I wrote to the Chancellor in front of me but essentially I suggested three things:

1. Change the tax regime so that people who make loans – investors – can aggregate their total ‘wins’ and ‘losses’ for the purposes of tax. So, if you make 10 loans and nine of them fail, you should be allowed to offset them again the tenth loan that made you money.
2. Consider allowing people to use P2P within their ISA allowances.
3. Bring P2P within the remit of the small loans guarantee scheme. It is this area that I think could have a great impact in the small business sector. If people are prepared to bet their own cash on a business, then they are likely to conduct as much, if not more due diligence on the company as any bank. And when the banks make silly, greedy, short term risk averse decisions, groups of small private investors can step in.

Relevance to Bankwatch:
Thats a lot of debate for something that doesn’t matter.

[another disclaimer; I am involved with CommunityLend in Canada, a P2P Lending company]

LendingClub

53% growth in quarterly loan originations, from $5,374,850 in Q4 2008 to $8,239,950 in Q1 2009

From January 1st  to May 31st 2009:

• 60% growth in total loans issued by Lending Club, from $25M to $40M
• 70% growth in total Lending Club membership from 82,000 to 140,000
• 72% growth in loan applications, from $212M to $365M
• The average net annualized return earned by Lending Club investors grew from 9.05% as of December 18, 2008 (as reported by analyst firm Javelin Research) to 9.73% as of May 31, 2009

Kim came up with the idea several years ago while at business school and left PNC to form the company.  He brought a dual focus on getting the regulatory package right alongside a smooth and simple customer experience.  He recognised the need for more simplicity and borrower concerns on privacy, and tried to incorporate solutions to those concerns in the Pertuity Direct model.

Borrowers enter the process and are guided through to having their loan approved.  Kim says the target audience of young tech savvy people will find an intuitive and straightforward design.  Pertuity Direct under the guidance of their own Chief Risk Officer conduct loan underwriting following their own credit policies, approve the loan and allocate the interest rate.  In this model the lender is Pertuity Direct.

On the lender side their are funds set up as separate organisations, regulated under the Investment Company Act of 1940.    There are two funds with one dealing with loans of FICO 660 – 720, while the other is 720 and above.  From the conversation I took it that there is a clear focus on prime borrowers and risk management.  The loans are bundled and sold to the funds who then sell units to investors.  Charlie pointed out that there is no restriction or qualification required on the investors who purchase those units, which differentiates Pertuity from the Lending Club model, and possibly from the Prosper model (Prosper is not approved as yet).  The responsibility of the trustees is fiduciary responsibility to purchasers of units in the fund.

Clearly the credit policy and FICO cut offs are designed to minimise risk, but in the event of collections, standard practices are followed by Pertuity Direct.

They expect the customer base will be types that would be comfortable shopping online, probably use etrade or Schwabb, and broadly fall in the self directed category of individual investor.

Kim’s views the market opportunity as large.  He sees Pertuity Direct as the ideal hybrid between Capital Markets, traditional lenders and P2P lenders, bringing a scalable lower cost platform that institutionalises the lending /P2P process.  It also brings the social aspect by introducing Pertuity Bucks that lenders can allocate to borrowers, and which reduce the borrowers costs. 

He describes this opportunity as a “game changer” bringing a “next generation social lending platform, that allows borrowers and lenders to come together in a community environment, but with the backing of traditional financial services practices”.

The company is described as “well capitalised” and licensed to operate in 35 states.

I came away from this conversation impressed with the grasp of their market and of their opportunity.  Their approach to the securities issues that surround P2P Lending is unique in the marketplace.  I follow banking and P2P lending closely professionally through this blog, and Pertuity Direct appear to have a model that is differentiated.

______________________________________________

In conducting this interview, I spoke with:

Kim Muhota, CEO & Founder

Lisa Lough, SVP Marketing

Charles A. Schliebs, Independent Board Member, National Retail Fund

As the founder, Kim has a solid background in financial services having been with PNC Bank in various positions including Line of Business Head, Strategy & M&A. 

Lisa has been with Pertuity since July and brings a background of marketing from etrade financial, CapitalOne, and MCI Worldcom. 

Charlie is one of the Independent Trustees of the National Retail Funds and brings experience as an international Securities Lawyer, and VC experience.

[disclosure:  I have an interest in CommunityLend a social lending company in Canada]

Beyond the age of leverage: new banks must arise | ft.com

Call it the Great Repression. The reality being repressed is that the western world is suffering a crisis of excessive indebtedness. Many governments are too highly leveraged, as are many corporations. More importantly, households are groaning under unprecedented debt burdens. Worst of all are the banks. The best evidence that we are in denial about this is the widespread belief that the crisis can be overcome by creating yet more debt.

He goes on to offer specific ideas on how the great deleveraging could manifest:

• bank debt write offs with terms designed to give banks time to sort themselves out within a fixed time – he proposes 10 years.

“There are precedents for such drastic action, notably the response to the Swedish banking crisis of the early 1990s. The critical point is to avoid the nightmare of a state-dominated financial sector. The last thing America needs is to have all its banks run like the rail company Amtrak or, worse, the Internal Revenue Service. State life-support for moribund dinosaur banks is an expedient designed to avert the disaster of a generalised banking extinction not a belated victory for socialism. It should not and must not impede the formation of new banks by the private sector. So recapitalisation must be a once-only event, with no enduring government guarantees or subsidies. There should be a clear timetable for “reprivatisation” within, say, 10 years.”

• “The second step we need to take is a generalised conversion of American mortgages to lower interest rates and longer maturities.”  He goes on to highlight systemic changes to debt and terms of debt contracts over the last 150 years that were used as vehicles to bring the economy back in line.

Point for economists and Keynes.  Ferguson says:

Today’s born-again Keynesians seem to have forgotten that their prescription of a deficit-financed fiscal stimulus stood the best chance of working in a more or less closed economy. But this is a globalised world, where unco-ordinated profligacy by national governments is more likely to generate bond market and currency market volatility than a return to growth.

Relevance to Bankwatch:

All in all another thoughtful piece directed at broad based solutions that deleverage the world.  His argument that the approach of all world governments to borrow and create government based stimulus is not directed at the problem crisis symptoms, and sounds common sense.  When asset values have collapsed in the world by 40 – 50% and debt remained unchanged, how is more debt a solution?

It strikes me there is an opportunity here for banks’ to consider new and innovative products that alter terms, conditions and rates of existing debt that relieves pressure as suggested in Fergusons 2nd point above.  I would add that not just ‘New banks must arise” per Ferguson’s title, but that financial alternatives must arise too.

S-1/A

At first glance it is similar to the first one, but includes a primary (loans originated on Prosper) and a secondary market (lenders seeking liquidity of earlier investments)

We will issue the Notes in series. Each series will correspond to a single consumer loan originated through our person-to-person online credit auction platform or a previously-funded single consumer loan offered for sale on our platform by one of our financial institution members. In this prospectus, we refer to these consumer loans generally as “borrower loans” and we refer to previously-funded consumer loans listed on our platform by one of our financial institution members as “previously-funded loans.” We refer to the borrower loan upon which a series of Notes is dependent for payment as the “corresponding borrower loan” for the series.

Loanio suspends operations

Prosper in violation of SEC; Loanio to halt operations

I would take a different view [disclaimer;  I am active with CommunityLend, a social lending company in Canada].

Social Lending / P2P lending is a disruptive influence to traditional financial services and that is a good thing.  Disruption infrequently comes from within – existing participants within an industry have little incentive or desire to promote radical change.  Such change can only introduce new risk and different results that will cannibalize their current state, and shareholders will no likely understand that either.  The better approach is to make tweaks to the status quo.

“You never change things by fighting the existing reality.  To change something, build a new model that makes the existing model obsolete” – Buckminster Fuller.

Having said that, there is little doubt that the world of financial services requires innovation, and people are expecting that.  People (consumers)also have a certain tolerance for risk associated with their financial services.  It is their money, and while risk tolerances vary amongst people, there is a range of high and low risk acceptance that accommodates all rational people. 

Social lending was produced by the confluence of technology capability, and peoples readiness to adapt and adopt new tools.  Within the industry there has been constant debate about the degree of regulation, and even the nature of regulation that ought to apply, or not. 

If we return to the disruption theme, would a rational person expect industry disruption to include elimination of regulation that is designed to protect people and ensure the appropriate risks are identified and understood?

Web 2.0 meets reality:

Web 2.0 has had something of a free ride to date, and that has been discussed at length.  All the talk of business models and gathering eyeballs for advertising does not change the simple reality that advertising is not a business model.  A business model requires people to buy things from people who sell things. [apologies to Austin Hill who said something similar at StartupEmpire recently].

Web 2.0 tools offer ways to fundamentally shift the way things work to a different model, and financial services is a definite candidate.  There is much that could be improved about financial services, where innovation is not often seen.  Many of the other uses of Web 2.0 are informational,  recreational, or small transaction based. 

The creation of a new system for lending that empowers borrowers is a welcome thing.  The creation of a new system that offers new classes of investments is also a welcome thing.

If we did a survey of borrowers and investors, and asked them whether they would consider participating in a new service when there are no rules, fallbacks or protection of any description it is doubtful such a model would stand up to that test, and it is equally unlikely it would develop the scale or scope to be called industry disruption.

There are over 60 p2p lending companies in 18 countries around the world.  At present, to the best of my knowledge there is regulation in Australia, Canada, US and Holland.  The nature of the regulation in the first three are securities regimes.  Holland is slightly different.  As for other countries, the question has to be asked, as to whether regulators are merely waiting in the wings or have actively decided to stand back.

In any event, the course is clear for US and Canada, and while web purists will not like what they see, it is worthwhile to take a deep breath and consider the alternatives.  The degree of regulation is certainly something that can be debated, but not whether there ought to be regulation.  Disruption is a difficult thing, and does not always follow a linear path.  The key is that is continues to move forward, and as we look at LendingClub, this can and will happen.

The stage is being set for a strong and legitimate industry in Canada, and US around the concept of social lending.

UPDATE:  Techcrunch have a summary and some interesting comments.

New Approach Puts Secondary Market to Work in P-to-P | American Banker [note:  access to full story requires registration]

Edward Woods, a senior analyst for Celent, a Boston market research unit of Marsh & McLennan Cos., said the model Lending Club and Prosper have chosen is the one most likely to thrive as this market matures.

“You’ll see fewer experiments” along the lines of what Zopa tried in the United States, he said. “I think the simpler, the better.”

Simpler is usually better, but hardly ever happens.  The original concept  of everyone lending to everyone is not going to happen.  The reason though is not what everyone expected. 

Internet allows lots of things to happen easily, but once you get into finance, you are dealing with peoples money, and that automatically fall within some type of regulatory framework.  The reason is simple – anarchistic finance will always fail because it will automatically re-centre within a small group that can trust each other.  But we want social lending to be relatively freely available.  This tension between the simplistic desires of the masses – “why can’t we just do it, because internet makes it possible” – conflicts with the other simplistic desire for protection of ones money – ‘how can the government allow my money to be at risk?”.

Ron also asked if the new model as we see it evolve, and it will evolve, is even p2p anymore.  Sensible securities law and regulation requires that investors are protected from unscrupulous and criminal offers.  Going back to an anarchist model, the unfortunate reality is that without a proper framework confidence will be eliminated as the extent of the bad will always overweigh the good.  The current credit crisis is proof of that concept.

We need the tension between business and regulation.  Management of that tension is a joint responsibility of government with their regulation powers, and business to continually open up new possibilities that people want.  If we leave it to one or the other we gain nothing.  What we are seeing with LendingClub, Prosper, and CommunityLend are examples of business working with the regulatory powers to extend the thinking into the possibilities that internet provides.

Relevance to Bankwatch:

Internet offers such potential and possibility by connecting people in a trusted yet open framework that surely something better can exist. 

This is the promise of social lending – one that stretches the known financial framework, yet offers the protections and knowledge that informed users of financial services deserve.

What is especially interesting and relevant for our times is that it was written in 1999.  This book predated the dot com crash, and predated the rise of social networks, yet it nailed the much of the direction of internet that we have witnessed through the twentyfirst century to date.

It does that because it takes a sweeping century wide view of social progress, and lays out the possible reasons for the shifts in a quite objective and analytical manner.

The basic premise is that the fabric of US society has altered dramatically in the last 1/3 of the twentieth century, and people are significantly less civically engaged than in the first 2/3.

We care less <here> about civic engagement, but more about the underpinnings of that shift.  In the discussion Putman talks about social capital, and the shifts in that capital.

I see relevance here for Banks to understand their customers from a perspective that normal segmentation will not pick up.  First some definitions that the book uses, then discussion.  I am keeping this deliberately relatively brief, and if you want to delve deeper, then 540 pages await you!  Worth the read if you care about this stuff.

First some definitions, which you can skim, then the discussion.

Definitions [from "Bowling Alone]:

Social Capital:

“How does social capital work?
The term social capital emphasizes not just warm and cuddly feelings, but a wide variety of quite specific benefits that flow from the trust, reciprocity, information, and cooperation associated with social networks. Social capital creates value for the people who are connected and – at least sometimes – for bystanders as well.

Social capital works through multiple channels:
- Information flows (e.g. learning about jobs, learning about candidates running for office, exchanging ideas at college, etc.) depend on social capital.

Social networks are important in all our lives, often for finding jobs, more often for finding a helping hand, companionship, or a shoulder to cry on.  [Fischer]“

Bonding Capital:

… inward looking and tend to reinforce exclusive identities and homogeneous groups.  eg fraternal organisations, church based womens groups, fashionable country clubs, ethnic enclaves, start up financing groups, etc. [sociological superglue]

Bridging Capital:

Bridging networks, by contrast are better for linkage to external assets and for information diffusion.  .. when seeking jobs, political allies the weak ties that link me to distant acquaintances who move in different circles from mine, are actually more valuable than the strong ties that link me to relatives and intimate friends, whose sociological niche is very like my own.   [sociological WD-40]

Thick trust:

Social trust embedded in personal relations embedded in personal relations that are strong frequent and nested in wider networks.

Thin Trust

Social trust that exists beyond thick trust.  e.g. an acquaintance at the coffee shop, or at work.  Think trust rest implicitly on some background of shared social networks and expectations of reciprocity.  A standing decision to give most people – even those whom one does not know from direct experience – the benefit of the doubt.

the test: “Generally speaking, would you say that most people can be trusted, or that you can’t nbe to careful in dealing with other people” – this taps feelings about .. thin trust.

Discussion:

Putnam discusses throughout the continual balance between legal trust constituted by law and order and civil law versus the thin trust that exists around us all.  This goes to reputation of people, of groups of cities, and of countries.  Generally he concludes that thin trust is less now than 30 years ago, and there are many drivers attributed to that including television, lack of personal time, commuting separation of home location and work location etc etc.  In any event people feel less engaged and are less engaged.

However what he notes and is interesting is that people still respond to social capital despite the disincentives in our modern life.  He notes in particular the potential of internet and information technology to dramatically improve the opportunities for social capital.  [note book written in 1999].

Whether we look at social lending, or social networks like Facebook, there is much discussion and optimism on topics of ‘friends’, and levering social capital in simple and convenient ways.  It is interesting to look at those two examples plus traditional banking.

What struck me the most is that these examples are largely based today on different kinds of trust.  Facebook is all about thick trust for the most part.  Exceptions are those that choose to gather lots of friends, and in those cases I would argue not even thin trust exists, but it may be somewhat developable.

Social Lending has thin trust established between the lender and the social lending service.  There is also thin trust established between the borrower and the lending service.  These thin trusts are based on trading of confidential information, between the borrower or lender and the service.  By accepting that role as the trust broker, the social lending service is able to allow the creation of a new thin trust to exist between the lender and the borrower that could not have otherwise existed.

Its clear that all social lenders are not the same, and the securities regulatory environment hinders the development of a  broad development of thin trust by imposing other rules that obscure the underlying benefits, nonetheless this is the promise of social lending and social finance in general.

Traditional banks have no such level of social trust that can be created.  Each relationship is unique and between the customer and the bank as an organisation.  Particularly in lending, that is managed through brokers or different personal lenders each time, the relationship is defined by gathering and validation of information each time.  One of the complaints I frequently heard in my banking career was the lack of continuity in the branch, and the lack of long term relationships being built with the bankers.

Lastly looking at the bridging vs bonding, then similar patterns emerge.  FaceBook is about bonding capital, based on thick trust.

Banks have neither bonding nor bridging.  Social Lenders are to various degrees creating hybrid elements of bridging capital, and although the users are anonymous to each other, they get to know each other by user name identifiers.

Relevance to Bankwatch:

The book helped me at least to differentiate the fundamentals of the model between banks and social lenders, and between social lenders and FaceBook.  The difference is in the type of trust that forms the basis of them  FaceBook is thick trust, and I would argue a bad place to establish a business.  The old adage of doing business directly with friends (real friends) is a bad idea, prone to future disaster for the friendship.

Banks I would argue have neither thin nor think trust.  They are based on legal relationships.

Social lenders, at least, have the opportunity to lever trust, albeit thin trust that could not otherwise exist without the social lending service, and establish some bridging capital.  Bridging capital is the more powerful capital in terms of impacts on people and society.

What Apple Knows That Facebook Doesn’t – Umair Haque

This conclusion also helps us answer another critical question on the minds of today’s investors, entrepreneurs, and would-be revolutionaries: when will today’s crop of startups start making serious cash? The answer: when they shift from platform logic to market logic.

He finishes by asking which players are being held back by platform thinking?  I worry about P2P Lending being held back back by that thinking, but feel a little better after going through this exercise.  First the background:

Platform logic vs market logic

Platform thinking; is based on consistent sets of principles including these taken from the book Platform Leadership: How Intel, Microsoft, and Cisco Drive Industry Innovation (Hardcover) that “drive success”.

1. Determine the scope of the firm
2. Design product technology strategically
3. Shape relationships with external complementors
4. Optimize internal organizational structures

The book was written in 2002, and the examples are interesting in that context.

Platforms are all about creating a monolithic enterprise that determines its own fate by being consistent and strong to the outside world.  Platforms are about convenience, including external and internal relationships, and products designed to dominate the space.  Platforms are about scale.  Think Microsoft, IBM, Intel, and in banking, Bank of America, Barclays, or HSBC. 

It sounds and feels very insular and inwardly focussed.

Market thinking;  is all about customers and offering something of value, for value.  Its about oferring something for sale that people want.  Market thinking will, as Umair says, “alter the basis of competition”.  This requires a structural shift and is designed to catch the competition wrong footed, not as platforms would, merely look to dominate, using corporate shock and awe.

P2P Lending is generally following a market logic approach

P2P Lending is in its infancy, so its hard to consider any of the players are market dominating at this early stage.

The three market attributes that Umair discusses are interesting though, to explore which, if any of the current players are exemplifying those attributes.

Markets alter the basis of competition
P2P Lending could be said to alter the basis of competition.  The interest rates and the customer processes vary, but generally they do achieve that. 

Markets cause strategic domino effect
Is there a strategic domino effect?  This will be based on scale, and as yet we are not seeing a shift in banking as a result of P2P Lending.  Or are we?  Banks are seeking ways to enter the space and test the waters, by becoming lenders in some P2P Lending companies.  P2P Lenders are springing up around the world, with the latest count being over 30.

Yet, there is somthing holding back the ‘domino effect’.  That is regulation.  The one thing that prohibits the domino effect is regulation.  I am living that with CommunityLend, and Lending Club have filed their revised S-1 in the US.  Once we start to see regulataory approvals in place, how will the picture change?

However many are not considering, or dealing with the regulations.  Is that a good thing or a bad thing?  Regulation, and the ability to have P2P Lending be seen as a friend of safety and security will ultimately be a key factor.  Borrowing and investing are matters of finance that are all the more important to everyone concerned, following the major ball-drop by Banks’ lately.

Markets atomise the value chain
This is where existing players see their processes and products chopped into tiny pieces and taken over by new entrants who see better ways to manage things.  P2P Lenders are doing a good job at this aspect. 

So it seems that P2P Lenders are pretty good on 1. and 3. but not quite so much on 2. yet.  Umair uses FaceBook and Apple to compare the platform to market approach.  He speaks of FB signing deals with incumbents <Microsoft> and thus failing on 2. 

What of P2P Lenders allowing Banks to participate in their services?  On reflection I think this is not the same as selling out to incumbents.  Rather it is requiring incumbents to adapt to the new model if they wish to participate, and places them on the same playing field as the others in the P2P market. 

However the regulation impact is still troubling and whether enough P2P lenders will be able to see it through to establish the domino effect is key. 

Time will tell.

I need to review the copy to figure out the changes and updates. More tomorrow.

www.sec.gov

As filed with the Securities and Exchange Commission on August 1, 2008

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Amendment No. 1

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

LendingClub Corporation

Social Networking Watch: Zopa, CEO Douglas H. Dolton – SNW Interview

What is your long term vision? Where could you see Zopa and the industry being in 10 years time?

I honesty think that the efficiency, convenience and trust that you get with dealing with an entity like Zopa will become more and more attractive to people. I can see this will be a multi-billion dollar business. 10 years from now or so, we’re going to have quite a bit of interactive social finance activities taking place with unsecured consumer loans and who knows beyond where that could go. Transactions involving currency exchange, transactions involved car insurance – that’s another thought, where a group of people will come together and pool their resources to provide the first tier of losses associated with car insurance and then they will buy a blanket coverage to provide a full coverage to everybody. As time goes on, we will see more and more of this democratization of finance taking place with transactions well beyond simply unsecured consumer loans.

FRB: Speech–Mishkin, Global Financial Turmoil and the World Economy–July 2, 2008

The subprime crisis exposed problems with the securitization of mortgages. In particular, it became painfully clear how poor the underwriting and credit-risk analysis were for a wide range of products. Some appraisers, brokers, and investment banks were motivated by transaction fees and had little stake in the ultimate performance of the loans they helped to arrange. Many securitized products were complex, and the ownership structure of the underlying assets was opaque. Investors relied heavily on credit ratings instead of conducting due diligence themselves, and credit rating agencies failed to fulfill their raison d’etre. The result has been rising defaults, particularly in the subprime mortgage markets, with losses to both investors and financial institutions.

The ultimate losses from the recent residential mortgage-market meltdown have been estimated by Wall Street analysts at about $500 billion–less than 3 percent of the outstanding $22 trillion in U.S. equities.² Why did a relatively small amount of losses on subprime mortgage loans lead to such broad-based financial disruption? After all, a 3 percent decline in stock market prices sometimes happens on a daily basis with hardly a ripple in the U.S. economy.

In part, the outsized impact of mortgage losses on broader financial markets probably stems from the fact that they exposed a more extensive set of problems in financial intermediation that were not limited to the original subprime loans. The liquidity shock that hit us in August has been described by one of my colleagues as a global margin call on virtually all leveraged positions.³ The liquidity shock quickly brought an end to the credit boom that preceded it, as a striking loss of confidence in credit ratings and an accompanying revaluation of risks led investors to pull back from a wide range of securities, especially structured credit products. Along the way, the inadequacies of the business models of many large financial institutions were exposed, and these models are now in the process of significant re-examination and rehabilitation.

However this statement, when the Governor spokeof the future, caught my eye. The agency problem he refers to, is the reliance on mortgage brokers, appraisers, and all catch points for mortgages. He explained earlier those agents had been motivated by mortgage volume, took their commissions, and ran. There was no incentive for those agents to offer quality, and in fact they were incented to offer volume, with poor or fictitious quality.

Although some of the most complex structured-finance products may be gone for good, securitization will only recover fully when new business models solve the agency problems that were inadequately dealt with in recent years

This highlights a market opportunity, where social lending can bring significant leverage to bear. In the speech, the Governor spoke of credit ratings failing, and he spoke there of the Moodys etc rating on the ABCP (Asset Backed Commercial Paper) market. There is another rating that becomes essential in all this, and that is the rating on the end borrower, the person who takes out the mortgage to purchase a home. The rating on that person must be complete, accurate, and transferrable. By transferrable, I mean it must be available for inspection, and due diligence up stream as the collaterisation process disseminates the mortgage into pieces that become CDO’s and other ABCP. Social Lending is not just about people lending to people. That is a great beginning, and offers the valuable inspection from the wisdom of crowds.

In the future the market may well see additional markets appear, and social lending must at a minimum outperform the old way of doing things.

Some more detail here.

sv1 Lending Club S-1 filing

The proceeds we receive from the sale of each series of Notes will be designated by the lender members who purchased the Notes of that series to fund an unsecured consumer loan originated through our platform to an individual consumer who is one of our borrower members.
… …

A series of Notes will be issued only if and when the corresponding member loan closes and is funded. A member loan will close and be funded if the borrower member loan request has received full funding commitments, or if the borrower member chooses to accept partial funding of the loan request after receiving funding commitments for the loan request.

And this taken from the description of the lending platform:

About the
Loan Platform

Through our online platform, we allow qualified borrower members
to obtain unsecured loans with lower interest rates than they
could through credit cards or traditional banks. We also provide
our lender members with the opportunity to indirectly fund
specific member loans with credit characteristics, interest
rates and other terms the lender members find attractive by
purchasing Notes that in turn are dependent for payment on the
payments we receive from those borrower member loans. As a part
of operating our lending platform, we verify the identity of
members, obtain borrower members’ credit profiles from
consumer reporting agencies such as TransUnion, Experian or
Equifax and screen borrower members for eligibility to
participate in the platform. We also service the member loans on
an ongoing basis. See “About the Loan Platform.”

The Notes. Our lender members will have the
opportunity to buy Notes issued by Lending Club. Lender members
will be able to designate the particular member loan that they
want the proceeds of each Note they purchase to be used to fund.
The holders of Notes of each series will have the right to
receive their pro rata portion of principal and interest
payments on their Note but only if, and to the extent, that we
receive loan payments on the corresponding member loan, net of
our service charge.

The Notes will be special, limited obligations of Lending Club
only and not obligations of any borrower member. The Notes are
unsecured and holders of the Notes do not have a security
interest in the corresponding member loans or the proceeds of
those corresponding member loans.

Lending Club is obligated to pay principal and interest on each
Note in a series only if and to the extent that Lending Club
receives payments from the borrower member on the corresponding
member loan funded by the proceeds of that series, and such
borrower member payments will be shared ratably among all Notes
of the series after deduction of Lending Club’s service
charge and any unsuccessful payment fees, collection fees or
payments due to Lending Club on account of the portion of the
corresponding member loan, if any, funded by Lending Club in its
capacity as a lender on the platform. If Lending Club were to
become subject to a bankruptcy or similar proceeding, the holder
of a Note may have a general unsecured claim against Lending
Club that is not limited in recovery to such borrower payments,
but, as described in more detail below, the matter is not free
from doubt. See “Risk Factors — If we were to
become subject to a bankruptcy or similar proceeding.”

In essence it appears that Lending Club make loans to borrowers. Lending Club then issues notes to investors, corresponding with the loans to borrowers. Seems simple enough. The rest of the prospectus details the risks as expected in any prospecus, and has a great amount of detail in words and tables on FICO scores, expected default rates, and other statistical data.

1. openness
2. peering
3. sharing
4. act globally

CNW Group | DON TAPSCOTT | Troubled financial markets need to embrace Wikinomics-style transparency says Don Tapscott

“For example, investors should be able to “fly over” and “drill down” into a CDO’s underlying assets. With full data, they could readily graph the payment history, and correlate information such as employment histories, recent appreciation (or depreciation), location, neighborhood pricings, delinquency patterns, and recent neighborhood offer and sales activities. Now that AAA ratings have proved worthless, currently investors don’t have a glimmer of what they are being asked to buy. And they won’t start buying until they fully understand what they are purchasing, and that the price is fair.

There is little chance that the Banks would do this together, but what if one or two did it first. In the book, Don offers the example of Goldcorp who were having difficulty locating their next gold find, and CEO McEwan was frustrated by the ‘glacial’ progress from traditional geologists. So he took all their supporting geological data, and offierred it online, in the form of a contest.

Within weeks, they received 100′s of submissions but not jsut from geologists, but from students, mathematicians, military officers etc. The contestants identified 110 targets, 50% of which had not been previously identified. Over 80% of the targets yielded substantial gold reserves. McEwan estimates 2 – 3 years were shaved from the normal process.

The Banking system suffers the same problem as Goldcorp. Glacial movement in determining the true underlying value of ABCP supporting assets.

Tapscott offers that if the data were made available online, the data that supports the paper, then the internet community could solve the problem faster and more effectively by providing insights, solutions, early warnings, and no approaches that could never be developed by information protective bankers.

The Big Trouble In Small Loans – TIME

And he’s getting more of them, from directions he never could have anticipated. Last year the Spanish multinational BBVA raised some $300 million to invest in microfinance, then reached across the Atlantic to snap up two Peruvian firms. “Everyone wants to do this now,” says Llosa. “And it’s not only Peru. This change is everywhere. Everywhere microfinance is working, it’s happening.”

FT.com / Companies / Media & internet – Web 2.0 fails to produce cash

Many members of the Web 2.0 generation of internet companies have so far produced little in the way of revenue, despite bringing about some significant changes in online behaviour, according to some of the entrepreneurs and financiers behind the movement.

The idea of web 2.0 germinated shortly after the dot.com crash that happened in 1999 / 2000. Three things have happened since then, at the macro level:

1. the rise of the social web
2. the rise of new web based tools, and a shift away from PC based tools
3. the rise of advertising as a model, with Google being the poster child

What is highlighted in the FT article is that web 2.0 has not produced any new business models of consequence. There has been talk to SaaS (Software as a Service) but so far just talk. It seems ludicrous to suggest that an entire economy would shift from a diversified revenue model to one of advertising, yet many web 2.0 guru’s still speak as if that day is coming. The consensus in Silicon Valley appears to be that advertsing is the only means of making money in the future.

Its time for a wake up call in terms of how web based companies and that includes Banks online, would make money in the ‘new economy’ if there is in fact such a thing. I know from personal experience with CommunityLend that building a service in that is web based, and that challenges the norms, requires to address regulatory needs for example, and it is hard work.

The article speaks about the expectation, espoused in the recent Charlene Li/ Josh Bernoff book, Groundswell, that the holy grail lies in making the connection between the social graph, and personalised advertising.

At the start of the decade, Google struggled to find a suitable way to
make money from search before alighting on the keyword advertising that
has underpinned its fortune. A similar hunt for forms of advertising
that suit the social media – where users want to engage with each
other, not corporate brands – has proved difficult. By common consent,
the key to commercial success lies in co-opting the crowd, though few
have so far succeeded.

A key hindrance to the above, is that people interact in social media because they want to not because they want to be advertised to. Back to the work at CommunityLend, making the link between social connections, and economics is complex, and introduces many nuances that have not been previously encountered. More to come on that.

Is it:

1. registered members with investments or loans at Zopa? (lower but a ‘real’ number)
2. registered users of the site (always a higher number)

Both numbers have importance, but the Finextra press release is written to suggest that the 10k number relates to 1. but I am betting now that it relates to 2.

I can’t locate this info on Zopa’s blog, something I also find odd … so am posting here.

Anyone from Zopa care to comment and clarify?

Finextra: Zopa reports 10,000 US members

After its first full quarter of operation in the U.S., Zopa, an online lending company that uses the power of community to help people reach their goals, has reached a number of significant benchmarks for success.

In addition to growing to more than 10,000 US community members, a number of Zopa borrowers have actually achieved a negative effective rate on their loan.

Co-participants are:

Expert Panel: Meet the Bloggers

Moderator: Steve Bowbrick

Chris Skinner, Balatro

Aneace Haddad, Welcome RT

Colin Henderson, Bankwatch

Scott Loftesness, Payments News

Dave Birch, Digital Money Blog

I am sure we will get into some good discussion about whats wrong with payments, and missing in electronic money/ smart cards/ alternative financial services/ social lending. What really interests me, is that I feel I know each of these participants personally, yet have met none of them … until Thursday.

I will be live-blogging while there, so if you are interested, feel free to listen in/ chime in. You can also follow quick updates here.

[ Digital Money Forum ]

The goal of the Forum is to encourage discussion and debate around the real issues at the heart of electronic money in all its forms. In addition to this Forum, every autumn we organise the annual Digital Identity Forum (see the web site at www.digitalidforum.com for more details), the sister event to the Digital Money Forum

As we evolve the conversation, I want to get beyond what happens here at Bankwatch, which is Bank oriented, and focus on p2p Lending in Canada, and around the world from a consumer perspective. What do consumers want and expect in their financial services? How do consumers see the balance between themselves and financial services changing?

Thoughts and comments welcome.

CommunityLend blog

Beginning the conversation about p2p Lending in Canada

FORUM Solutions Discovering the Social Economy

I tend to define the social economy a little more broadly: as that increasing part of our society’s economic decision-making that is influenced by emerging social tools. The water cooler is now global, and people can influence each other’s spending habits and brand preferences more effectively and instantly.

The Social Futures Observatory have an extensive paper on Social Lending. They make the point about the confluence of social capital with traditional economic capital. When that happens, they argue, the sum is greater than a simple economic transaction. People value their social capital, so when it is brought to bear upon economic transactions, much greater value is developed.

FTAdviser.com – Social lending set to soar

Since its launch, the enterprise has arranged more than £20m in unsecured personal loans in the UK and is preparing to launch in Japan, its fourth country after Italy and the US since it launch in the UK.

www.kansascity.com

Lending Club, for example, has entered a partnership with WebBank, a Federal Deposit Insurance Corp.-insured, state-chartered industrial bank organized under the laws of the state of Utah to originate the loans in a consistent manner nationwide. As a result, Lending Club loans are regulated under WebBank’s industrial loan charter.

The winds of regulation are catching up with P2P Lending in those jurisdictions where that had not been the case to date.&nbsp; However its also interesting to see how P2P Lending is not being unduly handicapped, in terms of business model, and in fact the credibility associated with regulation, and Bank alliances strikes me as being a positive trend.&nbsp; As Jim Bruene noted in his prescient December OBR, report entitled Person-to-Person Lending 2.0

Its (P2P Lending) consumer appeal could make it a good marketing platform for banks and credit unions.

Prosper Blog: Prosper, the online marketplace for people-to-people lending » Blog Archive » Are You Diversified?

The last 5% of my investment is with Prosper.com. One of the reasons I lend money on Prosper is that it further diversifies my portfolio. I have a few friends who got depressed when the Dow drops from 14,000 to 12,700. I slept very well at night knowing that 60% of my money was invested elsewhere.

william azaroff | blog

To me the social economy is the same as what others call the reputation or conversation economy. From the time humans started trading what they had for what they needed, we had a social economy. People’s knowledge of the others they were trading with was a crucial factor in those trades and dealings. The industrial age added a level of anonymity into our economy and set us up to pay fixed prices for goods and services from the money we earn from our labour. The information economy didn’t change this at all

So I posted this response on Williams blog, and wanted to go further here.

I am going to challenge everyone so here goes. Social economy, and reputation economy are misnomers. There is no fourth dimension that has suddenly appeared with new ways to buy and sell things. For an economy to operate basic elements are required to facilitate transactions, eg, mainly contract & currency, with heavy reliance on trust.Everything else is just a facilitator- social and reputation [in the way Web 2.0 means] are new elements that have been brought about by internet, and web based tools which provide disruptive alternatives to old ways of transacting.

I suggest what is needed are ways to capture social and reputation in meaningful ways that facilitate commerce. Then we can talk about economy.

Open questions for me – whats the financial value of a:

• FaceBook friend?
• a five star eBay user?
• an OpenID?
• a Prosper group lead?
• a prosper group lead who bid 25% on a prosper loan?
• a LastFM friend?
• a personal acquaintance who purchased something that you are now considering?

Relevance to Bankwatch:
Another word which is taking on new meaning in Web 2.0 land is friend. Robert Scoble and Jeremiah Owang do not have thousands of friends. They have thousands of acquaintances, whom they enjoy banter and debate with, but thats not what a friend is.

Wikipedia: Friendship is a term used to denote co-operative and supportive behavior between two or more humans. This article focuses on the notion specific to interpersonal relationships. In this sense, the term connotes a relationship which involves mutual knowledge, esteem, and affection.

In no way am I attempting to denigrate the new and evolving nature of the interactions which take place in social media, and I have made many new friends through this very blog. My point is only that when we turn to economy, money and risk of financial gain or loss, we have a long way to go before such online “friendships” can bring broad economic value and begin to assert themselves meaningfully on the economy.

One potential such connection is TripAdvisor. Many of us read those reviews and allow them for form part of the travel purchase decision. Similarly with Chowhound and restaurants. I would argue that is not economic, rather is a form of referral. If we place a financial slant on this; what if a Tripadvisor type service contained referrals for financial products? Would you purchase an investment based on the loosley defined TripAdvisor network? I think not.

I maintain for social and reputation to form part of the ‘economy’ we need more robust tools, risk assessment, and proof. I also think that is coming, and we see some building blocks underway, stumbling, and working at coming up with the right set of formulae.

Looking at the social lending space, Zopa manage it by taking a quite non-social, bank oriented approach. Prosper are the most ‘out there’ by experimenting in the full public eye, and kudo’s to them as they stumble, and regain their footing, but they will get it right.

There is a formula of interconnections supported by algorithms yet to be defined which will allow social and reputation to form parts of the economic structure, likely as part of the trust component.

Powered by ScribeFire.

Zopa going live with Credit Unions as partners

“The merging of financial services and social networking is a great way to reach the younger generation,” says Doug True, senior vice president of FORUM Credit Union of Fishers, Ind., one of Zopa’s launch partners.

Having said that, I will need more detail before I understand the model being implemented, that appears to involve CD’s at the Credit Unions.  I hope there is a simpler explanation that that provided at the WSJ.

Lenders, meanwhile, buy one-year Zopa CDs that are used to help fund
those loans. If a prospective lender wishes to help out a borrower, the
lender can direct all or a portion of the interest on the Zopa CD –
interest rates are currently capped at 5.1% — to help lower the
borrower’s loan payments. Whether a borrower repays their loan on time
has no effect on what an investor earns on a Zopa CD.
…..

Zopa lenders should get their principal back since their deposits are
insured for as much as $100,000 per credit-union member. Borrowers and
lenders don’t pay any fees, although borrowers — who will need a
minimum FICO credit score of 640 — could be subject to late fees.
Zopa, for its part, shares in the interest-rate spread that the credit
unions earn between the loans and deposits.

In order to participate in Zopa’s system, consumers
must sign up with one of the six credit unions participating with Zopa.
For their part, the participating credit unions hope to expand their
membership and stand out from the crowd.

Powered by ScribeFire.

Jim from NetBanker is on a panel this year, and its great to see bloggers pulled in.  Jim is an advocate for Banks’ to try new things, and having him at Prosper Days is a great add.

“Prosper Days” User Conference Videos Repurposed to Educate Customers (NetBanker)

The conference is an excellent idea, creating a buzz around the company and providing a platform for its most loyal customers to share success stories and network. It’s a model eBay has used successfully for years. The addition of Dubner should increase press coverage and attendance.

Technorati Tags: prosper, netbanker

Powered by ScribeFire.

1. trend of regular borrowers towards using Prosper, who would otherwise have used traditional lenders, and these lenders are Prime or Near Prime [Prosper designations]
2. borrowers seeking to pay off credit card debt;  typical retrenchment behaviour,  during rough times, but these borrowers are using Prosper, not Banks.

Media Room – Prosper

Of great interest is the anecdotal evidence of prime and near prime borrowers turning to Prosper for loans that would have historically been steered toward mortgage, auto, and home equity lenders. It will be very interesting to watch whether the wake of the liquidity crisis in the broader credit markets results in a definitive trend toward Prosper becoming an alternative source for financing down-payments on homes and cars, funding home remodeling projects, and finding relief from high-interest adjustable rate mortgages (ARM’s). Equally of interest is whether Prosper lenders will desire to help their fellow Americans by funding these types of loans.

…

While Prosper lenders are shying away from subprime, there is ongoing strong demand for the ever increasing number of prime and near prime borrowers coming to Prosper to consolidate their credit card debt at lower rates and to fund or expand their small business endeavors. For example, in October 37% of loans funded on Prosper went to prime borrowers, compared to 30% in September 2007 and 22% in October 2006.

Finally, Prosper have achieved 200% growth year over year, since they eliminated Sub sub prime borrowers.  $100 Million in loans, is not going to worry the Banks terribly yet, but the indications and trends suggest that a shift is occurring.

Somthing to watch relative to volumes is the filing last week by Prosper of a prospectus for $500 Million in a lending secondary market.  In essence this means that lenders in Prosper can bulk sell their loans to third parties … even Banks?

Technorati Tags: prosper, social+lending

Peer-to-peer lending | Crunchless credit | Economist.com

Why aren’t social lenders raising their rates? One reason is that, unlike banks, they are not facing higher funding costs caused by the seizure in money markets. Another clue lies in that word “social”. Mr Advani, whose business is designed to facilitate loans by family and friends, points out that parents tend not to foreclose on mortgages but to restructure them. Even when strangers are involved, lenders are usually not seeking solely to maximise returns.

Most intriguing of all is the possibility that social-lending sites do a better job than their mainstream counterparts of assessing risk. Zopa, which takes a stringent approach to credit assessment and will let only prime borrowers onto the site, boasts a default rate of just 0.1%. Prosper, which is more laissez-faire and has a default rate of 3%, provides measures of “social capital”, such as endorsements by friends, that help lenders to judge the risk of a specific borrower.

Relevance to Bankwatch:
The advantages that separate peer to peer lending from traditional banking, which the article highlights are:

1. lack of costly infrastructure:  peer to peer lenders do not have the costly infrastructure base that banks have tied up in, branches, staff, and old infrastructure based on a differently regulated model.  Banks must factor those costs into their pricing. 
2. broader view of return:  social lenders have different expectations on return than traditional Banks.  Social lenders factor the human element into their expectations.
3. risk assessment is better:  social lenders factor other elements into the lending decision, such as endorsements from friends or relatives.  The human scale of social lending facilitates a clear line of sight between lenders and borrowers, that is the antithesis of the Asset Backed Commercial Paper market that funds Bank lending.

The current market that peer-to-peer lending is tining compared to banking, but it is also brand new, having only begun circa 2005.  Banks would have to look to ways to insulate their own model from those disadvantages if they are to be able to compete with social lenders.

Technorati Tags: social+lending, peer+to+peer+lending, zopa, prosper, open+source+banking

Virgin Money launches US ‘friends and family’ lender – Independent Online Edition > Business News

Virgin Money, the business unit through which Sir Richard Branson hopes to acquire Northern Rock, yesterday launched the next stage of its US expansion, with a novel new service enabling friends and families to lend to each other.

Virgin Money USA launched the Family Mortgage after acquiring CircleLending, a specialist financial services company, earlier this year. It has pioneered a business model through which family members or friends can lend money to one another at agreed rates of interest on commercial terms.

So they are have announced the acquisition of CircleLending, which Jim reports at $50M.  More importantly in my view, Virgin are announcing their move into the mortgage space.  Northern Rock and CircleLending are both in mortgages.  The former being traditional mortgages, and the latter in ‘social lending’ morgtages. 

Listening to the back channels, I suspect that Virgin are looking at more than mortgages with the acquisition of CircleLending.  This company has done $200M in mortages so far … clearly a $50M purchase price is picking up a business model more than a portfolio.

Exciring times!

Technorati Tags: virgin+finance, social+lending

Some stats on lending club after their first three months. Its just very refreshing to see the openness of the data from LC, & Prosper. For more from LendingClub go here.

First impression is that the data reflects the Zopa and Prosper data closely. In other words we are seeing a trend.

Lender Rankings – Lending Club

Ranking of the top 100 portfolios ordered by estimated ROI (includes portfolios over $25 only)My analysis of the data:

Social lending is a new phenomenon, that people are approaching carefully, but approaching it they are. For now, its about large numbers of small portfolios, that are seeing much higher returns than Banks would pay. The average loan in the other lenders is $5,000, and I assume LC is similar. The risk is widely spread.

Technorati Tags: prosper, zopa, lendingclub, social+lending

The backdrop to that statement is here ….

Alistair Darling signals the end of easy money – Telegraph

The country now has a consumer debt mountain of £1.3 trillion. As this newspaper has warned, with a global credit crunch making its malign presence felt, that leaves a lot of people extremely exposed, as money gets more expensive.

Its clear that the lending environment that has existed for the last 10 years is at an end.  Time for new ways to think about lending.  The reason I say that, is that despite the comment from Darling, which is similar to how Finance Ministers feel everywhere, the consumer debt exists, and people need help during the transition.

Social Lending is purely focussed on the borrowers, their circumstances, and their ability to repay.  This is lending in its purest form, and thats why it will succeed.

Direct lending sites are drawing interest – MarketWatch

Lending Club has put a number of conservative constraints on borrowers. In order to apply for personal loans of $500 to $25,000, with interests rates of 7% to 17%, borrowers must have credit scores at or above 640. That’s typically considered the near-prime to prime lot, a good score that defies high risk. But even borrowers with prime credit are finding it difficult to qualify for a loan with banks now, and many people may find it easier to borrow through this site.

A rival site, Prosper, which raised $20 million in venture capital in July, originally set no floor for who could make a request for loans up to $25,000. The site later changed the minimum credit score for borrowers to 520, eliminating 45% of its loan listings, but still low enough to attract higher-risk borrowers in the sub-prime range.

Tiffany from Prosper commented on the piece and noted these statistics, indicating that  following elimination of high risk borrowers, greater activity has resulted.

Scott,
Thanks so much for your timely commentary. 

One clarification worth noting…When
Prosper announced its 520 credit score minimum at its Prosper
Days community conference (www.prosperdays.com) in February 2007,
we noted that at that point in time 45% of our loan listings consisted
of borrowers with scores below 520.  However, since implementing
the minimum credit score requirement, the number of active loan listing
requests on Prosper has actually more than doubled as have funded
loans… funded loans have increased by over 130%, growing from $36
million in February 2007 to $84 million today.

Best,Tiffany Fox at Prosper

Technorati Tags: prosper, lending+club, social+lending

First this from the Economist leader; as you read this, think derivatives and securitisation. The least understood methods, yet that which have largely been credited for the efficiency of global capital markets over the last 20 years. Incidentally, the correction we are seeing is a good thing for those markets, a good thing for social lending, and open source banking, but more on that later.

Risk and the new financial order | Surviving the markets | Economist.com

But there is a price that is only now becoming apparent. Because lenders expected to be able to sell on the risk of default to someone else, they lent too easily. After all, they would not have to pick up the pieces. In theory, that risk should have been borne by the people best able to carry it. But with everybody having sold on the risk to everyone else—and the risk often being carved up, repackaged and sold again—nobody is sure where the losses are. The fear is that some risks ended up with those who least understood what they were getting into, and fear is a potent force in this disintermediated world. In the interbank market, every counterparty was potentially vulnerable. Even small amounts of bad credit can drive out good.

I posted the other day about ‘know your customer’. The world of derivatives and other financial vehicles take financial instruments, such as bonds, currencies, commodities, mortgages, and divide them into different components, then re-assemble them as financial contracts that are traded amongst Banks, and investment houses. The nature of that division, and re-assembly means that the original debtor, the final person who must pay that debt is lost in inter-bank transactions. Know your customer is lost.

In simple terms, thats what has happened with the example of sup-prime loans. BNP in France who froze three of their funds this week, own some component of mortgages in homes in the US. The fact that a Joe Homeowner, hypothetically, in Main Street, Witchita, Kansas, is three months overdue on their mortgage payment after their interest rate and monthly payments rose by 3% is transparent to BNP. All BNP know is that the debt instrument they purchased and rolled into their fund(s) is no longer worth what they expected it to be worth. Worse still, they do not know how many Joe Homeowners there are, to what extent they will default, to what extent the home value will cover the foreclosure, and how long that will take. BNP thought they purchased an income stream, but actually they purchased an overpriced bad debt.

Back to Basics

This will take some time to sort out. There will be short term improvements, but there will also be significant reluctance to purchase obscure instruments, where the underlying credit quality is not guaranteed, so that will result in tighter credit conditions that Banks impose on their mortgage and loan activities.

It is incumbent on all social lenders to watch this carefully, and appreciate there is an opportunity to provide a valid and financially sound alternative to borrowers and lenders. Social Lenders still use the common approach of credit ratings to signal likelihood of payback on a loan. But they have the added advantage of additional factors that can be brought into the mix, the secret sauce of social lending, that traditional Banks can never replicate. Social Lending is highly transparent, and hiding is much harder in the open. The quality of lending that can occur within a well run social lending operation can greatly transcend the ‘by the book’ transaction that occurs in a one on one application and approval process typical of Banks.

Incidentally, as as aside, recently Prosper have been having issues, bringing out phrases such as ‘lender revolt’ and Prosper need to get that under control, and eliminate the emotion. Their issues go back to problems embedded in their early offerring, of lending to people with poor credit. That have since been corrected, but long time Prosper lenders are bearing those costs associated with that lending. Such lending has been eliminated from Prosper since early 2007. They saw the problem, learned and eliminated it.

Social Lending by definition carries the promise of at least eliminating the problem that the financial markets experienced this week. A promise of a simpler financial process, one that is easily understood and explainable. It won’t replace the worlds capital markets, but if it can provide at least a small alternative to those who choose, then mission accomplished.

________________________________________________
________________________________________________

Background:
It is such a powerful piece, here, is the full leader from The Economist. I strongly recommend you buy it, and read the other related articles:

Risk and the new financial order

Surviving the markets

Aug 16th 2007
From The Economist print edition

The new financial order is undergoing its harshest test. It will not be pretty, but it is necessary

Illustration by Jon Berkeley

THE lifeguards had been scanning the horizon for an oil-price shock,
a bankrupt buy-out or a terrorist attack. But when the big wave struck
last week it surprised them by coming from inside the financial system
and threatening to swamp an unlikely shore, the money markets where
banks lend to each other to help cover their daily operations.
Investors have been asking for years if the frantic innovation in
finance, especially the securitisation of just about every form of debt
into a tradable asset, was a way to spread risk efficiently, or whether
this left the financial system prone to rare—but cataclysmic—failures.
It looks as if investors are about to find out.

Over the past week central banks have lent tens of billions of dollars to restore confidence to the markets (see article).
But it is already clear that this mess is about more than a bit of rash
mortgage lending to Americans who were in the habit of falling behind
with their monthly payments. Hedge funds and private-equity firms,
kings of the boom, are nursing big losses. Debt markets that once
handed out cash to all comers are tight or closed altogether. In almost
every asset market, investors are scurrying to reprice risk—which
mostly means to reduce it.

The gravest and most immediate threat is to the banking system. For
the time being, banks no longer trust other banks enough to lend them
money except on onerous terms; equally worryingly, they lack confidence
that other banks will trust them if they want to borrow. It is alarming
when the very outfits that exist to supply the economy with credit
start to hoard it from each other. At best this tightens monetary
policy; at worst, a shortage of cash will cripple the payments system
and cause runs on otherwise solvent banks and businesses that cannot
rapidly raise funds.

Underneath all the new technology and the fancy derivatives with
strange acronyms is a dilemma as old as banking itself. Anyone who
thinks that lending has been too loose—and many bankers do—should
welcome a purge: better now than later when the imbalances would be
bigger and the economy probably weaker. But if good banks fail and
money for good companies dries up, the purge will wreak huge and
wasteful damage on healthy parts of the economy. How likely is that?

Fear of the deep

Financial crises are always about the way people do business, and
not just the deals they have struck. Yet this one goes deeper than
most. The spreading panic has shown up weaknesses in some of the
foundations of modern finance. The past 20 years have created untold
wealth. As securities and markets have steadily taken the place of
old-style bank managers, the number of potential investors has grown
and the cost of capital has fallen. Much good has come of that.

But there is a price that is only now becoming apparent. Because
lenders expected to be able to sell on the risk of default to someone
else, they lent too easily. After all, they would not have to pick up
the pieces. In theory, that risk should have been borne by the people
best able to carry it. But with everybody having sold on the risk to
everyone else—and the risk often being carved up, repackaged and sold
again—nobody is sure where the losses are. The fear is that some risks
ended up with those who least understood what they were getting into,
and fear is a potent force in this disintermediated world. In the
interbank market, every counterparty was potentially vulnerable. Even
small amounts of bad credit can drive out good.

In theory, ratings agencies and mathematical models help investors
price the risk they are taking on, even if the securities they are
buying are scarcely traded. Yet when some supposedly good-quality
assets proved to be worth little, people lost faith in the models and
the ratings. Across the board, investors had failed to take account of
how fast and how far asset prices fall when everyone wants to sell at
the same time. Hard-to-sell long-term securities had been bought with
short-lived debt, which left borrowers vulnerable to a change in
sentiment every time the debt fell due. It does nothing to restore
confidence when the biggest model-driven hedge funds had to get in new
money. The people at Goldman Sachs lost a packet when something
happened that their computers told them should occur only once every
100 millennia.

Reassess, reprice and then rebound

The retreat to a new level of risk was never going to be orderly or
free of casualties. Neither should it be. Bankers and investors need to
suffer precisely because the methods of modern finance have been found
wanting. It sounds Darwinian, but the brutal demonstration that you pay
for your sins is what leads the system to evolve. Markets learn from
their mistakes. Only fear will spur investors to price risks better and
get them to put more effort into monitoring their counterparties.

If these lessons are to sink in, central bankers must stand
back—as, by and large, they have done. Every intervention now will be
taken as a sign of what the regulators will do next time. If they bail
out banks that have mispriced risk, the mispricing will continue. And
when the central banks do step in, it should not be to save the
financiers. The cost of intervention is warranted only to save the rest
of the economy from the financiers’ folly. By that test, central banks
were right to lend money to the banks in recent days, because it
ensured that a liquidity crisis did not become a solvency crisis. They
may yet have to take over a failed bank, though only if that is needed
to stop a run. It is still far too soon to cut interest rates.

Because this crisis taps so deeply into the newly devised structures
of finance, anyone who says the worst is definitely over is either a
fool or someone with a position to protect. As risk has become
bewilderingly dispersed, so too has information. Nobody yet knows who
will bear what losses from mortgages—because nobody can be sure what
those loans are really worth. Nobody knows if tighter lending standards
will oblige borrowers to raise more capital, triggering more sales in
stockmarkets and more pain. Nobody knows how messy the inevitable
bankruptcies will turn out to be. What markets need now is time to
piece that information back together. Time before the next wave
strikes.

Home Equity Share: Find Real Estate Co-Ownership Partners

Home Equity Share is the online marketplace for real estate co-ownership. We help home buyers overcome the high price of real estate by matching them with investors, allowing both parties to co-own property and enjoy the benefits.

Use Home Equity Share to find a real-estate partner, calculate your profit potential, and complete the Equity Sharing Agreement, all for free.

I see some real risks here, and I was not able to satisfy them in reading the site, because it is very American oriented.  It is also interesting timing given the jitters emanating from the Sub Prime fiasco.  In fact, this model probably won’t work without a sub prime mortgage marketplace to support it. Some thoughts:

1. 100% financing is encouraged here, and that is dangerous in a soft or declining market
2. the built in calculator defaults to 6% annual real estate value increase over the next 5 years – a dangerous assumption for neophytes
3. down payment financing is not permitted in Canada for insured mortgages, and highly frowned on by Banks for any mortgage.  The US market is different, but is tightening, so it is not clear to me how the 1st mortgage is arranged in this scenario.

We shall watch with interest.  I still look for a P2P lending site for mortgages, that follows normal lending practices, yet offers an alternative to using Banks.  I do not see this company in that light.

Thoughts?

University of Maryland, Baltimore County
Using the link structure, following are the main categories of users on Twitter:

• Information Source An information source is also a hub and has a large number  of followers. This user may post updates on regular intervals or infrequently.  Despite infrequent updates, certain users have a large number of followers due to the valuable nature of their updates. Some of the information sources were also found to be automated tools posting news and other useful information on Twitter.
• Friends Most relationships fall into this broad category. There are many sub-categories of friendships on Twitter. For example a user may have friends,family and co-workers on their friend or follower lists. Sometimes unfamiliar users may also add someone as a friend.
• Information Seeker An information seeker is a person who might post rarely, but follows other users regularly.

They go on to make some suggestions that would facilitate usage for people.

Based on our analysis of userintentions, we believe that the ability to categorize friends into groups (e.g. family, co-workers) would greatly benefit the adoption of microblogging platforms. In addition featuresthat could help facilitate conversations and sharing news would be beneficial.

Relevance to Bankwatch:
To better understand the dynamic driving online usage and how customer experience is changing, and developing, as Web 2.0 rapidly evolves.

Technorati Tags: social+networks, microblogging, twitter, facebook, open+source+banking

Finextra: Prosper forms JV with SBI for Japan launch

Prosper, America’s first people-to-people lending marketplace, and SBI Holdings, a holding company for SBI Group, the financial innovation leader of Japan, today announced an agreement to form a joint venture to facilitate the launch of Prosper in Japan and explore other Asian markets.

Technorati Tags: prosper, social+lending, Japan

This from Gallup explores the old causes of a crunch arising from a dramatic drop in liquidity, and points out despite a worldwide glut in liquidity, the potential exists for a credit crunch now.

Looks Like an Old-Fashioned Consumer Credit Crunch

What causes a credit crunch? In today’s financial markets, many lenders make loans but do not hold them in their portfolios. Instead, they sell them to investors in the form of securitized investments. What appears to be happening in recent weeks is that the huge losses associated with some subprime mortgage investments are not only creating significant new risk premiums but also causing potential investors to shun all mortgage investments not guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae.

For example, on Friday various mortgage lenders announced that they could no longer sell various types of jumbo mortgage loans and special feature mortgage loans to the investment markets. As a result, some lenders decided to stop making various types of mortgage loans and sharply increase the pricing of the loans they would make.

The key will be the extent to which the effect spills over into unsecured, and personal loan lending. 

I would argue that social lenders will view things differently, because the issue for them is not Bank liquidity.  Nor is the issue a change in borrower circumstances, caused by changes in the employment market, or high inflation.  Social lenders are well placed to represent borrowers well, and it will be interesting to watch how this plays out for the relative competitiveness of social lenders, in North America.

Technorati Tags: social+lending, zopa, prosper

Longer term, these platforms will need to focus on working with open standards so that (bank) applications can have a chance to work in more than one place, or risk being ignored, with concominant risk to their own business model.  The attraction for firms to build on their platform and provide value to customers, cannot be in any kind of non standard development work.

Bebo signals plan to open up networking site to developers – Telegraph

Social networking site Bebo is likely to follow Facebook’s lead and open up its site to developers to create applications that work within the site.

Chief executive Michael Birch signalled the move at the dotcom networking event Second Chance Tuesday. “It’s a positive direction for social networking and I think you’ll certainly see more and more of it across other social networks,” he said.

On a related note, William at BarCampSeattle, notes Wesabes latest thinking to focus on iPhone as a means to cover multiple channels, and deal with this problem short term.  I read into that, focussing on Safari, since thats the only way into iPhone, and the result will work in many places beyond iphone (Mac, and Windows).

Technorati Tags: social+networks, web+applications, web+platforms, customer+experience

First some definitions from the experts.

Benjamin at Forrester defines Social Computing — a social structure in which technology puts power in the hands of communities, not institutions.

Jim Bruene at NetBanker defines Social Personal Finance:  – Sharing personal finance questions with others in a defined online community

I believe as do these folks, that social finance will change Banks and financial services.  We can debate the degree of change and the timing, but change will nevertheless happen.  For me part of the conversation lies in identification of the drivers of change;  those core elements that represent tipping points taking the industry in a different direction.  I see one core element within both definitions, that embodies social interaction.  This implies direct contact of some nature, hence the debate my post created.

Its always hard to determine cause and effect, and easy to confuse them.  For example, I have spoken in this blog about dis-aggregation of financial services, but i see that as more of an effect, that arises because they can be dis-aggregated, and re-aggregated in other ways, within new networks.

Social Finance is a driver in my view.  It is basic to human nature.  Internet and modern Web 2.0 tools merely provide a platform for such natural activities to occur.  So when I use examples in defining Social Finance, I want to try to be laser clear on what that means.  Social Finance successes and failures will be defined by the participants, and generally Banks would prefer if it just went away. 

In reviewing results from players in Social Finance, I think we should be looking at the execution of Social Finance, and attributing the results to that execution.  This requires a more detailed analysis at times of the execution, so that we can properly attribute value created.

Examples of potential outputs that could define Social Finance / Computing success:

1. interest rates – better or worse for borrowers, and lenders
2. customer engagement – mass or niche – will this be a long tail impact or more broad
3. Bank participation – customer loyalties are being swayed by the social finance
4. Scale – gain the process, and coverage benefits that other ecommerce sites have developed, and eliminated, or at least dramatically reduced the manual verification costs, normally associated with lending
5. consolidation – to what extent that social finance operations are consolidated and integrated, eg Virgin Finance and Circlelending
6. horizontal integration – social finance integration with other services, beyond finance, eg social networks, reputation management systems, financial planning

Technorati Tags: social+finance, social+computing