The Next Best Thing?
Recently, a friend of mine attended a credit union conference in California. He told me that a panel discussion led by large credit union CEOs identified peer-to-peer lending as the biggest challenge facing the credit union industry. As a general rule, I believe that anyone who agrees with me is right, so these CEOs are on to something.
The good news is that peer-to-peer lending has the ability to make borrowing cheaper for the American Consumer; the bad news is that this misunderstood phenomenon is moving at the speed of the Internet. It’s time for regulators to start regulating peer-to-peer lending, and yes, that includes limiting its reach.
In its pristine form, peer-to-peer lending can evoke the banking equivalent of a barefoot child picking daisies in a meadow on a sunny day. Instead of Joe Hardworking Consumer and Sally Hardworking Mom having to go to the big bad bank for that debt consolidation loan, or to get financing to turn their great idea into a small business, they can turn to an online lending site that is only a click away on their smart phone. Their fellow consumers can get a decent return by fronting them money while Sally and Joe get a better rate than they ever would at a financial institution. In the utopian view, technology has done away with the need for a bank, or credit union for that matter, to connect lenders and savers.
Now, for reality. Believe it or not, your average consumer doesn’t have that much extra money to lend to a neighbor. Increasingly, behind most of these lending sites are some of the same personalities and investment banks that brought us the last financial mess. For instance, the latest high priest of financial innovation in the peer-to-peer lending market is Lawrence Summers. Yes, this is the same Larry Summers whose resume includes advocating for the innovation in the Clinton Administration that laid the groundwork for the “too big to fail” banks that now are too big to be effectively regulated and forcefully advocated for the Obama Administration not to be too tough on them once the consequences of these policies brought us the Great Recession.
In a recent speech, Summers, who sits on the Boards of two peer-to-peer lending companies, argued that while regulators need to ensure there are adequate disclosures put in place for peer-to-peer lending activities, regulators should not move too quickly to restrict lending activities lest they squelch this brilliant innovation.
To me, Summers and his ilk are the Blues Brothers of financial innovation: they constantly want to get the old band back together, even if it ends in disaster. Peer-to-peer lending has its place, but here are the questions regulators should already be asking.
- Should capital requirements be imposed on investment banks that specialize in holding peer-to-peer loans? This question is crucial since peer-to-peer lending isn’t being driven by Libertarian idealists, but by investment bankers who see the next great investment opportunity. These gurus argue that analytics now make it possible to predict repayment ability better than ever before. This is true, but I still don’t want trillion’s of dollars of unsecured loans floating around the economy next time things go bad as lenders have no collateral to absorb the losses.
- Should we make sure that peer-to-peer lenders have skin in the game? In other words, we don’t want to create another origination platform for banks more interested in securitizing packages of loans than they are in credit quality.
- Should the number of personal loans that can be taken out by any one consumer be capped?