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P2P Lending: “This will not end well”

The Sunday Morning Herald, an Australian newspaper, recently had an article that started like this:

“Is peer-to-peer lending out of control? There's certainly some cause for concern.”

It cited the industry's rapid growth as one of the reasons for this worry.

To back this up, it quoted Tania Modic, head of Western Investments Capital, a family-office based in Lake Tahoe, Nevada: “Yes, these platforms are low-cost distributors of loans, and investors are frantically chasing yield. But loans take time to season and go bad…The music will stop – it always does – and this will not end well.”

Rapid growth is no cause for concern

Lots of things grow rapidly without causing any concern. A new start-up with an innovative product grows rapidly. That's not cause for concern for anyone except its competitors.

In the same way, it's no cause for concern when a new industry is growing rapidly.

The P2P lending industry has an awful lot of room to grow into. Global lending to individuals and businesses is measured in the trillions, not the low billions. So new competitors such as P2P lending websites have an awful lot of room to grow into comfortably.

As the article states, P2P lending is less than 0.1% of the global lending market to businesses and households. Despite its rapid growth, I'm not sure how that can be called a P2P lending “boom”!

When to get worried

I think Tania did have half a point.

There will be tough times when investors lend too much, interest rates are too low and the more careless investors will lose a lot of money. These cycles happen with all investments and P2P lending will be no different.

But to say “this will not end well” is to suggest that this time is imminent. It clearly is not.

Worse, it suggests that that will be the end of the story. But a downturn is just one phase of it. Like the stock market, property market and all other investments, after such a crash there will be a recovery and, on average, investors can expect to do just fine provided they follow simple sensible strategies. (See the 4-Step Strategy to Safe Peer-to-Peer Lending.)

“Chasing yield”

Tania also said that individual lenders are “frantically chasing yield”. This is when interest rates fall, so you lend your money in riskier loans in order to boost them again.

I think that some investors might be doing this a little bit in the UK, but at the moment most people are still over-cautious about lending their money in this way, so interest rates seem mostly reasonable to me.

No one at 4thWay, not the main founder or our new chief risk modeller either, are concerned at this stage. Interest rates are mostly high enough that there's an awful lot of margin for error in case another major recession strikes one day soon.

High share prices are no warning sign

The article cited the high stock-market valuation of the US' largest P2P lending website, Lending Club, as another reason that “this will not end well”.

If the share price is too high, that's a problem for people who have bought shares in Lending Club only.

It's not a problem for Lending Club and it's not a problem for people who lend in loans through Lending Club, who will lose nothing in the event of a share-price collapse.

Subprime-mortgage style disaster is not imminent

The article also compared P2P lending to the recent subprime mortgage boom (which was partly to blame for the 2008-10 financial crisis), because P2P lending websites are beginning to split and repackage loans in a similar way.

“Wall Street loves to package and pass along risk,” Tania said.

However, this “securitisation” (as it is called) has occurred in many industries for a long time. Just because it went wrong in subprime recently, it doesn't mean all securitisation will end badly all the time.

And those of us who continue to lend directly through the P2P lending websites cannot be affected by securitisation problems unless and until that repackaging grows to staggering levels that could affect the economy and our jobs.

We're so far away from that that it's not worth writing any more about at this stage. It's something to keep an eye on as it develops, but not yet.

It looks to me like this was just hype to get Western Investments Capital in the newspapers. Or perhaps I'm being unfair and there really is a P2P bubble going on across the pond. But I wouldn't know about that.

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