Web 2.0 loaning and banking!
Today in Wired news
Got Cash? You Can Loan Money Like a Big-Time Banker
Prosper co-founders John Witchel (left) and Chris Larsen smile for the camera.Photo: Chaddus Bruce
Jane Boon wants to see you stripped down to your financial undies. Boon, an engineer whose husband is former Time Editor-in-Chief Norman Pearlstein, is a new kind of loan officer, but she is not affiliated with a bank.
Boon is one of 30 or so wealthy individuals who have lent out more than $100,000 apiece through Prosper, a 15-month-old venture that combines social networking with online auctions in an attempt to create a lucrative new marketplace for loans.
Using Prosper, lenders like Boon are rerouting money from banks, mutual funds or other assets to thousands of U.S. residents, who are borrowing the money for myriad reasons, from consolidating credit-card debt to expanding an existing small business.
"We're imposing Web 2.0 concepts on a very old-guard business," says John Witchel, chief technology officer and co-founder of Prosper.
Prosper's marketplace is a blend of eBay-like bidding auctions and social networking, and is conceptually related to the emerging world of microcredit.
But unlike microcredit ventures such as Grameen and Kiva, Prosper is aimed at U.S. borrowers, not the developing world.
Wannabe borrowers give Prosper permission to verify their identity and allow the company to access their financial data as collected by Experian, one of the three big credit-scoring agencies.
Prosper then gives the borrower a credit rating and helps match his or her loan request with a number of lenders. A $5,000 loan, for instance, might be funded by 50 people who each lend $100.
Lenders use borrowers' credit scores and other financial data to set interest rates that balance risk and return, while borrowers assemble their loans piecemeal from lenders' offers, giving preference to the lowest interest rates offered to them.
Borrowers have been attracted to Prosper because its auction model offers the possibility of getting lower fixed rates, particularly as part of a group of borrowers, and loans can be funded quickly -- sometimes just days after you've applied. Also, Prosper makes it easier to get loans for certain kinds of businesses, like eBay storefronts, that are difficult to fund through traditional bank loans.
Prosper is a chance for lenders to invest in an arena formerly off-limits to all but the biggest corporations: consumer debt. Prosper CEO Chris Larsen says the traditional money market is a paternalistic system where access to information is restricted and an elite few decide how it plays out, whereas Prosper is open to anyone willing to put in their money.
"It is the first time this large market has been opened up to the average investor," says Larsen, who sold his previous online lending business, E-Loan, for $300 million in 2005.
The ability to invest in a lucrative market formerly restricted to money managers is what attracted Boon. After an initial $2,000 investment to test the waters, she went all in. "The potential returns seemed great so I transferred more money," says Boon. To date, she has loaned a total of $125,000 to more than 800 people. (See related story, "Top 10 Lessons From a Microlending Pioneer.")
Greg Bequette made a similar calculation when deciding to lend using Prosper. "I was afraid that I would miss the opportunity," says Bequette, an accountant for the University of California system. Moving to lock in loans early, he transferred half a million dollars within the first two moths after joining Prosper, making him the second-largest lender in the system.
Behind the scenes, lender profiles and activities are public, making it easy to track who's a successful investor -- and what they're doing right. That troubles some, such as Jonathan Hoenig of Capitalistpig Asset Management in Chicago. "I manage money for other people," he says. "I like to keep my cards closer to the vest." He has loaned around $150,000 to nearly 1,500 people.
Additionally, the number of loans that have gone bad is higher than what was initially predicted. Because of this, Bequette, Boon and Hoenig are holding off investing fresh money.
Bequette, who expected an 18-percent return, is now concerned he won't beat the 11 percent he had with his mutual funds. His guess is that as a new market, Prosper has attracted people who couldn't find loans anywhere else, thus driving up the default rate and hurting overall returns.
Hoenig says Prosper's interest-rate caps of 30 percent aren't high enough to compensate for the dangers of lending to high-risk borrowers.
To keep bad loans from poisoning the well, Prosper blocks borrowers who have defaulted on their loans. Over half the company's engineers work on antifraud measures, according to Witchel, and Prosper insures lenders against money lost due to identity theft. Working with federal law enforcement, the company had its first arrest a few months ago. "Criminal communities tend to chat about who is weak," says Larsen. "We think it is very important to put a line in the sand early on."
At the end of the day, as with all new markets, there is a learning curve for early adopters. "They key thing for us is not stepping in and saying what people should do, otherwise it is just what banks are doing at the end of the day," says Larsen.
