Prosper.com, P2P Lending Startup, Shut Down by SEC [pdf]
sec.gov
sec.gov
Incidentally, I am a Prosper lender to the tune of $300. The dirt on this story could fill a small book, or a large forum (http://www.prospers.org)
The long and short of it: Prosper really wanted to be a technology play like Paypal which disintermediated banks and then got to take a small slice off each transaction. However, their model required that they, in effect, take on a lot of banklike aspects -- including investigating borrowers and collecting on deadbeats. They were woefully unprepared for both of them, thinking at the beginning that the lending peers would crowdsource it, before they realized that this would be very, very illegal.
(Privacy/harassment laws + telling 50 pissed people the identity of a single mom late on her payments + Google + lawyer = you tell me how this story ends.)
Anyhow, Prosper expected that despite the complete lack underwriting and neigh-total lack of fraud checking they would get default rates roughly similar to that of banks. Then, BEFORE the financial crisis started, reality set in and lenders started losing lots of money. This made Prosper's claimed rates of return ("Hey, if you loan money at 20% and only 5% default that means you make 15% APR!"[1]) extraordinarily rosy. Rather than accepting the data and revising the claimed rates of return downward, they instead started slicing it in smaller and smaller pieces (creating, for example, a Prosper Select Index filled with their best quality borrowers -- are we hearing the word "tranches" yet?) to claim that the rate was still exceptionally positive.
Representative ad:
[Edit: Thank you to commenter who pointed out my URL was borked. I'll TinyURL it: http://tinyurl.com/63em2c ]
Funny, "Earn 8.00% to 12.00% rates of return" looks like a security, it sounds like a security, it feels like a security... except if it were an actual security, well, the accountant who approved those numbers would be locked up. (Seriously. I liked the company, but the math is THAT bad. The average rate of return lenders of size were actually achieving was, at the time, closer to 3%. About 25% were losing money. Only about 10% every achieved the rates that were claimed in 36 pt font. And for what its worth, although my $300 doesn't make me a large lender by any stretch of the imagination, up until my first late payment a few weeks ago I was earning close to 18%.)
[1] Despite two years of trying to educate them about how math works via their forum and their email, we lenders were unable to penetrate their ignorance about high school math. Seriously. Three years after opening they still thought 25% interest and 20% defaults meant a 5% return. Even if the defaults were almost instantaneous, as most defaults on the platform are.
From the borrower's perspective, if you can't qualify for a traditional bank loan, they were amazing. (I fit that description at the time: there was a dearth of traditional banks which were well set-up to service a young white professional whose salary was paid in yen.)
My loan was one of the success stories: I couldn't have gotten a student loan through a traditional lender ("Your brother is going to cosign this? From Japan? Via fax? Pull the other one, kid, it's got bells on"). My peers, other lenders from the official forums (which were later closed), trusted me after several months of online interaction. I asked them for $5,000, they crowdsourced it in $50 and $80 and $230 increments. They got all their money back and 13% interest besides. Prosper got $50 and 1% APR for providing the platform. My little brother got to register for classes at Notre Dame on time. Everybody won.
And for a while, I thought loans like that were going to be common enough to paper over the (numerous) faults. I was catastrophically wrong.
William Gibson, eat your heart out...
As a prosper borrower, I loved the service (which helped fund my startup - http://fangamer.net ) because it was kinda like high school -- easy to excel with nothing more than a little effort. Not hard when your 'competition' is a picture of a dog and the words "gotta pay credit cards im very trustwrothy w/ $$$".
I haven't gone back to Prosper since I paid off my loan much earlier this year, though, so it's depressing to see that such a brilliant idea was handled so poorly.
Hopefully some enterprising young turks can find a way to make it work...hint
http://www.netbanker.com/WindowsLiveWriter/ProsperAdvertisin...
Well, the test didn't go well and I've been steadily withdrawing my money over the past couple of years. At the end of the day, I expect (pending the outcome of this new development) that I'll lose about $3k total.
I'm actually a huge fan of Prosper - I'm a lender with $500 invested, and I've actually gotten a 20% return because I spent a lot of time screening my borrowers, who have still yet to make a late payment, much less default.
I only accepted B and above credit ratings and generally just used common sense when selecting a borrower; very well written, well thought out profiles got priority, limited (1 or 2) late payments in the past were required. I always checked how much of their credit they were using versus how much they made, I never funded a loan near the $25k borrowing limit to avoid a hit-and-run default, I only funded good causes that suggested the borrower spends wisely, etc. Prosper gave a lot of financial information about these people, so I felt that I could make a pretty educated decision.
I hope Prosper registers with SEC so they can continue doing business. The platform is pretty amazing, and I think they really added value to the world. I was totally looking forward to scaling up my selection system by automating it, and Prosper was working on an API that would actually let me do that.
I never bought into their math, and didn't even really think about it. My plan was always to pick loans very carefully so that very few if any would default. In retrospect, I'm glad I didn't do any subprime lending. :)
That said, I probably jinxed myself now and everyone in my portfolio will default...
Though I wasn't using 35:1 leverage.
Regulations exist for a reason. As long as your willing to follow the regulations (which exist to prevent mis-selling, market abuse, insider trading, and other such things) getting SEC approval isn't that hard.
The other alternative is to partner with a regulated firm and use their approval, this it the route Zopa has taken. But again you need to make sure your company follows SEC guidelines.
If the computer industry was regulated like this, the Internet would look like Compuserve circa 1990. And your PC would still only have 640K of RAM.
Oh I get it.
That said? If you knew about the particulars of this situation, which I covered a wee bit about in a post above, you would say Prosper is about as close as you can get as a poster child for Why The Market Should Be Regulated without being founded by Ponzi himself.
They weren't malicious, they were just stupid.
Anyway, I was referring to the banks "investors/shareholders" that have been fleeced, not those the bank lent money to.
I do believe that most of the people making the decisions that led to this crisis had the standard capitalistic intentions of making money for themselves and their shareholders. I wouldn't say they were "ripping off" their shareholders, though they certainly did let them down.
On a smaller scale (relative to this crash), the dot com boom saw massive public market fraud as well. I was in the middle of it in NYC during this time and personally witnessed massive fraud and insider trading with NASDAQ entities. The direct result was that the outside public investors paid for this fraud.
I have seen enough details of what bank and related financial entities have done over the last 10 years (and another cycle of bad behavior another 10 years prior and then another) to understand that they did not come close to disclosing the nature of the risks on and off their books. This is actually pretty scary to think that a public financial entity can even have such a thing as an "off the books" position.
Having said that, there are sensible reasons for regulating companies in the financial industry, for example preventing unsophisticated customers from losing lots of money.
And that's precisely why they will be always shut down. Government hates competition. Gov also shut down Liberty Dollar which was a commodity-backed currency.
"Community currencies may present problems for users because there is little to stop the issuer from producing more currency."
ahh...brutal irony in a wikipedia article ;)
Did anyone else listen to NPR yesterday morning and hear the open admission that they were printing to fund their new failout package?
I'll give you X dollars-today, in exchange for 1.1X dollars-N-months-from-now.
Or I'll give you X dollars-in-a-month in exchange for Y Euros-today.
Does the SEC regulate currency trading markets?
And, if not, why can't dollars-today and dollars-6-months-from-now be traded as separate currencies [taking into account expected inflation/deflation, as well as the time-value of money]?
Isn't that the very definition of interest?
Am I missing something?
http://en.wikipedia.org/wiki/Islamic_banking#Modern_Islamic_...
So even if charging interest is forbidden in one way, there are ways to circumvent that.
However it doesn't work if you can't guarantee a fixed rate of interest (as in this case).
However, I think usary protections should exist and we need to repeal all these loopholes.
And NOW...prosper is "off the air"...fascinating.