Tuesday, October 9, 2012

Be the Bank

I first learned about Lending Club via a guest blog post on Megan McArdle's former blog for The Atlantic (she writes for The Daily Beast now). Curious, I googled Lending Club to get more information. And the more I read about it, the more I became convinced that this was the best thing since Dancing Jesus. The concept is pretty damn simple: formalized peer to peer lending.

Lending Club (LC) acts as a broker between individual borrowers and lenders. Borrowers apply for credit and LC underwrites the loan and determines a fair market interest rate. Prospective lenders can then review the loan and decide to invest in it in 25 dollar increments called "notes". Loan lengths are either 3 or 5 years, with the borrower making monthly payments. LC collects the payments and then distributes them to the lenders.

You essentially become a credit card company, because the rates that Lending Club charges are about the same as what credit card companies normally charge. Many borrowers are consumers who consolidate their credit card debt into one monthly payment at a lower interest rate. The debt is also unsecured, which means that failure to pay only means that the borrower's credit score gets hurt.

 This idea is absolutely brilliant to me. I became sold one hour after reading that blog post. I immediately opened an account and invested 1k of my own money into it. 6 months later, almost all of my notes are still current (one potentially unscrupulous individual is currently in his grace period). I'm on track to have an annualized gain of 12.5%.

I don't expect that 12.5% to hold up over the full length of my loans (average maturity is slightly less than 48 months), but LC has crunched the hypothetical numbers and tells me that my overall ROI is going to be somewhere around 8 to 9%. In today's low yield reality, 8-9% is an absolute steal.

 I recently put in another round of funding, and I'm considering doing an additional third round soon. To minimize risk to principal, LC recommends that you have 800 notes (20k) for optimal diversification. I'm nowhere near that amount, but I'm going to try and work my way up to that magic number in the coming years.

It's too soon to tell whether my experiment with Lending Club will be "worth it" or not, but so far so good. There are obviously things that can lose me money, such as another economic downturn (which would hurt a borrower's ability to repay an unsecured loan), but I feel confident that we'll muddle through for the medium term.

This is the kind of financial innovation that genuinely helps people. It's no secret that the modern economy runs on debt. But giving individuals like me the ability to invest their savings to give credit to a person who needs it is a net plus for the economy. It allows borrowers lower rates on their credit, and it gives individual lenders a taste of the same kind of risk/reward dynamic that the banks operate on.

What people need to realize is that there is essentially zero distance between us and big business. Collectively, over half of America works for a business that employs 500 or more people. If more people had significant stakes in business, I think the attitude in Washington would be a lot healthier when it comes to business policy. And good business policy is good for everybody in the United States.

A left leaning cynic might argue that I'm essentially putting a new polish on "what's good for General Motors is good for America", and they'd be right. But that's always been the case. When American businesses succeed and prosper, Americans succeed and prosper.

Think back to the nadir of the financial crisis. Everybody is panicking that the economic world is ending. And then what was the policy reaction? We bailed out Wall Street, the insurance industry, and the American automobile industry. The backlash came later when things stabilized and people became more confident that the world wasn't going to end. But when it mattered, the American people and the Federal government instinctively moved to protect the biggest businesses.

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