Imagine that you sit at the small loans desk at the local bank. A well-dressed customer walks up and asks to borrow $5000; " I need a loan ", he says; "I need it to pay off my credit card debts, and I'm willing to pay you 20% on this loan". He does have reasonable credit, but something about the situation doesn't make sense to you. If he's paying 20% interest just to pay back another loan, how is this even help them save anything? Maybe this is how you would think sitting behind a desk at the bank, but apparently, if you are on the Internet looking for a place to park your spare cash, you'll just give it to anyone who asks just because he promises to pay you 10-15% interest, which you figure is twice what you would get on the stock markets.
They call this person-to-person lending; you just go through a classifieds website that does a certain amount of vetting for borrowers who want to list their needs, and you send your cash over to anyone who asks. The return seems so wonderful that you just feel like it would be a shame to ruin this good fortune, daunting a wonderful thing. This whole concept was set off by the Internet startup Prosper.com. And did they prosper! When they set up shop a couple of years ago, somehow, the Wall Street Journal and Time magazine raved about the ingenuity of capitalism. People would ask for loans for the funniest things - someone would put up a note on the website and say,"I need a loan to set up a business making and selling new recipes on the Internet", or "I need to get a nose job done", or anything else. Even Harvard business review couldn't stop admiring the ingenuity of it all. There were soon other Internet companies that came up to follow this business model.
You would think that these magazines and authorities on finance, once they held forth on this idea, did follow-through and check to see if they were right, and if person-to-person loaning actually did work in the real world. Well, this certainly says something about how responsible the reporting at these magazines is. The founder of the Prosper site is ecstatic anytime he weighs in at an interview on the ingenuity of it all. If America was in the middle the credit crisis where no one could get a loan, people just needed to go and plaintively say I need a loan - and a loan they would get. If only people could trust each other through websites like Prosper.com, the economic downturn and other such problems could be set right.
But really, this has been tried before: it is called subprime lending. The banks did exactly this in the last few years - make loans at high interest and low security. They ran up huge debts and could not recover loans. In many cases the banks went under for their misdeeds. The same went for the housing business too. This particular lending website has linked nearly $200 million so far; if I need a loan that I'm willing to pay such high interest rates for, usually it's because I have no idea how to work my numbers. And I'm likely to get myself into a hole very quickly. About one out of three borrowers on these websites typically defaults. And the individual lender, the housewife who has a little spare cash, the retiree who thinks he has to take this risk to survive, all of these people found themselves on the street for the trouble of trusting strangers for no reason.
Maybe, at first, people were mesmerized by the idea of just handing over their cash to anyone who walked up and said the magic words "I need a loan", but today there is plenty of information on how dreadfully the lenders are smarting for having trusted this business practice. Just repeating on a small scale the bad and ill advised greedy business practices of the large bankers, will never pull the country out of its recession. If anything, it could dig it in deeper.
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