Why Getting a Loan Just Got Harder
First, the subprime mortgage implosion. Then, the collapse of Bear Stearns followed by Bernard Madoff and his $50 billion Ponzi scheme. As the economy careened into a recession over the past year, the Securities and Exchange Commission's regulatory failures played a part in these debacles and several more. And while the financial market's top overseer often opted for inaction on Wall Street, it has recently chosen to target the online peer-to-peer lending industry at a time when credit lines are shrinking, interest rates are soaring, and traditional banks are wary of supplying loans to most borrowers.
Through peer-to-peer lending websites, small-business owners or other people seeking a loan can borrow directly from individual lenders, eliminating banks from the process. On some sites, like Prosper.com, lenders bid on the interest rate they are willing to give a borrower. On others, like LendingClub.com, interest rates are based solely on the borrower's credit history and set by the company itself.
In November, the SEC filed a cease-and-desist order against San Francisco-based Prosper Marketplace, which runs Prosper.com, ruling that the loan notes being offered on the site were securities and needed to be registered with the commission. Prosper had stopped facilitating new loans the previous month in anticipation of the ruling, and to start the registration process to set up a secondary marketplace where lenders could package and sell loans to each other. Prosper also reached a $1 million settlement with the North American Securities Administrators Association, the membership organization for state securities commissioners. As a result, another peer-to-peer startup, New York-based Loanio, decided to do the same in November, only a month after launching. London-based Zopa.com also closed its U.S. peer-to-peer lending site in October.
"A successful registration can take several months," a note on Prosper.com said in December, "but we assure you we will do our best to move forward as quickly as possible."
Loanio posted a similar statement on its website. Neither company can talk publicly while in their "quiet period."
For its part, the SEC says it is simply trying to protect the lender-investor, according to Laura Josephs, an assistant director with the commission's enforcement arm who led the case against Prosper. "Generally, we are always cognizant of new companies trying to do something innovative," she says. "It's in nobody's interest to stomp out innovative products."
As of the end of the year, San-Francisco based Lending Club was the only one left standing. The company first started talking to the SEC in October 2007 about setting up a secondary market for lenders who, in search of liquidity, wanted to package and sell their loan notes to other lenders, according to Renaud Laplanche, Lending Club's founder and CEO. After SEC staff members started hinting that Lending Club should register its loan notes for the primary market as well, the company decided in April to stop facilitating new loans and enter the registration process. It cost Lending Club several million dollars, but the company was able to restart its operations in October.
"Any disruptive innovation in financial services is going to end up getting regulated, and for good reason," Laplanche says. "And it's a good thing for us because we're now perceived by lenders as being more credible."
About 25 percent of Lending Club's borrowers are small-business owners, according to Laplanche. In an environment where credit continues to get harder to come by and more expensive, the peer-to-peer industry offers an alternative to the traditional loan process for the self-employed.
Angela Hwang is one business owner that is happy to see at least one site remaining. Hwang, founder and CEO of Blue Star Tees, a Danbury, Connecticut-based retailer that sells superhero T-shirts on Amazon.com and BlueStarTees.com, recently applied for a $2,000 loan through Lending Club. She usually charges business expenses on her American Express card and pays the balance in full when it comes due. But she feared that she might not be able to do that in December if holiday sales didn't pick up, and that she would be subjected to the card's 18-percent interest rate. After a friend told her about Lending Club, Hwang completed the online application process and was happy to learn that she qualified for an 8 percent rate. The money reached her account two days later and she planned to use it as back-up in case she needed it to pay off the credit card.
"Someone like me, I'm not trying to get a mortgage or something," Hwang says. "I just need a few thousand dollars here and there."
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