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  1. Home
  2. / Investing
  3. / Technology

Capitalizing on the Future of Loans

The rise of peer-to-peer lending is poised to accelerate rapidly.
By ROGER ARNOLD Sep 09, 2014 | 03:30 PM EDT

The financial media is now fixated on Alibaba's bright-and-shiny, $21 billion initial public offering (IPO). There's another IPO in the offing that is far more important but also much less bright and shiny: LendingClub, for something closer to $500 million. 

Alibaba's IPO is bigger and will generate more investment banking fees than LendingClub's will. But Alibaba is an evolutionary company in a sector that has already moved into Internet commerce.

LendingClub, on the other hand, represents what I believe will be looked back on as one of the important events that marked the beginning of the revolutionary destruction of finance and banking, and its recreation into something different and better for society and the economy -- not only in the U.S., but globally. The principal commonality between Alibaba and LendingClub is that they are both in the business of profiting by using technology to bring together the producers and providers of goods and services and their consumers.

In LendingClub's space the investment bankers bringing the company public are aware that they are helping to facilitate the growth of an industry that will seek to replace them in the future. It's what they do though and they have no choice than to participate now and let future generations of investment bankers and their lobbyists in Washington, D.C. deal with the competition for their services that LendingClub and the rest of the peer-to-peer lenders present.

I wrote about this process last March in the column, Creative Destruction, in which I referenced LendingClub and some of the other similar and growing companies in the peer-to-peer lending space.

One of LendingClub most interesting aspects is that that company was started in 2006 at the height of the housing boom. The subsequent housing bust that wiped out the subprime mortgage and consumer lending sectors helped to create a customer base for LendingClub.

By severely limiting the ability of bankers to make loans by dictating specific underwriting requirements, the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 helped to ensure that LendingClub and the other peer-to-peer lenders would have a customer base. I discussed this issue in 2011 in the column, Pre-Subprime Loans Returning, as well as the rebirth of "hard money" lenders, which had been pushed out of business or marginalized by the institutionalization of securitized subprime loans.

There's an even larger and more important structural component to the rise of the peer-to-peer lenders than the advancement of technology that makes them possible and viable and the financial crisis that has helped ensure their growth.

That issue is that the financial industry has been structured on a rentier capitalist model that has ensured that grossly outsized returns have been funneled to it. This has allowed it to exist without competition because legislation and regulation have created barriers for those attempting to do so too large to overcome.

The biggest of these structural issues is fractional reserve banking, which allows banks to leverage their assets at roughly 10x their reserves. As a result, non-bank, hard money lenders have traditionally not been able to compete on an offered loan rate basis to borrowers.

However, the monopoly on leveraged money creation should have allowed the cost of bank originated loans to be much lower for consumers, both retail and commercial, than it has traditionally been. Instead, the industry has extracted a toll from consumers through fees and loan rates. This has compensated the bank far more then the value-add they brought to any transaction -- whether it was making a consumer loan, structuring a bond offering, or bringing a company public and everything in between.

Nobody does business with a bank or banker because they like them or because it's a good deal. They do so because they have to and they do so begrudgingly, regardless of what they tell their bankers.

The nascent rise of the peer-to-peer lending industry is poised to accelerate rapidly and expand from simple consumer loans into autos, mortgages, commercial loans, and investment banking. Their customers will come from everywhere as the legitimacy of this new way of bringing providers and consumers of capital together grows.

The existing financial infrastructure is not prepared for it and cannot become prepared. There is no way to legislate or regulate this technology away. The days of rentier finance are beginning to draw to a close and that will be beneficial for everyone who is not in that industry.

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TAGS: Investing | U.S. Equity | Technology

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