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Monthly Archives: September 2012

Ways to Improve Peer-to-Peer Lending

30 Sunday Sep 2012

Posted by Oren Litwin in Credit, Economics, Finance, Investing

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Tags

Borrowing, credit score, disintermediation, lending, Lending Club, lending money, P2P, prosper.com, social lending, unbanked, usury, Zopa

For a long time now, I’ve been interested in the potential for Peer-to-Peer lending (P2P). Rather than people depositing money with a bank, which then turns around and lends the money to borrowers while keeping most of the profit, in P2P lending some service matches borrowers and lenders directly. Ideally, this allows borrowers to get loans at a cheaper rate, while still giving lenders a better rate of return. It also allows nontraditional borrowers to get funded, if they can tell a good enough story. But there are problems with P2P, to which I would like to propose some solutions.

Right now, the biggest names in American P2P lending are Lending Club, and Prosper.com, where I was a small lender back around 2007 or so. When I participated on Prosper, I was able to see instances where the model worked perfectly, and other instances where the model caused problems. Among the advantages were that groups of people who knew each other (whether In Real Life or on the internet) could provide each other with funds at below-market rates, as an expression of their fellowship. This is something I liked a lot, since Judaism tends to frown on lending money at interest anyway. (More on that topic in another post…) Additionally, some borrowers whose credit score was relatively low were able to convince borrowers that they were a good risk anyway, because of factors that their credit score did not reflect.

The bad news came from several sources. First of all, because all money had to be provided by the individual lenders, as opposed to a centralized source of funds like a bank, many otherwise-attractive borrowers who didn’t know how to market themselves went unfunded. Second, the need to market yourself in the first place can be a turn-off. Borrowing from people you know can lead to tension and a loss of privacy. One of the biggest advantages of the modern system of bank or credit-card lending (as opposed to borrowing from friends and family, as the “unbanked” tend to do) is that banks can lend functionally unlimited amounts of money if they choose to, and your financial circumstances are strictly between yourself and your banker. With Prosper as it stands now, neither of these two factors are at work.

The next problem was due to greed. In the early years, lenders were attracted to the high rates paid by low-quality borrowers, particularly “HR” or high-risk borrowers who could be made to pay up to 30% interest per year. The problem was that in most cases, these borrowers were staggeringly bad risks; those of us who jumped in with both feet ended up losing quite a bit of money when the loans were not repaid. Ultimately, we lacked the knowledge and temperament to tell a good borrower from a bad one, and to resist the lure of fat profits for taking unacceptable risks. There is a reason that (until the era of government bailouts) bankers had a reputation for sobriety, prudence, and conservatism. Bankers who lacked these qualities soon ceased to be bankers.

Note that Prosper responded, ultimately, by excluding the lowest-quality borrowers from the market. This managed to improve default rates; but the fundamental problem remains, that lending decisions are being made by amateurs, many of whom do not understand the risks well enough.

Another institution that claims to be P2P, the British institution Zopa, avoids this second problem by soliciting investor capital and simply making all the lending decisions itself, as a traditional lender would. But in this case, there is no actual interaction between borrower and individual “lenders”; Zopa is actually something like a mutual fund for lending with investor funds, rather than bank capital. It is not really a true peer-to-peer vehicle.

Is there a way to mitigate the problems of P2P without going to the other extreme and quashing the social aspect altogether?

Suppose that you have a Lender institution, a depositor (David) who wants to earn some money, and several borrowers (Brad, Ben, and Betty). David puts a chunk of money (say $5000) into his bank account with the Lender. The Lender then asks David if he is willing to lend money to particular people, at any point in the future, and at what minimum interest rate. David knows Brad, Ben and Betty; he decides that he would be willing to spot Brad up to $500 at a time, but only at the market interest rate—he’s not a close friend or anything. Betty, on the other hand, is someone that David likes, so while he’d only trust her with $200, he’s willing to lend the money to her at a nominal 1% interest to cover fees. He knows that Ben is irresponsible with his money, so he’d rather not risk his own money on Ben.

Note that during this process, David does not know if Brad or Betty are actually trying to borrow money right now. That information is kept from him. So Brad and Betty get to keep their privacy. If Brad or Betty should choose to lobby David for more money, that’s their choice. In the meanwhile, money that’s not specifically earmarked for particular borrowers can be treated like a normal bank deposit, earning some amount of money for David and having some level of guarantees.

Now suppose that Betty finally decides to borrow $20,000 for a new car. The Lender can see her credit score, and other such raw numbers; but it also can see that David, and several other depositors, are willing to trust Betty with money. This does two things: first of all, it shows Lender that people trust her, which can be an additional factor in the Lender’s decision to lend or not. Second, it means that they have to risk less of their own money for the same profit, because they can use money from the depositors who know Betty while still earning servicing fees.

The final decision is the Lender’s; if Betty remains a bad risk, Lender can protect the depositors from her. But on the flip side, if people who know her only pony up $5000, the Lender would be able to make up the difference with its own funds if they like Betty as a borrower, instead of letting her languish in social-lending purgatory. The portion of the money coming from depositors directly could be at below-market interest rates if they like, keeping the social aspect of P2P lending. The balance, coming from Lender, would be at market rates.

Obviously, such a system would not be for everyone. Some people would do well enough on Prosper.com or similar sites, even without such a system. Others might prefer Zopa, or even a traditional bank. Still, I think that the proposed system would make P2P borrowing and lending more attractive for a lot of people, mitigating some of the problems while keeping most of the advantages.

(Anyone who likes can implement this system. I only ask that you drop me a note or a comment letting me know, if you got the idea from this post.)

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On The Proper Design of Monuments

07 Friday Sep 2012

Posted by Oren Litwin in Education, History

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Tags

history, Martin Luther King, memorial, Thomas Jefferson

Earlier today, I visited the new memorial to Martin Luther King, Jr. in Washington DC. I had previously read descriptions of the memorial, focusing on the Chinese designer, the resulting resemblance between King’s statue and a statue of Chairman Mao, and so on; so I was prepared to not like elements of the design. However, even beyond what I already had known, I was very disappointed with the memorial. It seems to me that it failed to accomplish the point of having a memorial in the first place.

Back of the envelope, monuments could have three general purposes, which could and should overlap. First, a monument can be intended to teach the viewer about the significance of the subject of the monument. Second, a monument can be meant to honor the subject for the subject’s achievements (particularly in the case of casualties of war; in the ancient world, honoring dead soldiers was a crucial task of such monuments, in part to offer soldiers the chance of eternal glory should they die in battle). Third, a monument can be meant to teach new things to the viewer, perhaps by using symbolism to suggest new meanings or understandings of familiar elements.

An excellent example of a monument that accomplishes all three would be the one to President Thomas Jefferson. Beneath the monument is an underground passage, full of educational murals and videos that discuss the history of President Jefferson. (Admittedly, they downplay the really interesting bits, but such displays can’t get into the juicy details, I suppose.) The monument itself contains a statue of Jefferson, and the walls are carved out with quotes from his writings, which capture the essence of who Jefferson was, what he believed, and his significance for the history of our country and the world in general. (Some other time I might write about how the Declaration of Independence had effects that reverberated throughout South America as well as North.)

The choice of quotes is also meant to impart a lesson to the viewer; I am particularly fond of Jefferson’s statement, “I have sworn upon the altar of God, eternal hostility against every form of tyranny over the mind of man.” This statement is inscribed around the rotunda, giving it pride of place, and indicating to the viewer that this is the key lesson of President Jefferson, something that we too can learn from and put into practice. But all of the quotes are variations on the same theme: liberty, freedom, justice in society. Among these is an extract from the Declaration of Independence: the viewer cannot forget that Jefferson is its author, and a crucial figure in the Revolution.

Compare the foregoing to the MLK memorial. In form it is a massive block of stone, out of which is carved King’s likeness. Flanking it on both sides is a curving wall, which bears several quotes from King’s writings and speeches. I shall ignore the demerits of the statue itself, and focus on the quotes. None of them, none of them at all, indicate to the viewer that King’s life work was fighting against the segregation of blacks from whites in America. None of them indicate that King was a religious figure, or anything about his life history, or that he was assassinated as a martyr to the cause of racial equality. In fact, if you knew nothing at all about the man before visiting the memorial, you would leave it knowing nothing still.

To be sure, the sentiments expressed in the inscriptions are often lofty. But they are too lofty—so lofty that the quotes are entirely metaphorical (for example discussing light driving out darkness), or discussing the universal brotherhood of humanity (rather than the concrete struggle for black freedom). Other quotes seem non-sequitors, particularly the one about people deserving three meals a day. It has significance only if you already know who King was, why he was important, and the stature he has within the American consciousness. So the quotes end up seeming banal and trite, because we do not know why they mattered.

In short, this memorial utterly fails to teach the viewer about who King was. It honors King himself, but only in a general sense; the task that he dedicated his life to is not made explicit, and so is cheapened by omission. Similarly, his assassination is not acknowledged or honored. And finally, because none of the groundwork is there, there is no sense that the arrangement of the memorial can convey any new meanings, in metaphor or imagery.

Why am I discussing this on a blog devoted to structuring our environments? (Aside from my not posting anything for the last month…) Because really, anything we do can be a memorial in the sense discussed above. Much of how we arrange our environments is meant to guide our behavior, either by explicit teaching and direction, or by implicit metaphor and influence on the mind. Knowing the principles of a good monument can be useful in many areas of life, I suspect. And the more people who can tell good monuments from bad ones, I hope, the better constructed our public spaces will be.

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