Have Your Cake and Eat it Too
One of the exciting things about the wave of technology sweeping society is that generally it is providing unprecedented control. It seems we always talked about capitalism in terms of a grand trade-off: yes, we could have efficient markets but they would always be brutal and unkind to the average person. We talked as if the best economic system always had some necessary evil – particularly during the Cold War as we struggled against the Soviet system which had no redeeming value. The exciting thing about the P2P technology revolution is its core premise that we can have our cake and eat it too: That purely capitalistic, open markets not only strengthen society but provide the average person unprecedented power to shape and decide how society moves forward.
A Borrower’s worthiness – you decide
This is at the heart of why we built Prosper. We believe that the core advantage of a person-to-person system is the ability of each person to shape how and why money gets allocated and at what price. As such, we believe it is vital to move away from expert systems where a small group decides how markets will work. Thus, core to Prosper’s model is our auction system which allows anyone to judge and price the worthiness of a borrower. It may seem like a small thing, but it has huge consequences.
What is the essence of credit? It’s a promise by a borrower to repay an obligation. At the end of the day – a loan bidder is judging that person’s ability to make good on a promise. Banks and credit committees still make these judgments on a fairly narrow set of data – such as credit history and income. But we all intuitively know that other factors are at work here and eventually over time all of those factors – reputation, association, and the ability to get friends to participate, are relevant in the judgment of that promise.
Add to this complex set of borrower variables an equally complex set of loan bidder variables – that is, why does the bidder bid? To make a return plus help a friend or make a return plus help a woman entrepreneur – the realm of possibilities becomes extremely exciting. Only an open market with millions of people can sort through and establish a true value for these kinds of transactions. Expert systems are coarse and slow and will never be able to capture the true breadth of possibility in allocating and pricing money.
Further, as we see in other markets, liquid markets are much faster at converting knowledge and data than experts. Consider the recent experience of Countrywide – the largest American mortgage lender. Their credit officers are among the most skilled in the industry, yet they were continuing to build their mortgage operations well into the summer when it was plain that the sub prime mortgage meltdown had already begun.
Shifting indicators of creditworthiness
On Prosper, as the credit crunch accelerated into 2007, we saw a very dramatic shift by Prosper market participants into prime lending. Sub prime loans dropped from 25% of total loans in 2006 to a mere 5% in November of 2007. Similarly, home ownership, which used to be a strong indicator of creditworthiness, has been increasingly discounted as an indicator. This isn’t something we the administrators of the market did, but rather the invisible hand of tens of thousands of bidders collectively judging the world we live in right now.
Over time, this advantage will only strengthen as more factors can be statistically evaluated by bidders, and borrowers increasingly associate non-traditional variables to their ability to make good on a promise.
This hope of democratic open markets is what drives us forward. It may be bumpy along the way, but no question that this will create both the most efficient credit markets and the kind of democratic society Americans have always longed for.