Author Archive

One of our primary objectives in making Prosper market data fully transparent and freely available via an API is to allow and encourage anyone to study the Prosper market and consumer credit markets in general.  We deeply appreciate the level of diligence and analysis so many have contributed using Prosper’s marketplace data.  We are also very encouraged that an increasing number of economists and professional credit analysts have taken the time to conduct deep studies of the market and share their conclusions publicly.

One such study was released yesterday by Economists Ginger Zhe Jin and Seth Freedman of the University of Maryland.  The study looks at Prosper’s market since inception to determine average returns and other interesting conclusions about the market. Among their findings:

1. The average Prosper returns since inception were estimated at 6.05% with a 5.72% standard deviation and were trending up as credit quality continues to improve (see table 9 and figure 8.3).
2. The highest returns were in Near Prime loans (grades B-D) at an average of 8.27%, followed by Prime loans (grades AA & A) at 6.78% and sub-prime loans at 1.73%.
3. The probability of default of a Prosper loan peaks at month ten and then edges down (see Figure 9). This is a major reason why Prosper’s performance tool shows more conservative returns. Prosper’s performance tool does not adjust for this later default moderation, which is significant given that the average age of the Prosper portfolio is currently 9.7 months (i.e. at the peak of the default curve).
4. The study showed that the highest returns occurred for loans priced up to 25%. Loans funded at more than 25% actually showed lower returns because defaults increased disproportionately. This implies that borrowers willing to pay very high rates show higher adverse selection, which is logical (see Figure 8.1).
5. The study found that lenders learn quickly - adjusting their bids and strategies as performance is revealed. New lenders also learn from their observations of earlier lenders in adjusting to marketplace dynamics.

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Chris Larsen is the CEO and Co-founder of Prosper.

Here is the Opening Prosper Days 2008 Keynote delivered by Prosper CEO Chris Larsen.  All of the videos can be found at Prosper Days 2008 Videos.

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. 

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Chris Larsen is the CEO and Co-founder of Prosper.

The essence of the Web 2.0 movement is taking the systems that operate our markets and society out of the hands of the elites and putting them into the hands of the masses.

In effect, the movement is a continuation of hundreds of years of struggle to distribute power and create a pure form of democracy. These are still the very early days of the Web, and there is much debate as to whether this power shift will lead to a better society.

Two central questions associated with this debate are: Why should the masses perform better than our most brilliant elites? Will Web 2.0 usher in the wisdom of the crowds or the dumbing down of everything.

I believe that the wisdom of crowds will prevail, and that the outcome of this power transition will make markets more durable and efficient, while at the same time doing a far better job aligning the objectives of markets with society.

The Peer-to-Peer Marketplace is Toppling Cathedrals

Many in Silicon Valley have embraced The Cathedral and the Bazaar, which started as a justification for open source technologies, but has since morphed into a manifesto for Web 2.0. The book makes the point that while Cathedrals (the elites) are more impressive than Bazaars (the people), Cathedrals are also much more vulnerable.

When disrupted, Cathedrals have a single point of failure which can take years to reconstruct. Just look at the impressively elite CDO market that is behind today’s mortgage meltdown. This market is certainly a Cathedral to financial engineering both in scale and complexity. Yet it has essentially stopped working and might be fatally wounded. How could this have happened? The CDO market is among the very largest on earth. The weakness lies in the reality that it is controlled by a few hundred people.

These “experts” were in near lockstep when the market was booming and they continue to remain largely united as the market grinds to a halt. The participants – borrowers and investors – were merely passive followers, setting up the moral hazard we are seeing now. Both sides are now hurt: borrowers with what they can now not afford, and investors with what they cannot see or price. Even the Fed Chair recently remarked, “I wish I knew what these were worth.”

This Cathedral has certainly fallen.

In contrast, the Bazaar, is far less beautiful, but much more durable and adaptive. Destroy the Bazaar and the next day it will be working again – maybe in a new location or different form, but it will be functioning. This durability has great value to society and has wide application.

Shifting Power Back to the Bazaar

The Internet itself is a Bazaar: the Web’s central organizing theme has been to decentralize. Open source is also a form of the Bazaar, as is Web 2.0 and person-to-person finance – a market of hundreds of thousands and soon millions of people bringing their own views, judgments and hopes. This durability is drawn from independence and accountability. Rather than blindly following the experts, the buyers and sellers in the Bazaar see exactly what they are buying and participate rather than passively accept. Accountability is inherent, not assumed.

“Money then Merit” - The Life Approach of the Greedy Elite

Web 2.0 markets have the potential to end the elites’ destructive “money then merit” model. This is the elites’ practice of dividing one’s life into a money making phase where success at any cost is the key objective, and a merit phase where you make up for your sins.

Think Michael Milken’s journey from bond thief to cancer crusader.

Elites are comfortable with this bi-polar way of life. Becoming an elite requires a single minded focus on money and power until their position is secure. Once on top, concerns about legacy kick in, and the elites begin worrying about the merit of their actions. It’s easy to become a Philanthropist After Your First $100 Million.

It is even worse with cynical corporate elites where earning merit, such as promoting free speech or protecting privacy, is rarely more than a compliance or PR issue. The often greedy and sometimes corrupt loan and banking industries are vivid examples of this. The elites pretend that markets and society are different, which is destructive and primitive.

“Money and Merit” - A Balanced Approach to Success and Happiness

Individuals don’t really see the world in the same destructive and self-serving way as corporate elites. The average person conducts him or herself more holistically and in a manner where money and merit can work together. Individuals want to be successful and happy, which is very different from being number one at all costs. By merit I am not suggesting charity. Rather, I am talking about conducting oneself with conviction in the way one’s life should be lived.

Since starting Prosper, I have met some Prosper lenders who are among the most strident free-marketers I have ever known. They make Ayn Rand seem like an indecisive liberal. You would assume that these individuals are just like the elites I described in being singularly focused on money. Yet their belief in free markets is not a cold calculation of power; their belief is driven by a conviction that free markets will move humans forward. Whether we agree with this view misses the point, it is that most people’s conduct in the market is consistent with their conduct in society. In surveys of lenders on Prosper, people want to make a good return and feel that they helped someone at the same time.

Imagine that. Lending with a conscience in a free and transparent marketplace.

And it is not just Prosper leading the charge. A sea-change is afoot, as other progressive companies like Zopa in the UK and Lending Club in the U.S. see that providing a way for people to help people, as all benefit, is the way of the future.

Money and merit is the seed to a living market: a collective efficiency that will do a better job serving the needs of society. Any evidence of a dumbing down of the market should be temporary and should be blamed on the technology infrastructures that support the people, not on the value of the people themselves.

It is the responsibility of Web 2.0 companies like Prosper to find the right balance between transparency, privacy, freedom and safety to unleash the full potential of the Bazaar. The companies that get this right will succeed; those that do not will crumble. Either way, people empowered with technology to share and collaborate will win their struggle because their conduct is inherently more valuable than that of the elites.

Be well, and prosper.

Chris Larsen is the CEO and Co-founder of Prosper.

In last week’s Wall Street Journal article “Interest Rates Defy Rate Cuts,” James Bianco, president of Bianco Research LLC, a market-research firm in Chicago said, “Even though the Fed has eased three-quarters of a percentage point since September, the market has only gotten between 0.25% and 0.50% of that easing. If you look at it from a saver’s and borrower’s side, it shows you that the market is still not functioning properly.”

Although borrower rates and lender rates of return on Prosper are not formally tied to moves by the Fed, the dynamics of the broader credit markets, which have led to a string of rate cuts, clearly seem to be having an impact on the Prosper marketplace. For example, in October average borrower rates for all Prosper prime loans and Prosper Prime Select loans were 12.27% and 9.50%, respectively; down 0.39% and 0.65%, respectively, since the Fed rate cuts.

Continue reading Lower Borrower Rates, Fewer Subprime Loans Funded