The Consumer Financial Protection Bureau (CFPB) recently announced that it would start accepting consumer complaints about marketplace lending. Marketplace lending, previously known as “peer to peer” or “P2P” lending, emerged in the aftermath of the financial crisis. A combination of tightening credit markets and low interest rates created a perfect marriage between consumers looking for loans and investors looking for profit. In its first incarnation, peer to peer lending served as an online matchmaking service, allowing prospective borrowers to post requests for loans to be reviewed by individuals willing to make those loans. “Peer to peer” referred to the fact that the lenders were ordinary people, just like the borrowers. The loans are non-recourse, meaning that if the borrower fails to repay, the lender is simply out of luck. Although these would appear to be risky loans, in fact, the default rate has been surprisingly low: 4.9 percent at market-leader Prosper as of the end of 2014, and 5.3 percent at the other leader, Lending Club, during the period between Q1 2007 and Q1 2015.
The loans have performed so well that the market quickly attracted institutional investors and more sophisticated business models. As the two leading providers of marketplace loans today, Prosper and Lending Club use the same (somewhat complex) model. The companies issue notes to investors that are obligations of the issuing company. Simultaneously, WebBank, a Utah-based FDIC-insured bank, originates a loan which is sold to the company. The company pays for the loan with the proceeds from the sale of notes to investors. The loan is disbursed to the borrower. The borrower repays the funds in accordance with the terms of the loan. And the payments from the borrower are used to pay the purchasers of the company’s notes. The payment of the notes is explicitly dependent on the borrower’s repayment of the loan.
Since marketplace lending has gained momentum, there have been concerns about its regulation – expressed both by those who worry that it’s completely unregulated (not true, but there have been no new regulations specifically targeting the industry), and by those–like me–who worry that its innovation will be smothered while the industry is still in its infancy.
Although the CFPB has not announced any plans (yet) to write new regulations specifically aimed at marketplace lending, and although there is an argument that much of the industry actually falls under the SEC’s jurisdiction, the move to solicit complaints certainly seems to signal an interest in regulation down the road. Aside from general concern about regulating an industry still in the process of defining itself (how do you know what problems may work out on their own through better solutions that regulation could provide?), there is a specific problem with using customer complaints as a foundation for regulation, or even for supporting an argument in favor of regulation at all, and that is that there is clear self-selection at play. Who is more likely to seek out the CFPB’s complaint portal: the happy borrower who has secured a loan at a favorable rate, or the disgruntled borrower?
While the American public has always been free to “petition the government for a redress of grievances,” actively seeking out those unhappy with an industry smacks of a regulator looking for a reason to regulate. If the CFPB is concerned about marketplace lending, a more sound approach would be to hold old fashioned hearings which, while sometimes more a performance than an inquiry, at least tend to include representatives from both sides of an issue.
One law firm has dubbed the CFPB’s announcement the establishment of a “beachhead” in the marketplace lending industry, planting a flag signaling new regulation ahead. I, unfortunately, tend to agree.