28: Finance's Hot New Thing Ended Up In An Old-School Scandal

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Joe Weisenthal (0:23)

Hello, and welcome to another edition of the Odd Lots Podcast. I'm Joe Weisenthal, managing editor at Bloomberg Markets.

Tracy Alloway (0:30)

And I'm Tracy Alloway, executive editor at Bloomberg Markets.

Joe Weisenthal (0:34)

Tracy, you sound very distant. Why is that?

Tracy Alloway (0:38)

Well, it might be because I'm across the ocean from you. I'm over in Abu Dhabi.

Joe Weisenthal (0:44)

Amazing. So today's kind of like a special edition of the podcast, not just because it's the first one that you're recording from Abu Dhabi.

We also had a guest lined up for today, and at the very last second, within the last few minutes, and we're not going to name them because that wouldn't be right, but within the last few minutes, the guest pulled out because they were nervous. So Tracy, what's going on? There's a big scandal, and a guest that was going to talk got nervous. What's happening?

Tracy Alloway (1:12)

Yeah, for once it's a scandal that doesn't come directly from the banking industry. Instead, it's something to do with what's known as peer-to-peer lending, or also known as marketplace lending. And we'll get into why it's described by two names.

But basically, we had huge, huge news out of one of the first ever peer-to-peer lenders earlier this week. The CEO resigned amid a major scandal. The shares went plunging.

The company is now worth basically a fraction of what it used to be worth. And we are going to dig into why all that happened.

Joe Weisenthal (1:57)

Awesome. I can't wait. So our guest who is very familiar with this industry, given the heat going on right now, decided not to talk. But let's step back. So we have this industry. Oh, well, the good news is that, Tracy, you are an expert on this industry, and you have been following it essentially since its inception. And frankly, you are probably the best guest for it anyway. So let's take a step back. Years ago, idealists founded this concept called peer-to-peer lending. Rather than going through banks, you could borrow money online, you could go on, lend money to your peers. It was supposed to disintermediate the traditional financial system.

Tell us about this origin of peer-to-peer lending, how it started, and where we are today.

I guess that's kind of ambitious, but...

Tracy Alloway (2:48)

I think we can do it. I believe in us. All right.

It actually started before the financial crisis, and there were a couple companies that came up with this idea of using the internet, using online platforms, to directly match borrowers with lenders. So instead of me going to a bank and asking for a small loan so I could, I don't know, remodel my kitchen or something like that, I could go online, and someone online would agree to fund the loan.

Joe Weisenthal (3:22)

So basically, you go on, you say, I want to borrow $10,000 to remodel my kitchen, here are some stats about me, my credit score, how much I make, et cetera, and then I might have $10,000 in cash sitting around, and then say, oh, I'll fund that loan. Is that basically how it works?

Tracy Alloway (3:40)

So in the beginning, it was very unlikely that a single investor or lender would be funding an entire loan. Instead, what you would do is you would fund small pieces of loans, right? So you wouldn't put up $10,000, but maybe you would put $500 up on the platform so that you could buy pieces of various loans of various quality.

Joe Weisenthal (4:02)

So diversify the credit risk.

Tracy Alloway (4:05)

Exactly.

And as a borrower on the platform, you wouldn't necessarily say, here are all the things about me. You know, there'd be some forms that you would fill out. But the interesting thing about using the online platform to borrow money was that a lot of the underwriting process was automated. So you would give these peer-to-peer companies permission to access some information about you, that was available online, and then they would automatically go and do that and kind of fill out these profiles. And if you were an investor on the platform, one of the selling points was that you would get really good detail about the person you're investing in. Actually, in the early days, you could see all sorts of information where the loan was coming from, you know, the salary, the employment status of the person.