Two recent articles—one in Reuters and the other in PYMNTS—tell a distressing tale of just one of China’s person-to-person lenders’ fraud schemes that in 2015 wiped out the investments of 900,000 individuals for a total of US$7.6 billion. The P2P lender (Ezubao) admitted to fabricating projects so that investors, seduced by clever branding and television advertising, handed over all those billions in just two years. It helped that the company boasted of (fraudulent) returns as high as 14% in a country struggling with a lagging economy and low interest rates, along with a failing investor housing market.
What happened in China is a cautionary tale for governments and individual P2P (or online, marketplace, crowdfunding, alternative) loan investors worldwide. For governments, it must be a wake-up call. Regardless of how many times consumers are told that past performance, etc., they need to understand that for P2P or marketplace loans—in which many may be investing without even knowing it—there is no insurance for monies lent and no way to retrieve savings lost. Translation for the United States: There’s no handy insured and regulated bank on which to dump nonperforming loans (oops, order a buyback on mortgages).
In 2016, there is very real probability that U.S. consumers investing in alternative loans (whether knowing so or not) will suffer significant losses. To the extent that 401(k) or pension funds are being invested—particularly in small-business loans with high interest rates—in the hopes of securing decent to above-average returns, the potential for losses is great. It is well past time for national regulators like the Consumer Financial Protection Bureau, Securities Exchange Commission, and Federal Reserve to get involved and begin active supervision of alternative lenders to ensure the integrity of both the lenders’ financial performance reporting and their credit risk mitigation in sold loans or portfolios. And to help educate consumer investors.
As regulators are beginning to do, it is certainly important to look at alternative lenders’ credit algorithms to determine compliance with fair credit rules as they pertain to borrowers—but inquiries about fiduciary duties are critical as well. The recognition that there are consumers at risk on the funding end of the loan should focus supervisory attention on the investments of consumer funds in these types of loans:
- Small-business or nonbank-originated consumer loans
- Mortgage loans originated and funded by online lenders
And it might be a good idea to target first the alternative lenders promising the largest returns (and charging the highest interest rates) to small businesses, in particular.