Online marketplace for lending and borrowing, accomplished outside the established financial system.

From the "I'll gladly pay you Tuesday for a hamburger today" department...Part 2. While Pocket MBA was covering the credit crisis for the past couple years or three, some people were actually out doing something about it. P2P Lending has been around for less than ten years, but it has already made a big splash — in the marketplace, at the SEC and, more recently, in Congress. As PMBA reported last week, the Wall Street Reform and Consumer Protection Act (H.B. 4173) contains a provision that classifies P2P Lending as a consumer banking service, as opposed to a security offering. It had been considered to be the latter, which had led the SEC to halt one leading P2P Lending firm from conducting business in the U.S. Now, the road to the P2P ATM seems clear for these upstart businesses to ply their trade and for resourceful individuals to work around the traditional banking system, both to obtain and to make loans.

At its most basic, P2P Lending is simply the eBay-ification of lending. Like the venerated Internet-based auction site, P2P Lending aims to connect willing buyers with willing sellers, allowing the buyers to bid for the sellers' product — in this case money. As with a traditional bank, the lenders are, essentially, invested in the borrowers' ability to repay the money they borrow. Of course, it's one thing if PMBA lends a friend $500 with the proviso that the friend will pay PMBA back the $500...or even the $500 plus a bit of a fee for PMBA's trouble. It's another for PMBA to lend money to a complete stranger. Frankly, PMBA has handed over money to any number of people on the street, complete strangers all, but has no expectation of being paid back. P2P Lending creates a community where that transaction results in not only the return of the principal, but interest to boot, and interest that is set between PMBA and the borrower. That may sound crazy, but that's no different from PMBA going on eBay and offering to pay $37 for a video game it couldn't find in the store. So how does this P2P Lending work?

First things first: PMBA has never engaged in any aspect of P2P Lending, so to the extent it mentions companies here, it is not doing so with an interest in any. (PMBA didn't even know anything about these companies until two weeks ago.) To get a handle on the basics of P2P Lending, head over to the website of Prosper: The Loans Marketplace. PMBA will summarize here to give you a flavor of what's going on out there. Just because there is no traditional bank involved in P2P Lending doesn't mean there isn't a "middle man," Prosper being one of many. That is, Prosper makes its money by bringing willing borrowers and lenders together, taking a small "closing fee" for every deal consummated. Prosper sets minimal ground rules and lets the participants do the rest. The ground rules are that participants agree to "unsecured, 3-year fully amortized personal loans," with an interest rate "fixed for the life of the loan," regardless of the borrowers' payment history on the loan. Interested borrowers open an account with Prosper and post how much they want to borrow and at what maximum interest rate. Those who have joined Prosper to invest (i.e., lend) then bid on the loan. Just like with eBay, when the time set for the deal expires, the deal is finished; unlike eBay the sale goes to the lowest bidder.

Now, while Prosper limits itself to personal loans, P2P Lending isn't so limited. There are P2P sites that connect entrepreneurs with venture capital; that connect businesses holding accounts receivable to willing buyers of those accounts and even a "centralized marketplace for illiquid assets, including auction-rate securities, bankruptcy claims, collateralized debt obligations, limited partnership interests, private company stock, residential and commercial mortgage-backed securities, warrants/restricted securities in public companies, and whole loans." These varied platforms are all members of the Coalition for New Credit Models, which we discussed last week.

Anyway, back to Prosper. As noted, Prosper lenders are called "investors," and Prosper issues loan notes in connection with closed deals. This is what interested the SEC, which considered such activities to constitute securities offerings without effective registration statements or exemption from registration requirements, in violation of Sections 5(a) and 5(c) of the Securities Act of 1933. As a result, the SEC halted Prosper from operating. See Order Instituting Cease-and-Desist Proceedings Pursuant to the Securities Act of 1933, Making Findings and Imposing a Cease-and-Desist Order in In the Matter of Prosper Marketplace, Release No. 8984 (SEC, 11/24/08). The cease-and-desist order was lifted last year. And now, as noted above, Congress is trying to ensure that P2P Lending can continue without the restrictions of the securities laws at all. We'll see how that all plays out as this year progresses. Regardless, it seems as though P2P Lending is here to stay. So, next time you hear someone calling out "$10,000 going once, $10,000 going twice, $10,000 going three times...sold," there may well not be a painting involved. To paraphrase an old Vulcan saying, "Prosper may help you live long and prosper."