Slate Questions Riskiness of Prosper Marketplace, Peer-to-Peer Lending

Mark Gimein set of a fire-storm in the peer-to-peer lending industry this week after publishing an article titled “You Are Unlikely To Prosper” about the risks associated with becoming an investor into Prosper Marketplace and other peer-to-peer lending companies.

“To look at the results of Prosper’s loan marketplace, though, is to see not a solution to the credit crisis, but a microcosm of it. Loans to unqualified borrowers; reliance on mathematical models that turn out to be a lot less useful than they seemed; failed hopes that high interest rates could make subprime loans profitable; sky high default rates—Prosper has it all,” wrote Gimein.

One of Gimein’s primary criticisms of Prosper is the high default rate of some of its earliest loans. According to Gimein, “Close to $38 million of that $136 million in loans has already been charged off as bad debt.” Gimein noted a comment by Prosper Marketplace CEO Chris Larsen in 2007 that they expected to have default rates of about 2.7%

Prosper Marketplace came out with guns firing criticizing the piece. The company published a blog post entitled “An Open Letter to The Big Money: Retract Your Story”, criticizing the author for relying on “almost entirely on a hodgepodge of anonymous sources” and referred to the story as “disappointingly inaccurate.”

The company went as far as contacting the editors of the publication suggesting that they retract the piece for the author’s “erroneous perspective on Prosper and the peer-to-peer lending industry.”

Prosper commented about Gimein’s calculation of Prosper’s alleged negative average rate of return, “Mr. Gimein discusses Prosper’s loans in the context of only cumulative unit default rates rather than in terms of the average annual returns lenders have earned. “ The post continued, “What he doesn’t say is that the annual yield on these loans was 16% and the annual loss experienced by lenders was actually 20%, resulting in an annual average return of negative 4%.  Although this return is negative, put in the context of the largest recession in generations, and the performance of other asset classes during the same time period, this paints a very different and more accurate picture of how lenders have fared on Prosper.”

Prosper also defended recent changes in its rating system suggesting that they will have much lower rates of return in the near future. According to the post, “The early results from the new rating system are excellent.  Prosper is estimating returns for lenders above 10% for loans originated since our July re-launch and the early data supports these expectations. “