Be Happy Larry Summers Sits on the Board of Lending Club

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For much of the summer, Washington’s policy elite have been focused on the question of who will become the next chairman of the Federal Reserve. One of the most powerful positions in the federal government, the role of Fed chair has only become more important in this era of increased banking regulation and unconventional monetary policy.

The conventional wisdom dictates that the race for the Fed-chair nomination has come down to current vice chair Janet Yellen, and former Treasury Secretary Larry Summers, with Summers as the favorite. The press, for the most part, has been critical of Summers’ candidacy for reasons ranging from his prickly personality to questions about his commitment to using Fed policy to fight unemployment.

But a third line of criticism has emerged recently, suggesting that Summers is far too invested in the business of finance to serve as its primary regulator. A recent piece in the New York Times, for instance, raised questions about Summers’ wealth and associations with Wall Street. Indeed, over the past two years, Summers has taken flak for going to work with the much maligned Citigroup as well as hedge fund D.E. Shaw. But the piece also criticizes a lesser-known association: Summers sits on the board of a peer-to-peer lending startup called Lending Club, which the Times says “falls into a regulatory gap that consumer advocates say may lead to risky borrowing.” The article goes on to criticize the Lending Club for not necessarily verifying the income or employment status for each borrower that takes out a loan, implying that Summers could be profiting from shady lending practices.

Summers isn’t the first potential financial regulator to be criticized for his ties to the industry — many a former SEC chair or Treasury Secretary has made millions on Wall Street. The hope is that these candidates possess a diverse enough background that they are able to effectively balance the concerns of rival constituencies. And this is exactly why those who criticize Summers’ ties with too-big-to-fail banks should be happy that he is working so closely with a startup like Lending Club.

Lending Club is an online network that matches individuals or small businesses looking for three- or five-year unsecured loans with investors who want to put up the capital. The average borrower takes out just over $13,000 and pays an annual interest rate of 14.5%, though the rate can go higher or lower depending on credit history.

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For those who are looking to earn some extra return with their savings, Lending Club allows investors to invest in these loans in $25 increments — enabling backers to amass a diverse (and therefore less risky) pool of loans with relatively little capital. After taking into account fees and defaults, that average 14.5% interest rate becomes an 8.5% annual return for the investor, though returns (and risk) vary depending on the pool of loans.

Peer-to-peer lending is a relatively new phenomenon, and it makes sense that consumer advocates would be worried about the potential for abuse. But there’s nothing any more predatory about Lending Club’s business than your average credit-card company’s. What a business like Lending Club does do is keep the big banks honest by drawing away their lending business with better rates. Indeed, more than 80% of Lending Club’s business is folks taking out loans to consolidate existing credit-card or bank debt. It’s difficult to see how the company could win such business without simply being a cheaper alternative.

That is not to say this is a business model that poses no danger to the public. Federal and state regulators should pay close attention to peer-to-peer lenders to make sure that they aren’t misleading investors about potential risks and likely returns. And as these platforms become more popular, there will be more incentive to originate loans to meet investor demand. This could lead to lower underwriting standards, lower returns and investor losses.

But as it stands, peer-to-peer lending makes up a tiny fraction of the overall debt market in the U.S. Lending Club has funded more than $2 billion in loans since opening in 2007 — a healthy figure, but insignificant compared with the $11 trillion in consumer debt that’s outstanding in the U.S. today. In other words, Lending Club has plenty of room to grow before it runs out of credit-worthy borrowers.

Furthermore, Lending Club could actually play a role in restraining predatory lending and securities sales by increasing the competition for both borrowers and investors. Credit-card companies and stockbrokers are less likely to get away with charging exorbitant fees or interest if peer-to-peer lenders offer a low-cost alternative.

Summers may not be the best candidate for Fed chairman, but his experience on the board of an upstart lender like Lending Club should instill confidence that he is not hopelessly in thrall to the big banks, which often earn money by using their scale and influence to restrain competition and take advantage of their customers. The last thing one wants is a Fed chair who would aid this venture by helping to create unnecessary hurdles for innovative firms that are trying to make finance more efficient. Whatever else his flaws, Summers’ interest in peer-to-peer lending suggests he can at least envision a financial-services industry with a little more healthy competition.

2 comments
CShaz
CShaz

LARRY SUMMERS . . . BAD CHOICE

Once again, the name of Larry Summers surfaces as Obama’s choice for Chairman of the Federal Reserve. If Larry Summers is the next Fed Chairman, corporate fascism will become a reality instead of a threat. When Mr. Summers was Treasury Secretary under President Clinton, he went out of his way to destroy the financial stability of the nation. He was the main player in abolishing the Glass-Steagall Act, which allowed his “Big Bank” and Wall Street friends to combine commercial banks and securities firms. Larry Summers was also instrumental in doing away with limits for the derivatives market. These actions virtually opened the floodgates for all sorts of risky highly leveraged investments that brought about the economic downfall during 2008. The devastation many middle class Americans have endured over these last five years lies in glaring contrast to the massive profits for Wall Street and the CEO’s and executives of large investment banks.

JohnDavidDeatherage
JohnDavidDeatherage

The problem with the Fed is the dual mandate to both control prices (inflation) and provide for full employment. Until 1977, the Fed wasn't tasked with the folly of full employment.  End the dual mandate and return the Fed to the job of controlling inflation.

Jobs are the by-product of economic activity, not the intended outcome. By trying to create jobs, we in fact, hurt employment in the long run...