Wall Street’s Latest Craze Meets Small Short In Derivatives

It began with a seemingly wacky idea to reinvent banking as we know it. But no one is scoffing at peer-to-peer lending anymore -- least of all, Wall Street.

Barely a decade old, “P2P” has gone mainstream and is now being co-opted by some of the big financial players it was supposed to bypass.

Investment funds can’t get enough of this business, which involves lending to people over the Internet and hoping they pay you back. Investors are snapping up the loans directly, while the banks are bundling them into securities, much as they did with subprime mortgages.

Now peer-to-peer lending and its Internet enablers like LendingClub Corp., the industry leader, are being pulled into the high-octane world of derivatives. While many hail Wall Street’s growing involvement, others warn investors could get carried away, as they did during the dot-com era and again during the mortgage mania. The new derivatives could help people hedge their risks, but they could also lure speculators into the market.

“It feels like the year 2000 again,” said Frank Rotman, a partner at QED Investors, an Alexandria, Virginia-based venture- capital firm that has invested in Prosper Marketplace Inc., Social Finance Inc. and 13 other P2P lending platforms. “Everyone is chasing ’it,’ but they don’t know what ’it’ is, and that is kind of scary.”

Lured by Yield

It’s easy to see why investors are so enthusiastic. In today’s low-interest-rate world, high-quality P2P loans yield about 7.6 percent. Two-year U.S. Treasuries, by comparison, were yielding a mere 0.59 percent on Friday.

But P2P’s rapid growth also raises questions about the potential risks, including whether the firms involved might lower their standards to stay competitive. During the mortgage boom, Wall Street’s securitization machine fueled questionable lending practices. Derivatives tied to the debt were blamed for spreading their risks around the globe, and then amplifying investors’ losses when the housing market crashed.

Now a firm led by Michael Edman, a veteran of Morgan Stanley, is creating derivatives that will give investors a new way to bet for -- or against -- peer-to-peer loan performance. Edman has ridden credit booms before: he was a figure in “The Big Short,” Michael Lewis’s best-seller about the buildup to the housing bubble of the 2000s.