P2P Lending

When it comes to diagnosing society’s ills, I sometimes find myself in friendly disagreement with friends, family and colleagues. We agree on what’s wrong with our debt-addled, freedom-starved society, but I tend to part with the consensus when it comes to why and what to do about it.

Basically, I don’t buy the argument that “the government” is to blame for everything. Sure, politicians and bureaucrats are a huge part of our problem. But I don’t think people in government are uniquely evil and/or incompetent. Nor do I think that if they would only get out of the way, the free markets would solve all of our problems.

It’s a comforting simplification, but a poor guide to navigating the real world. Looking for devils in government alone means you’ll miss them in the private sector.

Nowhere is that more true than at the top of the U.S. financial sector, where markets are anything but “free.” I think it’s where the source of the rot afflicting the United States is to be found … as well as the seeds of a potential solution.

Economists vs. Stock Analysts

People see the economic world differently depending on their perspective.

Stock analysts tend to focus on the metrics of specific firms, like stock prices, P/E ratios and debt burdens. They see markets in terms of supply and demand and take as a given the institutional arrangements within which firms and markets operate. Government is an external force, operating on its own logic, usually to the detriment of profit-seeking firms.

Economists (like me) take a wider perspective. We tend to focus on markets as aggregates rather than on individual firms. We also see government as an economic actor in its own right, providing public goods and other essentials that markets don’t because of externalities and market failure. We know the “logic” of government leads it to overreach, but most of us don’t imagine that we can live without it.

“Political economy” delves deeper into the interactions among institutions, markets and politics. Most importantly, political economists evaluate markets and their actors over time.

The history of the U.S. financial sector, for example, shows that the current economic position of “Wall Street” and of U.S. high earners (“the 1%”) isn’t the result of pure market forces. Political and market design decisions have produced a specific result — one that involves income and wealth inequality so severe as to undermine the foundation of the economic, political and ideological systems that made 20th-century America stable and prosperous.

If you doubt that, ask Jeb Bush.


Certain 19th-century political economists were influenced by the philosophical notion that everything is a combination of “opposites.” Life can only be understood in terms of death. The “freedom” of Greek city-states or southern U.S. planters required slavery. Fantastic wealth produces instability, which threatens wealth creation.

This perspective led to the observation that many institutions contain the “seeds of their own destruction.” Slavery produced rebellion and a tendency toward moral decay. Unbridled industrial capitalism produced militant workers living in close proximity, where they refined ideas of revolution.

Today’s financial system is a perfect example. Our “too big to fail” (TBTF) banks grew out of smaller, simpler firms that performed the essential function of “intermediation.” The massive capital requirements of industrialization in the 1880s through the 1920s produced specialized firms that assembled money from scattered investors and passed it on to firms that used it to build factories and produce goods.

As long as this was easier and cheaper than having investors invest directly in industrial firms, Wall Street’s role was secure … until it wasn’t, circa 2008.

P2P Lending: The Seed That Will Destroy “Too Big to Fail”

By that time, the conservative proprietary financial houses of the 1920s had become gargantuan trading institutions, controlling so much money and engaging in such fantastic forms of leveraging that they had become literally above the law. That gave them the political clout to write their own rules, with predictable results.

Ultimately, though, Wall Street is still doing what it has always done — acting as an intermediary between those with money to invest and those who need money to grow.

That’s why the burgeoning phenomenon of “peer-to-peer lending” (P2P lending) is so fascinating to me.

P2P lending uses Internet technology to match people with money to invest with people who want to borrow, including small businesses. It largely bypasses the banking system, in the same way that Uber bypasses taxi companies and Airbnb bypasses travel agents and hoteliers. You can loan directly to individuals or purchase part of a bundle of loans.

P2P lending is riskier than conventional investment, but it’s doing two things that TBTF bankers aren’t: It’s getting money to people who mainline banks ignore, and it’s generating better returns.

Since 2009, average net annual returns for investors who lent money through the largest U.S. P2P lending platforms have ranged from 5% to 9%. Compare that to about a 1.5% yield for a five-year Treasury bond and about a 2% yield on AAA-rated, five-year corporate bonds.

Now, there are plenty of caveats — such as liquidity issues for investors — but something about the fact that 30 years of Wall Street-backed IPOs for tech start-ups has produced a profitable alternative to those very banking institutions makes the political economist in me smile.

Seeds of destruction, indeed. We can only hope.

Kind regards,

P2P Lending Platforms Chart