Familiarity might breed contempt, but it seems nothing brings out the detractors like success. After a meteoric rise, marketplace lending has had its share of challenges and scrutiny, but the future should still be bright for such an industry on the forward edge of technology and consumer needs. Yet marketplace lending seems to be ending 2017 under an unwarranted attack from regulators and commentators determined to find similarities in marketplace lending to the subprime mortgage market in the years leading up to the financial crisis.
Everything Subprime? I Don’t Think So
At Credit Chronometer, we’re always on the lookout for a little bit of history repeating, including the subprime mortgage mess. But lately, it seems people are looking for subprime in all the wrong places.
We were among the several folks to immediately realize something was amiss with the now-retracted report by the Federal Reserve of Cleveland regarding online lending’s impact on consumers that erroneously mixed data relating to traditional loans with peer-to-peer loans. Prior to that report, an article in American Banker questioned whether marketplace lending posed the next systemic risk. It’s a question worth asking, and a discussion worth having, but the risk of an unhappy ending doesn’t seem significant at this point. Although there are similarities to the early stages of the subprime mortgage market, including the number of new lenders and service providers flooding the market, widespread harm to consumers is not one of them.
In fact, given the number of entrants over the years, we do expect to see significant consolidation and contraction in the market, but that is par for the course for an emerging and evolving industry. If anything, that presents the opportunity to create financially stronger competitors with necessary scale to push innovation forward. And though risk has shifted away from the banking sector with this growth, critics have confused expediency enabled by technology with underwriting enabled by leniency.
States’ Rights Battles are the Main Event
These recent criticisms are fairly easy for the industry to shake off, and they may be just a distraction compared to the threat posed by aggressive state action. The renewed passions brought to the ageless battle of states’ rights versus federal policy in connection with human rights issues, such as transgender access and reproductive rights – and now confederate monuments – may embolden states to flex their muscle on consumer rights and commercial lending issues.
Representative Patrick McHenry may have recognized this when he questioned the motivation of the Federal Reserve of Cleveland in issuing a report just before Congress was going to debate the Protecting Consumers’ Access to Credit Act bill. The bill would codify the “valid when made doctrine,” thus facilitating preemption of state usury loans in the context of assigned loans. The bill’s status in committee remains active.
In the meantime, “true lender” and “valid when made” challenges remain at the center of states’ claims as they try to stab at the heart of the bank partnership model. If states cobble together enough victories, they have the potential to disrupt the industry and significantly impact the cost of consumer lending and viability of securitizations. This threat is the main event and it requires a strong response – other criticisms and challenges may be a mere sideshow.
James Serritella, a partner, and Massimo Giugliano, an associate, contributed to this post and are members of the Insolvency, Creditors’ Rights & Financial Products Practice Group of Davis & Gilbert.