Thinking About Lending

Calculated Risk is one of my regular reading blogs for watching the sub-prime housing implosion. In the process, however, there's some commentary on lending that is relevant for Prosper lenders. Tanta had a long missive on what defines sub-prime, and I find it to be a good read for anyone lending on Prosper.

That said, what it’s about is just working through the complexity of the variations on three things that have been the core of mortgage underwriting since roughly the dawn of time: the three Cs, or Credit, Capacity, and Collateral. Does the borrower’s history establish creditworthiness, or the willingness to repay debt? Does the borrower’s current income and expense situation (and likely future prospects) establish the capacity or ability to repay the debt? Does the house itself, the collateral for the loan, have sufficient value and marketability to protect the lender in the event that the debt is not repaid?

There is no New Paradigm, there was no New Paradigm, there is not going to be a New Paradigm. The Cs are the Cs. What we “innovated” was our willingness to believe that we had established the Cs with indirect or superficial measures (that are, not coincidentally, cheap and fast compared to direct measures).

The early and giddy days of Prosper were dominated by people who ignored credit worthiness and capacity to repay. The listing description was substituted for information from the credit report. The worst violations have been corrected, mostly by lenders losing lots of money, but new folks entering the Prosper market must learn where others have failed.