The Power of Collective Risk Absorption

Every time there is an innovation in risk absorption the economy flourishes. The invention of the shared stock company by the Dutch and the English allowed merchants to take advantage of risks and ventures that the crown would never have had the stomach or the pocketbook to undertake. The creation of burial insurance -- thankfully called life insurance later, created a new way to allow people who were working in the newly industrialized cities of Europe and the United States to help to defray the risk that their families had if they died unexpectedly. The creation of mortgage-backed securities, done correctly, is also a great boon to risk absorption because it is cheaper for mortgages to be traded in large pools than individually as it lowers the cost of financing.

Early in 2009, I predicted that peer to peer lending would continue to be an important trend in the economy as part of the "important ideas" published by Harvard Business Review.  I'm happy to report that Lending Club continues to grow at 10-15% per month.  Lending Club allows peer to peer lending and often they fund borrowers for less cost and faster approval than traditional lenders.

They still need to prove that they can become a major force in the lending market, but I believe that firms like Lending Club can help to define a new paradigm where the community bank of old can be more scalable and efficient.  Given how tight the credit market is today, a more collective approach to lending might help to continue to expand useful credit.  If we get a shock to economy with higher interest rates, some time in the future, this peer to peer infrastructure might even be more important.

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