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Is The Great Contraction Coming Soon To Alt Lending?

There is nothing we love more here at PYMNTS than … well, payments. There is little we find more inspiring than money moving from one point to another, with the possible exception of how better, smoother transfers can be used to reinvent a consumer’s entire retail (and perhaps living) experience.

But if we had to pick a favorite sideline, it would be logical fallacies – amazing leaps of logic that upon closer inspection fall apart and usually reveal some wacky assumptions about the world.

There are a variety to choose from, and we like point them all out: an appeal to authority, which tells you the status of the arguer is more important that the quality of the argument, are a particular favorite (see Karen Webster on Theranos  or Karen Webster on The Cool Kids). Vagueness, equivocation, and false continuity are all also popular.

But for sheer persistence, we have to hand it to the associative fallacy, wherein someone associates a person or thing with another person or thing, and then draws conclusions about the first thing based on the properties of the thing it’s being associated with. It pops up in payments and commerce all the time.

The positive version was on display often a year ago: “Uber is a brilliant idea, this startup is the “Uber of X,” therefore this startup is a brilliant idea.” Millions of dollars of equity funding went out (and in many never came back) on the basis of that logical fallacy because, as it turns out, being kinda like Uber and actually being Uber are very, very different.  

“Of course, it would be great being the Uber of Something,” Karen Webster recently wrote about the wave of fallacy-backed Uber-like firms. “But a lot of entrepreneurs are more likely to be the Uber of Nothing and burn up a lot of VC cash, because they think platforms solve all problems and ignore just how hard being a platform is.”

Excessive exuberance is the chipper side of the associative fallacy coin; rapid onset universal skepticism is the less chipper side. And that story is currently being acted out over in the online lending segment, as the recent high speed, multi-phase come apart over at Lending Club has markedly destabilized the entire segment.

OnDeck, another marketplace lender — though one entirely unassociated with Renaud Laplanche or any of LendingClub’s recent difficulties — IPOed at over $24 a share. Since the LendingClub news broke, it’s had extreme difficulty keeping its stock price above $5 a share. It’s not alone, and the experts agree it’s about to get much, much worse before it gets better.

So is the associative fallacy running wild, and burning good businesses along with the bad? Well, hold that thought — the answer isn’t that simple, because it seems the harder anyone looks at the segment, the more troubling the picture is getting.

The Coming “Culling Of The Herd”

It’s never good news when startups in a space go from being compared to mythical creatures like unicorns to livestock like cattle. And yet livestock was the go-to metaphor for Pat Grady of Sequoia Capital when he addressed a FinTech conference recently.  

“Upside has been grossly overestimated” in the business, Grady said, meaning that the only and probably best thing that can happen now in the online lending space is a “culling of the herd.”

Bad news isn’t getting any better for dozens of marketplace lending startups, and a lot of players are quietly but quickly looking for fast exits. Ron Suber of Prosper, another massive marketplace lender, noted at the same CB Insight Conference that Grady spoke at that he is increasingly aware that “a lot” of his competitors in the space are shopping themselves at present. That observation was seconded by Kathryn Petralia, co-founder and head of operations at online lender Kabbage. She noted that consolidation is looking like the best possible plan for a lot of these emerging players who are suddenly finding capital hard to come by.

But buyouts, Grady noted, may be an over-touted solution, because to get bought out, someone has to actually want to buy you — and many of these companies didn’t have a clear path to profitability when market conditions were ideal. Things aren’t exactly looking better in the post-Lending Club, increased interest rate era.

Moreover, regulatory authorities, which had previously treated marketplace lenders with something like benign neglect as the industry was laboring to define itself, are suddenly rapt with attention, and very concerned about reining in the marketplace. Given some of the recent news, it is hard to blame them. And that means the pressure is on these lenders to get profitable, and to clean up even the mere appearance of impropriety.

“This is definitely a period of retrenchment and consolidation,” noted Scott Kessler of S&P Global Intelligence. “There has been a lot of talk about access to capital.”

Continuing Troubling Signs

As recently as a few weeks ago, the folks over at CNBC were cautioning leering investors that one scandal did not mean marketplace lending was essentially flawed or doomed.

Recent reports indicated that now endemic loan stacking is emerging as the latest threat to marketplace lenders.

While stacking has some valid uses, the not-so-good one it is most often associated with is a borrower deceiving or withholding information from a lender. While some lenders actually embrace the practice, viewing it as a form of loan consolidation, others argue the practice can obscure the true risk of a borrower.

According to reports, alternative lending’s use of innovative risk mitigation and underwriting techniques, combined with inconsistent reports of loans to credit bureaus, can mean financing that slips through the cracks and makes it easier for customers to stack their loans.

According to LoanDepot Chief Risk Officer Brian Biglin, stacking is “causing problems with the whole industry.”

Other industry players, like Lending Club and Avant, told reporters that they are aware of the issue of stacking but, according to reports, “downplayed the risks and did not provide examples of specific actions taken to prevent the practice.”

OnDeck and Prosper, meanwhile, told reporters that they have integrated algorithms in their risk assessment strategies to detect and avoid loan stacking.

So what did we learn about the meltdown in marketplace lending this week?

First of all, once a meltdown starts, it clearly can start feeding on itself, in much the same way positive buzz does. Marketplace lenders have hit the mother load of negative buzz. But, it’s buzz that they all might have earned, especially if it turns out that the much touted, much invested in algorithms to detect risk, especially if said algorithms  can’t figure out if consumers are gaming their platform to borrow beyond their means.

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