Zopa and credit crisis

Monevator left a comment interesting reflections on experience as a Zopa lender – and speculations about what will happen in a crunch.

The biggest issue for me is Zopa has not yet been tested in anger. We haven’t yet seen how individual borrowers will behave in a peer-to-peer system if money really becomes tight. With some economists predicting a 1980s-style recession in every way except the shoulder pads, that’s a very real risk.

I have a hunch, just a hunch, that peer-to-peer will turn out to be more robust in a crisis than institutuional lending – becuase I think if better cultivates a more primal human sort of trust than the purely mechanical efforts of banks. But we’ll see, I guess!

Monevator also suggests it may be time for another Zopa podcast…

4 thoughts on “Zopa and credit crisis

  1. Graham Hill

    Johnnie

    That’s an interesting hunch. My own hunch is that assuming there are no barriers to quickly extracting money from Zopa, that lenders will act similarly in risky situations; they will pull in their horns and extract their money just to be safe.

    Do you have any hard evidence to the contrary to support your hunch?

    Graham Hill

    Independent CRM Consutant

    Interim CRM Manager

    Reply
  2. Johnnie Moore

    Hi Graham, hope you’re well. I said hunch because I have no hard evidence at all. Just this sense that it’s easier to remove money from an institution, an abstraction, than from what appears to be some kind of human life form!

    Reply
  3. Monevator

    Glad you checked out the article Johnnie, thanks for the link.

    @Graham: Interesting. There are some barriers, in that if money is lent out, it can’t be extracted until repaid (as I understand it).

    I’d expect lenders to increase their participation provided Zopa can demonstrably keep its defaults down (defaults are currently less than even its predicted defaults in nearly all markets). That said, if I saw a huge spike up in borrowing requests at Zopa I might do as you say (where possible), as I’d worry about the quality of borrowers coming over deteriorating. A bit like the smaller building societies closing their doors at the moment.

    Reply
  4. Jolinar Maktub

    Hi,

    Having worked in Financial Risk Management for the last 4 years at a large bank, I was in a unique position to analyse the technical causes behind the current so-called “credit crisis”.

    Financial Risk Management involves the use of ‘pricing models’ to estimate potential future values of financial instruments. These models calculate the risk of an instrument based on the number of variables, and with interest based products, the most important variable used is the ‘mean time to default’.

    The “mean time to default” is basically the credit rating. So as long as these CDOs had a credit rating of ‘AAA’, the model would assume that the mean time to default of about 8 years, whereas a subprime mortgage debtor has a mean time to default that is closer to 3/4 years, which would be a credit rating of B or CCC.

    (I’m simplifying, more information here https://www.blaha.net/Finance%20Corporate%20Debt%20Ratings.php)

    Now not all of the mortgages in the CDO were subprime, as these types of instruments are generally made up of tranches of different mortgages on the bank’s mortgage book. So the risk on the whole of the CDO was definitely not B, but it certainly wasn’t AAA either.

    The real crunch here though is that the credit rating determines the coupon (interest) rate. AAA assets have a very low yield, because their risk is virtually non existent. B assets have a high risk, and so investors expect a much higher yield to cover the risk (this is known as the risk premium).

    So the banks were selling BBB instruments (CDOs) at AAA risk premiums, and making the spread between them. Given that there is often a large (up to 100 basis points) spread between those two I can see why the banks were keen on this practice. Lend at 600 and borrow at 500? Where can I get me some of THAT action !! ??

    Given the massive profitability of this fraud for banks, one has to question the role of Moody’s/S&P in all of this in their rating the CDO paper as ‘AAA’. No doubt they will claim they were duped by financial whiz kid quants at the banks, but I think only the American taxpayer would be silly enough to believe that story.

    On that final note, the Rest Of The World ™ would like to extend a big ‘Thank You’ to the American taxpayer for volunteering to pay for our investment mistakes in your financial system. We could have done our due diligence on your mortgage backed derivatives ourselves and found them overpriced for the risk, but instead we decided to buy them anyway, and now you have agreed to pay the risk premium through your taxes.

    THANK YOU, and remember not to vote!

    Reply

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