What happens if Lending Club goes out of business?

In Investing on December 28, 2009 by carlos Tagged: ,

A reader recently emailed Five Cent Nickel about what would happen should Lending Club goes out of business. In its prospectus, LC devotes a paragraph to the scenario.

Q: If Lending Club were to become subject to a bankruptcy or similar proceeding, who would service the member loans?

A: We have executed a backup and successor servicing agreement with Portfolio Financial Servicing Company (“PFSC”). Pursuant to this agreement, PFSC stands ready to service the member loans. Following five business days’ prior written notice from us or from the indenture trustee for the Notes, PFSC will begin servicing the member loans. If our agreement with PFSC were to be terminated, we would seek to replace PFSC with another backup servicer.

If Lending Club begins suffering a long, slow drown-out death, you can bet there will be a “borrower run,” where the many of those who owe money will renege on their debts. LC can implement punishments and issue warnings to people who skip payments, but some people will grab any sign that gives them reason to think they can stop paying. And just like a bank run, the dynamic becomes self-fulfilling: As more and more debtors forgo payments, the microfinance entity loses solvency, giving more reason for more debtors to forgo their payments. The Economics of Microfinance says this exact scenario has occurred in countries.

This would also mean that note owners would start selling off their notes on the marketplace. Supply, provided by creditors wanting to cut their loses or not deal with the unknown PFSC.

If LC shuts down overnight, and the third party assumes ownership of the debt, then the new third party would likely be cutting their losses on the debts and be willing to settle the debts for a mere fraction of their original value. The new third party would not likely be eager to repay the borrowers.

Also important is to not confuse being the owner of a LC note as being a shareholder. These notes are not securities; they are not SIPC insured. A note owner has no ownership stake.


Stock market of the 2000s: Worst decade. Ever. (Sorta)

In Investing on December 21, 2009 by carlos Tagged: , , ,

Via the WSJ, the 2000’s were the ever decade in terms of stock returns.

From 2000 through November 2009, investors would have been far better off owning bonds, which posted gains ranging from 5.6% to more than 8% depending on the sector, according to Ibbotson. Gold was the best-performing asset, up 15% a year this decade after losing 3% each year during the 1990s.

This past decade looks even worse when the impact of inflation is considered.

Since the end of 1999, the Standard & Poor’s 500-stock index has lost an average of 3.3% a year on an inflation-adjusted basis, compared with a 1.8% average annual gain during the 1930s when deflation afflicted the economy, according to data compiled by Charles Jones, finance professor at North Carolina State University. His data use dividend estimates for 2009 and the consumer price index for the 12 months through November.

The 2000’s were bookended by the and subprime mortgage bubbles. That the decade of the 2000s performed worst among about 20 decades of American stock market records is a curious piece of trivia, but I am not too worried about consistent investing in stocks over the long run. The story continues:

To some degree these statistics are a quirk of the calendar, based on when the 10-year period starts and finishes.  The 10-year periods ending in 1937 and 1938 were worse than the most recent calendar decade because they capture the full effect of stocks hitting their peak in 1929 and the October crash of that year.

To get a visual idea of just how poor stocks performed over this 10-year period, I used the handy What If I’d Invested Tool over at Sharebuilder.

The first chart assumes a simple 1,000 investment in January 2000, with dividend reinvestment. You lose 8% of your principal, and even more after accounting for inflation.

Next, I assume a $500 investment each month. With this strategy, you gain 5.2%, though inflation, broker fees, and capital gains on dividends will eat into your gains. (the chart unfortunately does not stretch to show the major post-2009 stock market gains).

In short, I think the lesson of this factoid is

One, only by stretching your investing horizon can minimize the risk. Usually, 10 years is a long time. But sometimes it is not.

And two, simply changing stats and assumptions can have huge differences in data.

Slow, consistent investing is the way to go. Don’t invest everything at once.


Local government taxing students on their tuiton

In Economics on December 18, 2009 by carlos Tagged: , ,

Via the New York Times, the city of Pittsburgh is apparently set to begin collecting a 1% tax on their college students’ tuition. The tax will collect $16.7 million per year to pay for city employee pensions—a tone deafness, incidentally, which I find remarkable. Just look at the smarter tactic being used in New York. In an to save money in the face of budget shortfalls, the New York Metropolitan Transit Authority announced a budget that cuts free rides to school kids. That’s a much wiser way to frame your budget shortfall.

This line amused me:

Students and college officials argue that the tax will drive students away and place an unfair burden on institutions that already contribute substantially to the city. They add that the measure comes at an especially difficult time for colleges, as endowment values have fallen and requests for financial aid have risen.

The city, I’m sure, would much prefer to collect the tuition receipts from the school, but presumably it cannot directly tax the nonprofit entities for tuition dollars. So instead, they charge the students a measly 1% tuition tax. 1% is nothing, especially when you remember that universities nationally, , have been increasing fees and tuition at a pace greater than inflation. The schools seem to want a monopoly on soaking students.

Part of the article mentions the city wants the students to pay for what they use. Not that I believe anybody at the city believes statement, but it’s a particularly transparently wrong statement. Students go to restaurants, to bars, they watch movies, rent apartments, go to games, and buy cheap furniture. Some even some stick around. Obviously, the reason wants to tax the students is because they don’t vote in local elections. Most probably aren’t even registered to vote. It reminds me of the taxes that levied on hotel visitors. The logic is that they visitors vote in elections, they live in another city, so it’s not taxing residents.

As somebody who only recently got out of graduate school, I would resent them taxing me more. But the truth is, I never voted once in the local election, and 1% is less than the tuition increase the school itself charged me during my second year of graduate school. I hate taxes as much as the next guy, but tuition is very inelastic (meaning increases in prices has a less than proportional effect on consumer response), and the economic loss to all involved would be very minimal. Have at it, Pittsburgh.


Credit cards and gotcha games

In Credit Cards, Economics, Frugality on December 18, 2009 by carlos Tagged: , ,

“You make the stupid laws, I’ll comply, and I’ll make money … Tell me the rules, and then I’ll outsmart you all,” That’s the great quote uttered by Shailesh Mehta, Providian ex-CEO, quoted the Center for Responsible Lending’s report here.

An eternal debate in the personal finance blogosphere is over the use credit cards. A few people are so anti-debt that they forgo using credit cards whenever possible. The logic, I suppose, being that their use is the first step along the slippery slope of credit and debt Armageddon. It makes some sense–people don’t feel as strong of a sense of financial loss when they use their plastic as they do when they use tangible cash or use a debit card that automatically deducts from their checking accounts.

I’ve never had a particular problem with credit cards. In my own brain, there’s no difference between spending on a credit card and on a debit. It’s equally painful either way. I pay off my card balance every month, and like the option of floating a small loan every month and earning a modest 1% discount on purchases. And I get small benefits, like doubling the warranty.

But one thing that is not mentioned enough in the personal finance blogosphere is how credit cards are designed to make you screw up. It’s not like cards have fair, easy-to-understand rules like a stop light. Green go, yellow warning, red stop. Nope, cards are systematically designed to catch you (at the risk of mixing metaphors here) to forget the dot the i’s and cross the t’s.

The cards are designed, to borrow the phrase from Nudge, for humans and not quants. Quants are the 100% rational people, the ones who always remember to do everything perfectly. They spend all day researching information, and for everything they sign, read (and understand!) the tiny-typed, obtuse terms and conditions. They are the people able to resist eating peanuts at a party because they know it’s against their diet.

To wit: Check out the report, Dodging Reform: As Some Credit Card Abuses Are Outlawed, New Ones Proliferate. For the most part, it’s true, if you are perfectly responsible with your card, and pay off the balance every month, you will avoid the fees. But again, they’re designed to trip you up. They’re funny products, credit cards, when you think about it. The bulk of the profits don’t come when people use the card “responsibly”; instead, the banks make their big profits when you use them “irresponsibly” and fall for the gotcha tricks.


The above chart shows the difference in the advertised fees and the actual fees that credit card users pay. Since 2005, the Top 8 card issuers, who hold 86% of all balances started using tiered rate fees. The highest tier is typically $250 or above. They write: “Rather than making fees proportional to the violation, tiered late fees seem designed to appear low while in reality a high fee is assessed.”

This other chart shows the average and maximum interest rate increase from pick-a-rate pricing, where the issue will now use the maximum prime rate in the previous 90 days, rather than current rate.

And check out the nickels and dimes they make off of you by “trailing interest.” Say in last month, a user carries a balance. This month, they get the bill and pays off the balance. But next month, they discover they owe a couple bucks on interest. That’s because between the time the bill was printed and the time the bill was paid, a few cents of interest accumulated. Those nickels and dimes got bumped up to a couple bucks because of the minimum finance charge.

I remember that Google Onion News story back in August. Sure, you can avoid having your personal info being collected by Google—if you’re willing to move to some remote village somewhere. Just like enjoying perfect privacy and living in modern society are mutually exclusive, living without a modern necessity like a credit card is impossible.

Allowing the marketplace sort itself out is almost always preferable to government regulation, but credit card companies have discovered nickel and diming and playing gotcha games with customers is more profitable than winning over customers with service. Part of the reason, I think, is because of how difficult it is to change products. When you discover your Gatorade drink isn’t good, you can buy PowerAde. Or you can substitute for plain ordinary water. (If you’re addicted to wasting money on drinks, you can even buy bottled water). Not the case with credit cards. Once you’re locked into one service, changing takes a lot of work and hassle, and might even effect your credit score.

That’s a major reason the CARD Act is so necessary. The rules are blatantly unfair. The relationship between credit card user and issuer is asymmetrical—the issuer enjoys more time and expertise in gaining the upper hand in terms of tricks and information. True, as Mehta brags at the top of this post, the card issuers will always be a step or two ahead of the consumer and the government. But Creating rules (regulation, the same thing, can have dirty connotations) simply means the relationship between credit card issuer and user is fairer.

For now, the best way to defend yourself is to pay the bill on time and try your best not to screw up. When you do, you can probably negotiate away the first fee. But it’s very difficult to do to be perfect, particularly for us non-quant humans, and particularly when the game is rigged.


Microloans very difficult to diversify

In Investing, Peer to Peer Loans on December 16, 2009 by carlos Tagged:

When it comes to P2P, you need to invest in hundreds of people to be diversified. And if you do so, even if you invest in hundreds of people, remember that you’re still concentrating your money in one company that can go bankrupt. Overinvesting in one single company is just as foolish as is investing with one P2P lender.

Even the smallest banks and credit unions are gargantuan institutions that can lend millions, if not billions, of dollars to thousands and thousands of borrowers. The large number of loans allows banks to broaden their pool of risk. Their lending expertise awards them the ability to make reasonable predictions about default rates. The small P2P lender, on the other hand, is shackled by a limited budget and cannot invest as widely as a bank. Somebody like me, investing in 20 microloans of $25 each, is not sufficiently diversified. So if one of my loans default, my pre-inflation, nominal 9% expected rate of return decreases by a half percentage or so.

What to consider: If you want to issue a handful of microloans, you will not be sufficiently diversified, and your expected rate of return is not high enough to invest. Plus, if you invest with only one P2P lender, you overly invested within one single company’s future. Bottom line, feel free to invest a few hundred dollars in peer-to-peer, but leaving too much money savings in a single company’s hands is simply foolish.


ING signals its existence

In Banking on December 16, 2009 by carlos Tagged: ,

People might be fine with using the internet as the dominate medium for friendships, billpaying, photographs, and music.But I would venture to say most people remain uncomfortable with the prospect of banking through something that seemingly exists only at a URL, be it,, They worry it’s a Nigerian scam at worst, that it would be too awkward to deposit and withdraw at minimum. When you’re talking about money, people need, understandably enough, some tangible proof that their bank exists.

ING Direct, lacking branches that dot street corners, lacks the physical presence that signals permanence. Instead, they advertise. The billboards, I noticed, lacked the a webpage URL. I’m betting that’s because they aren’t trying to persuade people to open accounts (that’s what the online advertising is for). Instead, they’re attempting to supplement word of mouth and seal the deal for customers uncertain about opening a new account. The prospect of problems with people’s money is a hurdle too high, even in the face of the enticements of some extra money in the form of higher interest rates each month. The advertisements, I believe, serve to trim that hurdle.


Serpico: Still tilting at windmills

In Movies, Reviews on December 16, 2009 by carlos Tagged: , , , ,

In the 1960s and 1970s, New York City hit its nadir. Summer riots where as expected as sticky August humidity. It was a time when the sanitation worker strike led to 10-foot high piles of trash stacking city streets, a time when affluent and middle class whites fled the city for the suburbs, depriving the city of its tax base. Years after the events of the movie, the city avoided bankruptcy only after a federal bailout. And police engaged in widespread corruption. As the New York Times wrote about the corruption of the era: “From organized shakedowns at bars and construction sites, to payoffs from gamblers and drug dealers to ignore their growing influence, no officer seemed to be immune from the scourge of a department found to be riddled with graft and unable to police itself.”

Serpico tells the story of Frank Serpico, a plainclothes officer who refused to participate in this culture of graft and corruption. He instead became an NYPD whistleblower, and as a direct result of this, a pariah.By the last frame of the movie, he is deaf, stoically sitting against a railing as he awaits for a boat to take him to Europe. The movie portrays Serpico, played by Al Pacino, as an idealist who became a cop out of love for his New York and fellow New Yorkers, and for the rush of fighting crime. Throughout the movie, Al Pacino possesses empty, anxious gaze and frequently avoiding eye contact with his fellow policemen (at this time, they were all men). He is burdened in sprit by the omnipresent corruption around him, and by the anticlimax that is the end result of his lifelong goal.

Subtly, the movie suggests that Serpico is the type of person so purely independent of—or, depending on one’s semantic choice, isolated from—clique, group, as to be a bit of a loner. He is the Greenwich Village-living counterculture guy who worked as a cop; he was a cop who wore long hair, listened to opera and liked ballet, and hung out with drugged up dreamers. His obsession with being a straight cop cost him relationships both romantic and professional.

Most relevant to the money blog is also how the movie illustrates the luxuries of living without the constraint of money, and its branches/ tentacles of career, family and children, status, and debt. A couple scenes I found to be illustrative of this aspect of the movie:

One scene has him following, while still on duty, his plainclothes partner, Don, into an apartment. “I keep this place for socializing,” quips the partner. “Someday we’ll get a couple of broads, huh? Have a little party.” When the partner attempts to hand Serpico his cut of the money, Serpico waves him off. “Look, Don … if I was broke, if I had a family … I don’t know. But I’m not broke, and I don’t have a family. So why the fuck stick my neck out? You know what I mean?”

Don responds: “It’s already out, Frank, not taking the money.” People, generally, act rationally, and when they act irrationally, there’s a fundamental misplaced rationality to it. For Serpico to decline the kickback money was to expose himself as a troublemaker in the eyes of both his peers and supervisors; to become the “corrupt” deviant. Besides the career and financial incentives, the fact was that in these neighborhoods, the pimps and drug dealers officers accumulated more patronage power than the officers themselves–a textbook precondition to police corruption.

Obviously, self-interest wasn’t what trigged Serpico to wave off the money. Instead, it was being true to his self. In most circumstances, people are constrained by adulthood and responsibility, by children, family, debt, career, status. Not Serpico. He lacked a domestic life; had no debt; his career, status, and identity derived from working as a straight cop in the city of New York—not income levels and status within the NYPD.

Two other separate scenes gel in mind as one. Serpico attends a Greenwich Village party with the woman he was dating at the time. She wants to be an actress, she says. At the party he meets her friends: The poet who works for an advertising agency, the actress who works for a photographer, the novelist working for an insurance company. Upon learning that he is a cop, incidentally, the friends slink away. “How come all your friends are on their way to being somebody else?” he muses to her between meeting people.

Later on in the movie, they’re bathing together. She announces that unless he marries her, she will marry somebody else and leave for Texas in a few weeks (it is counterculture, you know). Serpico asks her about her intent to pursue her goals. “A girl has to get married some day,” she says. “You’re a long way from some day,” Serpico says. He never answers the question about marriage, and she is never seen nor heard from in the movie.

The scenes suggest that everybody has goals, hopes, and dreams we want to pursue. But money, life, and adulthood constrain the pursuit of the goal. She had to give up her dream at some point, as did the poet and novelist, as do most of us when we realize that we are merely tilting at windmills. But again, not Serpico. He was free: No money, career ambition, no ambition but to be honest cop, and no constrains. He possessed the iconoclastic personality that was attracted to being the outlier. For Serpico, that “some day” never came.