BY AMIE TSANG
PITFALLS ON THE FRONTIERS OF BANKING Upstart online lenders have taken on big, lumbering banks with outdated branches and skittish risk departments. They have won plaudits for their low costs and straightforward terms. But now, they are starting to exhibit their own troubling traits, Michael Corkery reports in DealBook.
Billions of dollars of investments from hedge funds and other Wall Street firms are flowing into these marketplaces. Marketplace lenders are also forming partnerships with the same banks they are seeking to disrupt. Smaller banks are buying up marketplace loans as investments, while others are offering co-branded loans.
Although the $12 billion in marketplace loans issued last year represents only a fraction of the overall consumer and small-business lending market, the industry has all the ingredients to become systemically significant. Now many, including the Treasury Department, are weighing the benefits and the risks of this booming industry.
Moody's, the credit-ratings firm, has warned that the marketplace industry bears some similarities to mortgage lending in the period leading up to the financial crisis because the companies that market and approve the loans quickly sell them off to investors. It noted that marketplace companies do not suffer direct losses if the borrowers default, which may embolden them to lower their credit standards.
Lenders defend themselves, saying that unlike mortgage bankers during the financial crisis, they still have plenty at stake if something goes wrong.
Lending Club, for example, does not earn a fee servicing loans that are written off, so it has less incentive to make risky loans. Servicing accounts for 20 percent of its revenue. Investors would also stop buying the loans if the company took too many risks.
Some borrowers and lawyers have also taken issue with how their loan payments were collected.
In signing up for loans from the marketplace Prosper, borrowers must give the company direct access to their bank accounts so it can electronically deduct loan payments. Moody's noted that the automatic withdrawals made it more likely that "strapped borrowers" would pay their marketplace loans ahead of other expenses.
Prosper says having access to borrowers' bank accounts allows the company to deposit the loan funds quickly and allows borrowers to make loan payments conveniently. A spokeswoman for Prosper said borrowers could contact the company to stop the electronic bank withdrawals.
New Innovative Products, a maker of specialty carrying cases, borrowed $70,000 in December from OnDeck, an online lender whose largest shareholders include a venture capital unit affiliated with Google. OnDeck was allowed to withdraw $604 from the company's bank account each day.OnDeck crossed the line, a bankruptcy judge said, when it continued to collect payments after being informed multiple times that New Innovative Products had filed for Chapter 11 bankruptcy protection. In July, a bankruptcy judge imposed sanctions on OnDeck and ordered it to return the money.
OnDeck also took cash from Wayco Ham, which cures and sells hams, after the company had filed for bankruptcy protection. After its filing, Wayco Ham opened a new bank account. In a move a judge called "particularly willful and malicious," OnDeck tapped Wayco Ham's new bank account and took out the loan payments. The bankruptcy judge had not granted OnDeck access to the new account, according to court documents. In a statement, OnDeck said: "We are taking all corrective actions to rectify the situation, including complying with the court and making any required payments."
When borrowers sign up for a loan from Lending Club, it defaults to automatic bank withdrawals. The company's website informs borrowers that they can opt out of the electronic withdrawals, but that they have to pay a $7 processing fee for each paper check. "It is more cost-efficient for us, and we pass those savings along to borrowers," said Renaud Laplanche, the chief executive of Lending Club.
THE FED'S POLICY MECHANICS RETOOL When the Federal Reserve decides it is time to raise interest rates, it will be relying on a new system, Binyamin Appelbaum writes in The New York Times. A team led by Simon Potter, the head of the Fed market desk in New York, has been testing and fine-tuning the details by moving billions of dollars around the financial system.
The Fed requires banks to set aside reserves in proportion to the deposits the banks accept from customers. The reserves can be kept in cash or held at the Fed. Banks that need reserves at the end of the day can borrow from those that have a surplus. Before the crisis, the Fed controlled the interest rate on those loans by modulating the supply of reserves: It lowered interest rates by buying Treasury securities from banks and crediting their accounts, increasing the supply of reserves; it raised rates by selling Treasuries to banks and debiting their accounts.
As the crisis hit in 2008, the Fed pressed this system to its limits. It bought enough securities and pumped enough reserves into the banking system to drive interest rates on short-term loans to nearly zero. The federal government now pays about a dime to borrow $1,000 for one month. Companies with good credit pay about a dollar to borrow $1,000 from money market funds and other investors.
It continued to buy Treasuries and mortgage bonds to eliminate havens, forcing money into riskier investments that might generate economic activity. As a byproduct, the Fed kept expanding the supply of reserves.
As a result, the banking system is awash with money. In June 2008, banks had about $10.1 billion in their Fed accounts. The total is now $2.6 trillion.
The Fed would need to sell most of the securities it has accumulated before short-term rates would start to rise. Selling quickly could roil markets; selling slowly could allow the economy to overheat. So the Fed has found another way.
Instead of draining all that excess money, the Fed decided to freeze it, Mr. Appelbaum writes.
For the last seven years, the Fed has encouraged financial risk-taking as part of its campaign to increase employment and economic growth. By raising interest rates, the Fed intends to gradually discourage risk-taking. Part of the plan is persuading banks not to make loans.
In a serendipitous stroke, Congress passed a law shortly before the financial crisis that let the Fed pay interest on the reserves that banks kept at the Fed.
If the Fed wanted to raise short-term interest rates to 1 percent, it could not easily do so by reducing the availability of money because the glut of reserves is so great. Instead, the Fed plans to pre-empt the market, paying banks 1 percent interest on reserves in their Fed accounts, so banks have little reason to lend at lower rates.
At first, Fed officials thought that paying interest to banks would establish a minimum rate for all short-term loans, exerting the same broad influence as the old system. But rates on most such loans remained lower than 0.25 percent. The rest of the financial system is also awash in cash, and lenders - like money market mutual funds - pull interest rates down as they fight to attract borrowers.
The Fed lacks the legal authority to pay these lenders a minimum interest rate on deposits. But two years ago, Lorie Logan, one of Mr. Potter's top aides, suggested the Fed could achieve the same goal by borrowing from these companies at a minimum interest rate.
The resulting deals, known as overnight reverse repurchase agreements, are a significant break from the Fed's history of working through only the banking industry.
"We're pushing more activity out of the regulated banking sector, and somonetary policy has to take account of the unregulated sector," said Jon Faust, an economist at Johns Hopkins University who until recently served as an adviser to Ms. Yellen. "The world is changing, and I think the bigger risk is not changing along with it."
ON THE AGENDA Fabrice Brégier, the chief executive of Airbus, will be a guest on CNBC at 8:40 a.m. Mohamed El-Erian, the chief economist at Allianz, is a guest on CNBC at 10 a.m.
BANKS SETTLE IN SUIT OVER FINANCIAL CRISIS Large banks are preparing to pay $1.865 billion to settle accusations that they conspired unfairly to control a derivatives market that stood at the center of the financial crisis, Nathaniel Popper reports in DealBook.
Lawyers for several large investors, including a pension fund in Los Angeles, argued in a suit filed in 2013 that the 12 banks - essentially the largest ones in the world - conspired to keep competitors out of the market and allowed banks to charge higher prices. A lawyer for the investors said on Friday that they expected to complete the settlement in the next two weeks.
One of the lawyers for the investors, Bruce L. Simon, added on Friday that the banks have also agreed to changes to improve the transparency of the credit default swaps market.
The United States district judge overseeing the case, Denise Cote, gave the two sides until Sept. 25 to complete the terms of the settlement for her approval. The pending settlement is expected to be one of the largest antitrust cases since the financial crisis.
The role the banks play in the credit default swaps market came into the public eye in 2010 when The New York Times published an investigation detailing the private meetings in which the banks worked to keep competitors, like the hedge fund Citadel Group, out of the market. The banks were said to have worked to shut down an effort by Citadel to create an exchange where the swaps could have been traded more transparently.
Banks have been accused in several suits of maintaining anticompetitive control over crucial financial markets before and after the financial crisis. The government has pursued the banks for their conduct in several markets, but the private lawsuits have gone in front of different judges and ended very differently.
One of the most prominent suits, involving the key interest rate benchmark known as Libor, was thrown out by a district judge in Manhattan, who said that rate rigging was not anticompetitive conduct and therefore not a candidate for an antitrust lawsuit.
A different federal judge in Manhattan allowed investors to proceed with their suits accusing the banks of conspiring to fix prices in the foreign currency markets. Those cases have collectively yielded over $2 billion for investors.
Vista Equity Partners to Buy Solera for $6.5 Billion The private equity firm will buy all of the outstanding shares in cash of Solera, which provides software to insurance and car companies.
Tele Columbus to Buy Pepcom for $570 Million Tele Columbus agreed to acquire Pepcom for about $570 million, combining Germany's third- and fourth-largest cable providers.
Oil Search Rejects Woodside bid Oil Search has rejected a $8.2 billion takeover bid by its Australian rival Woodside, saying that the proposal was "highly opportunistic and grossly undervalues the company," but indicated that it would consider other offers.
Shire Considers Sweetening Offer for Baxalta Shire is weighing options for sweetening its multibillion-dollar, all-stock offer for the biotechnology firm Baxalta by putting cash into shareholders' hands sooner, The Wall Street Journal reports, citing people familiar with the matter.
NCR Is Said to Resume Attempt to Sell Itself The move comes after talks to sell itself to the investment firm Thoma Bravo fell through this summer.
Insurance M&A Goes to Investors' Heads A string of recent insurance deals has pushed up shares in Lloyd's insurers so that almost all are now valued as if they had a deep-pocketed Japanese buyer, like Mitsui Sumitomo Insurance, in the wings.
Breakingviews: How Jeffrey Immelt Is Staking His Legacy on Alstom Buying the French energy provider is a steal. The acquisition also serves as a symbol of G.E.'s shrewd refocus on industry over finance.
Bank of America Vote Brings Out Broader Complaints Some investors would like the longest-tenured directors on the board to leave, while others would rather see more financial experts or new blood on the board's governance committee.
Why China's Next Bad Bank May Not Be All That Good China wants to tap more foreign capital to help clean up its debt mess, but investors should steer clear, according to The Wall Street Journal's Heard on the Street column.
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