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Credit Market Turmoil and Peer-to-Peer Lending

Over the past couple of weeks, I’ve spoken to a lot of reporters about what the troubles in the credit markets might be doing to small businesses in the United States. While it’s easy to answer their questions based on anecdotal information, it’s tougher to do it on the basis of statistics. By the time most government statistics will be available to answer their questions, the reporters will be interested in something else.

To try to get some statistical data to answer their questions, I decided to take a look at peer-to-peer lending. Peer-to-peer lending gets at part of the effect of the credit markets on small businesses because some entrepreneurs borrow money from other individuals to finance their businesses.

Using data from Eric’s Credit Community, I charted the 30 day moving average of interest rates charged by lenders on Prosper.com [1] for AA (the best credit rating) and HR (the worst credit rating). In an ideal world, the sites that track peer-to-peer lending would break out the business borrowers from the rest so I could look at just them, but they don’t. So I looked at the overall numbers.

The graph I created on September 20, 2008 is below.

Since mid-November 2007, the average interest rate charged to people with the best credit has increased only slightly — what looks like about one percent. However, over the same period, the interest rate charged to the people with the worst credit has increased substantially — what looks like eleven percent (11%). So in November 2007, the people with poor credit paid twice as much to borrow money as people with good credit, but by September 2008, they were paying almost three times as much.

Because entrepreneurs with poor credit have to pay so much more than entrepreneurs with good credit to borrow money from their peers right now, the former are probably unable to borrow money at rates that let them profit from the opportunities they are pursuing. This pattern supports what many economists have said recently: the entrepreneurs with poor credit are the ones facing a severe credit crunch.

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About the Author: Scott Shane [2] is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of eight books, including Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.