It was only a matter of time before Wall Street turned peer to peer loans into a huge money maker

Derivatives, obviously.

From Tracy Alloway and Matt Scully at Bloomberg:

Investment funds can't get enough of this business, which involves lending to people over the Internet and hoping they pay you back. Investors are snapping up the loans directly, while the banks are bundling them into securities, much as they did with subprime mortgages. Now peer-to-peer lending and its Internet enablers like LendingClub Corp., the industry leader, are being pulled into the high-octane world of derivatives.

Synthetic P2P loans! What could go wrong? Here's more:

"If you could create a synthetic product that mimics all the features of a P2P loan and had the same risk and yield tradeoff, there would be a lot of demand to buy that paper," said Dickinson, whose firm has invested in LendingClub and Orchard Platform and is looking to invest $5 million to $10 million in a firm trying to create derivatives on P2P loans. Other small firms are racing to create P2P derivatives before big banks try to muscle in.

People are afraid of synthetic loans because synthetic mortgage loans are what helped bring down the economy in 2008. But they also give investors a way to bet against the market and push down the price, which can be a good thing.

And then there's this counterpoint, which Matt Levine floated in his newsletter this morning:

One generic data point is that the availability of short selling tamps down bubbles: People who disagree with the bull thesis have a way to express their disagreement that keeps down the price. And one intriguing theory that I've heard about the financial crisis is that synthetic collateralized debt obligations of mortgage-backed securities helped restrain the mortgage bubble, not only because synthetic CDOs were a way to get short mortgages, but also because they were a way to get long mortgages that didn't require creating more mortgages.

The argument as it applies to P2P derivatives would be that it gives the market exposure it wants - with interest rates at 7% or so, there's a lot of demand out there - without lending companies having to drastically increase supply. There's then less pressure to loosen underwriting requirements, which potentially makes the market safer.

That's an argument that one could make.

Then again, if the people currently qualifying for these loans over the internet start defaulting at a high rate, the number of people losing a lot of money is quite a bit higher than what it would be without the derivatives. And that could become a problem.