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What Is Social Capital?

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When I was at Prosper's annual conference, there was a lot of buzz around the term "social capital." I thought I was alone in wondering what it was. However, when I caught up with Wealth Boy, I found that he hadn't heard the term used before. I'm going to go out on a limb and hazard a guess that you haven't either.

Wikipedia defines social capital as the "connections within and between social networks" and the value that they have. Social capital sounds to me like a complex way to define reputation. Others may say that reputation is only a part of social capital. After reading that article, I would expand my layman's definition as "reputation amongst people of influence."

My grandfather had a lot of social capital amongst various business owners in his small town. In my world that's becoming less common. It has been replaced with online social capital. For some it's Facebook and MySpace, while others have LinkedIn. Personally, I have looked into the value of an MBA simply because, from the right school, it provides an incredible amount of social capital. Instead, I developed my social capital as a software engineer in Boston. For better or worse, when I moved out to California I decided not to invest heavily in creating that social capital. I focused on creating social capital with many personal finance bloggers and you, my readers - a decision that I have not regretted.

Prosper was liberal with the use "social capital", because it's core to what they are trying to do. They showed a great example of a Prosper group in Hawaii. Hawaii has a state law that places a strict cap on interest from personal loans - around 12%. For this reason, very few lenders would take anything other than perfect credit from a borrower. Yet some borrowers are getting loans with fairly poor credit history. Why? The Prosper Group leader meet with each borrower individually. She's been to their home, possibly shared a lunch or two, and has vetted that this person is responsible. The result is that the group has zero defaults. Lenders and borrowers are very happy with their transaction - which in turn makes Prosper happy.

The Hawaii group is just one version of social capital at Prosper. Netbanker reported on the effect of endorsements from bidders and how these loans perform 35% to 50% better than loans without endorsements from bidders. RateLadder put his social capital to the test. He is pretty prominent in the Prosper community. People realize that he has incentive to pay loans back on time and that give them great confidence in getting a return on their money. When he examined his loan, he realized that his social capital shaved about 2.5% off the average interest rate. These are examples of very real savings.

At least I know what to call the phenomenon of "It's not what you know, it's who you know."

Last updated on August 1, 2011.

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5 Responses to “What Is Social Capital?”

  1. RateLadder says:

    The Hawaiians have a loan that is going into bankruptcy. It is a AA. So far that hasn’t seemed to tarnish the group.

    Life happens to everyone.

  2. In the era of the internet referrals, the bigger your social capital the more income you can achieve ( prosper, lending club, ing direct)

  3. you’re right, i wasn’t aware of this concept. i guess its a form of ‘popularity index’ and it can be directly proportional to your financial success.

    good post.

  4. Seth says:

    maybe its too late to comment on this post. But in my field economics, there is a lot of work on social capital particullarly dealing with loans. Most of my work deals with developing countries. If you are in a small enough community and your neighbor loans you money and you do not repay them, then you lose standing in your community. You might also trust to loan money to someone you know more even if that wont lose face if they don’t pay you back.

    The idea of social capital is also tied to being part of an organization. If you were part of my church, bowling league, alumni association whatever, then we have an instance connection. I’m more likely to trust you. More likely to loan you money or start a joint project with you.

    A good read on the subject is Robert Putnam bowling alone, about the decline in social capital in the US.

  5. Great post! I’ve been looking into getting an MBA as well, but I’m not sure it would be worth my time.

    As far as Propser goes, the Hawaii group sounds like one of the few that are well managed on the site. It’s nice that their group leader checks out all borrowers so thoroughly!

    My social capital is probably much better looking at my anonymous online identity than what it is in real life. I wish I could combine the two, but alas, that would get me into trouble at work. :)

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