In today's post Tired But Happy commented that he had a couple of Prosper.com loans that are late, and he thinks that "the Prosper folks are making payments on one of the loans".

I sincerely hope that this isn't true, as using incoming funds to pay interest to existing shareholders at a high rate of return, so as to attract more new investors, is typical of a classic "Ponzi" type pyramid scheme. I've previously said I'd be careful about "investing" in unsecured loans via Prosper.com without doing a comprehensive evaluation of the risks.

Reading through the Prosper.com FAQs the following items stick out:

There are no guarantees that your loan will be repaid.

and

Prosper is not directly insured by the FDIC, but lenders' deposits are covered up to $100,000 by FDIC pass-through insurance provided by our banking partner, Wells Fargo Bank.

What exactly does this mean? How does "pass-through" insurance work? Just how safe is your money if Prosper.com went out of business?

I also find the published figures for default rates on existing Prosper.com loans unbelievably good. What happened to the normal risk:reward relationship? If the loans were really as low risk as these default rates suggest, the interest rates being bid for these loans would be lower.

Prosper's FAQ give an example of how the default rate would affect your returns if you spread your investment across several small loan amounts:

If you make 100 loans to B-rated borrowers at 8%, and B-rated borrowers have an expected default rate of 1.8%, then you might have 2 borrowers default, which would lower your return by 2%. After annual lending fees of 0.5%, this would give you an annual 5.5% return overall.

But, as Prosper says:

A credit grade is a measure of the likelihood that a borrower will repay his or her loan. We also provide the following table to lenders, which shows historical default rates by credit grade for borrowers with normal (