Consumer Credit Bureaus Need Reform, Too

President Obama’s effort to reform the banking system doesn’t address the system’s biggest problem, which is how consumer credit is underwritten in the United States.

Without exception, no material consumer loan is made in America without the borrower’s credit bureau first being polled by prospective lenders and a credit score used to classify the borrower as good, bad or middle risk. Credit scores are supposed to accurately predict the probability of default by consumers, but in practice, credit scores don’t predict much of anything. Banks blindly rely upon the junk put out by consumer credit rating agencies and are getting burnt by ignoring the most basic rule of underwriting, which is to know their customer. While banks know borrowers' credit scores and information on the credit report, that isn’t the same thing as knowing their customer or things like their customer’s assets, liabilities and earning power.

Every bank, regulator, non-bank entity and institution such as Freddie Mac (FRE) and Fannie Mae (FNM) instantly thinks that they know their borrower simply by being told a three digit credit score. Credits scores under 650 are a problem, over 720 is to be good and around 670…well…maybe marginally OK.

If anyone wonders whether or not the system blindly relies on credit scores, just try to get a loan to buy a house or car or apply for a credit card without the bank pulling a credit report and a credit score. Without a credit score, the loan won’t happen, and if people want to live in the United States they don’t have a choice but to submit to the power and will of the consumer credit rating agencies. Imagine trying to get a loan at the “best interest rate” with a credit score of 600. It doesn’t make a difference if the credit score is wrong or based upon erroneous information, the loan just isn’t going to be made. Without exception, credit scores are the ticket to the dance of consumer credit in America.

It is amazing how everyone is ignoring the fact that the single common thread connecting every defaulted consumer and mortgage loan is that each borrower had their credit evaluated by the consumer credit rating agencies and a loan was made based upon the score.

Of course, in the case of sub-prime mortgages, lenders should have understood their risk. After all, the words “sub-prime” refer to the prospective borrower’s poor credit score, which is below average and therefore not “prime”. However, it’s hard to explain why there are more delinquencies and defaults in prime mortgage pools, i.e., pools of mortgages where the individuals had good credit scores, than in sub-prime mortgage pools.

Clearly, something is wrong and the system is broken.

The current system has two obvious big problems.

· Garbage in/garbage out credit scoring – Credit scores are only as good as the information that is used for calculation. If the information is wrong, then the credit score will be wrong. Very often the information used to calculate credit scores has one or more errors, and over time the cumulative effect of bad information destroys the usefulness of credit scores for many if not most Americans.

As an example, I have a close friend whose credit score recently went from the high 700s to the low 700s despite her credit improving. The reasons that the credit score went down are because she decided to save money and pay cash for a recent car purchase.

This particular individual is a saver, not a spender. About a year ago she had cash on deposit at a failing money center bank that was far in excess of the then applicable FDIC insurance limits. My friend decided that it was prudent to spread her cash around a bunch of banks so that all of her bank deposits would be insured by the FDIC.

She went to four other banks to open new savings accounts and each bank told her they needed to “run a credit inquiry” as a condition to accepting her money. They never really explained why depositing cash in a bank required the scoring of a depositor’s credit; after all, by depositing money in a bank, my friend was lending money to the bank and not the other way around. The inquiries were reported by every bank as if my friend had applied for revolving consumer credit rather than having deposited $100,000 at the bank. As a result, my friend’s credit bureau showed inquiries from a number of banks and each inquiry lowered her credit score.

Six months ago my friend decided to purchase a new car for her son. She paid for the car with a check, i.e., she didn’t apply for a loan and paid “cash”. The car dealer “ran a credit bureau” on my friend before accepting the check. This credit inquiry showed up on the credit report as an outstanding automobile loan for the amount of the car with no reported payment information. Again, my friend’s credit score went down.

The only other “new item” on my friend’s credit bureau was a disputed account for $128. This amount was reported by a medical laboratory that attempted to overcharge my friend for a medical test and then used the threat of reporting the $128 amount to the credit rating agency as a tool to extort the payment.

My friend’s family income is in excess of $1 million per year and she and her husband have no reported mortgage debt and revolving credit outstanding of less than $25,000. Obviously, since there are large savings on deposit at various banks my friend has lots of liquidity and large cash balances.

Her FICO score, as reported yesterday by Equifax (EFX), was 710 and is down from approximately 780 a year ago.

This week there was a real cost to my friend from the lower credit score. She bought another new car and was excluded from a promotional interest rate offered by the manufacturer because the cutoff for the lowest interest rate was 720.

Garbage in/garbage out credit scoring dropped what should have been in excess of an 800 credit score to 710. Bad information used to calculate credit scores isn’t an isolated phenomena and is causing consumers, in the aggregate, to pay billions more in interest to banks than is justified by their risk.

Of course, we only hear about credit scores that are too low because the credit rating agency messed up, never about scores being too high. So, when bank analysts wonder how consumers with prime credit scores can be defaulting on their mortgages as if they were sub-prime borrowers, keep in mind that for every mistake that incorrectly lowers a credit score there is an unreported mistake that raises a credit score. And when banks blindly approve consumer credit based upon credit scores, they are just kidding themselves when they think they have an underwriting process with integrity, or that they know their customer, which is the most basic rule of good underwriting.

· No one knows how the credit scores are calculated and the consumer credit rating agencies are shrouded in a veil of secrecy – The consumer credit rating agencies operate in a shadowy world of non-accountability and anonymity. They are as hard to penetrate as the Pentagon and more secretive than the CIA. The three for-profit companies determine the cost of credit for virtually all Americans, yet virtually no one knows who runs them or how they operate. And if the consumer credit rating agencies make a mistake, like when one of them gave out my information to a scamster last year, they are immune from both prosecution and accountability.

It seems like consumer credit rating bureaus act in concert, like a cartel oligopoly, with little of substance to distinguish their products and services. Consumers aren’t given a choice as to whether or not to participate in the consumer credit rating agency process. If someone decides not to participate they have effectively excluded themselves from the banking system, insurance companies and many jobs. People who want out of the consumer credit rating agency system need to move to another country or go to jail (there isn’t a lot of need for credit in prison). Consumer credit agencies determine the cost of our debt, where we can live and who we can work for, without our consent or approval and without any reasonable supervision.

The three consumer credit rating agencies protect their “formulas” for calculating credit scores like it is the secret to eternal life with the certainty that everyone will be instantly turned to stone if the secret gets out. When something is a secret it usually means that there is no accountability and no way to find out or correct errors. And, when financial products and services are protected under a Burka, history teaches that sooner or later major problems happen.

For example, what if my friend’s credit score was just calculated incorrectly, i.e., the inquiries and cash purchase of a car were reported correctly but just coded wrong by the credit rating agencies? How would anyone know and how would she be able to fix it? What is to prevent an entire class of people from being discriminated against (like immigrants, blacks or just people who live in a certain zip code)? And how would anyone know if there was a conspiracy to lower credit scores so that banks could justify higher interest and fees?

Consumer credit bureaus are used by businesses and banks as a semi- governmental and authoritative source of accurate information and authoritative analysis. Unfortunately, more often than not consumer credit rating agency information is wrong and misused.

If President Obama wants to enact serious reform, then fixing consumer credit rating agencies and overreliance on credit rating scores is the place to start. After all, the single most important common thread in the current credit and banking crisis is that every single defaulted mortgage file has in it a credit rating score that was assumed to have the authority of a biblical pronouncement.

The days of automated consumer underwriting based upon computer models that use bad information from credit bureaus and wrong credit scores need to end.

Comments

[user369285:]

There is no oversight or accountability on a "service" that can wreck your life? I assume they get their information from public records, otherwise how do they defend the "invasion of privacy". Where is the famous Civil Liberties Union on this issue?-Too busy defending ACORN ?

Sep 18 09:57 AM

[KirbyJF1:]

With your friends kind of earnings & net worth, why would they care what their credit score is at any time. I assume they have a main banking relationship & that bank would know their client. I think your making something out of NOTHING.


Kirby

Sep 20 03:06 PM

[trp2:]

Your understanding of the process is faulty. The credit bureaus are repositories of information fed to them by various entities with whom you have a credit relationship. They themselves add nothing to the credit record. The processes under which they operate are governed by the Consumer Protection Agency, Fair Credit Reporting Act and the FCC. They can fix your record with your help but if the reporting company ( Mobil Gas Credit card, e.g.) sends uncorrected information next month along with its other 5 million records and it is loaded to file with other companies' 100 million updates for that month, your file will be back to where it was before. They (the bureaus) cannot check each and every updated record to file.
As for the score drops, those inquiries to file, if done in the absence of permission, were done in violation of law. Any look into the actual credit information of an individual must result in a firm offer of credit: if none was offered, there exists a violation. ( remember the days when you would get a real pre approved working credit card in the mail!!?!) Other reviews of a general nature of your credit record, such as your file may get before you receive a credit card offer are done at a treetop level without specifics and your file will carry a P or an indication of a promotional/marketing review which has NO impact on the credit score. Did the friend in the story actually give permission for them to pull a credit bureau report?
While each of the bureaus have credit scores, their usage is limited. Fair Isaac's FICO scoring models for various products are the standard.

Sep 24 08:12 AM

[a fat panda:]

"If anyone wonders whether or not the system blindly relies on credit scores, "

In all the time that I worked in banking, I never heard anyone question the wisdom of lending against a score. They looked at historic default rates, and assumed that they would be similar going forward. So, the biggest problem in banking is that depending upon FICO was rewarded with success. That success wasn't the effectiveness of FICO, but the housing bubble covering up incompetent loans for many years. The tide is out, and the effectiveness of the scoring is now swimming naked.

Believe it or not, bankers did not preceive the effectiveness as FICOs basic problem. They viewed that it was too much of a commodity. Everyone could get FICO. So the big push in banking has been "Universe Expansion", where you build an internal score which gives you an equivalent performance on loans outside the standard FICO universe.

Sep 25 09:54 AM

[User 413123:]

I don't fit the profile of the "perfect borrower" even though, in fact, I am exactly that, and I'm tired of being treated by the financial industry as a slimebucket. It's totally unwarranted and while I don't spend time whining about it (excepting now) it really does feel unfair.

It's all because of a very flawed system of trying to plug my numbers into risk calculators. Maybe those predict risk accurately most of the time, but the clearly don't, when it comes to me. Until and unless there is reform, I'm on my own - and while no one NEEDS to borrow money from anyone else (or any entity) this system truly gives an advantage to people clearly irresponsible as compared to me. Any bank should be pleased to do business with me but they don't know it, by way of the "scores" spit forth from the credit bureaus. That's what I get for managing my money unconventionally, as compared to the average consumer.

Sep 25 10:03 AM

[SAUBW:]

The author is absolutely right that these three bureaus have way too much power over an individual's financial well-being. Unfortunately they skulk along under the public radar most of the time, like Dr. Frankenstein in his isolated lab.

They never, ever accept any responsibility for any errors they make, or for errors that others make. These allegedly neutral organizations enshrine and preserve accurate, inaccurate and misleading information with an equal fervor. One gets the impression they perceive it almost as a religious duty (kind of like self-important government workers). But, these credit rating agencies are after all, the contemptible spawn and by-product of the banking industry. So, what else would you expect from them?

Everyone knows that the banks shenanigans of late have reduced credit lines for pretty much everyone, regardless of the banking industry's rationale for doing so (hint - the reason is to worsen credit ratios across the board so that banks can charge the masses more interest to make up for the financial industry's gambling losses - (free fed money and inter-generational debt for their benefit is not enough, you see... ).

And credit inquiries actually are definitely made (or required) more consistently today, for obvious reasons. It is actually quite clever of the banks, although it is equally despicable. But, they think most everybody is too stupid to notice, or too preoccupied with other problems to do anything about it, even if they do notice.

Both of those actions in-arguably have and will continue to lower credit scores across the board, but neither tells you anything directly about anyone's ability or likelihood of paying a debt. It just tells you the bank has figured out one more angle to shaft the public. It is designed into the system by people who may very well be thoroughly greedy and crooked, but they are not stupid.

It is similar to the ability of card companies/banks to take money or charge against your debit/credit card account instantaneously - but mysteriously they somehow just can't figure out how to put it back instantaneously. You must wait for days to get your money back.
The banks, of course just blame the merchants for that problem, although it is the bank's system which was deliberately designed to take your money as quickly as possible and to hold on to it as long as possible...

It is actually the banking industry that built both the credit agencies and the credit card industry (I don't recall any consumer group harping for the creation of either of these blights on the country)...Many people, like the author's friend (including myself), have had significant unused lines of credit cut in half and card rates raised astronomically - even though they consistently pay off everything every month (and banks hate that....).

From an actual creditworthiness perspective, the reason behind the resulting credit score drop due to the aforementioned bank or consumer actions realistically means nothing. But, for the banks and credit agency duopoly, it is really just figuring out how to make their gambling errors or their unilateral actions to translate into a justification to charge everyone else more interest.

So, the public gets the double-whammy of a higher interest rate to start with and then compounds this by a lower credit score/rating to jack it up even more for those unfortunate enough to have to borrow anything.

And this is not the fault of the rating agencies (or the design of the process/calculations they use, if you prefer)? Of course it is! If these agencies had any ethical substance or hint of responsibility to consumers at all (they don't - they only serve the banking masters...) they would not be the unbreachable wall that they consistently are to the public.. They would accept contradictory information from consumers as readily as they do from lenders and creditors. And they would not mindlessly lower scores,; because "that's the formula we use."

It is all just math and these so-called services only serve the finance industry - period. If you have an objection to any inaccurate item, these clowns just blame the other morons who reported it to them. But they really don't change anything unless you pull out all the stops and become an annoying problem for them.

In their eyes, you are definitely guilty until you prove yourself innocent and their lame solutions to file any kind of dispute are completely inadequate and laughable at best. They have simplistic flowchart-like processes to categorize your complaint and insist you use that process. The process is designed to only allow certain kinds of disputes and only allow certain ways to pursue them. Its as if only they know what constitutes a legitimate dispute and there can't be any other kind of dispute or process other than theirs, because they said so. Very much like dealing with the DMV..

To actually get any satisfaction, you have to go after the reporting company or agency itself, since the three credit bureau's (tools of banking) will staidly profess their innocence and claim the inability to do anything (definitely the DMV...). Unless you are determined enough to cause them a lot of trouble by filing complaints with attorney general offices and consumer protection agencies, they too and will consistently be unresponsive and try to point you to somebody else (to get rid of you...)..

The only way to deal with this or any tier of these a****** when they have inaccurate information on file, is to make it easier for them to withdraw the erroneous or inaccurate info than to deal with you any longer. Courteous logical inquiries will get you nowhere - they will just stonewall the average person. This is a big part of the reason people who have suffered identity theft have such a huge job in straightening it out.

These three self-worshiping organizations regard their crappy records like some kind of holy scroll that must not be modified after they have blessed the world by recording it. Credit score significance alone is to actual creditworthiness what GDP alone is to the economy - just one factor to consider in the overall picture and since both are frequently and grossly in error, why would you rely primarily on them to make a decision or conclusions?

But, the days of the old banking system where there is a personal relationship behind loans is probably too much of a dinosaur to survive in the computer age. We probably would be better off using our energies to get rid of both the bankers and the credit rating agencies alike. I know, we will replace all of them with computers!
Why not? We are all really just a number anyway, and computers do numbers quite well, don't they?

Sep 25 01:34 PM