The Political Economy Of Equifax And Easy, Bad Credit

Yves Smith makes a very important observation about Equifax, the data collection company that was unable to secure personal data on 143 million Americans (boldface mine):

Understand what happened here. Methods of screening borrowers that would seem to be common-sensical, such as looking at their incomes, were deemed to be suspect and any bank that used them would have some ‘splaining to do to the FDIC. By contrast, banks that relied heavily on FICO scores would get a green light.

This is pure regulatory laziness. Bank regulators have the power to do proctological exams. They can also respond to consumer complaints. Giving a grossly simplified, low-information metric like FICO scores such elevated importance was neither necessary nor desirable. It was merely convenient.

But that convenience was part of the business model:

The FDIC also failed to take steps to assure the integrity of the information used in this credit scoring process, nor did it obligate banks to hold the credit bureaus to certain standards, which would have had an effect similar to that of regulating them directly. Pray tell how good are models if the data in them is lousy, as regular consumer complaints and credit bureau refusal to correct errors confirm is a long-standing issue? Even Consumer Financial Protection Bureau supervision has only made some improvement in credit bureau responsiveness.

Banks could wean themselves off their heavy dependence on credit bureaus. More important, regulators should recognize that using single scores results in information loss and poorer lending decisions. But politically, readily available credit has become the antidote to stagnant real wages. You can’t promise the modern version of a chicken in every pot unless consumers can spend more. The preferred economic model since the Reagan era has been to let them borrow more rather than increase wages. The 2008 crisis showed that the US and many other advanced economies had hit the limits of that paradigm. The cost of trying to keep it on life support has been low growth, ever rising levels of income inequality, and political instability. Equifax is a tiny example of the many problems with our financial system that were papered over rather than fixed. So if were it to fail under the weight of litigation, that might force some overdue changes.

In other words, the easy metric of FICO scores isn’t really useful if you’re interested in making low-risk, well-investigated loans. However, it is useful if you’re trying to shovel loans out the door as fast as you can and need a procedure to screen out utterly horrible risks (while screwing over some people who aren’t risks), while at the same time, be able to claim you have a procedure to reliably screen borrowers.

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