

The Tyranny of the Credit Score - dminor
http://www.nytimes.com/2010/07/24/business/24nocera.html?_r=2&ref=business&pagewanted=all

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MartinCron
There is another side of credit scores, not mentioned in the original article
or in the comments.

There was a time, before credit scoring became ubiquitous, when you would walk
into a bank and get a loan from a loan officer directly, who would have very
little to go on besides what you immediately present. That meant that women
and minorities, even ones who would be excellent credit risks, were less
likely to be able to get credit.

Sure, the current system has lots and lots of flaws (mostly from reducing
everything to a single immutable number), but there's something fundamentally
good behind the intention of judging people based on their concrete financial
activity instead of just on the color of their skin and/or the cut of their
suit.

~~~
asnyder
Interestingly enough Super Crunchers ([http://www.amazon.com/Super-Crunchers-
Thinking-Numbers-Smart...](http://www.amazon.com/Super-Crunchers-Thinking-
Numbers-Smart/dp/0553805401/ref=sr_1_1?ie=UTF8&s=books&qid=1280297185&sr=8-1))
goes into this in some detail and shows that the FICO score is really another
barrier to minorities. Statistically speaking it's minorities, mostly with
non-white skin that don't have a credit history. It states that the score is
no more than an accepted form of racial prejudice.

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hnal943
The use of the credit score as an indicator of character is also frustrating
for those of us that don't borrow money. Even if you don't borrow money you
run into resistance trying to get insurance, etc.

~~~
Unseelie
Because I've always paid with cash on hand, because I'm paying with cash,
phone companies expect me to pay more. When did cash become less valuable than
debt?

~~~
adolph
Depending on what you mean by phone companies, a cash transaction is generally
less valuable because it doesn't generate a relationship. They have to exert
themselves for each transaction.

~~~
Unseelie
Acttualy, I think it means more what I mean by cash. Which is misleading,
because I'm dealing in digital money, no cash involved, but rather than a
credit agency, my own bank account, ergo debit transfers.

The relationship, as far as I can see, is the same as that of credit: they
bill me, and I send them electronic funds. What am I missing?

------
mrj
The senior credit officer at my company will give you a long rant about the
inaccuracy of credit scores if you ask about it. They use it as informational
only (really high or really low might tell you something worth investigating).

Each business is different, and a competent risk analyst will build an
algorithm based off the portfolio's actual history.

The problem is the credit score _might_ have meaning in some cases, like
unsecured debt, to show how likely you are to payoff what you have little
incentive to return. It's a measure of all financial behavior, but all loans
are not the same.

A credit score isn't going to tell you how likely somebody is to make their
mortgage. Unless there are really desperate circumstances, most people will
pay their mortgage. A middle-of-the-road credit score really doesn't tell you
much about how likely somebody is to have desperate circumstances. That makes
it a poor predictor.

~~~
anamax
> A credit score isn't going to tell you how likely somebody is to make their
> mortgage. Unless there are really desperate circumstances, most people will
> pay their mortgage. A middle-of-the-road credit score really doesn't tell
> you much about how likely somebody is to have desperate circumstances. That
> makes it a poor predictor.

The above implies that a company that does not use credit scores when making
mortgage loans will outperform one that does.

What's the the name of your company that makes mortgage loans and does not use
credit scores? More to the point, are you taking investment or borrowing
money?

~~~
mrj
Sorry, I have to keep my online activities and work separate. :-) But I didn't
mean to infer my company doesn't use credit scores... They use them plenty.

>The above implies that a company that does not use credit scores when making
mortgage loans will outperform one that does.

The point is, while we don't really know how these algorithms work, we know
they don't control for the type of loan. You just get one number. That one
number is not always meaningful.

------
kareemm
The biggest problem, imho, is that there's no incentive for the credit rating
agencies to care about accuracy.

I paid for 30 days access to check my credit report a few months ago and I had
to fix a whole slew of errors dating back almost 10 years. When I followed up
to see if they had fixed the errors, I was told that since 30 days had passed,
I had to pay again to get an updated look at my credit report. Talk about
messed up incentives.

~~~
amalcon
I think the real issue is that we're trying to use a single number (well,
three numbers, but they all purport to mean the same thing) as a predictor of
whether or not an individual will pay back any given loan (or continue to pay
any given bill). The lenders (or, specifically, their employees) want a single
number because they want a single thing they can point to when asked to
explain their decision. "How could I have expected him to default? His FICO
was 750!"

Imagine if we tried to apply this approach to other areas. For corporations,
instead of reporting total assets, total liabilities, earnings, payments, and
such, they instead give all this information to an "Accounting Disclosure
Bureau", who produces an "Expected Profitability Index" based on those
numbers. While the report contains other information as well, people usually
just look at the EPI. Would that be a functional investment climate?

~~~
grandalf
This is a great point.

In the recent past, many people's credit scores were artificially inflated due
to the low perception of systemic risk in the economy.

Now that that risk is better understood, the same person who had a 750 score
might have a 650 score, etc., even if all payments have been made on time.

I'm curious about the incentive this creates. Suppose someone had a score of
680 and was paying everything on time and had $5000 of available credit. Now,
he/she has a score of maybe 640 and no available credit.

What is the benefit to this person of continuing to care about any no-recourse
debts in this case? He/she might imagine paying the debt off over 5 years as
originally planned, or may consider abandoning/defaulting on the debt and
saving the money instead, which would improve the person's financial picture
over the next 5 years, and by 7 years out the default would be expunged
anyway.

------
adamsmith
Is this a business opportunity?

If the premise of the article is true, that people who should be getting
credit are not, why can't we start a credit-extending company that does a
better job of assessing risk?

One or more of three things must be true here. Either:

1) there is an untapped business opportunity here,

2) the premise of this article is false and the machine is working fine, or

3) there are regulatory barriers getting in the way of making the machine work
well.

~~~
illumin8
There is a great opportunity here, if you have unlimited funds and can hold
your own loans. The problem is that nobody with the money wants to take this
risk on themselves, so they need to securitize these debts. Securitization
requires categorizing different loans into risk pools or tranches, which are
only categorized by FICO score.

In other words, sure, if you've got $billions lying around and are willing to
hold 30 year loans for their full term, feel free to start a business doing
this. If you're like any other bank and you want to off-load it to
Fannie/Freddy immediately or securitize them and sell them to hedge funds, you
need to put a FICO score on every loan and that is the only thing anyone cares
about.

It's obvious this is why our financial system is so screwed up. There are
people with 800 credit scores that are upside down by hundreds of thousands of
dollars, yet they can still get as much revolving credit as they want because
of their credit scores. Then, there are people like me who have actual cash
reserves in the tens of thousands and 0 debt, and refuse to hold revolving
credit, who have sub-700 because we don't buy into the whole debt ponzi
scheme. The system is broken and it will take a lot more than a new business
model to fix it. It will literally take several acts of congress.

~~~
adamsmith
Thank you that's very helpful.

Maybe hedge funds need to get into this business. Or maybe I should find a way
to show hedge funds that my new risk assessment is better.

Though one of the challenges is getting new types of hard-to-fake data. If my
risk assessment looks at a person's email account or does machine vision on
their facebook photos, those things are easily forgable.

~~~
TheCondor
Hedge funds did get in on it. That's why Goldman was sued for fraud.

Didn't the hedge funds just game Morningstar against AIG against FICO scores?

~~~
ZachPruckowski
>Hedge funds did get in on it. That's why Goldman was sued for fraud.

Goldman wasn't sued because of what they offered as investments, they were
sued because they misrepresented the net positions of at least one major
player, allegedly deliberately.

------
pragmatic
As a counter point. It's funny that on a site where the virtues of algorithms
are extolled daily (Google, etc), one of the first widely (and very
successful) uses of the algorithm (the FICO/credit score) is decried.

Companies use it because it works pretty well or well enough in most cases.
Yeah there is some really bad data. However, half of that blame probably goes
to the institutions reporting the data. (That's just a hunch)

However, because I've worked in the finance industry for many years, I've made
it a point to check my credit and try to keep it clean, because I know the
credit bureaus lack the incentive to do it.

I'm cursed because I have a common name and someone with the same name is very
bad about paying his bills. I usually end up disputing something every other
year or so.

~~~
jbooth
If Google sucks at their algorithm, I'm free to go use Bing, or not use
internet search if I don't want to.

If these credit companies suck at their algorithm, which they apparently do,
I'm screwed. It doesn't help that they're most likely totally captured by the
financial companies.

------
ghshephard
The entire worshiping of Credit Scores is somewhat laughable to me. My Father
was a mortgage broker and land developer, who developed properties and then
funded the mortgages that people took out -with his own money-. That subtle
difference, between selling mortgages with OPM (Other People's Money) and your
own money makes for a certain "clarity of perspective."

He always used to recite the Five C's, Collateral (what percentage of the
value of the property where you borrowing against), Capital (How much money do
you have in the bank), Capacity (what is your income) Character (what type of
person are you) and Credit (The infamous credit score).

When you are lending with your own money, only of those Five C's is worth a
squat - and that's collateral. What percentage of the asset where you lending
against. Anything north of 50% was considered risky.

------
shaggy
Nice article. I'll be very interested to see if the new legislation actually
leads to improvements in this area. It's always made me furious that the
credit bureaus collect and compile all this information about me that I
already know, but then want me to pay to see it in the format they present
(unless I live in a state that allows a yearly view for free).

~~~
jerf
All "states" allow a yearly view for free, because that's actually a Federal
law. See this page:
<http://www.ftc.gov/bcp/edu/pubs/consumer/credit/cre34.shtm>

They did stagger that law in by region, but it's completely phased in and has
been for a while.

Bear in mind you are entitled to a dump of the raw data they have, but you are
not entitled to the final number they call your score. They make you pay for
that. In general, it isn't all that useful to know that score IMHO. (At
specific times, perhaps, but not in general.)

------
d78g
This is an interesting/useful reply
[http://www.marginalrevolution.com/marginalrevolution/2010/07...](http://www.marginalrevolution.com/marginalrevolution/2010/07/beyond-
fico.html)

~~~
techsupporter
From that article: "A number of people (Slacktivist, Kevin Drum, Matt
Yglesias, Megan Mcardle) are debating the use of credit scores in employment.
_Credit scores are useful at predicting all kinds of things including, for
example, car accidents so there is good reason to believe that they are useful
in employment._ "

I now seriously question anything further in that article. The idea that
credit scores can predict car accidents is ludicrous. The author probably
meant that credit scores can be used to predict claims on automobile
insurance, but that, too, is just as incorrect. Consider that many people with
low credit scores are going to buy the least expensive vehicles and insurance
they can find. This means carrying liability-only coverage, which does not pay
to the insured, just to anyone the insured might hit. That means that the
insurer is now using the credit score of the insured to "predict" the decision
of a completely unknown third party who may or may not even exist.

Credit scoring, when used outside the context of granting credit (and, often,
even in that context), is simply a way to continue to gouge people who have,
for whatever reason, a damaged set of credit reports long after that damage
has occurred.

~~~
hugh3
_I now seriously question anything further in that article. The idea that
credit scores can predict car accidents is ludicrous._

Do you find the idea that credit scores are correlated with car accident rates
to be ludicrous?

I find it very plausible. Some people are careful, others are careless.

Of course, one should be very careful in using vague correlations to determine
policy in specific cases. I bet I could draw up a correlation one way or the
other between accident rates and skin colour, but you'd be in serious trouble
if your insurance company tried to use _that_ to set premiums. (Oddly though,
they're allowed to take your sex and age into account.)

