Joe Nocera’s Terrific Report on the Tyranny of Credit Scores

NY Time’ columinist Joe Nocera’s report on the tyranny of credit scores is right on the money. He points out that Fannie, Freddie and the banks that write mortgages depending on one thing–the applicant’s credit score. Nocera gives examples of perfectly credit-worthy consumes whose credit scores are low for odd and irrelevant reasons. For example, a consumer’s “credit utilization may be high on only one credit card. Using FICO’s formula, this adversely affects the credit score.

But Nocera notes that it is not FICO that comes up with a borrower’s score — it just sells the algorithms. The three national credit bureaus, TransUnion, Equifax and Experian, gather input about the prospective borrower’s lending history from various lenders like credit card companies and auto dealers, plug them into a formula and derive a credit score.

Nocera writes that you would think, given the critical importance of an accurate score, that there would be rules about the information that is submitted to them. But there are no rules. “Lenders can submit information about your credit history to one of the bureaus, all of them or none of them. Some of them turn over information right away; some take months; some don’t do it at all. Some are sticklers for accuracy; others are sloppy. The point is that the credit score is derived after an information-gathering process that is anything but rigorous.

He adds that FICO scores are not even the best predictor whether someone will default. The amount of equity a person has in his home, his debt-to-income ratio, his job stability and his cash reserves are all better predictors than credit scores according to the chief executive of Primary Residential Mortgage, a leading mortgage lender.

Moreover, lenders don’t take into account the many, mistakes that are found in credit reports. He mentions a number of errors on his own credit reports. TransUnion is reporting that Nocera works for Rite Aid!

Ed Mierzwinski, who is with PIRG in Washington, D.C., tracks Fair Credit issues. His equally interesting report on credit scores and some pending legislation is below the fold.

Credit scores, while based on proprietary algorithms presumed to be as top-secret as the Coca-Cola formula, are really nothing much more than a numerical summary of the information in credit reports. They’ve been reverse-engineered by everyone, from the Federal Reserve to individuals and, most certainly, by lenders. When lenders use that knowledge to withhold information (such as credit limits) from credit bureaus to game the scores (to keep their own customers captive and unable to shop around by making them appear to other lenders as weaker risks than they actually are), or lenders or credit bureaus make errors, credit reports and scores suffer. So do consumers.

During the rise of the housing bubble, reliance on scores grew — after all they were technological and whiz-bang and fast, compared to the old methods of verifying ability to pay, such as calling lenders on the phone to confirm information in credit reports. Both Fannie and Freddie placed nearly 100% reliance on “automated” underwriting, nearly killing the manual underwriting industry that actually makes phone calls to confirm consumer information.

Meanwhile, the Congress continues to look at credit reporting and scoring issues. Recently the House Financial Services Committee held an important hearing featuring our colleagues Chi Chi Wu of the National Consumer Law Center and medical debt expert Mark Rukavina of the Access Project. If you watch the archived webcast on the hearing page (grab the time bar and scroll forward to the very end at about 2hrs. 50 minutes), you will see a fascinating exchange where Rep. Steve Cohen (D-TN), a reform champion, goes at it with Stuart Pratt, chief credit bureau lobbyist, over whether credit scores derived from Pratt’s association members (the Big Three credit bureaus), violate the civil rights laws because, as I have often blogged about, all other things being equal, non-whites have lower scores than whites.

Chairman Barney Frank (D-MA) has scheduled a vote Tuesday on Rep. Mary Jo Kilroy’s (D-OH) PIRG-backed HR 4321, the Medical Debt Relief Act, to limit the impact of paid medical debt on credit reports because, from the bill’s findings, “according to credit evaluators, medical debt collections are more likely to be in dispute, inconsistently reported, and of questionable value in predicting future payment performance because it is atypical and non-predictive.”

While Rep. Kilroy has 104 co-sponsors, we expect Stuart Pratt and his horde of Consumer Data Industry Association (CDIA) lobbyists (word is even Bob Dole was hired by the bureaus against the successful Mark Udall credit score disclosure amendment to the Wall Street Reform and Consumer Protection Act) to offer various gutting amendments.

Rep. Cohen and others have also introduced legislation, HR 3149, the Equal Employment For All Act, backed by U.S. PIRG, NCLC, the NAACP and others to restrict the use of credit reports for employment purposes. In this horrible job market, should a mistake on your credit report deny you a job?

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