Equifax Critics Are Missing The Bigger Point
Fair-lending laws turned consumers into anonymous credit scores—and a target for identity thieves.
The Wall Street Journal
September 14, 2017
Outrage that Equifax exposed more than 143 million credit records to identity thieves misses the point. We really should worry about what makes impersonation so easy—why do lenders know so little about the people to whom they issue credit?
Because laws meant to ensure fair lending also reduce individuals to anonymous credit scores. Regulators enforcing the 1968 Fair Housing Act and the 1974 Equal Credit Opportunity Act look askance at lenders who rely on judgment instead of scores to screen loan applications.
Even broadly relying on statistical scores doesn’t get lenders off the hook. Regulators also frown on “discretionary overrides,” especially if lenders allow frontline staff to overrule scores instead of having someone at headquarters do it. A branch-based banker in direct contact with customers may be better positioned to determine whether an applicant’s score reflects true creditworthiness. But regulators worry that giving branch staffers this authority may invite discrimination, so it’s a no-no.
Federal fairness examiners also worry about “customized” scoring models that can include variables excluded from credit-bureau records, such as education. It isn’t entirely forbidden, but regulators worry those variables could correlate with factors like race, ethnicity and sex. Lenders often resort to using a “generic” bureau score, popularly called a FICO score, to mitigate regulatory risk.
Federal agencies, notably Fannie Mae and Freddie Mac, have made FICO scores the main determinant of the creditworthiness of mortgage applicants. In 1994, Fannie and Freddie sought to automate screening—and prevent racial discrimination—by “removing subjective reasoning.” Not coincidentally, Fannie Mae had concurrently pledged $1 trillion in targeted housing finance for disadvantaged groups. Pressed for time, the agencies accelerated automation by relying on FICO scores, which had been designed for consumer lending, not mortgages. Fannie and Freddie’s endorsement then prompted private mortgage lenders to embrace bureau scores as well.
The use of bureau scores itself was predicated on a system of credit reporting and scoring nourished by Washington. In the 1950s and ’60s, as Citibank and Bank of America started marketing credit cards in states where they weren’t allowed to open branches, they used bureau scores to screen applications. This led to increased concerns about inaccurate bureau records.
In 1970 President Nixon signed the Fair Credit Reporting Act, which barred lenders from providing inaccurate information to credit bureaus, required the bureaus to ensure maximum possible accuracy, and encouraged consumers to correct errors in their reports. The rules helped increase confidence in credit-bureau scores and records. Increased confidence in turn promoted even wider use of the scores by lenders and regulators.
Yet bureau scores don’t play a major role in small-business lending. That is because government watchdogs don’t niggle small business lenders for allowing discretionary overrides or customizing credit scoring. The Small Business Administration does not mandate the use of bureau scores for the loans it guarantees. And there is no evidence of significant discrimination in small-business loans.
Rules driving consumer lenders to seek the safety of credit FICO scores risk more than large-scale identity theft.
Practical considerations—such as verifying someone’s educational background—prevent factors that affect creditworthiness from being part of FICO scores. The scores also rely on “statistical information” that ignores crucial local circumstances. They do not recognize substance abusers or distinguish judges with life tenure from workers in plants scheduled to close. This allows lenders to mass-produce loans at low cost, but it also increases lending mistakes and the risk of credit bubbles. Growing anxieties about indiscriminate FICO-enabled credit card, automobile and student lending—while “artisanal” lending to small businesses languishes—have sound foundations.
Fair lending rules may well have reduced unwarranted denials of mortgage and consumer loans, but they have prevented warranted denials of credit. Congress should scale back fairness rules to make consumer lending more like small business lending. And regulators should relax enforcement of fairness rules. These simple steps could discourage nearly blind lending—and sophisticated identity theft.
Outrage that Equifax exposed more than 143 million credit records to identity thieves misses the point. We really should worry about what makes impersonation so easy—why do lenders know so little about the people to whom they issue credit?
Because laws meant to ensure fair lending also reduce individuals to anonymous credit scores. Regulators enforcing the 1968 Fair Housing Act and the 1974 Equal Credit Opportunity Act look askance at lenders who rely on judgment instead of scores to screen loan applications.
Even broadly relying on statistical scores doesn’t get lenders off the hook. Regulators also frown on “discretionary overrides,” especially if lenders allow frontline staff to overrule scores instead of having someone at headquarters do it. A branch-based banker in direct contact with customers may be better positioned to determine whether an applicant’s score reflects true creditworthiness. But regulators worry that giving branch staffers this authority may invite discrimination, so it’s a no-no.
Federal fairness examiners also worry about “customized” scoring models that can include variables excluded from credit-bureau records, such as education. It isn’t entirely forbidden, but regulators worry those variables could correlate with factors like race, ethnicity and sex. Lenders often resort to using a “generic” bureau score, popularly called a FICO score, to mitigate regulatory risk.
Federal agencies, notably Fannie Mae and Freddie Mac, have made FICO scores the main determinant of the creditworthiness of mortgage applicants. In 1994, Fannie and Freddie sought to automate screening—and prevent racial discrimination—by “removing subjective reasoning.” Not coincidentally, Fannie Mae had concurrently pledged $1 trillion in targeted housing finance for disadvantaged groups. Pressed for time, the agencies accelerated automation by relying on FICO scores, which had been designed for consumer lending, not mortgages. Fannie and Freddie’s endorsement then prompted private mortgage lenders to embrace bureau scores as well.
The use of bureau scores itself was predicated on a system of credit reporting and scoring nourished by Washington. In the 1950s and ’60s, as Citibank and Bank of America started marketing credit cards in states where they weren’t allowed to open branches, they used bureau scores to screen applications. This led to increased concerns about inaccurate bureau records.
In 1970 President Nixon signed the Fair Credit Reporting Act, which barred lenders from providing inaccurate information to credit bureaus, required the bureaus to ensure maximum possible accuracy, and encouraged consumers to correct errors in their reports. The rules helped increase confidence in credit-bureau scores and records. Increased confidence in turn promoted even wider use of the scores by lenders and regulators.
Yet bureau scores don’t play a major role in small-business lending. That is because government watchdogs don’t niggle small business lenders for allowing discretionary overrides or customizing credit scoring. The Small Business Administration does not mandate the use of bureau scores for the loans it guarantees. And there is no evidence of significant discrimination in small-business loans.
Rules driving consumer lenders to seek the safety of credit FICO scores risk more than large-scale identity theft.
Practical considerations—such as verifying someone’s educational background—prevent factors that affect creditworthiness from being part of FICO scores. The scores also rely on “statistical information” that ignores crucial local circumstances. They do not recognize substance abusers or distinguish judges with life tenure from workers in plants scheduled to close. This allows lenders to mass-produce loans at low cost, but it also increases lending mistakes and the risk of credit bubbles. Growing anxieties about indiscriminate FICO-enabled credit card, automobile and student lending—while “artisanal” lending to small businesses languishes—have sound foundations.
Fair lending rules may well have reduced unwarranted denials of mortgage and consumer loans, but they have prevented warranted denials of credit. Congress should scale back fairness rules to make consumer lending more like small business lending. And regulators should relax enforcement of fairness rules. These simple steps could discourage nearly blind lending—and sophisticated identity theft.
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