What’s Yours is Mine: The Dangerous Implications of a “Right” to Free Credit Scores

by on May 4, 2010 · 12 comments

I’m recuperating today after wrist surgery #2 but I just had to say something about a hugely important proposal introduced today that would bring us one step closer to information socialism. No, I’m not talking about the discussion draft privacy bill released today by Reps. Boucher & Stearns (which Adam and I already commented on here) but about the amendment introduced today by Sen. Udall that would “require credit-rating agencies to divulge credit scores, free of charge, to consumers when they access their free annual credit report.”

Actually, there is an important analogy between the two bills: both will have populist appeal because they can claim to giving consumers a “right” to “their” information—but both would impose real costs that will ultimately be borne by consumers. On the privacy side, Adam Thierer and I have warned repeatedly that data collection is critical to the online advertising that supports the publishers of the Internet’s cornucopia of content and services. Everyone takes this for granted but few of us really think about the quid pro quo at work: users receive “free” content and services in exchange for seeing advertising and sharing data about their browsing habits, which makes advertising more relevant to them, more effective for advertisers, and therefore more profitable for publishers.

Unfortunately, a similar free lunch mentality is at work with credit scores. If we think about them at all, most of us probably resent and/or fear them. Yet credit scores, and the entire credit reporting system, are truly one of the wonders of information capitalism and a boon for consumers. Before they developed, lending decisions were far riskier because lenders didn’t really know whom to trust with their money. Thus they had to build in a risk premium into their interest rates to account for the fact that some users might default or fall behind on payments. This punished good borrowers and rewarded bad ones. Getting a loan was difficult, often required special connections, and was often arbitrary and thus sometimes downright discriminatory.

This situation was bad for everyone. While nobody likes being in debt, we often forget how radically empowering credit can be in allowing us to expand our opportunities in life. For example, Startup Nation cites Small Business Administration data that “more than three out of five small enterprises will borrow to start or grow their ventures, frequently using credit cards, home equity loans and loans from friends and family to get started.”

The great Peruvian economist Hernando de Soto explained in his masterpiece The Mystery of Capital, that the lack of clear land titles is a key reason why so much of the developing world stays mired in abject poverty–denying the poor access to credit by preventing them from using the one asset they have (the piece of land they live on, however modest) to secure loans and thus lower the risk to potential creditors of lending to them. That’s the extreme example of a dysfunctional credit market and its calamitous consequences. But it illustrates the broader point, and credit scores aren’t so very different: They offer a single, objective measure of how credit-worthy someone is and allow those without the assets needed to secure loans (think why your car and home loan interest rates are so low!) at far lower interest rates than they could obtain if they had to try to essentially “interview” for loans in the way we interview for jobs.

This is all made possible by the collection of data about our borrowing habits. While many “privacy advocates” dread the idea of anyone having “digital dossiers” about us, those files can create great value for us, allowing lenders to vet us instantaneously and cheaply. Similarly, but without the need to personally identify us, such “dossiers” allow publishers to show us ads we’re likely to find relevant, increasing the ad revenues they need to keep the gravy train rolling for us all.

But what about the gravy train of easy, fast, objective and cheap credit? Like everything else in life, there is no free lunchsomeone has to pay for everything. With online content and services, that someone is generally advertisers eager to compete for your patronage. But with the credit system, things are more complicated.

Credit Scores & Reports

The credit reporting agencies (CRAs)—mainly ExperianTransUnion, and Equifax—aggregate the raw material of payments, balances, account info, etc. that make up credit reports. Under the Fair and Accurate Credit Transactions Act of 2003, CRAs are required to give consumers one free credit report annually but may charge a “fair and reasonable fee, as determined by the [Federal Trade] Commission” when a consumer requests their credit score. The CRAs didn’t challenge the credit report disclosure requirement even though it cut into their revenue because there was, and remains, a strong argument that consumers have a right to know the objective facts in their reports (missed payments, etc.) so they could play an active part in correcting errors in their data. (It’s a common anti-capitalist canard that lenders just want an excuse,  any excuse, to charge higher interest rates. In fact, they want the most accurate assessment possible so they can charge the right “price” for their product. As with any market, over-charging doesn’t necessarily increase revenue because of the interplay of supply and demand.)

While credit report giveaways help ensure the health of the credit system, credit scores are a very different matter. While reports are costly to produce and maintain, they are essentially data and copyright doesn’t protect pure data. (They’re not just data, given the work involved in producing them, but the CRAs agreed to give them away, so their copyrightability isn’t at issue.) The issue raised by Sen. Udall’s proposal isn’t really about copyright but the basic approach of copyright is relevant: When someone  transforms raw data into something useful, like a credit score, government generally protects that.

Unfortunately, Sen. Udall would essentially socialize this profoundly important and socially beneficial data service, taking the intellectual property of companies that expend huge resources not just collecting and verifying data, but also honing the effectiveness of the elaborate algorithm they use to transform that raw data into a piece of information that allows us all to take advantage of the miracle of credit at prices commensurate with the risk of lending to us. (The FCRA defines a credit score as “a numerical value or a categorization derived from a statistical tool or modeling system used by a person who makes or arranges a loan to predict the likelihood of certain credit behaviors, including default.”)

The supposed problem isn’t that these scores cost too much, but that they cost anything at all. The FTC concluded in 2004 that there was “an extensive and dynamic market for credit score products” and that stand-alone scores ranged in cost from “approximately $5 to $8.13″ where available. Why shouldn’t credit reporting agencies be allowed to charge for these at all?

This “What’s Yours is Mine” attitude is deeply antithetical to America’s capitalist tradition. It destroys the fruits of capitalism and corrupts the ethic of private property with an infectious, avaricious spirit of entitlement. If I have a right to the product of your algorithm, you’ll have to find some other way to pay for it–or service will inevitably suffer. Money doesn’t grow on trees, and neither do credit scores! Again, we’re not talking here about companies hiding data from consumers or even about their charging “unreasonable” prices for it. The principle at stake is whether the government should compel private companies to give away their products for free. Where else will that pernicious principle lead? What other information products will be someday be socialized citing this precedent? This is a grave question for the future of our digital economy.  As digital age guru George Gilder taught us, “privatizing the risks and socializing the rewards” is a sure-fire investment and innovation killer.

Practical Problems

What’s particularly puzzling about this proposal is that it presumes that the credit scores generated by the credit bureaus are the all-powerful, static and universal numbers that rule our financial lives. In fact, many lenders use the credit bureaus’ credit reports to generate their own credit scores using formulae customized to the risk issues particular to the circumstance. If the goal were to increase transparency in lending, it might make more sense for lenders to disclose to potential borrowers the score (or corresponding percentile) upon which a lending decision was based when notifying the credit applicant of their lending decision. Of course requiring this would raise its own tough questions, but at least it could be said that lenders are in the business of making loans rather than, like the credit bureaus, offering credit scoring.

The reason this would make more sense is that getting your credit score once a year along with your free credit report doesn’t tell you nearly as much as you might think; indeed, it might breed a false confidence—or alarm. Credit scores aren’t like property tax assessments, fixed every year and simple. Instead, they are highly variable, depending heavily on recent behavior to predict likely future behavior. You might think it unfair that your high score can plummet suddenly because you miss a credit card payment, say, but how is a lender to distinguish between an innocent error and real financial distress? If you can’t keep up with your bills, you’re a credit risk, and trying to suppress that information only makes the credit system work less well for everyone in terms of higher credit costs.

Again, consumers need to take responsibility for themselves if our miraculous credit system is going to continue to allow us all convenience and flexibility in our consumption, while also fueling countless start-ups and small-scale entrepreneurs. The Internet would be a very different place if an entrepreneur couldn’t use a good credit score to borrow the money needed to give their best shot at a clever business idea—and so would Wall Street and every Main Street in America.

The “Financial Reform” Christmas Tree

And speaking of Wall Street, it’s worth noting the great opportunity for legislative mischief created by the push for sweeping “financial reform.” Udall proposed to hang this amendment on the sprawling legislation currently under fierce debate in the Senate. Since most Senators are focused on the broader future of our financial system, “Too Big to Fail,” bank break-ups, and bank bail-outs, it’s not surprising that so little thought is being given to the implications of socializing a small but critical piece of that system for the rest of that system or for non-financial products.

As I’ve noted (herehere and at this PFF briefing), the “Wall Street Overhaul” bill passed by the house in December would “put the FTC on steroids,” in the words of Jim Miller, FTC Chairman from 1981 to 1985. With vastly expanded powers, the FTC could impose sweeping new regulation touching virtually every sector of our economy. While those powers probably wouldn’t extend to compelling giveaways of products and services as Udall’s amendment would do, I shudder to think what the regulatory environment of the future will look like if both go through.

I worry even more about the policymaking process that allows such radical ideas to go be tacked on as extra ornaments on a huge “Christmas Tree” of a bill that no one really has time to think through. If “Too Big to Fail” leads to “Too big to Read,” we may all suffer. As John Steele Gordon noted yesterday in Commentary:

Roscoe Conkling, senator and Republican political boss of New York State in the 1870s and 1880s, once remarked that “when Dr. Johnson said that ‘patriotism is the last refuge of a scoundrel,’ he was obviously unaware of the possibilities inherent in the word ‘reform.’”

A Final Note About Privacy

I end, several Percocets later, where I began: noting the analogies of the fights over credit scores to the debates over advertising and privacy. It’s nearly impossible to separate any discussion of the credit bureaus from the intense hatred directed at them by some self-appointed “privacy advocates.” That’s exactly the kind of motive that could drive efforts to cripple those companies by any means necessary. But it’s worth pointing out the irony here: Credit scores significantly enhance our privacy by serving as a trusted, objective metric that substitutes for the vast amount of data we might otherwise have to share about our finances every time we applied for a loan.

Rather than attacking it, policymakers should be celebrating the beauties of our modern, evolving credit system.

  • Brett Glass

    I am the author of my life; therefore, I own my credit score.

  • Ryan Radia

    Information that happens to be about you isn't necessarily yours. Your credit score is determined by using information you've disclosed to third parties, generally in exchange for financial services. If you don't want credit bureaus to have any information about your credit history, don't use credit cards or borrow money from financial institutions. Or, take out loans anonymously. Oh wait, that's illegal under the Bank Secrecy Act. Never mind.

  • Jardinero1

    In the mortgage industry, over reliance on credit scores at the expense of other underwriting factors was one of the key reasons for the real estate boom and bust. In the credit card industry, over reliance on credit scores at the expense of other underwriting factors is leading to default rates of ten to fifteen percent. This will lead to the inevitable collapse of credit card lending as we know it. So while credit scores were an interesting experiment which helped to contrbute to the crack up boom; they are truly not one of the vaunted “wonders of information capitalism and a boon for consumers. Before they developed, lending decisions were far riskier because lenders didn’t really know whom to trust with their money.' It would seem that lenders still really don't know whom to trust with their money.

  • http://srynas.blogspot.com/ Steve R.

    In support of Brett, the companies use your personal information to establish your credit score (worthiness). This information is then used by others as a tool to evaluate whether they want to do business with you or not. As such, how the credit score is determined should be transparent to that person. What happens if the credit information is blatantly wrong or even purposely manipulated to malign a persons credit score?

    True, if you don't want the credit bureaus to have any information, make every transaction a cash transaction. But then it gets a bit difficult hauling around bars of gold!

    We live in a world where a certain degree of personal information has to be disclosed as part of a business transaction. The question then becomes by what right can a company then claim “ownership” of ones data? I say they have no bases for asserting ownership.

    Here is my typical bad analogy example. When you buy content these days, such as a CD the companies assert that you don't own the content but are merely leasing it. Well, by that logic, when you disclose your personal data, you are merely leasing it to the company for purposes of that one transaction. So, every time they use that data you should be entitled to a royalty.

    Obviously my example is ludicrous for I believe that when you buy content, such as a CD, you own the content. When a company acquires personal data I acknowledge that they have a limited right to use it, but you should have a fundamental “right” to inspect your information for accuracy. (How your credit score is determined could be considered proprietary.)

  • http://techliberation.com/author/berinszoka/ Berin Szoka

    Steve, I think you're confusing reports and scores, As I stressed, reports are already free and should be for just the reason you mention: we all need the opportunity to review and correct them. But scores are completely different.

  • http://techliberation.com/author/berinszoka/ Berin Szoka

    Of course scores aren't perfect predictors. But what would you prefer?

  • http://techliberation.com/author/berinszoka/ Berin Szoka

    No, you might well have a right to your report (objective facts about you), but not your score (the fruits of a complex model based on those facts).

  • http://srynas.blogspot.com/ Steve R.

    My apologies. The scores can be considered proprietary.

  • Ryan Radia

    Given the screwed up FCRA regime that exists in the US today, perhaps it's reasonable to require credit information bureaus to make credit reports available to people for free. But in a world in which today's messy patchwork of onerous financial regulations didn't exist, I'd tend to oppose any credit report disclosure mandates. From a libertarian perspective, why should you have a right to access information about you if it's been legitimately collected with your knowledge via a transaction in which you participated voluntarily?

  • cryptozoologist

    while my own credit is fine and i have never had any (serious) problems with the reporting, a very good friend of mine has had his credit score destroyed by the actions of his ex-wife. mind you these are things that happened after their divorce. he has spent much time and energy trying to correct these bogus numbers that have a real effect on his life. should he have to pay $5-$8 every time he needs to check if an error (and there have been many) has been corrected? multiply this times 3 agencies and it adds up.

    and by the way, this quote is a jaw dropper: “(It’s a common anti-capitalist canard that lenders just want an excuse, any excuse, to charge higher interest rates. In fact, they want the most accurate assessment possible so they can charge the right “price” for their product. As with any market, over-charging doesn’t necessarily increase revenue because of the interplay of supply and demand.)” are you suggesting these lenders are breaching their fiduciary responsibility to their share holders by not trying to charge as much as they can? that would be anti-capitalist.

  • Jardinero1

    The last three years have shown that credit scores show no positive or inverse correlation to the likelihood of default. Lots of borrowers with high credit scores are going into default and foreclosure and lots of borrowers with bad credit are still paying. Those who went into default did so because underwriters failed to pay attention to more fundamental factors such as income, strength of collateral, loan to equity, character of the borrower, age of the borrower, marital status of the borrower, job history of the borrower, et al. On unsecured debt, traditional underwriting factors are even more important since there is n no collateral.

    Credit scores should modify the terms on a loan already approved using traditional underwriting factors, not determine what the terms are. In the last 15 years credit scores have driven the terms on a loan and become the single most important underwriting factor.

    On real estate transactions originators could call and check or write and check every part of an applicants application. Until 18 months ago, that hadn't been done on the vast majority of mortgages since the mid nineties. Not as many deals would get done, but each deal would be less likely to blow up.

    I know of two separate one-and-a half-million dollar home loans, in 2005, that were approved for an applicant who had no income and presented faux 1040s which created the impression of income. But he had a high credit score. The applicant was caught after both loans had closed and someone bearing a grudge blew the whistle on the applicant. The originator(at one of the TBTF Banks) didn't even bother to verify the sources of income.

  • Jardinero1

    The last three years have shown that credit scores show no positive or inverse correlation to the likelihood of default. Lots of borrowers with high credit scores are going into default and foreclosure and lots of borrowers with bad credit are still paying. Those who went into default did so because underwriters failed to pay attention to more fundamental factors such as income, strength of collateral, loan to equity, character of the borrower, age of the borrower, marital status of the borrower, job history of the borrower, et al. On unsecured debt, traditional underwriting factors are even more important since there is n no collateral.

    Credit scores should modify the terms on a loan already approved using traditional underwriting factors, not determine what the terms are. In the last 15 years credit scores have driven the terms on a loan and become the single most important underwriting factor.

    On real estate transactions originators could call and check or write and check every part of an applicants application. Until 18 months ago, that hadn't been done on the vast majority of mortgages since the mid nineties. Not as many deals would get done, but each deal would be less likely to blow up.

    I know of two separate one-and-a half-million dollar home loans, in 2005, that were approved for an applicant who had no income and presented faux 1040s which created the impression of income. But he had a high credit score. The applicant was caught after both loans had closed and someone bearing a grudge blew the whistle on the applicant. The originator(at one of the TBTF Banks) didn't even bother to verify the sources of income.

Previous post:

Next post: