Occupy Wall Street Is Only Half Right About Credit Reform

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A scene from last fall's Occupy Wall Street protests.

Do we really want to take financial advice from a bunch of kids living in tents? Surprisingly, we just might.

Occupy Wall Street’s Alternative Banking Group last month wrote to Consumer Financial Protection Bureau chief Richard Cordray, proposing changes to our nation’s credit scoring system. I agree that the current system is deeply flawed: Who actually likes the idea that a credit bureau can sell our FICO scores to banks while preventing us from finding out what they are?

Even so, the Occupiers’ roadmap to a better system may not be the best solution.

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As you’re likely aware, your credit data not only affects your ability to take out a loan, but also the interest rates and insurance premiums you’ll get, whether or not you’ll need a security deposit when leasing an apartment, your eligibility for certain jobs, and countless other key considerations that have enormous impact on consumers‘ lives.

However, the current system allows the three major credit bureaus (Experian, TransUnion and Equifax) to play favorites with consumer data, ensuring that only themselves and a handful of companies can provide credit-related products and services to consumers. Sometimes, the bureaus simply price out the competition. Other times, they outright withhold data from companies perceived to be competitive threats.

For example, in 2009 Experian stopped making the most popular credit score — the FICO score — accessible to consumers. Why? Because in a credit bureau’s ideal world, there would be no competition in the credit scoring business. Withholding data from FICO and thereby preventing consumers from accessing the FICO score would help devalue its importance and make it easier to supplant with in-house alternatives. Consumers’ understanding of their finances was merely acceptable collateral damage in a quest to dominate the market.

What can be done? As I see it, there are essentially two routes forward from here — in addition to the status quo, of course, which I don’t consider an option.

One possible approach — advocated by Occupy Wall Street – essentially calls for greater transparency. This plan for credit reform is based on the belief that the entire process should be open, equitable, and easily understood. Instead of three separate credit scores, each person should have just one, it says, and everyone should know exactly how it’s calculated. Credit bureaus should also be barred from business practices that promote conflicts of interest and must make sure that their scores are not somehow biased against any consumer group.

All this sounds reasonable on the surface. And I believe OWS is on the right track in drawing attention to both our broken credit system and the troublesome conflicts of interest that dictate credit bureau business practices. Sure, if all banks used the same credit score, it would be exceedingly simple for consumers to determine a) their credit score (of course); b) whether they would get approved for financial products; and c) what interest rates they’d likely be offered.

But the group’s suggestions would lead to other problems. For one thing, such transparency would likely have the unintended consequence of killing inter-bank competition and stagnating innovation in the industry. That’s because underwriting sophistication — the ability to accurately gauge the risk associated with lending money to a potential customer and adjust rates accordingly — is the main differentiating factor between banks. Whoever can most accurately predict consumer risk generally makes the most money. Creating a single “objective” lending criteria would essentially end that competitive endeavor.

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This would lead to a perverse secondary effect: The most financially responsible consumers wouldn’t be able to get the best deals. Why? Well, since no credit score is perfect at predicting the future, a portion of the people identified as highly responsible by any given scoring formula will inevitably default on their obligations. After all, there will always be some people who go bankrupt for unforeseen reasons. With no incentive for the industry to continually refine it’s lending criteria, however, the very best customers would have to be content getting terms capped by a glass ceiling designed to mitigate the risk of their compatriots.

The answer to this, of course, is to maintain the competitive nature of the underwriting business, but at the same time to eliminate the conflicts of interest and require that credit bureaus operate in a manner conducive to meeting the needs of consumers.

That’s easier said than done, you might say. But all the government would need to do is require credit bureaus to sell their data at a uniform price to any company that has customer consent to access it — rather than allow them to withhold it for business reasons and thereby hurt consumers. The companies that, in turn, created the best derivative credit scores would get the most business – both from consumers looking for additional insight into their finances and from banks looking to calculate risk – and we’d be in the midst of a race to the top, rather than a freefall toward the bottom.

Creating such a system would, of course, require some action from the Consumer Financial Protection Bureau. But that’s what the CFPB was created for, right? Credit reform is indeed needed, and an approach focused on increased competition and the elimination of cronyism seems like the best course of action for bringing it about.

Odysseas Papadimitriou is a former senior director at Capital One and is the current CEO of the credit card comparison website Card Hub.

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