Wednesday, September 30, 2009


A recent cover story in USA Today got me thinking. The story (USA Today, September 22, 2009) was about the use, by lenders, of credit scores and how people's scores can be effected by things over which they have no control. In particular how a lender lowering a borrower's credit limit can cause that borrower's credit score to go down.

First, a little refresher. The FICO credit score was created by the Fair Issac Corporation in 1958 as an aid to lenders. The idea is that if you gather together a history of a persons use of credit, their payment history and other like information and then apply a mathematical/statistical analysis to the data, it is possible to predict who will pay back a loan and whole will most likely default. That is, one can predict risk. The resulting "FICO score" is a number in a range from 300 to 850. The higher your score the better. High scores can result in lower interest rates, better loan or credit card terms, or even that you can get credit at all. There are other credit scoring companies in the market place so Fair Issac is not the only game in town. Sounds fairly straight forward, right? Maybe not.

As the article reveals;

...consumer advocates say regulators and Congress need to address lender actions that are unintentionally hurting credit scores. They say that as underwriting standards tighten, even a small change in a credit score could affect what rate consumers get on a loan — if they get one at all. Some analysts also say the fact that consumers’ credit scores can fall even if they’ve never missed a payment or exceeded their credit limits raises questions about the score’s usefulness.
“All these changes are new structural changes in the financial system,” says Leonard Bennett, a Newport News, Va., lawyer who has testified before Congress about credit-reporting issues. “The ability to predict risk and integrate that into a credit score — based on historic data — is logically impossible.”
See, when your credit card company sends you that notice that says your credit limit has been reduced to say, $10.00 more than your current balance, they're just making a sound business decision to protect themselves, and their stockholders, from risk. But wait a minute. Lowering your credit limit means that your Credit Utilization has changed. Credit Utilization is a fancy way of looking at the ratio between the amount of debt you have versus the amount of available credit you have. If you could borrow $1,000 but you only have $100 in outstanding debt then you have a good ratio. If, on the other hand, your balance is $990 then your ratio is not so good. Credit Utilization makes up 35% of your FICO score, so it's not a small factor.

What the credit card companies are doing, then, is changing your debt to credit ratio seemingly without regard to payment history or anything else that you may have done. And that lowers your FICO score. Now another credit card company (we do all have more than one, don't we?) sees that your score has gone down, so they lower the limit on their card (see, they HAVE a reason) and your score gets even lower. Can you say vicious cycle?

Now, all of this has been addressed other places by people with way more financial knowledge then your humble Curmudgeon, but there is one aspect that hasn't been looked at. Why the hell should my or your ability to get credit be in the hands of same faceless corporation that gives out a score that we have basically no control over? And further, should our banks and credit card companies trust these scores?
Tom Quinn, a vice president at Fair Isaac, which created the FICO credit score, says its data show the scoring formula “is working,” because it’s able to rank consumers’ riskiness.That sounds familiar. Isn't that the same thing that was said about the companies that rate investment instruments? I seem to remember (I may be old, but not that old) that last September we heard about AAA rated securities that turned out to be the so called "Toxic Assets."

So let's review. The financial industry
uses the services of rating companies to determine the riskiness of securities using
mathematical/statistical analysis. Those companies get it wrong and a bunch of highly rated paper turns out to be worse than junk which almost causes the world economy to implode. The same financial industry uses rating companies to rate our credit worthiness using mathematical/statistical analysis which can be shown to NOT reflect what we the borrowers do, but which can be manipulated by the said financial industry and we are just supposed to take it and thank them for the privilege of having to beg for our next car loan. Do I have that right? What a world!

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