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The Globalization of Consumer Credit

Module by: Ed DeShields. E-mail the author

Summary: Each day, billions of consumer credit records are collected, stored and reported. Sophisticated credit scoring models determine to what degree a consumer is allowed to participate in a globalized credit system. Unfortunately, "the watched" are not aware how "those watching" use what the industry quietly collects.

A consumer’s ability to buy and sell is strongly influenced by a new set of rules. Risk-based credit scoring models, with incredible reach and thoroughness, present new challenges for consumers. Some are threatened with elimination from the credit markets. Others, particularly the new immigrants, won't be able to participate.

In fact, millions of consumers will pay more for – or be denied – credit, insurance, rent or utilities because of the growing use of the consumer “Credit Score”. In virtually every household budget a secret sacrifice is being waged on consumers as creditors use the credit score to justify increased fees on the highest level of consumer debt in history. This system of consumer judgement is quick and terribly efficient. The Information Policy Institute called this system "the envy of the world" before the U.S. House Committee on Financial Services, May 8, 2003.

The credit system is a complex process of reporting, scoring and distributing information on consumer credit. The credit system works along side an alarmingly small number of private entities carefully supported by governmental laws. These laws are fiercely protective of these collection and scoring systems because without them consumer spending might be threatened. Governments must protect and promote the extension of credit and ensure its spending economies have accuracy and widespread availability. The process is designed to remove risk from the credit system. The risk, however, are consumers that make up the system itself.

In 1946, outstanding U.S. consumer credit was $55 billion. By 1970 it had reached $556 billion, a ten-fold increase. Today outstanding consumer credit stands at $7 trillion. Alan Greenspan, in a speech to the U.S. Congress in 2003 stated that "unless we have some major sophisticated system of credit evaluation continuously updated, we will have very great difficulty in maintaining the level of consumer credit currently available because clearly, without the information that comes from various credit bureaus and other sources, lenders would have to impose an additional risk premium..."

Even without this uncertainty, risk premiums are not retracting but dramatically expanding. The risk premium infrastructure is created, in part, by the Fair Credit Reporting Act or its equivalent internationally. The credit score has created a system that lenders can use to exploit its algorithmic power to model debt data. This gives them the ability to squeeze more profits from their debt portfolios. For evidence of this, one has to look no further than the dramatic rise in sub-prime mortgage notes, or stratospheric interest rates in the credit card industry as premiums for auto and home policy rates soar. Even the utility industry has discovered risk-based pricing. In some states, including Texas, the credit score allows utilities to justify increased rates on low-score energy users.

However, governments have a responsibility to protect the consumer. Through a series of consumer protection statutes, in countries around the world, new laws are tightening up the loopholes in the credit system. Many of these changes focus on who has a permissible purpose to view the reputation of a consumer and how is the data being used in the name of privacy. Despite the public good of protecting the consumer, it is the consumer reporting and scoring system government aims to most protect.

Contrary to popular belief, the credit reporting system is not a consumer-purposed instrument. Its customers are the firms to whom it sells its data. The raw material used to manufacture its database is voluntarily provided to it by a creditor community, that in turn, continually re-purchases its data on consumer reputations. Therefore, the consumer is not a direct party to this complex transaction. He is merely the judged.

As the world’s major credit bureaus quickly proliferate into a worldwide network of consumer spending habits, the consumer is mostly unaware of what how these data bureaus work. Credit data is voluntarily reported. Typically, creditors in the U.S. report both positive data (white data) and negative data (black data), such as delinquencies and collection accounts. In reality, the exact balance of this reporting is unknown. This contrasts with practices in some other countries where only black data is reported. However, in the interest of protecting privacy, some countries continue to ban the reporting of white data such as account balance and credit limit on accounts that are not delinquent. For example, Australia’s Commonwealth Privacy Act allows reporting of only "black" information about borrowers, plus inquiries from potential creditors. This is common in other countries, including the U.S., where the collection industry buys and sells the same debt account many times -- each time reporting only black data -- under a variety of different creditor names.

It has been estimated that over 75% of all credit decisions are based on the credit score produced by an American company, Fair Isaac Company. Their credit score, known as the FICO score, has a monopoly on the formula that controls the majority of lending decisions. The FICO Score, and variations of it developed for the major credit bureaus, is sold through the major worldwide credit bureaus. It has few meaningful competitors and vehemently protects its franchise. Since it is a privately-held company, it is largely immune to suggestions that it should reveal how its score grades customers because intellecutual property laws properly protect its trade secrets. Moreover, a developing nation government is unlikely to force the hand of these private enterprises, as they must protect the credit system's continued proliferation and technology thereby protecting its own consumer spending economy. The maintenance of consumer spending, a government's private economic engine, is consequently becoming a function of a small group of private companies themselves protected by the need for privacy and the lack of transparency. Interestingly, it has created an industry of practitioners that use the secretcy of the scores' formulary to promote their own personal belief that they seem to understand what makes a FICO score go up, or down. This industry, called the credit repair industry, has overwhelmed the consumer with fraud and mis-information.

Unfortunately for consumers, the credit scoring method is a well-guarded secret. Not even the lender that denies you credit can tell you exactly why you have been given your particular score. There are companies who have developed credit scores and readily reveal how they work. One such company is Community Empower who works with consumers to provide credit education. Without a definitive knowledge of how a scoring models works, credit education is impossible. Tragically, credit-challenged consumers, who are often the less sophisticated consumers, increasingly find themselves without hope of ever understanding how to outrun the efficiencies of the modern credit system.

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