FICO Gets Creative With Credit Scores to Facilitate Getting More Americans in Debt

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Normally, I would relegate this item to a snarky long comment in Links, but this development is sufficiently appalling, while being perversely predictable, so as to merit special attention. From the Wall Street Journal:

Fair Isaac Corp. creator of the widely used FICO credit score, plans to roll out a new scoring system in early 2019 that factors in how consumers manage the cash in their checking, savings and money-market accounts. It is among the biggest shifts for credit reporting and the FICO scoring system, the bedrock of most consumer-lending decisions in the U.S. since the 1990s.

The UltraFICO Score, as it is called, isn’t meant to weed out applicants. Rather, it is designed to boost the number of approvals for credit cards, personal loans and other debt by taking into account a borrower’s history of cash transactions, which could indicate how likely they are to repay….

This is occurring at the same time the consumer-credit market appears relatively healthy. Unemployment is low and consumer loan balances—including for credit cards, auto loans and personal loans—are at record highs, and lenders are looking for ways to keep expanding loan volume.

Before we go further, you need to understand what this is about. Banks sell a substantial majority of the consumer loans their originate, typically via securitization. Investors use FICO heavily in evaluating these risks. So the FICO move is to enable banks to make more consumer loans by putting its Good Housekeeping Seal of Approval on them so banks can hawk them to investors.

Oh, and they’ve been testing this new fancy model in a super long, albeit not terribly robust expansion. So one also has to wonder how well they stress tested it. Back to the Journal:

The UltraFICO score will function as an appeal of sorts, likely boosting many applicants with less-than-ideal records. If an applicant’s traditional FICO score falls short, a lender can offer to have the score recalculated to reflect banking activity….

Applicants will be able to choose which accounts they want considered when the score is recalculated….

FICO said about seven million applicants who have low credit scores as a result of thin borrowing histories would likely see their scores improve under the new system. Separately, some 26 million subprime borrowers will end up with higher credit scores, FICO said, with nearly four million seeing an increase of at least 20 points.

Consumers with an average balance of at least $400 who haven’t overdrawn in the prior three months would likely get a boost, FICO said.

$400 and no overdraft in three months??? So the target is people at or barely above the going from paycheck to paycheck level. Help me. And help them.

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  1. skippy

    Recently someone was talking about the Chinese social credit score and I responded with what did they think about FICO.

    1. Enquiring Mind

      Social and financial credit scores to me mean giving up more of one’s identity and self-determination to some vaguely defined and fickle ‘groups’. Those scare quotes don’t quite capture the revulsion that I feel at the whole process. Too much Existential Lit in college, I guess.

      Back in the day, I had to watch out for companies probing my demand curve. Then they got more sophisticated with all of the Economic Value Added (or Subtracted!) while folks got reengineered. The new kids arrived to show how to get people to make themselves the product and to volunteer all the labor and network information donation. In the end, I will be fortunate to retain zero Consumer Surplus. Somewhere, someone is combining the scores to develop ways to monetize further some Consumer Deficit. Oh, joy.

      1. skippy

        “Existential Lit in college”

        Yeah good old demand education [tm] seems to have done a Temple Grandin on that worrisome administrative concern.

      2. ChristopherJ

        Yes, EM and Skip. I think the chinee are throwing a bit more at it; this new UntraFico is just an improved method to help the banks price discriminate even more than they do already.

        btw next time you buy something on line, do it from somewhere you haven’t done it before. Those AIs know an awful lot about your phone and your other methods of going on line… what you’ve done in the past and what they know about you gives them a perfect look at your demand curve and how much you are prepared to pay. That’s why they would prefer you to log on before they display the prices…

        Saves me heaps every time I buy anything – even ebay’s doing it

        Price discrimination should be illegal

  2. Alex

    How did FICO end up being *the* score in the US? In other places I’m familiar with like the UK and Russia nearly every lender uses its own scores. Is the difference due to securitisation which made everyone use the same model in the US and which is less prevalent elsewhere?..

    1. Clive

      Not really. Individual lenders add their own risk tolerance and customer insights to the basic FICO to try to get a little better at pricing to risk than the competition. But FICO is always the foundation, certainly in the UK. And for new to brand, all you’ve got to go on is the FICO, you’ve no particular knowledge of how a customer is going to manage their account because you’ve not provided them (yet) with an account to manage. I can’t speak for Russia, this would be an entirely different market and setup.

      Ironically, this whole crappy-FICO is an unintended consequence of the industry and regulatory harrumphing trying to get more borrowers into the tender ministrations of the so-called mainstream lenders, rather than leaving them with no option but to use payday loans or check cashing. Once you fall off the end of the prime cliff edge (usually somewhere between a 600 to 700 FICO, depending on the lender) the complaint of the lenders was that there’s insufficient granularity in the sub-prime FICO to try to tell who is currently sub-prime but might be a potential to move into prime (such as they’ve gone through, say, a divorce, trashed their credit, but have a good income and are getting back on their feet, financially) versus who is a no-hoper (only social security income or highly irregular income and big, fixed, outgoings).

      But the snag with this is, it all assumes people’s lives are all nicely linear and predictable. A medical co-pay sideswipe, home maintenance costs, auto repairs, a tax hit if you’re self-employed, a family expense if an elderly relative falls ill — these can come out of nowhere for anyone and your “getting better” trajectory is revealed for the precarious phantom it always was.

      Even taking a suggestion that someone is currently sub-prime but potentially able to step into the prime limelight again makes an assumption that is based on them not suddenly being saddled with a new debt burden. Fundamental affordability will always be a bigger factor than some notional “net free cash per month” calculation. Rebuilding creditworthiness is about giving yourself a financial cushion (building up savings equivalent to 6 month’s outgoings, reducing your gearing such as by paying off a car loan then keeping the car so you only have maintenance and fuel to worry about which are variable costs to a degree rather than a loan payment which you have to make on time, stopping all the rubbish payments which grow like topsy when you’re not paying attention such as ratcheting cable and movie service subscriptions, the never-ending mobile phone upgrade cycle you don’t know how you got into, junk fees and insurance that seem to appear out of nowhere), not about playing some stupid numbers game with your FICO score.

    2. Yves Smith Post author

      Due to the hour, I didn’t go into the reason its use was promoted, but it is all about creating tradeable consumer loan securitizations. See this abstract of an article by professor Amar Bhide, admittedly written in econspeak:

      Why does the securitization of residential mortgages, credit cards, auto loans, and other such consumer debt in the U.S. exceed the securitization of such debt in Europe by several trillion dollars? The author points out that lemon problems do not stop the sale of used cars but they do prevent the operation of a market in which buyers place sight‐unseen bids for used cars offered by unknown sellers. Buyers prefer to know who the seller is and test‐drive vehicles. Similarly until the 1980s, creditors were willing to forgo the information they could secure in private transactions to get tradability mainly in the case of bonds issued by governments or a few blue‐chip companies. U.S. government policy encouraged the securitization of trillions of dollars of loans made to millions of borrowers. U.S. rules—rather than new financial or information technologies—have strongly encouraged originators of mortgages and other consumer loans to rely on credit scores (commonly referred to as FICO scores) produced by credit bureaus. And reliance on scores that loan originators use but don’t produce helps overcome the information asymmetry problems that would otherwise constrain securitization. The argument turns the usual concern about securitization on its head: transferring risks to investors is normally expected to discourage careful screening of borrowers, but the author’s analysis suggests that formulaic, FICO‐based screening actually enables risk transfer by reducing information asymmetry problems. Moreover, while limiting screening reduces the upfront costs of lending, it also increases loans made to uncreditworthy borrowers. And because increasing loans made to bad borrowers raises the rates good borrowers have to pay (to compensate investors for higher defaults), U.S. rules that sacrifice information for more “complete” markets may be a bad bargain.

      My recap of a more layperson-friendly paper that Bhide wrote (embedded in the post)

      Bhide describes the consequences of bank regulators, as well as Fannie and Freddie, promoting the use of FICO scores, as opposed to other hard and soft forms of analysis that banks had used traditionally to make consumer loans. Not only do you have the loss of information that would help reduce loan losses (local knowledge of how the outlook for his employer and the local economy) but more homogeneity of approaches, which creates the possibility of everyone replicating the same mistakes, like assuming a national decline in housing prices was impossible. And as he explains, one of the big costs has been the near-death of small business lending, when small businesses are the drivers of job growth.

      1. flora

        This bears repeating:
        Bhide describes the consequences of bank regulators, as well as Fannie and Freddie, promoting the use of FICO scores, as opposed to other hard and soft forms of analysis that banks had used traditionally to make consumer loans. Not only do you have the loss of information that would help reduce loan losses (local knowledge of how the outlook for his employer and the local economy) but more homogeneity of approaches, which creates the possibility of everyone replicating the same mistakes, like assuming a national decline in housing prices was impossible. And as he explains, one of the big costs has been the near-death of small business lending, when small businesses are the drivers of job growth.

        And, I’ll add, the loss of thousands of small local banks in the US since 1990, where local knowledge was strong and traditional underwriting was carefully practiced, especially for small business loans.

  3. Larry

    What fantastic innovation in the private sector. Thankfully there is never a downside to this wondrous thinking that must be picked up at the expense of the public.

  4. Dogstar

    Will the fact that I haven’t made a student loan payment in 6 years still negatively affect my credit?

    A good way to attempt living outside the credit system is to move to a small town. Lots of trade and off-the-books opportunities. When you remove the anonymization of big cities, people start to become people and seem more willing to extend a hand to help you up. By the same token, you aren’t getting away with being an a-hole in your day-to-day behavior.
    Big cities are “by-the-books” corporate. Small towns lean more toward “we’ll figure something out”.

    1. perpetualWAR

      Yep. I moved to a relatively small town. Because I fought foreclosure for 10 yrs, no opportunity to obtain a bank loan again. But, simply because the former owner of my home knew my friend, they entered into a owner-financing situation with me so I was able to become a homeowner again. Here, it’s all who you know.

    2. jefemt

      Small-town realities… Another reality with securitization of debts is there is no one noteholder to talk with or to negotiate with — whether it is late payments, or the other end –buying the note at a discount, negotiating a re-write. Local small town bank, in-house lending— pretty old-school, but it has some merits. Think “It’s a wonderful life” when Jimmy Stewart explains local banking to the rabble during the bank run.

      In the case of default/ loan issue, the small town bank eats it and resolves it locally— in securitization, the entire collective we eats it, including dear Aunt Minnie’s retirement account– thus the rationalization that the collective ‘we’ must bail out the ‘ lender’ — who in reality is long gone, made their dough on the transaction, possibly the servicing. Three card Monty.

    3. Clive


      “Will the fact that I haven’t made a student loan payment in 6 years still negatively affect my credit?”

      Clive’s A: Yes.

      Unfortunately. It’s not as bad as a default (and there’s no concept in student loans as a “missed / late payment”). But it’s probably costing you between 10 and 50 FICO points because a) it shows you’re on an income which isn’t at a level where the student loan gets a declining balance and the amount of time this continues for is a good indicator for your eventual earnings potential and b) the presence of a student loan means in any bankruptcy or debt management plan all the other creditors are automatically shunted one step down the line as they are lower in the pecking order than the student loan so even if you then have some realisable assets and income the stundent loan gets first refusal on these (obviously once your income goes above the repayment threshold).

      It also doesn’t allow a potential lender to see how consistent — or spotty — you are at adhering to a repayment schedule, so you don’t get potential FICO points for being “best boy (or girl) in the class”.

      Yes, it does stink.

      1. ChristopherJ

        Good on you, Dogstar. Student loan is the killer though as it will follow you your entire life and possibly after death.

        I’ve got kids that have borrowed and didn’t take my advice, so there you go.

        Yes, you can evade your creditors, but you need to move cities, change your phone, your bank, never contact the government and so on – become invisible, virtually offline and offgrid.

        You can do that in a small town and, in Australia, if you can avoid contacting your lenders for 7 years, time runs out for them to sue you for not repaying the loans. Usually, the lender offloads non-performing loans to debt collectors for cents in the dollar and these companies, who are very skilled at finding you, will pursue the whole amount and interest.

        However, if the debt is student, you need to move countries. Is same here in Australia. I got my Economics degree for virtually nothing except student union fees (early 80s).

        And then some idiot suggested that, as a college degree conferred some earning increase on graduates, then the new ‘user pays’ principle ought to apply. (That new econo speak – purchaser provider, privatisation, new and better ways of doing things. Many of us fell for the meme…)

        Now, the very idea that there is a huge element of public good associated with an educated population; well that linkage is just about lost in history

  5. Michael Olenick

    Credit reporting has a whacked history. It started with religious fanatic Lewis Tappan and his band of busybodies who would secretly stake out brothels and gambling houses in NYC in the early 1800’s. The Tappan brothers made their money with a store. To their credit they went from fervently busting hookers to fervently opposing slavery and became violent abolitionists. This didn’t sit well with their southern customers (and plenty of northern one’s) who organized a boycott. In response, they started selling on credit which was something at odds with their religious background but the lesser of two evils.

    A recession caused a lot of customers to default and bankrupted the Tappan brothers. They started to rebuild but still needed to extend credit. They knew, from their earlier work, that some customers were more likely to pay than others. How to sort them out? They returned to their busybody roots and enlisted a national series of “reporters” – basically, spies – who would send in reports about people and businesses that touched on morality as much as anything else; the Chinese model. One of their early reporters was Abe Lincoln, while he was still a lawyer. This system built larger and larger.

    Tappan sold the business to his manager, Benjamin Douglas, who was a pro-slavery Southener; money won out over their opposition to slavery. Douglas eventually handed the business to his son-in-law, Robert Graham Dun. Dun Had published a report on using statistics rather than morals to make credit decisions. After defending and losing a bunch of libel suits Dun merged the firm with its largest competitor run by John Bradstreet, who had a system less prone to libel suits. The company was renamed Dun & Bradstreet. So you’re not imagining it: the genesis of credit reporting really is moralistic hypocritical busybodies.

  6. JW

    OK, please don’t get mad but a little pushback here: what if this is an anti-homelessness initiative?

    The problem is, FICO is widely misused by landlords to screen tenants, so people are made homeless by FICO. If FICO makes itself meaningless surely it would help these individuals?

    1. Clive

      Unfortunately that is like trying to ban rainy days. Going back to the middle ages, society has had an unavoidable need to identify who is a good risk for credit and who isn’t. Letters of Credit, references, “introductions” (just read pretty much any historical novel and these will crop up, sometimes incidentally, sometimes they are essential to the plot) are just some of the pre-FICO FICO equivalents and I can’t say that I find these any better a solution. If you have the concept of extending credit, you have a record of how the borrower performed. Even if you don’t aggregate various sources of information into a notional “score”, these are still matters of public record (mortgage amounts in the county records office against titles, default judgments from court proceedings, bankruptcies, divorces — no-one could or should suggest these matters be kept sealed as a matter of a routine).

      What you’re effectively describing is better controls on who can collate credit scores and how they should be available in terms of what is, as a concept, your own personal data. Plus how they should be used — or not used. Personally, I think it is outragous that a FICO should be used as any part of a job hire.

      In terms of housing, you could legislate that anyone who has more than 5 housing units must make three of them available at “market” pricing, one of them must be “stabilised” rent and one must be a social or “conrolled” rent and bar the use of credit scoring for assessing who rents the asset for the latter two. That way, there’s always a percentage of the necessarily fixed housing stock available regardless of your FICO. Or, horror of horrors, the state could build high quality public housing and offer it at controlled rents to anyone who needs it (say on less than 150% of the federal poverty line). But that’s socialism, isn’t it? Which we can put in the “not here, we don’t” box…

      1. JW

        Clive, thank you for your thoughtful response.

        I agree with all your points, but my point is that FICO was never designed to be used for tenancy and studies have shown that it does a poor job of predicting the risk of nonpayment/late payment of rent. In particular, someone can have a large outstanding debt at low interest with little impact on their ability to pay rent. Landlords use FICO because there is nothing else. Why there is nothing else, I don’t know.

        But factoring in overdraft history might come closer to measuring risk of rent nonpayment or lateness. In reality we need some separate score for renters with some insurance that low scorers can buy to offset their risk, with government assistance in paying for such insurance. I don’t think landlords should have to bear this risk. In fact right now landlords are bearing the risk of a lack of a good system for recording rent delinquency and bad actors. It’s too easy for someone with a good credit history to fake everything else such as references.

        But ours is a nation of homeowners and renters deserve whatever fate befalls them in consequence of their sloth.

  7. Timmy

    Due to identify theft experiences, I’ve been monitoring my credit scores on a month to month basis over the last decade. Recently, I noticed a change. A calendar quirk has a bulge in my spending hitting in late August – auto and home insurance, vacation spending, all of which I put on one of two credit cards. My FICO now drops meaningfully when those credit balances hit because, I presume, they are larger than my normal balances, which I always pay off in full. My point is that my FICO score drops within two weeks of those balances hitting and even before the due date for the monthly cycle. This is a really rapid response time – a veritable hair trigger – that immediately marks my credit score down even when its an calendar anomaly. This is financial surveillance on a literal week-to-week basis. And I’m a good credit.

    1. Arizona Slim

      Another identity theft victim here. I froze my credit with the big three reporting agencies. So far, I’ve had no need to unfreeze it.

      1. Jeremy Grimm

        My ‘identity’ has been ‘leaked’ at least twice that I know by non-other than the DoD. I’ve kept my credit frozen at all three reporting agencies for years. I’m not sure that protects my bank accounts from other attacks and I have little faith that the credit agencies will without fail keep my credit frozen if they have security and careful processes similar to those which seem characteristic of Equifax.

  8. Iguanabowtie

    As an ex-retail banker: this is probably a good thing.
    The banks aren’t going to submerge people with $400 chequing accounts in debt, they’re going to give them the $500 (the minimum amount) visas that they didn’t qualify for before. Some will max them out & be on the hook for 21% interest or more, but more will stop paying the poverty tax of not being able to shop online, rent cars, etc.
    Visa & Mastercard are evil cartels that need to be killed with prejudice, but in the short-term letting the precariat use their basic services is probably justified.

  9. Anonymouse Coward

    This does solve a problem for some people.

    seven million applicants who have low credit scores as a result of thin borrowing histories

    This was me a few years ago. I avoided credit like the plague, on principle. I made good money and had multiple banks accounts with tens of thousands of dollars in each. When I moved to a new city I found I was unable to rent housing due to poor credit (due to a lack of credit history). Having bad credit surprised me, because I made six figures and had savings but no debt.

    To solve my immediate problem, I was lucky enough to have parents willing and able to co-sign my lease — although that was a touch embarrassing for a thirty-something with a good job, savings, and no debt to need to do.

    To solve my long term problem, I got credit cards (which make me feel dirty every time I use them: handing a portion of the vendor’s profits [which is usually a small business] to wall street) and took out an auto loan I didn’t need to establish a credit history.

    Under the new score, it seems, I would have been able to show that my finances were in good order despite a credit history.

    The big lesson, for me, with credit scores (not counting the new way of calculating this article suggests) was that avoiding the big financial institutions on principle has serious consequences, including the denial of housing. The modified scoring system would have allowed me to live by my morals (support small businesses, not wall street / extreme wealth concentration).

    However, the “$400 and no overdraft in three months” shows that the new score isn’t aimed to fix the problem I found myself in, but rather to prey on more low-income people.

    1. JW

      How unfortunate you didn’t have student loans! /snark

      At least they’re a great way to build (and then destroy) a credit history.

    2. Stillfeelinthebern

      Paid off mortgage and auto loan early last year and became debt free. FICO score promptly dropped and has not recovered. Not that I care because being debt free is wonderful.

  10. Jeremy Grimm

    The securitization of debts disturbs me for a different reason related to but peripheral to the FICO redesign. I believe this trend toward securitization of private debt also tends to drive other resales of debt. I suspect vendors in the Education Industrial Complex and the Medical Industrial Complex build-in bumps to the charges they extract in anticipation of immediately selling the debt to a collection agency at some markdown of its face. This practice adds to the vendor’s take from the collection agency purchase of the note and the added collection agency middle-man makes it far harder to contest what are often capricious even fictitious charges. I suppose the new FICO score might stimulate new designs for packaging the debts sold to collection agencies if that isn’t already a practice. The growing uses of the FICO score would add leverage to collection agency attempts to collect.

  11. Sound of the Suburbs

    There was a fatal flaw in the economics of globalisation, it didn’t consider debt.

    The 1920s roared with debt based consumption and speculation until it all tipped over into the debt deflation of the Great Depression.

    No one realised the problems that were building up in the economy as they used an economics that doesn’t look at private debt, neoclassical economics.

    It’s still the same.

    At 25.30 mins you can see the super imposed private debt-to-GDP ratios.

    China, the US, the UK, Japan and the Euro-zone have all done the same thing that they did in the 1920s US.

    The world borrowed money from the future to bring prosperity into today and that economic model has reached the end of the line.

    The last engine of debt fuelled growth, China, has now realised a Minsky moment awaits if they keep doing what they did before.

    Game over.

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