By Jerri-Lynn Scofield, who has worked as a securities lawyer and a derivatives trader. She is currently writing a book about textile artisans.
The Wall Street Journal ran a story this morning about a problem confronting banks: the COVID-19 pandemic has made it difficult to decide who remains credit-worthy and who not,.‘Flying Blind Into a Credit Storm’: Widespread Deferrals Mean Banks Can’t Tell Who’s Creditworthy
As regular readers know, banks have been profligate in awarding credit before any of us had even heard of COVID-19. But in this game of credit musical chairs, the music has stopped, and an unknown number of chairs have beeen yanked away. The models banks used to allocate credit when the game began can no longer predict who will find a seat. (I leave aside the broader question of whether they ever could do so accurately.)
Over to the WSJ:
Banks have pulled back sharply on lending to U.S. consumers during the coronavirus crisis. One reason: They can’t tell who is creditworthy anymore.
Millions of Americans are out of work and behind on their debts. But, in many cases, the missed payments aren’t reflected in their credit scores, nor are they uniformly recorded on borrowers’ credit reports.
The confusion stems from a provision in the government’s coronavirus stimulus package. The law says lenders that allow borrowers to defer their debt payments can’t report these payments as late to credit-reporting companies. From March 1 through the end of May, Americans deferred debt payments on more than 100 million accounts, according to credit-reporting firm TransUnion, TRU +0.96% a sign of widespread financial distress.
The credit blind spot has further clouded the outlook for lenders. For years, strong consumer spending and borrowing helped propel them to record profits. Now the economy is in shambles, and they are trying to figure out what is going to happen to all of the debt Americans racked up in better times
I know, I know: Cry me a river. The banking industry usually enjoys close control over our Congresscritters. Seems, however, that the COVID-19 pandemic blindsided it – as it has the rest of us.
The real problem here is that banks no longer really know their customers, but have seemingly placed over-reliance on a magical number – or more accurately, algorithm, which calculates one’s credit score.
What’s a banker to do?
Alas, you can be sure thie industry’s solution to the dearth of information isn’t one that will assist most of its customers in these trying times. Per the Journal;
Lenders that are having a tough time spotting risky loan applicants are approving fewer borrowers for credit cards, auto loans and other consumer debt. They are also hunting for new data sets that could indicate who is in financial trouble and how much they need to set aside to cover soured loans. The Federal Reserve last week said the biggest U.S. banks could be saddled with as much as $700 billion in loan losses in a prolonged downturn.
“Without accurate information, their only option is to pull back on credit,” said Michael Abbott, head of banking for North America at consulting firm Accenture PLC. “Banks don’t know who is going to pay and who isn’t. It’s like flying blind into a credit storm.”
Banks started tightening their underwriting standards in March, when the first wave of coronavirus layoffs began.
By early April, 33% of banks that responded to the Federal Reserve’s senior loan officer survey said they had increased their minimum credit-score requirements for credit cards over the previous three months, up from 14% in January. Bank respondents tightened lending standards for all consumer-loan categories tracked by the survey.
Loan originations have fallen, a result both of the tightening and a decline in consumer demand. An estimated 79,000 personal loans were extended in the week ended May 10, compared with 226,000 in the week ended March 22, according to Equifax Inc.EFX -0.24% Auto loan and lease originations fell to 266,000 from 390,000 during the same period. General-purpose credit-card originations totaled 483,000, down from 856,000. In 2019, weekly card originations rarely fell below 1.2 million.
What will be the consequence for the bottom lines of banks? It’s well above my paygrade to analyze the problem, but I can speculate that the answer won’t please borrowers. Only now are banks addressing the latent flaws in their models. accoring to the WSJ:
“Banks are looking very carefully at their underwriting models to see if they need to be adjusted to factor in latent risk,” said Rob Strand, senior economist at the American Bankers Association.
And, just in case you weren’t already completely paranoid about how your smartphone is used by banks to hoover up seemingly innocent data, the Journal mentions:
Lenders are looking for data that will help them figure out which applicants are a safe bet and who’s likely to run into financial trouble.
They are also considering using unemployment data—such as cellphone records that show unemployment office visits and benefit-deposit data—that could help them figure out how to account for future loan losses, according to people familiar with the lenders’ discussions. Some banks are reviewing cash flow in deposit accounts to get a better idea of the risk lurking in their loan books, the people said.
Credit-reporting companies have been in discussions with lenders about additional data sets that could help identify hidden risks. The conversations also involve how to pinpoint applicants who fall short of lenders’ credit-score cutoffs but are likely to pay back their loans.
Fair Isaac Corp., FICO -2.44% the creator of the widely used FICO credit scores, is rolling out an index that will appear next to loan applicants’ scores and inform lenders how likely the applicant is to withstand financial difficulties during the downturn.
“It gives [lenders] that extra filter of how a person is going to handle an economic downturn,” said FICO Chief Executive Will Lansing. “The increase in approvals will be more than the increase in rejections.”
Do you believe that? If you do, there’s a bridge I’d like to sell you that’s located mere miles away from my Brooklyn home.
So let Gates/fintech do it, with social credit scores …
They’ve been doing it for at least 6 years – and that’s when I first heard about them, so it’s likely they had appeared earlier.
The first time I read about reputation scores was in Cory Doctorow’s 2003 Down & Out in the Magic Kingdom (fiction).
Is borrowing our way out of the hole is not on anymore?
Borrowing our way out is still the preferred technique, since it’s the only method we have, but the banks want to have a record of everyone’s assets. In order to make loans they will require that an arm, a leg and a firstborn be added to your list of assets. Your risk is your collateral. Why does the WSJ try to fluff over that fact? With nonsense about howt new algorithms will improve approvals. Right. This is politically correct language to hide the fact that Congress and Treasury made a big mistake when they handed the banks the responsibility to make loans which could be deferred or even forgiven – but they failed to create a chain of deferral and forgiveness that included the banks. It’s haphazard. Because it leaves ultimate risk unaddressed. Who wouldn’t like to know “who can withstand the corona crisis”? The answer is likely to be nobody can survive it financially. Why is Congress playing these games – pretending like the “risks” are “hidden”.
Historians have spoken about how the “company town”, especially in mining, turned out to be more profitable than slavery.
This is the Third Wave of that, where they will burden you with debt and only let you acquire just (tiny probably shared quarters, 1500 calories/day maybe) enough to stay alive to keep serving them. They don’t even have to lay out a physical town or direct what you do.
I don’t know how you write dystopian sci-fi anymore. Sci-fi needs some distance from the current truth to be compelling. The majority also has at least relatively happy endings, which will seem harder to believe than ever.
ambrit says a return to the 1700s, I wonder if that would be wistfully regarded as a preferred option for the plebes..
Congress is full of banker mercenaries, who are robbing the country blind while they are distracted by COVID-19. By the time any American is out of their distressed state they will find the oligarchs have left the scene, exited the US assets they are bag holding, as they did in the latter days of the Soviet Union.
America doesn’t deserve this, but have decided to remain complacent and take freshly printed USD in exchange for their vigilance.
This is personal credit, what about commercial credit? So many small businesses rely on rolling lines of credit to bridge the time delay between operation expense outlays and income that this could be a man made catastrophe. The classic self fulfilling prophecy.
If I have understood what I have read here and elsewhere, modern capitalism relies on credit for it’s large scale “footprint.” What I see as a main result of this is a return to an Eighteenth Century version of capitalism.
We say that we are immune because we are not embroiled in the credit treadmill, but the second order effects will impinge on us.
It looks like Wall St. sold living paycheck-to-paycheck to the masses, then drank their own koolaid. Cirque du Soleil filed for bankruptcy protection today with $900 million in debt… WHAT?! Ho… how!? Sears has been able to limp along for so long due to it’s real estate holding (read: low overheads) and this has caused much head scratching.
I wonder if Private Equity is simply the apex version of this while the rest have blindly followed suit, and now that there’s a, thus far, minor interruption of the flow of capital they all find themselves in hot water.
If only they’d saved for a rainy day…
If only they’d saved for a rainy day… campbeln
Perhaps there are disincentives to saving such as negative real interest rates? Caused by government privileges for private credit creation, aka for “the banks”?
You missed the snark in my comment. But I’d argue that living paycheck-to-paycheck, be it a person or business, is… sub-optimal.
It would sub-optimal in an honest economic system so apparently we don’t have one.
But that should be no surprise to anyone who understands our banking model.
In the UK they are giving 50k 100% government-guaranteed loans to every business that asks, with no creditworthiness checks whatsoever. In addition there is a 80% government-guaranteed program for larger amount. Tens of billions have been disbursed already. It will be interesting to see what comes after that.
It sounds like the UK understands what money is. Maybe because their central bank threw in the towel in 2014 and admitted what the stuff really is and where it comes from.
Whereas Jerome Powell is reduced to going on daytime TV (!) and saying “I’m printing lots of money!” when in fact he is able to do no such thing.
Reminds me of a Depression-era ditty: “If I had some ham I’d make myself a nice ham sandwich, if I had some bread”
Meanwhile, in the USA, I’m still waiting on my disaster loan application from mid-March.
No creditworthiness checks, at least they didn’t make me do that bit of theater.
What do you mean by a “return to an Eighteenth Century version of capitalism”?
Is it too much to hope for that this means credit reporting agencies are going to be banned by law along with the data brokers?
This caught my eye:
Seriously? They haven’t been doing it before? This is one of the most basic checks that can be made.
It would depend on how ‘granular’ that ‘review’ is. The banks already have to keep track of transfers over $10,000 USD for the anti-money laundering laws.
Now, the posibility is raised of a ‘granular’ perusal of an individual’s money flows to detect “unapproved” activities. This is the Panopticon writ large. Couple this with the ongoing ‘War on Cash,’ and we see the emerging lineaments of a real ‘1984.’
All this was firmly in “Conspiracy Theory” territory a decade ago. Now it is nascent policy.
One can never be too cynical in these Interesting Times.
One of my kids is looking to rent an apartment. The property manager would accept NYS unemployment while they were laid off, but not the Federal $600/week for income verification due to the short duration of the fed money. Now that they have a new job, the pay stubs provide the necessary proof for the property manager.
I suspect banks will need to see more pay stubs. i think that is why mortgage applications will be able to continue to be processed as they generally require proof of income sources. Car loans are probably less of an issue as they can just repossess the car, but unsecured credit is going to require some head-scratching.
The credit companies already have a huge business in employment and income verification and have been making tons of money from it verifying prior employment for states during the Covid crisis. Lenders, landlords etc get employment and income verification as part of the credit services they buy. No one needs to see a pay stub after the first week or two of new employment.
What banks are actually going to have to know their customers and apply expertise to their decisions?
Say it ain’t so.
There’s a related issue in play here that’s more important IMO. Banks have a unique responsibility in our economic and social system. They create about 97% of the money in circulation through the creation of credit. That money can be used for either unproductive purposes to drive up financial asset and real estate prices that result in asset price inflation, bubbles and financial crises, as has been occurring; or it can be used to support the operations of productive businesses engaged in the creation of products and services and the consumption of those goods and services in the real economy.
Pivotal time during this supposed “Bailout of Everything” when we should be asking questions of and proposing legislation to politicians to re-establish the primary purpose of banks, as well as reducing the power of the bankers, lobbyists and bank regulators who are quietly doing another end run on the Volcker Rule. We should re-establish the separation of speculative finance from the payments and depository system, break up the concentrated political and economic power of the “Too Big To Fail” banks, and implement a decentralized system of smaller not-for-profit banks that emphasizes sound underwriting for productive purposes in our monetary system.
From talking to small business owners in my corner of rural Mass, if you didn’t raise the cash before this, you can’t get it now.
One of my favorite lines from the “GFC” regarding LOC’s, and refi’s was: the homeowner was selling their home to the bank, the bank just didn’t know it.
I wonder how many small businesses are doing the same with their business lines or even the PPP?
Also, this “recession” is a sniper. Seems like places are either getting killed or not being affected too much. My little “essential” manufacturing company is pretty solid. Other guys around are just shut down.
I am so grateful for the loans I took out at the end of February at a super low rate of interest (well, not as low as the Lords of Universe are getting), since I anticipated this situation (partly thanks to NC).
The best part is that payments have been suspending since the end of March on the biggest loan.
“fintech” to the rescue: Banks will want to “crawl up your orifice” to know moar and moar about you: things God didn’t evolutionarily enable other human’s to know, cpu’s will profer. Welcome to capital-ism. WSJ to run article cheering this savior trend in a year’s time!
Banks don’t really care about credit quality. They bundle the trash, get it rated as triple A, then take out insurance and sell it to suckers.
“The real problem here is that banks no longer really know their customers, but have seemingly placed over-reliance on a magical number – or more accurately, algorithm, which calculates one’s credit score.”
In 2004, I was amazed at the prices houses in my town were fetching. I wondered how these folk could afford such prices. (at the time I knew nothing about CDS, MBS synthetics ect ect) I only knew I was doing fairly well and “I” could not afford those prices. The following spring I sold my house and moved into a rental. We all know the rest of the story regarding housing…
In 2009, I went to my bank, in which I had my business account, my personal account and various CD’s that held the proceeds of the house sale. I sat with the branch Mgr and requested a line of credit for investment purposes. 2 days later I received a call from the same branch Mgr explaining I was ineligible because I had “no credit history”.. I replied of course I do, I’ve owned houses, Cars, and boats and always paid my loans on time and in full. Yes, she said but nothing in the last two years. By design, I replied. I sold my house, my boat paid off all debts and rented while the entire financial system collapsed. I have large deposits in your bank and you can see the activity in my business account to know it is profitable..
The answer “Sorry”………. My thought ” They’re (family blogging) Idiots !!!!!
When I said you know I have extended large unsecured loans to your bank and you are forcing me to call them…… They looked at me as if I had two heads… No idea to what I was referring…..
I now bank with a local bank and when I enter they greet me by name and I respond with theirs (from branch Mgr to tellers)… When I cash a check no one asks me for ID and if a need something they help me get it…. When I asked for PPP loan they did most of the work and I was in the first round….
I have loaned money (five figures) to two friends, one was starting a new business, one during the GFC when he almost lost his business. Both times on a handshake. Both times I would not accept interest.
I knew their character, not their balance sheet… Both loans were repaid….
Models are BS, they failed during the GFC, They cannot predict change, they cannot know character.
Know the person who is your customer.