Why Traditional Credit Reporting Sucks
By Doug Levinson
Most people understand that if they’re planning to buy a house or a car their credit score will be important. But, many people don’t understand or appreciate that credit scores can have wide-ranging impact on their “everyday” lives -- they can affect whether or not you get a job, whether you qualify for insurance or, even, whether you can buy a new mattress.
The almost universal reliance on credit scores wouldn’t be so troubling if credit scores were a simple and accurate way of determining whether or not a consumer is credit- worthy. But, that’s far from how the credit reporting industry works. Here’s how it really works:
First, credit reporting agencies are for-profit businesses. The credit reporting industry is dominated by 3 companies -- Equifax, Experian and TransUnion.
Experian is the largest of the three credit agencies. It is a British public company with annual profits slightly below a $1,000,000,000. Its CEO earns over $5,000,000 per year. Equifax is a U.S. company with roughly $500,000,000 in annual profits. Its CEO is paid roughly $15,000,000 per year. TransUnion -- also a U.S. company -- is the smallest of the major credit agencies. Its annual profits are approximately $120,000,000. Its CEO’s annual compensation is approximately $10,000,000.
While there is nothing wrong with a for-profit company, there is a problem with companies claiming they are protecting consumers when they are actually deceiving consumers. All three of these companies have been fined by the government recently for deceiving consumers.
Second, the credit reporting industry does not provide objective windows into consumers’ credit-worthiness. Rather, companies have their own distinct ways of collecting, analyzing and reporting information. Each company relies on proprietary algorithms to determine credit scores. And, these secret and different processes can, and often do, result in substantially divergent scores.
Third, since credit agencies work for companies, not consumers, if they’re going to make a mistake, it’s always going to be in one direction -- unfairly denying credit to someone who deserves it, not granting credit to someone who doesn’t. Credit reporting agencies don’t work for consumers, they aren't paid by consumers and, so, they have no financial incentive to serve consumers in any fair or individualized way.
Fourth, the major credit reporting agencies pay no attention to the personal character of consumers they report on. For example, credit reporting agencies don’t give any thought to a consumer’s community involvement. Likewise, credit reporting agencies don’t consider whether a consumer has a particularly stable or noble job, such as police officer, firefighter or teacher. And traditional credit reports certainly don’t reflect whether or how any recent life events have impacted an individual consumer. Consider, for example, how traditional credit reporting agencies would treat a consumer who -- having consistently made timely payments for a decade -- misses a couple payments while recovering from a heart attack. The late payments will have a disproportionate impact on the consumer’s credit score, while the decade of dependable payments will be much less significant.
Fifth, with existing technology -- a customer-centric credit worthiness agency could leverage sophisticated artificial intelligence to analyze and interpret both traditional empirical information and much more subtle (and arguably more important) subjective information. The key words here are “customer-centric.” The power and insightfulness of artificial intelligence is highly unlikely to ever be put to use by traditional credit reporting agencies; they have a much greater financial incentive to be conservative than fair.
Doug Levinson is a Professor of Law & Business that has taught at UCLA, UC-Berkeley, & University of Southern California.