Prevent the Uber effect on credit scoring

The Federal Housing Finance Agency’s recent “listening session“ on updating the credit scoring models used by Fannie Mae and Freddie Mac signals the end of a very long journey, one that dates back to at least November 2014. Back then, the National Consumer Law Center first asked FHFA to move Fannie Mae and Freddie Mac away from Classic FICO to newer scoring models in order to reduce the inappropriate impact of medical debt. FHFA has now proposed four options on how to update the credit scoring method, but one of those — letting lenders choose which score to use — could result in terrible consequences.

Newer scoring models, such as FICO 9 and 10 and VantageScore 3 and 4, do not consider the impact of medical debt that is paid off, and they reduce the impact of unpaid medical debt. That’s huge. The Consumer Financial Protection Bureau just released a report documenting the remarkable extent of medical debt on credit reports, finding that 58% of debt collection items are medical in nature. Medical debt also disproportionately impacts Black and brown consumers. Moving to new scoring models is not just a good thing for consumers; it is also a matter of racial justice. (By the way, that means that non-mortgage lenders still using FICO 8, which reflects the impact of medical debt, may have disparate impacts in their lending.)

The FHFA listening session focused on the “how” of updating newer scoring models, giving the options of (1) maintaining a single score; (2) require multiple scores; (3) lender choice and (4) waterfall (i.e., if a borrower does not have the primary credit score, go to a secondary credit score).

Of these, letting the lender choose is absolutely the worst option. The history of the hijinks and shenanigans that mortgage lenders engaged in during the 2000s, which ultimately led to the Financial Crisis, showed us that when given the opportunity, lenders will game the system to the detriment of consumers.

Another reason to oppose the option of lender choice is to prevent the “Uber Effect” on credit scoring. FICO‘s sole competitor — VantageScore — is owned by the Big Three credit bureaus (Equifax, Experian and TransUnion) and the credit bureaus, not FICO, set the price for credit scores to lenders. FICO only collects a licensing fee. With lenders choosing, the Big Three credit bureaus will likely set a price for VantageScore that is super low, so low that FICO cannot compete, just as Uber decimated the taxicab industry by setting prices artificially low until the taxicabs were gone.

In the case of credit scoring, the Uber Effect would be even worse because it would result in an industry consisting solely of the oligopoly that is the Big Three credit bureaus and their jointly-owned credit scoring modeler. Despite valid criticism of FICO, having the entire industry consist of just the Big Three would be terrible for consumers.

Unlike Uber versus taxicabs, VantageScore is not more technologically advanced than FICO, and I’m skeptical of claims that VantageScore will expand access to mortgage credit for millions of consumers. VantageScore is able to score more consumers because it scores “dormant” credit files (i.e., files that do not meet FICO’s criteria of either six months of activity or activity within the last six months). But VantageScore’s own data shows very few of these consumers get a prime credit score, which is 660 or above. And many unscorable consumers are not in the market for a mortgage — the Government Accountability Office found that nearly half of credit invisibles are under 24 or over 65 years old.

If FHFA really wants to expand access to credit, it needs to do so in other ways, such as allowing the use of certain types of alternative data such as bank account cashflow data — but only with consumer choice and protections — and using that data in alternative scores. And it’s FICO that has developed these alternative scores, e.g., UltraFICO and FICO XD, not VantageScore. That makes sense because these alternative scores use data that is outside of the Big Three’s main credit reporting files — and of course, the Big Three own VantageScore.

FHFA should pick an option other than lender choice and avoid making the oligopoly power of the Big Three credit bureaus even worse.