New Consumer Credit Scores Promote Risky Lending

The Wall Street Journal reported the most often used creator of consumer credit scores, Fair Isaac Corporation (FICO), is introducing a new metric for rating consumer credit worthiness.  These metrics will use consumers’ payment history for items like utility bills and how often they have changed their address.  Previously, FICO scores have been created from information obtained by the major credit reporting firms.

In making the announcement, FICO indicated that over 50 million Americans who currently do not have acceptable FICO lending scores would be able to obtain them under the new system.  This fact alone should raise significant concern as to the motivation behind FICO’s change.  However, for those that need more convincing, the FICO’s rating changes come as a result of significant pressure from lending institutions and the real estate industry.  These self-interest groups do not seek change for any other reason than a desire for greater profits.  In the past, relaxing lending standards has resulted in significant economic damage to the greater society.

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Subprime Loans are Back Again

It was just six years ago that the world was at the brink of economic Armageddon.  The crisis was brought on by the cheap loans made available to borrowers including those rated as subprime with credit scores below 640.  The cheap mortgages to those with limited assets helped create a huge bubble in the housing market.  When the economy slowed down and home values began to depreciate, many borrowers began to default on the mortgages, which placed at risk major financial institutions worldwide that invested in these bundled mortgages.

Banks and others that owned the collateralized mortgages then required bailouts from the government to stave off failure.  This did not eliminate the debt, but merely moved it from the private sector to governments; i.e. taxpayers.  In addition, the bailouts inordinately benefited companies and their shareholders who made the imprudent loans.  Without the bailouts they would have encountered substantial financial losses.

There is also been a more incipient result of the bailouts of investors who made imprudent loans in the subprime market.  Without suffering losses investors have had short memories and in fact they are back at it again in the subprime financing business, once again supported by low interest rate central-bank policies with interest rates worldwide remaining at artificially and historic lows.

Last month, the Wall Street Journal highlighted the growth of subprime loans in an article titled Borrowers Flock to Subprime Loans.  Today, subprime loans are not in the housing market, but in consumer goods.  The Journal published the following:

  • Subprime loans are at the highest level since before the 2008 financial meltdown.
  • Approximately 4 out of every 10 loans for autos, credit cards and other personal borrowing in 2014 were in the subprime category.
  • During the fourth quarter of 2014, total US household debt increased by over $300 billion.

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