People are told they need good credit. Credit scores are used -- illegitimately -- as a short hand for all shorts of stuff.
Unless you are the sort of person who is expected to have good credit, in which case it is never checked.
-- From a thing i tried to say earlier.
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Which is to say: its Vimes's boot. Everything is an equivalence to the Boot.
ReplyDeleteI don't know about the "illegitimately" part. There are pretty strict rules around who can access those and when.
ReplyDeleteI don't know them all but the gist is that it can be accessed only when you apply for a loan, for a job involving the the potential of embezzlement, or for insurance (because of long term payment commitment).
Those are all pretty legitimate reasons to use someone's credit score. Banks can't even access your score until after you submit the paperwork to apply.
*at least in the U.S.
I think it's fair to question what purpose the credit reporting system actually serves (as distinct from the purpose it claims to serve). If those purposes measurably diverge, there should be a term for that, whether "illegitimate" is the right one or not.
ReplyDeleteMy sense is that, broadly, the system claims to serve the purpose of letting banks make loans to people with an understanding of the risks involved.
Likewise, my sense is that, broadly, the system actually serves the purpose of letting banks turn away loans from people based on their upbringing and social caste.
Is the evidence there to prove a strong correlation? I'm skeptical.
And either way, William's point about the feedback cycle (where the entire financial system works to make life more precarious for those who are already poor, and more secure for the already wealthy) is a telling indictment.
Even if you have excellent credit they will check it when you want a loan to buy a house (I think this has more to do with bank policy than anything else).
ReplyDeleteEva Schiffer sure. And (I think) most people never buy a home.
ReplyDeleteWikipedia says that in the USA it's probably more than half of people. https://en.wikipedia.org/wiki/Home-ownership_in_the_United_States
ReplyDeleteCredit checks will, as a point of procedure, be done for everyone trying to negotiate a mortgage.
ReplyDeleteCredit checks are also done, unequally, when people wonder whether they should reject somebody, for insurance, bank accounts, car loans, employment (!) and rentals. And that's just the stuff I tracked down with a rudimentary search. I suspect there's more.
Oh yea, car loans are the other big one. Not a lot of people buy cars with cash and many people own cars.
ReplyDeleteI'm genuinely interested, Eva: Are you arguing here that the credit reporting system is applied equally, and without bias, to all people in the same circumstances? That has not been my personal experience, but if you've got evidence I'm happy to listen.
ReplyDeleteI've been credit checked for renting apartments, for getting internet service and (of course) when applying for credit cards. I dunno if they actually look at your credit score for those or if it's just a credit report (which is different), but yeah. Your credit history, inclusive, pops up in lots of places.
ReplyDeleteTony Lower-Basch No, I think there's all sorts of bias. I'm just arguing that people do actually use credit checks for everyone (what they do with the results is something else entirely).
ReplyDeleteIt seems odd that any one would consider determining a persons ability to pay by using metrics that evaluate a persons ability to pay to be illegitimate. Can't think of anything more legitimate than that.
ReplyDeleteThe expectation that anyone should be able to borrow based on need, and the lender should just hope to get paid if they're lucky seems way more illegitimate to me. No one is entitled to borrow other people's stuff.
If you have a shitty credit history, but get a good job and start making the money to afford things like a car or a house, the shitty credit history is going to keep you out of the best rates and be the difference maker for someone (like a landlord) who's evaluating you against other people, even if you have a better income now.
ReplyDeleteIt costs a lot of extra money to stop being poor.
It's gotten more brutal in the last ten years. The housing market especially has raised the bar on credit checks enormously and a lot of people who got burned by the bubble have huge black marks from things like defaulting and short sales. It takes about 7 years for those to slide off the end of the record, which is a long time to put off big purchases.
ReplyDeleteRalph: I'm largely in agreement with what Nathan said, but would take it further.
ReplyDeleteIt seems completely illogical to me to pay people less, and charge them more, when they have less. You can't expect anything but a positive feedback cycle (where the poor stay poor independent of their actions) from that sort of design.
If I designed a game that worked that way, I would expect a fairly large number of people to have a truly shitty time playing it (and Parker Brothers would sue me for infringing on their rights to Monopoly).
But I could almost buy it (from a selfish "You can't expect anything from anybody" free-market point of view) if there were evidence that the credit reports actually correlate with some "ability to pay today" that is independent of the credit reports. I haven't seen that evidence.
ReplyDelete"It seems completely illogical to me to pay people less, and charge them more, when they have less. "
ReplyDeleteTaken individually, that does sound illogical. But taken in the aggregate you've now moved into the realm of risk management and that's all about probabilities.
All risk management comes down to using probability to assess who subsidizes who. At the end point risk is either 0 or 1. You either defaulted or you didn't. But during, its a probability.
Those with low ability to pay have a higher probability of defaulting. The overall actual level of defaults is pretty low...but the overall profit margin on loans is also pretty low, so it doesn't take many defaults to create a death spiral (which is why regulators pay such close scrutiny to things like default rates and capital reserves).
So as a group, people with low ability to repay will experience a higher rate of default than people with a higher ability to pay. And therefor as a group they pay more...so that the high risk people who don't default are subsidizing the high risk people who do.
As a group, people with a high ability to repay have a lower risk of default. And so the lower risk people who don't default are asked to subsidize the lower risk people who do. By definition, since fewer lower risk people default...the subsidy needed is lower.
To do otherwise would be to have the lower risk people subsidizing the higher risk people...and that's just pure moral hazard disaster.
As far as evidence goes. The correlation between default rate and FICO scores is something the Fed monitors pretty closely.
ReplyDeleteHere's an analysis from a year ago that shows a very strong correlation. It goes from the opposite side "survival" rather than "default" and shows that the survival rate increases as FICO increases.
https://www.kansascityfed.org/publicat/reswkpap/pdf/rwp15-02.pdf
A similar study from a few years ago
https://research.stlouisfed.org/wp/2011/2011-040.pdf
Its pretty stat math heavy, but as I recall you're rather adept at that, so you'll probably find it interesting.
Ralph: That's not that math heavy. It's also not controlling for the feedback effect ... like, at all.
ReplyDeleteWhat I'm asking for is something along the lines of double-blind experimentation. Something where you would, in fact, prevent the hypothesis from impacting the data.
Because absent that, you have no way of proving that you're not just running the numbers on a self-fulfilling prophecy.
As a reductio ad absurdum analogy: Suppose I say "Male humans don't work as hard as females ... all the evidence from our Alien-Overlord labor camps supports that." Then you look at the labor camps, and note "Hey, I can't help noticing that you never feed the males. Do you think that might have an impact on the validity of your data?" And you say, reasonably enough, "Why would we feed the males, when that same food could be used to sustain the more productive females? And look, the evidence that they're more productive is absolutely overwhelming. Heck, most males cease biological function entirely within a month."
It's totally correct statistical analysis of the data, but it's asking the wrong question.
I'd be interested in data on how people with poor credit scores do, in terms of default rates, when they're actually on an equal playing field. Do we have that data?
What does "equal playing field" mean? What variables are you trying to control for?
ReplyDeleteI'm trying to get a double-blind test.
ReplyDeleteI think, in fact, that's a bit prior to the question of "which variables you control for."
I feel like I can't easily explain that without getting pedantic, and I don't want to assume you need educating on this point. Rather, I tend to assume you don't. Do you get why the data you've presented is not in any way a double-blind, and why that in turn compromises its power to offer predictions of what would happen if FICO score were handled differently than it was?
Go ahead and pretend I don't...because I'm not sure we're both thinking the same thing when you say "double blind test". I have no problem being educated by someone I'm confident has knowledge to share.
ReplyDeleteI'll give it a try. The type of isolation I'm aiming at is an experiment which, in the interest of showing that a property is intrinsically different from one sample to another, tries to assure that the samples receive the same treatment.
ReplyDeleteSo, if you were testing whether pudding decays faster than jello, it would be a failure of double-blind to keep your jello samples on a plate on the back porch, while keeping your pudding samples vacuum sealed in a refrigerator.
And while it is easy to say, in that scenario, "but you're just talking about controlling for the variables of exposure and temperature" the concept of double-blind experimentation is to control for all possible variations that could be non-randomly introduced, by not permitting the experimental procedure to depend upon the variable being tested. So a double-blind experiment would involve one experimenter packaging the jello and pudding into identical black boxes, and a second experimenter performing the experiment on the black boxes, not knowing their contents until data had been obtained.
The hope is to gain some evidence of how pudding and jello vary as substances, that will be (to some extent) proof against rival hypotheses that say 'that has little to do with the substances in question, and a great deal to do with different treatment of some sort.' After all, the original experiment I proposed would not have very strong predictive value for what would happen (for instance) to jello stored in a refrigerator alongside pudding.
Economics very rarely engages in actual controlled experiments, due to the difficulty of fitting a free market system in a lab, but the same concern for bias should be (but often isn't) present. When you are looking at statistics for stuff that happened in the real world, and trying to judge what that predicts about what would happen in a hypothetical world (set up somewhat differently) you want to look for situations in which people are treated just the same across a range of values in the measure you want to draw conclusions regarding.
An experiment that could aspire to something like a double-blind might be to have a single institution provide employment, rental and loans to a group of people, without reference of any sort to their FICO score. That would make the experimental procedure independent of the variable being experimented upon ... and you might very reasonably then draw conclusions if (for instance) people with high FICO scores defaulted on their loans much more often than people with low scores (or vice versa).
A very non-blind experiment, by contrast, would treat the samples very differently. People with low FICO scores would be subject to predatory loan practices, unethical ARM loans that disguise their long-term costs, less opportunities for employment, and higher rental costs than high FICO samples. As with the pudding and jello, this experiment would have limited predictive ability regarding anything fundamental to the samples. The extent to which they were treated differently would, of necessity, open the door to rival hypotheses along the lines of 'this isn't about anything fundamental to the people. It's about the way they're being treated.'
Does that make sense, as a concern about the usefulness of data acquired by observing market outcomes in 2004-2006 (when pretty much all the inequalities above were rampant)?
Right, so grab 10,000 people who want loans, grab 10 financial institutions to give them loans, give everyone identical loan packages without the lenders even knowing the names of the people they're lending to, then map the default rate to the FICO scores of the 10,000.
ReplyDeleteThat would be an interesting study, and easily done without putting too much money at risk, especially with a federal guarantee.
But I'm not convinced the results would be significantly different. The completionist in me would love to see the confirmation, but I don't have a high level of doubt sans such confirmation.
While FICO scores certainly have flaws, the number of factors being tracked and the fact that what's being tracked is probabilities not absolutes makes it unlikely that the results would be much different. Meaning the method isn't trying to ascertain whether Ralph Mazza will default. The method is trying to ascertain how many people like Ralph Mazza per 1000 will default...without much regard to which ones.
There's also a pretty strong element of, "if you could build a better mousetrap, someone would have already done so"' here. As a rule such assertions are highly unreliable, but the primary caveat of such an assertion is "given sufficient profit motivation". And here there's more than sufficient motivation. Create a model that's more accurate at predicting default rates and you pocket billions...literally...tiny fractional advantages in probability have huge returns. There are already so many brilliant people chasing those returns right now that the likelihood of something as simple as a double blind study revolutionizing the way risk is assessed strikes me as infinitesimal. If there could ever be a valid example of "someone would have already done it" this would be it.
Fascinating.
ReplyDeleteOf late, I've been pleased when Tony Lower-Basch has shown up in a thread, especially if I'm going to be away: the majority of the time, he eloquently argues a position similar to one I would take up.
Here's the situation I am initially describing:
A: Person A was born to lawyers or doctors, does well in school, and goes to college. Person A gets a job -- probably as some sort of professional -- and rents apartments, buys cars, etc. Person A has sufficient wealth buy a car -- probably starting with money from mom and dad, and then saving for the next one -- and does not need to have a credit check to buy a car. Maybe person A has student loans, and gets a reasonable rate from the fafsa which does not rely on credit. Person A doesn't need to use her credit rating -- which is pretty good! -- because she has enough money.
B: Person B is born to, say, bus drivers. People with a steady income, but not a lot of it. Due to her parents having changing schedules and having the most stressful job in the world, person B rarely eats breakfast before school. Does poorly, doesn't go to college, and gets a job that doesn't pay super well. This is no incitement on person B -- its really hard to learn when you are hungry! Person B needs a car, and doesn't have $5,000. So, person B finances one -- a hard pull on her credit rating. She needs that credit, and doesn't have near the same sort of history as person A. And maybe she loses her job and can't pay the car note -- now her credit is ruined for 7 years.
Person A may never need their credit report. It doesn't matter to her ability to go to college, buy a car, rent an apartment, get a job. People take one look at person A and say "Yeah, she can pay this. No problem." She gets the sort of job, with the sort of employer who doesn't bother checking your credit rating.
Meanwhile, person B is denied a job because her credit rating is not high enough. They deduce from this that she cannot be trusted. She gets worse jobs, and her credit rating goes down.
That's the problem. If person A ever needs a loan (perhaps for a mortgage), she'll get one at a low, low rate. Person B needs to borrow money constantly, and it costs her a lot of money to do. That is, she borrows a much higher rate. Her survival is contingent on banks being willing to give her money. Person A doesn't care about her credit report.
Furthermore, I'd claim this is intentional. This keeps money in the hands of money, without it getting dirty going into other peoples hands. This allows the continued stratification of US society, where the gap between rich and poor is larger than in other industrialized nations and growing.
ReplyDeleteOf course, this goes back to the obvious: It costs more to be poor than to be rich.
ReplyDeleteDo you have a solution that doesn't involve handing money to person B and hoping?
ReplyDeleteRalph: I'm going to loop back to your claim that systematic bias can occur in individual cases, but isn't present in data once it is aggregated into a statistical sample.
ReplyDeleteTo which I respond: No. That's false. Statistics is not truth-magic. If you give it systematically biased inputs, it will give you systematically biased outputs. The only noise that washes out of the system with larger sample sizes is random noise.
So, you're welcome to be very certain (in your heart of hearts) that if the current feedback cycle of poverty engendering poverty were somehow addressed, it wouldn't make any difference. You may even be right.
I don't have enough data to either confirm or deny that theory, and neither do you.
I'm trying very hard right now to resist the cognitive bias where, because you've raised flawed arguments for your claim, I think your claim is less likely. Hard as it is to discipline myself to it, I think nothing much has been proven on the topic one way or the other. But I want to go on record as saying that I remain skeptical of any claims that the feedback cycle doesn't have an impact, and I am unlikely to accept a priori arguments in the absence of evidence.
Perhaps take a sample of 1000 people and, in cooperation with the three major FICO reporting groups, assign them random FICO scores in the system ... then see whether how closely their default rate a few years out correlates with the underlying truth of their finances, versus how closely it correlates with the random FICO score. That might give an interesting statistical instrument with which to tease out the strength of the various causes (FICO causing default-risk, default-risk causing FICO).
Ralph Mazza To be sure: I like you being around. You're eloquent, and I disagree with you. That's a win-win for me.
ReplyDeleteTo the question:
Do you have a solution that doesn't involve handing money to person B and hoping?
... there seems to be an assumption that giving people money is either somehow morally blameworthy or, in the least, questionable. And, certainly, not useful.
That position is contrary to empirical evidence. As it turns out, if you give one-time injections of cash to poor people, the long-term (at least, so far measured) effects are large, meaningful, and relevant.
I speak of GiveDirectly, which gives money to the poorest people in the world. Then they go back and measure the effects of the intervention. They alter the experiment from place to place, to figure out what makes the biggest long-term difference.
So far, the evidence suggests that just giving people money results in them pulling themselves out of the poverty loop. That is, a large enough infusion of cash once, may well break the cycle of poverty.
Plus the evidence of housing-first programs combatting homelessness. Similar effects in a different economic arena.
ReplyDeleteWilliam Nichols no argument there. But that is not the purpose of credit ratings or FICO scores. FICO scores are there for when the business of lending money is a business.
ReplyDeleteThe social benefit of having an alternative source of financing for those who need money but aren't good business risks is a wide open topic. But nothing to do with FICO.
Ralph: Rather, the point of FICO scores is to extract wealth from those with no other source. Give people enough money to live, and you cut out that necessity.
ReplyDeleteNot in the least bit accurate. Lending is an important social function. It is a net benefit to society. But even if you postulate lending from a charitable motive rather than a profit based one, you still need to understand default rates...or the charitable lender runs out of money same as the for-profit lender.
ReplyDeleteFICO is a tool to evaluate the probability of default. Corporations face the exact same concept with their credit rating. Low rated companies pay more to borrow than highly rated ones.
Of all the various things you could point at as a powerful tool making the poor poorer and the rich richer -- like say Fed manufactured inflation -- credit scores are among the least offensive.
tl;dr -- Everything a business does is about extracting wealth. What else is the point?
ReplyDeleteDebt absolutely has an important social function, and has for -- what, 5,000 years?
I've said nothing about lending from a charitable position. I've talked about giving money to people who need it. Had I mentioned Kiva, sure, that'd be lending as charity. Currently, I'm not certain as to the long-term effects of lending as charity: does it actually help people get out of the shit, or do they reset to the same position because paying interest is destructive? I am by no means sure.
Lending to businesses for profit makes sense: the businesses need capital in order to generate more wealth. That makes sense.
Lending money so someone can survive makes less sense: they need that money to (for example) pay rent. They'll have pay rent next month, too, and an interest payment on the money they borrowed last month. If they miss the interest payment -- because it is too much -- then they also lose the apartment, because the landlord checks up on their credit rating.
And that is the destructive power, the my initial point: the credit score is used in innumerable places as a short hand. Because we think of owning debt -- and certainly of not paying ones debts -- as a sort of moral disrepute.
So, now, you've got someone who had a bad month, borrowed money to make rent, couldn't pay the interest payment the next month, and is now out of an apartment.
This happens. The unholy trio of: making less than you need, interest payments, and rent being tied to a fico score. These three, when taken together, destroy lives. If the fico was solely used for figuring out interest payments, it would be less of a problem. But, it ain't.
Couple that with this: I have had zero hard pulls on my credit in the last year. (Hooray!). Hard pulls, of course, reduce your credit score. Because I do not use my credit rating -- because I am lucky enough to not need to borrow money -- my credit score goes up and up. My apartment doesn't check credit rating, as the default rate of the people living here is too low to bother. My employer didn't do a credit check -- though they did do a background check.
Point is: Not only is FICO a means to figure out how much wealth can be extracted, but the relevance to your everyday life is indirectly proportional to your credit rating. That is, if you don't use credit, then you can have a pretty damn high credit rating. If you use it constantly and have the slightest problem, the score goes to hell. And you'd start with a higher interest rate, in virtue of having a low credit rating.
Consistently, credit is used as a vehicle of extract wealth. What else would be the point?
Plus: the importance of lending as a social function generally does not justify any particular lending system as being well-tuned for fulfilling that function morally. It's a null argument (as can be seen by the fact that it applies equally well to justifying the actions of loan sharks and Ebenezer Scrooge).
ReplyDeleteI usually get pretty scoffy about "Well, do you have a perfect solution? If not, the argument from status quo wins!" claims (and, I think, for good reason), but the question of "Do you have a better solution?" combined with an earlier claim that risk-pooling ("having low-risk people subsidize high risk") couldn't work has gotten me thinking ... because I work with health insurance professionally, and so I know that risk-pooling does work.
ReplyDeleteSo, I've put some thought in, and here is at least the skeleton of a proposal.
Executive Summary: Reverse the feedback loop. Make loans cheaper to those with low FICO, and more expensive to those with high.
Reasoning: A negative-feedback system (where the poor are given more opportunities to succeed, and the rich are given more opportunities to help) reliably produces middle-seeking results (elevating the poor from poverty, by pulling the rich toward the median (compressing the high-income long tail)). We severely need that sort of redistribution as a society (cf. pretty much every study on income inequality in the past two decades).
Details:
(1) I worry about shifting the borrowing market by shifting the incentives. However, as William points out, borrowing is often an inelastic demand. While I would expect to see some shift in the market based on such a change of incentives, we presumably have good numbers on how inelastic ... which is, literally, a measure of how much the market would shift if we changed prices for people. So this is calculable by simulation. The numbers could be checked, and would have to be. But I suspect that well-off people would still finance houses, and cars. What they would not do (for instance) is buy a house they do not need, in order to borrow money at 3.5% which they then invest to get returns at 5%. NOTE: Not a hypothetical. Actual financial planning advice I have personally received on numerous occasions from numerous sources. Rich people DO turn their excess security into money this way, because they're entitled dicks, and the positive feedback system encourages it.
(2) If a low FICO score is good, wouldn't people game the system by not paying their credit cards? Yeah, you'd need a better measure of FICO score, one that actually corresponded to when people had to default on a debt, as opposed to when they just flaked out. Doable.
(3) So what's to keep poor people from just borrowing, defaulting, borrowing again, defaulting? Nothing. By design. I'd recommend an update to the (sadly antiquated) bankruptcy laws, to help people who are in a default cycle to gain some oversight. Perhaps a lender-of-last-resort funded federally (yay for centralizing our social efforts!), that would help people get off a cash-in-hand basis, and work more on debits. Bankruptcy laws seem based on the concept of voluntary information sharing, whereas if your financial supervisor was also your banker, the technical infrastructure is there to give them a very detailed window into (and control over) spending patterns. The trick there would be to create gradations of financial oversight that balance people's freedoms against the need of society to get them back on financial track. But, as demonstrated by housing-first and direct-charity initiatives, the evidence indicates that even if the end result is just giving people cash, that's a better return-on-investment than other ways we have tried to address poverty through social services.
And that's the skeleton of a notion.
Tony Lower-Basch Why would rich people (who, as you say, are entitled dicks) participate in this?
ReplyDeleteWilliam: That's the bit I'm talking about, in terms of the inelasticity of demand for loans. My experience is that there is a fairly broad swath of folks who have very secure credit ratings, but who still do not buy houses for cash. Cars, maybe. Houses, no.
ReplyDeleteEDIT: But the point is that we don't need to depend upon my experience. The inelasticity of the lending market has been measured. I don't know what it is, but it's not some unpredictable thing. So the plan could be evaluated on that basis.
Tony Lower-Basch Let me rephrase the objection: Why would rich people adopt such a system? And if it became law, why would they not opt to loan money to each other at a rate based upon risk?
ReplyDeleteThis is the same problem with getting young people to buy health insurance, but worse: The capital is (effectively) in the hands of those with the most to lose.
Ohhhhh ... the whole "Why would our society do anything but what is best for the rich people?" question.
ReplyDeleteBecause we tell them to.
I get that it's a glib answer, but it's a bit of a glib question. The assumption that government will be run by the wealthy, for the wealthy, always seems unassailable and inevitable until people say "Screw the wealthy, we're making a society that works." Why would the rich adopt a system of social security, or unemployment insurance? It doesn't benefit them.
Another option: Offer the same rate to everybody. Do not allow banks to offer differing rates. Have one rate, perhaps lower for central banks and slightly higher for everything else. This one rate is a mixture of the risk pool -- that is, people who pay back their loans on time reduce the rate, and people who default raise it.
ReplyDeleteSuddenly, it becomes very much my interest for you to pay your debts. If someone is ripping off a bank through poor lending, it directly affects everyone.
You can also have all those people who decide if a creditor is worthy or not do something productive.
Also a good solution (at least to within internet-napkin-scribbling levels of detail)!
ReplyDeleteHonestly, if it were a question of actual policy I'd be inclined not to go with either of our solutions, but rather talk with some folks who have studied the economics of the situation more carefully than we have, but it's certainly fun to talk over different ways that the market could be structured, in order to optimize for different end results.
I like the occasional reminder that money isn't a force of nature, it's a tool of people, and we can change what it does.
Also, Tony Lower-Basch : Dianne Harris says your solution is better than mine, because yours creates the middle class. By virtue of borrowing money, yours guides you towards being middle class. And that is definitely a positive.
ReplyDeleteMine just pools risk to treat everyone the same, and does a thing I like thinking about: reduces societal overhead.
What do you think, Ralph Mazza ?
I'd question the assumption that demand for loans is inelastic. Rich people rarely borrow because they need it (being rich and all). Rich people borrow because it's convenient...and as a way to leverage their assets. If you have $10M in investments and want to buy a $3M home, you take a mortgage rather than liquidate your investments. Because over a 20-30yr period, you're going to make more on the investments than you pay on the mortgage.
ReplyDeleteThis works, because the risk profile of the borrower is virtually 0. So the lending rate is exceedingly low. Increase the lending rate by forcing low risk people to subsidize high risk people and you simply have fewer loans and the whole system breaks down. Same problem that required Obama Care to mandate low risk people subsidize high risk people.
Plus you have a bigger issue, the entire electronics transaction market that we've all grown accustomed to using (debit cards, ATMs, electronic bill payments, even paper checks) is paid for mostly by the profit spread from lending. Futz with the lending profits and you also will need to transform the entire transaction system that is currently mostly free.
There's a great book called Jimmy Stewart is Dead (a play on the the Wonderful Life character) that postulates a complete transformation of the banking system into one that solves a variety of problems (including Too Big to Fail) while making the system less oligopoly and more free market responsive. I'm a big fan of the proposal, but there's zero chance of seeing it implemented.
Short version, separate lending from deposit functions. Make the deposit functions fee based like any other service (cable, utilities). Make the lending functions funded by overt and intentional investors rather than regular people's savings and checking accounts, using essentially mutual funds vehicles to pool the funds and underwrite the loan. That way, investors could control exactly what level of lending risk they wanted to participate in (driven by fund prospectus rather than bank credit choices), there'd be plenty of opportunity for those funds to experiment with a variety of different lending standards, and defaults (no matter how large) would only harm the investors who chose to bear the risk, rather than the life savings of regular people.
But barring an overhaul of that scale, I don't think you have much wiggle room form messing with the underlying focus of the system. A better solution given the status quo (and unlike Tony I have zero faith the status can be unquo'd without bloodshed and revolution, nor that the new quo wouldn't be worse) would be to find a replacement for the predatory end of the lending spectrum. Big banks don't want to loan to poor people in the first place. There are actually laws in place forcing them to. There are literally requirements that a bank must have a certain number of branches servicing poor neighborhoods, must make a certain number of loans...etc. banks hate that, it's a huge money loser to bank poor people.
So step one, make it illegal for banks to bank poor people instead of mandate it. They'd be all for it.
Step two, create a different class of banks specifically for banking to the poor. Make them "mutual" / old style "credit union" businesses instead of shareholder driven banks. Give them different standards, different tools, and different backing. There's precedence for such with the old Savings and Loans and Farm Credit Banks.
Ralph: While I understand the feelings that lead you to think that the status quo cannot be shifted without bloody revolution, I will admit that every time I hear that prediction, I wonder "So who is the bully holding the status quo in place so strongly that they need to be defeated by force before permitting change?"
ReplyDeleteWe all are, Tony.
ReplyDeleteTony Lower-Basch talk to me after Bernie Sanders or Gary Johnson becomes president. I may be more optimistic about it then.
ReplyDeleteBy which I mean: If mortgage interest rates went from 3.5% to 10% (or 15!), the backlash would be brutal.
ReplyDeleteAnd personally, I'm interested if Eva Schiffer and Nathan Paoletta have other brain bits to add.
ReplyDelete