Just partial credit: government management of consumer financial data

Though many think that credit scores are issued by the federal government, in fact they are distributed primarily by three players, TransUnion, Equifax, and Experian, all for profit companies. In case you are unfamiliar, I’ll share a very brief, summarized overview on how these bureaus’ business models work:

1. Financial institutions share their customer data with the credit bureaus.

2. The credit bureaus aggregate that data to produce a total score for a customer intended to represent how trustworthy they are as a borrower.

3. The bureaus then sell this information back to the financial institutions and other parties, and the institutions use this information to underwrite lending or to make other product decisions.

Credit scores are a platform because a variety of other products are built off of the score. Of course, banks use the score to determine what financial products they are willing to offer a consumer and at what rates, but the importance to consumers is more than just accessing a mortgage- insurance providers, mobile phone companies, landlords and even employers also commonly use the score in offering products and rates.

Because credit scores are the bottom of ‘the stack’ of so many financial and non-financial products, the issuer of this score holds a great deal of power. Their decisions about the components, relative importance, and execution of the score will ripple through the decisions of a range of institutions.

However, it turns out that banks are able to claim the majority of this power because of the private status of credit bureaus and the dynamics of the financial services. Because of the existing business model in which financial institutions are the bulk of the bureaus’ revenue, their top priority must be retaining these customers and offering a product that meets their needs and desires. This prioritization is further magnified by the industry dynamics where there are competitor bureaus offering a largely undifferentiated product, meaning that the banks can cut a given bureau out of their underwriting process relatively easily. As if these dynamics weren’t enough to illuminate big bank’s asymmetric power, the dynamics for TransUnion, the only ‘big 3’ bureau that is privately held, are even more apparent- they are actually owned by Goldman Sachs.

This power dynamic leaves consumers at the top of the stack powerless and at the whims of the bureaus (which as we’ve seen are really the whims of the banks). This has created some very bad situations for consumers including errors in consumers’ scores are viewed as a ‘cost of doing business’ by the industry and preferential treatment given to 1% VIPs.

Given these dynamics, what can be done to protect consumers? What role should the government play in the credit scoring platform and the financial services stack?

To date the government has sought to work toward fair consumer protections in credit scoring and lending through regulation. Yet, this regulatory work is a highly partisan, contested issue which makes progress slow at best, and regressive at worst. We have seen this dynamic play out in the opposition to the Consumer Financial Protection Bureau which seeks to build a “consumer finance marketplace that works for American consumers.” In understanding the motivation for this opposition, it is difficult to look beyond the fat checks from big banks to these legislators and numerous former bankers in the ranks of Treasury and the White House.

Given the limits of regulatory action, it is tempting to imagine a world where the government owned this platform. Practically, this would not involve the score itself, but rather the underlying data which is the platform for the score. Imagine if the government passed legislation in the early 1900s that allowed them to manage a database of consumer information. They would provide access to this data to banks who have customer’s consent to view their information. This would certainly not eliminate the many flaws in our financial system, but it would address a few consumer affronts cleanly and effectively:

· The government could ensure that customer information was correct, and not accept a 99% accuracy approach as acceptable

· The government could create a fair, transparent, and easy process for consumers wanting to raise disputes with existing data

The power the government would have from platform ownership would also present some unique opportunities for moving the industry toward inclusive business practices:

· The government could include alternate credit scoring data shown to correlate with lending outcomes. For example, low income Americans may not have a credit card history, but are more likely to have a utility bill history. Investing to include alternate data like this would support the broader industry in extending financial services to more Americans.

Although the ship has sailed on government management of credit scoring data, the current state of affairs in credit scoring is an important reminder of the benefits of foresight in platform ownership. As our government looks ahead, there will be again be opportunities for government management of platforms that will become foundational to citizen’s lives.