How to fix credit scoring

For many Americans, their credit score looms large over their lives. The strength of it can decide whether they're offered a loan to purchase a car, buy a house, get an education, or start a business. Increasingly, it even determines whether people can get a job at all. In short, the credit score is often the gateway Americans must pass through to participate in the economy in the first place.

And the most vulnerable Americans are the ones who most often get locked out: About 19 percent of U.S. adults either have no credit score or have records that are considered "unscorable." Among low-income Americans, that number rises to 46 percent, versus just 9 percent of upper-class Americans. So people in the former group have to turn to the predatory markets of payday lenders and pawnshops instead. "They're caught in the credit catch-22," Michael Turner, the president of the Policy and Economic Research Council, told Gillian B. White in The Atlantic. "In order to qualify for credit you have to have already had credit."

White's article is a good rundown of how credit scores could be reformed. But to really understand the problem, we should step back and reconsider the basic role of credit scores.

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That role is all about the data that markets need to function. When we search for a restaurant, peruse a shoe store, or type "best HD TV" into Google, we're looking for the information to help us make the best purchase. This is no less true of the private businesses that make loans: They need information about the people they're lending to.

But information isn't just there. We have to put in enormous work to collect information and make it available. For consumers, all sorts of services and websites and companies have sprung up that offer reviews on everything under the sun — including the credit reporting agencies that put together credit scores.

This is where things get complicated. Since information is itself a commodity, it creates a bit of paradox: It's a commodity that gives us access to the markets where we buy and sell commodities. In that sense credit scores are not so different from roads or railways or electrical grids.

What does that mean in practice?

First off, if credit reports are a commodity, who's the customer? You'd think it would be Americans themselves, given how consequential credit scores are in their lives. But that's not quite right.

Ordinary consumers might pay the credit reporting agencies for services, but the agencies' main customers are the banks and private financial businesses that do the lending. So it's largely irrelevant if the way that credit scores function screws over huge numbers of people. As long as the big customers are happy, the business model will putter along just fine.

There might be ways to solve this. Turner and others advocate for something called "full-file credit reporting." Basically, Congress would pass regulatory changes that force the credit reporting agencies to use a lot more information when assessing people's scores: utility payments, rent payments, etc. Right now those things don't affect your credit score unless they include something really dramatic. Including them would allow more people to build credit histories by just living everyday life, as opposed to making big purchases or loans.

Critics do worry the flood of new information could make poorer Americans even worse off. But White's impression is that most researchers think the potential upside benefits outweigh the downside risks.

There's another problem, though, one that's becoming a very big issue across the economy: monopoly. If the market for a commodity becomes dominated by one company, or a small number of companies, they can descend into dysfunction without facing any consequences. Only three companies — Experian, Equifax and Transunion — do almost all the credit scores in America. All three have been sued by both individuals and the government for misleading marketing and deceiving consumers about their scores. As White noted, Americans are terrified of credit reporting agencies because there's no where else to turn.

There's one last, more radical solution, proposed by people like Darrick Hamilton, an economist at the New School: Just have the government provide credit scores.

This wouldn't solve the monopoly problem, per se, but it would solve the accountability one. If people were unhappy with how a government agency did the credit scoring, they could force it to change through activism, elections, and democratic pressure. And because government credit scoring wouldn't be done for profit to please big finance, it could serve all Americans equitably.

Turner doesn't think much of that idea: A government credit scoring agency would be much less likely to innovate, to build relationships with lenders, to adapt to the needs of the marketplace, and so forth. But so what? Like roads and railways and electrical grids, credit scores are essentially a public good: A resource that needs to be in place and universally accessible in order for markets to function. Asking the private sector to figure out credit scores means the process is far too biased in favor of lenders already. What ordinary Americans need from their credit scores is pretty straightforward. Losing the nimbleness and innovation associated with privatization is probably a trade most people would happily take to be treated more equitably in their credit history.

Ultimately the problems with credit scores originate with that initial paradox: that the information in credit scores is itself a commodity. The cleanest way to resolve the paradox might be to just de-commodify it.