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Bankers Get A Big Surprise: People Without Money Can’t Pay Back Their Debts

Con­sumer lenders that out­source their credit deci­sions to con­sumer credit rat­ing agen­cies aren’t learn­ing from past mis­takes. By now lenders should have noticed that blind reliance on credit scores doesn’t work. Even so, most lenders con­tinue to dis­re­gard good under­writ­ing fun­da­men­tals and then can’t fig­ure out why they con­tinue to have bad credit per­for­mance. It’s almost tragic to watch bankers repeat the same mis­takes year after year.

As I have often writ­ten, con­sumer credit bureaus and credit scores can­not be blindly relied upon by banks to make credit deci­sions. They have sev­eral flaws including:

  • A lot of infor­ma­tion on con­sumer credit bureaus is wrong;
  • Even if the infor­ma­tion on credit bureaus was accu­rate, it presents an incom­plete pic­ture of the finan­cial health and abil­ity to pay bor­row­ers because credit bureaus tell lenders noth­ing about income, assets or fam­ily oblig­a­tions of borrowers;
  • Credit scores are cal­cu­lated in a “black box” envi­ron­ment with­out any way for con­sumers or banks to check their accu­racy; and
  • Credit scores are sup­posed to be an inde­pen­dent pre­dic­tive sta­tis­ti­cal indi­ca­tor but because they are used by employ­ers to make hir­ing deci­sions, which in turn affects the abil­ity of bor­row­ers to ser­vice their debts, credit scores have lost their sta­tis­ti­cal independence.

A bet­ter way for banks to under­write con­sumer credit would be to actu­ally take a look at the income, assets and lia­bil­i­ties of bor­row­ers and make an inde­pen­dent assess­ment of the abililty of con­sumers to pay their obligations.

About 10 days ago the Wall Street Jour­nal ran an arti­cle on con­sumer credit that con­tained a chart illus­trat­ing the incred­i­bly high cor­re­la­tion between annual house­hold income and mort­gage delin­quency rates. The Wall Street Jour­nal accu­rately pointed out the obvi­ous, i.e., peo­ple with low earn­ings have more trou­ble pay­ing their oblig­a­tions than peo­ple with high earn­ings. After all, low earn­ers usu­ally don’t have a lot of money and and it is money that is needed to pay back creditors.

Set forth below is the chart from the Wall Street Journal.

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Bank man­agers that lend to con­sumers based upon credit bureau infor­ma­tion need to be replaced by share­hold­ers.  Fam­ily income is a lot bet­ter indi­ca­tor of cred­it­wor­thi­ness but takes work and effort to ver­ify.  Credit bureau infor­ma­tion pro­vides lazy bankers the cover to say that they are doing their job when they actu­ally aren’t.   

If the bank­ing sys­tem is going to get back its mojo, bankers have got to pay atten­tion to com­mon sense basics of good under­writ­ing and try a lot harder to do a good job. Credit deci­sions based upon com­puter cal­cu­lated credit scores doesn’t count toward effort or com­mon sense. 

After the sur­prise that bor­row­ers need income to repay their debts I won­der if bankers will relearn the mys­tery of loan to value ratios?

Posted in: BANKS, Credit Crisis, economy, Finance, Politics, Public Policy

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