If the premise of the article is true, that people who should be getting credit are not, why can't we start a credit-extending company that does a better job of assessing risk?
One or more of three things must be true here. Either:
1) there is an untapped business opportunity here,
2) the premise of this article is false and the machine is working fine, or
3) there are regulatory barriers getting in the way of making the machine work well.
There is a great opportunity here, if you have unlimited funds and can hold your own loans. The problem is that nobody with the money wants to take this risk on themselves, so they need to securitize these debts. Securitization requires categorizing different loans into risk pools or tranches, which are only categorized by FICO score.
In other words, sure, if you've got $billions lying around and are willing to hold 30 year loans for their full term, feel free to start a business doing this. If you're like any other bank and you want to off-load it to Fannie/Freddy immediately or securitize them and sell them to hedge funds, you need to put a FICO score on every loan and that is the only thing anyone cares about.
It's obvious this is why our financial system is so screwed up. There are people with 800 credit scores that are upside down by hundreds of thousands of dollars, yet they can still get as much revolving credit as they want because of their credit scores. Then, there are people like me who have actual cash reserves in the tens of thousands and 0 debt, and refuse to hold revolving credit, who have sub-700 because we don't buy into the whole debt ponzi scheme. The system is broken and it will take a lot more than a new business model to fix it. It will literally take several acts of congress.
Instead of mortgages, if you focus on the payday loan industry ( particularly online ), you won't need $billions of dollars. You could hold your own loans and probably scale up from 6 figures.
The issues are pretty much the same as mortgage and there is alot of room for innovation.
Payday loan firms charge up to 500% interest, too, which they're doing because they're not using the FICA scores. That said, there does seem to be a huge area in which one could undercut that market...if they were willing to hold the debt.
While we're talking about holding the debt, you could drop into microloans in the kiva style, and start with only four figures.
Maybe hedge funds need to get into this business. Or maybe I should find a way to show hedge funds that my new risk assessment is better.
Though one of the challenges is getting new types of hard-to-fake data. If my risk assessment looks at a person's email account or does machine vision on their facebook photos, those things are easily forgable.
>Hedge funds did get in on it. That's why Goldman was sued for fraud.
Goldman wasn't sued because of what they offered as investments, they were sued because they misrepresented the net positions of at least one major player, allegedly deliberately.
Ah, but you're assuming that the only purpose of the credit score is to accurately determine risk. The other purpose, from the point of view of the lenders who support the credit score system, is to encourage people to borrow money, since the only way you can build up a high credit score is to keep borrowing money and paying it back.
I'd tend towards 2. Seems there are some issues danced around. They mentioned that there are other indicators of risk: the equity in your home, savings, job stability. All things that also reduce your actual need for credit. Lenders can take that stuff in to account, a mortgage broker might not but if they work closely with the underwriters then they will. You can also leverage your savings and put more down payment in. What's harder is to take folks with little or no savings, little or no credit history, potentially sketchy credit history, and a real need for credit and then determine their future loan repaying habits. Some times they've seen the light and repay on time, every time. Other times they don't. We're not talking about people with lots of money and we're not talking about folks with no money, it's the middle folks that have probably been late with some payments and maybe got themselves in to "trouble" a few times.
What would the other factors be that you'd measure them on to do better? Race? Religion? Education? I bet there are some algorithms that work better but they might be more messy. I bet if you looked at the credit history of a client's circle of 6 closest friends, the credit history of their parents, whether or not they were married, whether or not their circle of friends and families thought they were happily married and their attendance records at work and school and the last education level they had you could make some good predictions. I wouldn't be surprised if there were some religions that had better loan payers than others and some that had worse. I also wouldn't be completely surprised if there were races that tended to have better loan repayment habits and some that had worse, I'm fairly certain that it's true if you limit your samples to certain regions. I wouldn't be surprised if you could correlate a borrower's child being a good or poor student with the borrowers credit risk. I woulnd't be surprised if you could correlate the number of children had out of wedlock with credit risk. I don't know that'd we'd want large institutions using these kinds of factors to make lending decisions, we want it to be clinical, sterile, and somewhat blind which leads us back to something like the FICO score.
Now if they showed mortgage brokers gaming it, that might be a different matter, they're simply complaining about missing the cut-off. Trying buying groceries with just a couple dollars less than what the bill comes to..
Or why not come up with a competitor to the FICO score? Something like Mint already has all of my transactions, why not base a score off of the number of times that I have been paying my credit card, car payment, house payment, etc?
If another company can just verify that "Yes, this person has paid all of their promised debts on these specific accounts over the last X years and currently has Y amount of debt that we know of" I think that would solve a lot of the confusion with these scores.
I suspect it's a bit of all of these, but mostly 3. There are strong regulatory barriers to setting up new financial institutions -- which of course work in favour of incumbent institutions. The banking industry could do with a bit of disruption.
If the premise of the article is true, that people who should be getting credit are not, why can't we start a credit-extending company that does a better job of assessing risk?
One or more of three things must be true here. Either:
1) there is an untapped business opportunity here,
2) the premise of this article is false and the machine is working fine, or
3) there are regulatory barriers getting in the way of making the machine work well.