Tuesday, May 25, 2010

The Fairness Doctrine

For many years I traveled every spring to Washington DC to participate in a grassroots lobby with the National Association of Mortgage Brokers. Before our lobby day came, during which we went up to the Capitol and petitioned our lawmakers about the issues near and dear to us, we sat through a two day conference planned by the leaders of our association, who scheduled training sessions, speeches by various politicians and agency directors, and normally a panel of consumer advocacy attorneys. The panels with the consumer advocates were always the liveliest and most contentious events of the sessions, since the attorneys representing the consumer groups made no attempt to conceal their contempt for us as vile and vulgar capitalist pigs who made our livings by loaning money. (One attorney from such a group drew the wrath of everyone in the room when she cooed condescendingly to us, "I suppose that all of you people here consider yourselves to be professionals.")

On one such occasion we were sitting in a crowded room with a panel of consumer advocates, when one of the female attorneys who was giving us her perspective of how the U.S. credit system should operate made the suggestion, "Wouldn't it be great if everyone could have a 7% rate?" The men in the room (the male attendees way outnumbered the female attendees at conference and they were so loud that a woman could hardly get a word in) immediately shouted from all parts of the room that her suggestion was both impossible and ridiculous. Nonplussed, the attorney stood her ground and just kept raising the interest rate until finally she got to 15%. Wouldn't it be great if everybody could have a 15% interest rate? By now we were all stunned. And then she made her point, "It doesn't matter what the rate is, just as long as it is the same for everyone."

I read a comment recently about the now disgraced ACORN, that said incorrectly that ACORN believed that every person was entitled to a home. That actually is not true. ACORN, and the attorney in my story above, and many of other consumer advocates I met in Washington, did not really want or expect to see everyone in a home. But they were deeply opposed to the credit system in the United States which they perceived was discriminatory.

Enter the new Bureau of Consumer Financial Protection and the Office of Fair Lending and Equal Opportunity. The stated purpose of the Bureau of Consumer Financial Protection is to "implement, and where applicable, enforce Federal consumer law consistently for the purpose of ensuring that markets for consumer financial products and services are fair, transparent and competitive."

While this sounds great on the surface, we have to remember that the credit system in the United States is by its very nature unfair and discriminatory, and that is the reason it works. Now of course, we have Fair Housing and Equal Opportunity Laws which prohibit discrimination against a person on the basis of race, religion, national origin, family status, and sexual orientation and these laws are rightly in place to allow every race, creed, religion, etc. a potential place at the table as homeowners. But beyond these protected classes, the system is a risk based one which discriminates heavily in favor of certain behaviors and lifestyles and against others. Without this discrimination--this risk based analysis of a person's situation--we could not have the credit and mortgage system we have today.

For example, take credit scores. Credit scores were developed in the late 1990's as a means for assigning a numerical value to person's credit history. The credit score enabled automated underwriting systems and opened up credit access at low rates for many Americans by allowing the development of a risk based program of lending which permitted the lender to use a high credit score to compensate for other factors lacking in the file--such as very little downpayment or very little savings. The credit scoring system in the U.S. is unique to us. I attended a workshop given by the FTC while at our legislative conference one year, and they explained to us that most other countries do not have a means of reporting both good and bad credit. For instance at the time that I attended this workshop(which was about 7 years ago) Australia did not have a system for reporting positive credit. The Australian system reported only negative credit, so if you had a credit report in Australia, and you charged off one item, but paid the rest of your credit perfectly, the credit report would show only the negative item and ignore all of the accounts you paid on time. Only the U.S. had a credit system which reflected all of the accounts which you had paid on time, the accounts which were not paid on time, how many open accounts you had, how much total debt was reporting, and used all of this information to formulate a score to determine your credit worthiness.

This system has allowed for a huge growth in access to credit at great terms and low rates, but it is completely discriminatory. A person with a low score is going to receive less favorable terms than a person with a high score. Ironically, since the federal government took Fannie Mae and Freddie Mac into conservatorship, Fannie and Freddie have changed their interest rate offerings to make them score based. A few years ago, if you got an approval through Fannie Mae, you got the same interest rate as any other person who also had the approval, regardless of your score. Today, a person with a 620 credit score will receive a much higher interest rate than a person with a 750 score on a thirty year fixed rate mortgage because of price adjustments for individuals with lower scores. To me, that seems unfair because I remember the system that was in place until very recently. I have talked to many deeply disappointed borrowers who cannot get a 4.875% interest rate on a thirty year mortgage because even though their credit profile is good, their score is too low. Only those with a 740 and above receive the best rates.

The system discriminates in other ways. It favors the salaried over the self-employed. It favors those who save money over those who spend everything they get their hands on. It favors the frugal who work to keep their debt down over those who are maxed out on their credit cards. To the consumer advocates in Washington, this is unfair because everyone should have the same rate, no matter how high that rate has to be. The only way to accomplish this is to either charge everyone a 15% rate, or to use tax dollars to subsidize a 7% rate for those who do not qualify for it. In the first solution, all homeowners are paying to make everything equitable and in the second solution, all taxpayers are paying to make everything equitable. But the government has effectively removed any personal incentive to correct whatever situations exist that cause this individual to be a poor credit risk.

Trying to make the credit system in this country fair is like trying to make life fair--it is just not workable. Experience teaches that most of us do not really want our situation to be fair; we want it to be advantageous. For instance, we may believe that life has been unfair to us if we compare ourselves to our brother who was accepted into Harvard, became a successful neurosurgeon and now has a booming private practice and a summer home in Italy. But we will seldom complain that life is unfair when comparing our situation to that of our sister who dropped out of school at sixteen and now works nights at a convenience store. In the first example, we may spend our lives grumbling that "Fred always got all the breaks," but in the second example we will congratulate ourselves that we were more responsible than Sally. If someone told us that they would magically make our position equal to that of our sibling, we would be busy picking out the curtains for our new summer home if we could be made equal to Fred, but we would protest loudly if we were to suddenly be made equal to Sally.

Our credit system rewards good behaviors, responsible choices, and in some cases good fortune. The system will be kind to the twenty-eight year old woman with the 770 credit score who has never really worked a full day in her life, but holds a great position with her father's company who pays her an excellent salary which he direct deposits into her bank account. Nobody stands behind her as she closes on her $300,000 house with gift money from her parents as a downpayment and says, "Don't give her that loan. Yes she qualifies for it, but only because of her parents and the breaks she had in life."

Likewise, the credit system does not see the life story of the small business owner who never took a vacation or a sick day, paid all of his taxes and was kind to his neighbors, but lost his business during the recession and has seen his house go into foreclosure. The credit system will not differentiate between his plight and that of the compulsive gambler who was foreclosed on because he took the last three months of mortgage payments to place a bet on a "sure thing" at the race track. The system is impersonal, mercilous, and unfair.

However, our system also has built into it a reset button that allows our mistakes to fall off of our credit reports automatically after seven years. The person who has suffered through tragedy through no fault of his own and the chronically irresponsible person who has refused to honor any of his contracts are both afforded this same privilege. This small dispensation of grace means that for each of us, no matter who we are, what we have done, or what has been done to us, we have the ability to make a fresh start if we are willing to change. Come to think of it, that is not fair either, but it is certainly advantageous.

1 comment:

  1. The parts of this article that talks about 'systems,' that is, 'how things work' is very well presented. It is when the subject turns to what is 'fair' that I believe Ms. Swann has gone astray.

    Although she does not define the word and thus can use it to mean whatever she wants it to, most of us use it to mean something like 'equal opportunity to use our strengths and assets by the same rules as others.' Her use of 'fair' drifts glaringly toward the favored use by the Left meaning 'equal outcome regardless of effort or labor on one's own behalf.'

    Just think a minute about 'fairness' in the context of a mortgage applicant who has suffered, through no fault of their own, but who does not 'qualify' for a loan under the systems Ms. Swann describes. She implies that it would somehow be 'fair' for that person to be given a loan because they are 'a good person.' But how fair is that to the investors who subsequently lose their investment because the 'good person' can't pay the mortgage and defaults on the loan.

    Don't go to the old 'they're so rich they'll never miss it' routine. The discussion is not about how rich someone is or isn't but about fairness.