Wednesday, February 04, 2009

Credit Bias

I'm in the market for a house. I'm resolved to not incur unsecured debt in any form, intent on saving money for the rainy day or the house that I want - or both. Is this the right way to go? Common sense would say "yes". But conventional wisdom says "no".

There is some anecdotal evidence to support this contention. I've heard a few stories that go something like this: I know this guy see, he pays cash for everything and has no debt. He works as an employee and he's saved up enough for a down payment on a house. But he doesn't have a credit history, so he couldn't qualify for a loan - any loan. He had otherwise sterling credentials, but since he never borrowed money, he was an unknown credit risk and didn't present the possibility for a profit for a lending institution. Can you say "FICO"?

So I've been talking to loan agents to see what I could qualify for in terms of a loan for a house. And what I've learned is that, essentially, unless we're willing to pay the banker interest, we cannot build a good credit score.

Never mind that I pay my bills on time. Never mind that I keep a prudent reserve. No, good behavior doesn't count unless it pays interest.

What were those economists and policy wonks saying again? "We need to get the banks to loan money again." Do you think if we had money in savings, that the banks would have money to loan?

There are huge systemic problems in our economy, and this is one of them: the need to use debt financing to generate profit. I used to work retail. How that happened when my trade is IT? I decided to do it just as an experiment to see if I could do sales. It was in an upscale home improvement store that was a subsidiary of a much larger corporation.

When I started there, I had to go through training. The training had a strong emphasis on the requirement to ask every single customer the following question: Would you like to put that on your (name of company here) credit card? And the follow up, "Oh, you don't have one? Would you like to open one? It will only take a few minutes."

The reason for this is that the company I worked for relied upon debt financing to make up for the low margins on the products they sold. The numbers were rather startling. For every $100 sold, they would earn $1-2 if paid in cash, $2-3 if paid by a third party credit card, and up to $8 by a company issued credit card.

The widespread use of credit cards has transformed capitalism in the US. Remember the traditional method of making a profit? (Maybe you don't because you can only read about it in history books.) You know, buy supply, or manufacture and deliver products efficiently at a cost below the sales price of your product? Instead, multinational corporations buy a huge amount of inventory to sell at a very low margin on their own lines of credit, usually in the form of commercial paper. Then they sell that inventory to their customers with a higher rate of finance. It seems that the art of selling a product for a profit is almost completely lost on the ability to use financing as a means of increasing or sustaining margins.

Or maybe that's a sign of globalization. If we can't compete domestically with imported goods, then it's a race to the bottom on price with debt maintenance payments creating the margins necessary to sustain the business.

Setting that aside, here's an interesting question: why isn't financial behavior, like paying the bills on time reported and/or given the same weight as making payments on a line of credit? Probably because the money isn't there, there's no incentive if you're not paying debt maintenance charges - you know, like interest. Which means that unless you get into debt, you can't get the credit rating needed to qualify for a home loan at a reasonable rate based on your perceived risk to the bank.

We've all heard about the meltdown and the Federal Government's effort to help out. Most of the help has strings attached. Some bank officials are worried that the compensation caps required by acceptance of this help would prevent banks from attracting real talent. With thinking like that, I'd hate to think of what real talent could do to the country.

I guess they're not that worried now. It seems that the major credit rating agencies want to be lenient on AIG. They're worried that if the rating cuts for AIG are too big, then AIG will have to put up a lot more collateral and pay a lot more in financing costs. It's nice to see how members of the financial industry can be so helpful to each other. What about the rest of us? When was the last time your health insurer gave you a break? Or your bank?

There is also the question of lobbying. The bank and finance committees in both houses took in well over $26 million in campaign finance contributions last year. Nice. So, really, what the banks want is firm control over the economy:

  • You don't get a credit history unless you borrow money and pay interest.
  • If banks make a mistake, taxpayers get to pay for or assume the risk for it, while executives get bonuses.
  • Banks can use interest rates to manage the economy in their favor.

Basically, what we're looking at is the top of the kleptocracy created by the banks. They get to sit on their bum and collect principal with interest while the rest of us work for our money.

It's clear to me at this point that public policy must change with regard to standards used for assessing risk for secured loans, such as for a home. A person or company that seeks to borrow money for a secured loan is a far lower risk than for an unsecured loan. Yet, the measurements used to assess the risks rely almost completely on the record of payments for unsecured loans, usually credit cards. In other words, you have to start with unsecured credit first before you can qualify for the really big stuff like cars and houses, which are used as collateral in a loan.

This is so totally wrong. The weight of emphasis should be on payment of day to day bills, not payments on credit cards. We need to reverse the emphasis and place it on paying the bills on time and saving money as the basis for assessing the risk for secured debts like houses or cars.

This just in: Now Experian doesn't want you to get access to your credit score. It's bad enough that we have to pay for our own information (if we want it more than once a year), collected by agencies that will sell the same information to other companies. But it could get to the point where ordinary people cannot get access to their credit files. Gone is the time where you could dispute information on Experian's files because you can no longer see it. Seems like I should be paid everytime my information is disclosed to someone.

I want to leave you with one last thing. This is courtesy of NPR. Go to this page and you will see a chart. Here, we see the comparison of Debt vs GDP. There are only two years in the last century to date that debt was 100% of GDP: 2007 and 1929. Can you sense the sea change?
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