Once Again, We Are Unlearning the Lesson of the Great Debt Bubble


Is this good news?

Millions of Americans unable to obtain credit cards, mortgages and auto loans from banks will receive a boost with the launch of a new credit score aimed at consumers regarded as too risky by lenders.

Here’s more:

The new score is largely a response to banks’ desire to boost lending volumes by increasing loan originations to borrowers who otherwise wouldn’t qualify, many of whom tend to be charged more for loans….The new score, which isn’t yet named, will be calculated based on consumers’ payment history with their cable, cellphone, electric and gas bills, as well as how often they change addresses and other factors.

….The new score could help applicants who don’t use credit often but are responsible with their monthly payments to get approved for financing….But many borrowers who don’t have a traditional FICO score are very risky.

….Besides increasing their pool of borrowers and loan originations, banks stand to earn more in interest revenue from riskier borrowers. Lenders charge higher interest rates and in some cases extra fees to borrowers who present a higher risk of falling behind on debt payments.

Color me deeply skeptical. Helping people who are denied credit simply because they don’t currently use any credit sounds great. And assessing them by their reliability in paying normal monthly bills sounds perfectly reasonable.

But I very much doubt this is really the target of this initiative. After all, people with no previous credit history already have access to credit. They just have to start slowly, with low credit limits and so forth. This new scoring system probably won’t change that.

What it will do is give banks an excuse to extend high-cost credit to risky borrowers—exactly the same thing they did during the housing bubble. As you may recall, that didn’t turn out well, and there was a simple reason: risky borrowers are risky for a reason. When banks start to get too loose with their lending standards they end up dealing with default rates much higher than they expected.

This won’t happen right away, of course. Banks will be relatively cautious at first. They always are. But just wait a few years and it will be a different story. Then the standards will be lowered just a little too far, the rocket scientists will do their thing, and we’ll be headed toward yet another debt crisis.

This is almost certainly a bad idea. We’d all like to see everyone get a chance, but there are good reasons to restrict credit to borrowers who are likely to repay. We should remember that.

UPDATE: Megan McArdle has a different take here. I’m skeptical, but it’s worth reading.