I thank the people at Credit Slips for asking me to guest blog this week.  It has been a great sounding board.  I want to close by highlighting a part of Charging Ahead about which I am not at all sure: my praise of the American credit reporting system.  As I explain there, you can say that our credit reporting system works well compared to systems in most other countries because it is private, centralized, voluntary and technologically advanced.

But as lending decisions become ever more standardized, I wonder if the incentives to game the process are starting to undermine it.  In particular, increasingly the hot-button disputes about credit reporting are not the inevitable problems about the hassle of correcting unintentional errors.  Rather, what we now see is a set of problems that relate to whether the system is sufficiently complete.  For example, Capitol One and Target want to keep the information about their credit limits private, because disclosing that information would make it easier for other lenders to poach their customers.  Credit card issuers in general have pressed the national bureaus to ignore available information about bankruptcy discharges.  As far as I can tell, most of the strategies move in one way — keeping "positive" information out of the system to make credit scores lower.

The natural response of many consumer groups, of course, is to try to force more information into the system.  But there are serious costs to an unbounded drive to gather all information into the credit reporting system.  In general, the added information is going to make it easier for lenders to identify and serve riskier sections of the market.  There also are serious privacy concerns, and not just for people of Euro-centric sensibilities.  Here, as in insurance rate-setting, do we really want a system with complete information?  Should the interest rate on my mortgage depend on the grocery store at which I shop?  The items I buy when I go there?

On the flip side, the recent growth of fringe lenders suggests that increased access to this information presents some real value to the lower middle class.  If the credit bureaus had as much information about those people as they have about the swath of the middle class that has a dozen credit cards and two mortgages per household, the rates charge in the markets in which those people borrow well might fall significantly from the levels that are so easily challenged as "unconscionable."

I don’t yet have a good answer to this.  Banking groups oppose regulatory intervention, claiming that smaller lenders will drop out of the system.  And our voluntary system obviously would be undermined if a significant group of lenders dropped out.  Still, I can’t accept the idea that lenders’ incentives are properly aligned with those of borrowers, so I question whether lenders should be allowed to decide what and how much to report.  Farewell!

Payday borrowing by the military has been a hot topic since an August 2006 DoD report estimated that as many as 17% of military personnel use payday loans.  But the spin surrounding this report has missed some troubling points.

First, I do not find it useful to accuse payday lenders of "targeting" military families by responding to demographics.  Military personnel always have been ideal customers for check-cashers.  They have relatively low salaries, and thus are persistently cash-poor.  They are unlikely to be laid off or to have their payroll checks late or dishonored.  So, it should surprise nobody that check-cashing stores, and the payday lending stores that have grown out of them, appear near military bases.  We might just as well say that bars "target" college students because they proliferate near the campuses that house their most profitable customers.  If there is a link between financial distress and payday lending, it affects both civilian and military populations.  And, I haven’t seen any evidence that military personnel are more susceptible to cognitive biases than the immigrants and other low-income civilians who routinely use these products.

Second, the report does not acknowledge a more significant disparity between civilian and military personnel — that the credit reporting system disadvantages those who do not own homes.  Because the credit bureaus collect very little information about non-mortgage expenses, they assign lower credit scores to families that make regular rent and utility payments, but not mortgage payments.  {Some make similar claims about payday transactions, but access to this data would only identify payday loan borrowers as potential customers for other subprime and fringe products.}  Unfortunately, the unstable location of military families makes them more likely to rent and less likely to own than similarly situated civilian families.  So military families as a group will have a harder time gaining access to intermediate and long term credit products.  In general, then, they will be more likely to use short-term products like payday loans.

What can be done?  The FTC’s plan to increase the reporting of rent and utility information is a start, but DoD’s responses are less useful.  The military would take away the product that the military personnel are using without either addressing the conditions that make the product attractive or facilitating a more reasonably priced alternative.  While a well-designed rollover ban would limit reliance on payday loans for intermediate credit needs, the 36% rate caps will make the national chains inaccessible to military families.  If enacted, we could expect to see those families depending more heavily on subprime credit cards, pawn shops, rent to own providers, and unlicensed payday lenders, all which in the long run will be worse for those families than the prohibited payday loans.

I understand that the military (as a large employer) has a real need to control the spending and borrowing activities of its employees.  But financial distress is not limited to the military.  Congress should view the military as an illustration of a general problem, not as a special case of activity that in other settings is benign.  As Jim Hawkins and I explain in a working paper, the policy issues are complex and deserve thoughtful consideration.