Joe Nocera has an article in today’s NY Times. A mortgage broker called him to complain about credit scores and how they are hurting more than helping. It’s a good article and it pretty much sums up my issues with the whole credit scoring industry.

A FICO score, he patiently explained, is merely a tool that lenders use to help manage their risk; criticizing it is akin to criticizing “a saw because the construction job turned out badly.” With big banks making thousands of credit decisions every day, they couldn’t possible do it without some standardized benchmark; a credit score provided that benchmark. Over the years, he added, the algorithm had gotten very good at predicting the odds of a borrower defaulting.

In fact, FICO scores are not the best predictor. The amount of equity a person has in his home, his debt-to-income ratio, his job stability and his cash reserves are all better predictors than credit scores, according to Dave Zitting, the chief executive of Primary Residential Mortgage, a leading mortgage lender. And yet, he said, “The credit score has become the line in the sand for the banks.”

So even though a credit score is not the best way to predict how people will be with loans, the lending industry doesn’t care.

And that doesn’t even get into the question of whether the prospective borrower is someone who once had credit problems and has now cleaned up his act — and his score is improving — or someone whose credit is in decline.

It’s a great point. You can have 2 people with the same score and yet be in completely different phases of life. They can have completely different jobs and opportunities but because they have the same score they are treated the same. This is a large downside to the credit scoring industry.

In the old days, you would be a customer of a bank. The bank would know how things are with you. They would work with you on your bank business. They would be able to tell whether or not you were are good credit risk or not. The credit scoring, wrongly, gives lenders the ability to say, hey, this score means X. In reality, it may or may not. But because they’re able to sell of their loan they don’t care.

It’s a bad way to do business and it’s also a large part of the reason that we have the subprime problem. If bankers actually knew their customers, they would know whether or not they were good credit risks regardless of any credit score. Yes it would take a lot more work on the part of banks. But, since banks supposedly have risk management groups, you’d think they would be all for this sort of risk mitigation. But they aren’t because they just sell the loans to the federal government.

It’s a good article by Joe and you really should read the rest of it. It neatly sums up my problems with credit scoring and one of the problems with modern finance in America.