A Whitewash of Creditor Practices

Jeff at Credit/Debt Recovery thinks the Federal Reserve study of creditor behavior mandated by the Bankruptcy “Reform” law that took effect last year, specifically whether they’ll lend to anyone who has a pulse and not necessarily the ability to repay, was, in essence, a whitewash (my word).

I have to agree.

Here’s the hysterical punch line from Page 3 of the actual study (PDF):

Currently, the principal means of solicitation is direct mail, the bulk of which is guided by careful prescreening of potential recipients regarding their financial condition and history.”

I guess the “careful prescreening” explains why direct mail credit card solicitations, as reported by CardTrak, increased to an alltime off-the-charts record of over 6 billion in 2005 — more than 40% higher than in 2003:

Now it may very well be, as the study claims, that the actual approval standards for those who respond to these offers and apply for credit are sound — in other words, that those who really can’t handle another credit line don’t get one (I have reasons but not proof for doubting this, which I’ll get to).

But this claim misses a huge point, which is the Money Tip of the Day, and is simply this: The credit scoring system penalizes you if you apply for credit too frequently. Literally, the more you apply for credit (after the first few in a roughly six-month period; they don’t tell us the exact impact), the lower your credit score will go, and the more likely it is you’ll get turned down for credit or have your existing credit lines trimmed.

The tidal wave of mail offers encourages those who don’t know better to keep applying, which only increases their futility, and certainly in some cases causes them to take a look at really bad borrowing ideas (the consumer-finance sharks, title loans, and payday “advances”).

As to whether card industry approval practices are actually permissive to the point that they encourage consumers to get further into debt, two points:

1. The card issuers are in many cases owned by the same banks who have, with their “creative” products and the encouragement of mortgage security giants Fannie Mae and Freddie Mac, lowered approval standards for conventional and subprime mortgage loans to the point where almost anyone who can fog a mirror can get a deal. Why should we believe that standards haven’t been similarly lowered in the card business?
2. I know this won’t apply to everyone, but many readers should ask themselves these questions:
   – What is the total of all available credit lines on my cards?
   – If I maxed every one out, could I afford to pay them back?
   – If lending standard are supposedly so rigorous, how has this been allowed to happen?

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UPDATE: Others aren’t pleased with the Fed whitewash, either. I’m not normally inclined to be in the same camp as the Consumer Federation of America, which publishes Consumer Reports and leans heavily left, but something is out of whack when lenders grant credit to the point where, according to Fed data, “27% of the lowest-income U.S. households that carry consumer debt, such as mortgage and credit card balances, paid more than 40% of their income toward this debt in 2004.” Since the “income” is a pre-tax number, that means families in this position need to make the remaining 40% or so of income cover everything else — a tall order indeed.