April 21, 2004

Issues with 'Credit Scoring' Presentation

Birny Birnbaum discussed the use of credit reports for purposes other than lending you money. Birnbaum suggests that we all know that banks are out to make money—He views this reality as being discriminatory against the low income and minority consumers and the young.

But how else do we propose that financial institutions manage risk? These factors have a track record for predicting the credit risk that individuals represents. Brinbaum equates these “biased” factors with de facto racial discrimination. It is true that these factors certainly present economic status discrimination and to the extent that economic status correlates with race and ethnicity, discrimination is indeed present, but this is a collateral effect.

It is unclear whether Birnbaum has any data to support a proposition that these factors are not predictive of risk—he suggests that financial responsible behavior would be a better measure. Accepting this proposition on this face, he does not suggest how to collect information on financial responsibility—would we need more information on consumers—how would that advance the goal of increasing privacy…would we not be advocating for even more intrusive data mining.

On the opposite side of spectrum, does Brinbaum suggest that we provide credit without assessing risk—should our society spread the cost of this risk…should the financially responsible subsidize the activities of the financially irresponsible?

If I am a safe driver, do I not feel entitled to paying less for my insurance, if I engage in risky behavior, should I not pay more for my insurance. It is acceded that the underlying premise of insurance on some level is risk spreading—maybe we need to revisit the concept of whether we should enforce non-differentiated insurance. But are we, the careful and risk averse, truly willing to subsidize the activities of the risk takers?

Insurance has long been recognized as the paradigmatic example of adverse selection—those who most fear the consequences of an accident or who are not judgment proof are the ones who most want insurance, they are also, arguably, the most careful.

Posted by amalie at April 21, 2004 11:00 AM
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