Congress faces critical decision about consumer credit legislation - the Fair Credit Reporting Act of 1970 and 1996 - Forum On Emerging Issues

Business Economics, July, 2003 by Joseph W. Duncan

Consumers have been the one bright spot in an otherwise sluggish American economy. Much of their ability to drive economic growth stems from relatively broad access to affordable credit. Growth in the availability of credit is a result of sophisticated risk modeling techniques that, in turn, rely heavily on access to robust data contained in the national full-file credit reporting system. One law--the Fair Credit Reporting Act (FCRA)--has largely governed this system of data exchange since 1970. The preemptive status of the single amendment to this law--the inclusion of strengthened consumer protections in 1996--expires at the end of the year and is currently the subject of substantial attention from both federal and state lawmakers.

This article presents the findings of a recent study (Turner, 2003) designed to quantify the likely consequences of a failure to reauthorize the FCRA) strengthened preemptive provisions. Using existing state legislative proposals, it models the impact on the predictive power of commercial scoring models as well as credit card models from a variety of data restrictions. Further, the subsequent impact on both access to credit, and the price of credit are measured and appended with socio-demographic data. Finally, this article reports findings from an analysis of restrictions on two uses of credit scores-prescreened offers of credit and automated underwriting of consumer mortgage loans.

In 1968 Congress began hearings to regulate the use of personal information in the analysis of personal credit. The result of this inquiry was the enactment of the Fair Credit Reporting Act of 1970.

Since its enactment, the FCRA appears to have successfully addressed the concerns of consumers by providing a relatively uniform federal standard for ensuring the accuracy and security of the information contained in credit reports. Changes in 1996--largely directed at strengthening recourse for consumers--improved the Act substantially. Any attempts to modify this regulatory regime should be subject to rigorous scrutiny in light of the performance of the market for consumer credit over the last three decades, and the success of the Act in protecting the concerns of consumers. This issue is of key interest to business economists since the role of consumer credit has emerged as a crucial factor in the U.S. economy.

In this brief article we will review the role of consumer credit in the 2003 U.S. economy, including considerations such as the rise of credit scoring and the need for standards in credit information. Next, we will present a brief summary of the FCRA, including the characteristics of a full-file data system. Then we will outline the research approach of the Information Policy Institute as it developed models and analysis techniques to evaluate the impact of changes to the existing conditions of the FCRA. The empirical results of the research are summarized in this article but the full results are available in the report issued by the National Chamber Foundation of the U.S. Chamber of Commerce (Turner, 2003).

This article briefly reviews the issues of privacy and identity theft, which are often associated with the issue of reauthorizing the preemptions that are central to the current FCRA. Finally, we comment on the implications of Congressional action.

The Chairman of the Federal Reserve System, Alan Greenspan, recently emphasized the importance of this issue. At the House Financial Services hearing on April 30, 2003, a hearing on U.S. Monetary and Public Policy, he made the following points:

* The complexity and sophistication of modern credit markets makes it impossible for individual lenders to efficiently evaluate individual borrowers based on personal knowledge.

* Without the ability to rely on continuously updated credit evaluation systems based on shared information, it will be difficult to maintain current levels of credit availability.

* It is in consumers' interests to have credit information flowing in order to reduce uncertainty and keep interest rates low.

The Fair Credit Reporting Act in Context

The Maturation Of Consumer Credit And The FCRA

Consumer credit is vital to the modern American economy. People use credit to acquire goods and services, acquire assets that hold value (notably, autos and houses), and invest in income-generating possessions (especially, education). It smoothes consumption during cyclic periods of unemployment and reduces the effects of swings in the business cycle, thereby maintaining demand in the market. An efficient consumer credit market also smoothes consumption over the life-cycles of borrowers. For new small businesses, revolving consumer credit provides financial resources for entrepreneurial activity when business loans are more difficult to obtain.

By most accounts, the consumer credit marketplace in the United States is the envy of the world. In just thirty years, balkanized local credit card markets, characterized by high and largely undifferentiated prices on credit, very subjective application processes, and limited access, have evolved into a national consumer credit marketplace distinguished by dynamic competition among lenders and broad participation by most American consumers.