Sunday, July 24, 2016

A Really Bad Deal.... From A Stacked Deck! One For Dennis Moriarity and...

(... and Gregg Stockdale!)

Many financial institutions in the U.S. have in the past been
lured into practicing risk-based lending.  Some were just flat-out duped and fooled; while others - willing victims - really didn't mind playing the fool at all.  

Lot's of money can be made fleecing the poor with risk-based lending. "The empirical legitimacy" which misapplied mathematics provides the practice, makes the shearing of the sheep mere child's play - easy pickings!!  And generally, when given a choice between "good and gold"... well, you know how that usually comes out these days!

In risk-based lending, credit scores are used to establish a rate chart with members with lower scores paying higher rates. The statistically valid idea is that if lower credit scores create higher loan losses, then those members causing the losses should reasonably be charged for those higher losses. No problem with that.....
.... except that it's a lie.  
Let me show you clearly why.

See the five face-down cards below? There are 4 jacks and a queen in the hand.  All five represent regular working folks, who all have low credit scores of 580, which implies that 1 in 5 (20%) of these folks will default on their loan over the next 24 months..  All are, therefore, charged the highest ("E-paper") interest rate.  Let me help you with a surefire fact, out of the 5 cards - the queen is the card ( the 20%), the 1 in 5 which will default in the future.
Pick the Queen!
Your odds are 1 in 5.

Now just for the sake of argument, let's assume you used a bit more rational, fair and defensible method of determining the actual risk of the borrower, rather than just "eenie-meenie" or "pick a card".   

Imagine that you actually sat down with each applicant individually and went over their financial condition, asked for explanations of the credit blemishes, and listened to them honestly as fellow members and human beings. Through the face-to-face interview and additional information gleaned, here's what the five borrowers look like to you:
Pick the Queen!
Too simplistic you say!  No not really.... it works in real life.... if you want it to....

But lots of folks don't want it to work.  Why?  Because the four jacks, with that old bad queen gone, are now "statistically certain" to pay, won't cause a loss, and deserve a much better rate.  You won't be able to statistically discriminate against them any longer and there goes the business plan, there goes the "bottom line", there goes the bonus....

Risked-based lending is a statistically "stacked deck", a bad hand, an unfair deal, a falsified game of chance played ruthlessly and recklessly against good-hearted, member-borrowers....  

And you hold all the cards!

But wait a minute, just a minute, whose credit union is it anyway?


William Brooks said...

Years ago before credit unions adopted an uncertain statistically proven risk based pricing system, all members got the same rate. The Board then gave an interest refund to adjust for a positive loan payment experience.

Anonymous said...

I wish we could charge higher rates and then give rebates to those who repay. But, the Aces and Kings (A & B credit score members) won't pay that rate because of the lower risk based pricing available in the marketplace. So, we use risk based PRICING to reflect the relative risks associated with each different card type. That way all members have access to fair rates compared to the marketplace and the credit union can operated safely. The differential pricing is very narrow in the real estate lending arena but a little higher on signature and car loans because of the higher rates of default.
Georgia Birddog