No company should have a monopoly on credit scoring

Promoting greater competition has been a key tenet of U.S. economic policy since the earliest days of the Republic. In 1951 the U.S. Supreme Court noted that the “The heart of our national economic policy long has been faith in the value of competition.”

Yet government policies to encourage more competition can only work if the new entrants don’t have a monopoly on one of the components used to make the final product. 

Take the case of VantageScore, a consumer credit-scoring model, created through a joint venture of the three major credit bureaus (Equifax, Experian, and TransUnion). VantageScore is currently being championed as an alternative to credit scoring models produced by the Fair Isaac Corporation, more commonly known as FICO.

{mosads}In fact, some members of Congress have drafted legislation that would encourage Fannie Mae and Freddie Mac to use alternative scoring models in place of FICO. Along those same lines, Federal Housing Finance Agency (FHFA) Director Mel Watt has stated that the agency is seriously considering allowing the government-sponsored enterprises to move beyond only using FICO credit scores, although he has acknowledged the decision is much more complicated than first thought.

Why is the decision to promote competition in the credit scoring model industry complicated? At first blush it would seem to make perfect sense. More competition could lead to lower costs for those who use the scores. Furthermore, it might increase the likelihood that some qualified individuals — who may not be approved for a loan under the criteria utilized by the FICO model — get access to credit.

The problem is not of course more competition. The credit scoring industry — and ultimately consumers — would benefit from more alternatives to FICO. This was discussed at an event I moderated this week in Washington, D.C. hosted by the Progressive Policy Institute.

The issue is the legislation to push for alternative scoring models may simply trade one dominant player (FICO) for another (Vantage).

The reason? Because the owners of Vantage control the supply of information currently used by FICO to make its determination. And given the history of monopolies, it would not be surprising to see Equifax, Experian, and TransUnion use that leverage to the advantage of Vantage, and eventually force FICO out of business.

At an August conference of the National Association of Real Estate Brokers, Director Watt argued that one of the issues complicating the decision on alternative credit scores was the question, “Does the credit repositories ownership of one of the credit score providers present implications for long-term competition in the credit scoring market?” The answer of course is yes.

The good news is there is a solution. Require the three credit agencies to sell their respective stakes in Vantage before going forward on changes to require alternative scoring models to be considered. Doing so would add a true alternative and ensure that neither FICO nor Vantage have an unfair advantage due to their relationship with the credit repositories.

It’s almost never a good thing for consumers when there are fewer choices about where to buy a product or a purchase a service. As any first year economics student will tell you, all things being equal, more competition should lead to lower prices. But sometimes policies to level the playing field and encourage more competition can actually do more harm than good — as is the case with the push to have Fannie Mae and Freddie Mac use alternative credit scoring models.

Paul Weinstein Jr. is a senior fellow at the Progressive Policy Institute and former White House policy adviser to President Clinton.