12 March 2010

Don't blame the actuarial messenger

The Atlantic | Megan McArdle | What Happens if You Close a Credit Card?

One of the repeated cri-de-coeurs about the various changes banks have been making in their credit cards is that they have a negative impact on credit scores. Slashing limits means that your balances are now a higher percentage of your overall credit, which hurts your score. So does closing one of your older accounts.
I had a conversation a couple of weeks ago about this with my generally-level-headed mother, who has more than a fair bit of financial and business savvy. She thought that credit agencies "just shouldn't do that." She couldn't really articulate why not, but it seemed to be some version of it not being "nice" or "right" or "fair." (In her defense, she quickly realized she wasn't being very rational about this.)  She seemed to view the knock on your FICO score as a punishment that credit agencies were handing out for a behavior they disapproved of.

So let me tell you the same thing I told her: that's not how it works. Fair Isaac isn't your teacher or your parent trying to scold you into the behavior it prefers. It's a company that implements statistical models to tell other people who don't know you how likely you are to pay your debts to them. People who cancel credit cards are less likely to pay their debts in the future. That's the statistical reality we live in.  Don't blame FICO, blame the people who canceled their cards and then reneged on their debts.

The bigger problem that McArdle hints at is that a fairly small ding on your FICO score can push you under one of the important thresholds for mortgage rates. But the problem isn't the dip your score took, it's that people use simple thresholds to make those decisions.

It's one thing when the movie theater makes anyone 59 years & 364 days old pay $12 and anyone 60 years and over pay $9. Thresholds are valuable when convenience is paramount. But businesses executives, and the regulators and legislators they tailor their practices to conform to, should be extremely reluctant craft rules with Heaviside functions.  It's sloppy and typically innumerate.

No comments:

Post a Comment