Seeking to alleviate financial hardships on consumers, two bills; H.R. 6370 and S.3508, ‘‘Disaster Protection for Workers’ Credit Act of 2020’,’ have been introduced in Congress that amend the Fair Credit Reporting Act by placing a moratorium on reporting any “adverse information” regarding a consumer’s credit history during the COVID-19 crisis.
While well-intended, these legislative proposals, if enacted, would severely reduce the availability of credit to consumers in general. A credit reporting moratorium would disproportionately harm low-income and minority consumers with marginal credit already struggling to maintain access to credit due to market responses to this legislation.
Such legislation could also set a credit-constraining precedent for every other federally declared emergency in the future. Already this spring, the U.S. witnessed flood and tornado disasters, and a busier-than-normal hurricane season is predicted this year.
The possibility exists that the proposed legislation could set up an ongoing practice of forcing a moratorium on consumer credit reporting in the wake of a major disaster. Instead of helping impacted people recover from these events, it would have just the opposite effect by restricting their access to credit when they most need it.
Ensuring consumers have access to credit at a fair price has been a long-standing objective of policymakers. Credit availability is affected by the business cycle, which in turn is influenced by a host of factors such as the demand and supply for credit and external drivers including macroeconomic shocks or external events such as the coronavirus pandemic.
Periods of economic contraction, as witnessed during the 2008 financial crisis, typically result in a reduction in the supply of credit as lenders adapt to deteriorating market conditions reflected by higher losses on loan products and a reduction in consumer demand for loans. The COVID-19 pandemic has sparked a financial crisis that so far appears to be worse than 2008 and threatens the long-term financial well-being of millions of consumers across the United States. As the economy struggles to recover, access to credit for consumers will be a critical determinant of the speed, timing and trajectory of the economy’s return to health.
Most consumer loan products heavily rely on credit scores in the underwriting process for credit granting decisions. Credit scores have been proven to be one of the most statistically significant risk factors in determining the likelihood of borrower default over the years for most consumer loan products, as well as being an objective and consistent mechanism to screen borrowers for credit quality when compared to manual underwriting, which requires greater subjectivity to assess and compare borrower creditworthiness.
In the absence of reliable information on borrower credit history, economic theory suggests that credit rationing is an expected outcome. In a recent study I conducted on this issue, I demonstrate how a moratorium on credit reporting would reduce the information content of credit scores and thus artificially dilute the relationship of credit history and default.
Lenders would respond to such actions by adding an uncertainty premium in the form of requiring higher minimum credit scores for loan products, which would have the effect of lowering the supply of credit below that observed prior to the credit moratorium. Those consumers with marginal credit profiles would likely be pushed out of credit markets as a result, contrary to the very objective of the legislation.
At a macro level, a likely credit contraction following a credit reporting moratorium would further retard any presumed accelerated recovery of the economy at-large. Thus, a credit reporting moratorium is not an appropriate policy response to addressing consumer credit availability.
With forbearance policies in place for mortgages to alleviate a major financial stress point for many borrowers, consumers would be better served if, for example, funds in the CFPB’s $1.2 billion civil monetary penalty fund were used with appropriate oversight and guardrails to provide additional support to consumers in need of financial education and improve their understanding and management of personal credit.
If Congress really wants to help consumers during the pandemic it should follow the doctrine of our brave healthcare professionals; primum non nocere; first, do no harm and not enact a credit reporting moratorium.