I love actuaries. So it is not really fair to blame them for supplying banks and federal regulators with the intellectual underpinning to create the biggest financial crisis in living American memory.
I am, of course, talking about how tens of thousands of small business owners with long and successful track records are going out of business because they cannot get a simple business loan from their neighborhood banker.
It is all about the credit score: The now four-year long Great Recession has not only hammered credit scores, it has caused banking regulators to raise lending standards and shot down our most important source of growth and new jobs.
As much as I love actuaries, we have to be careful how we use them. Their profession is great at supplying us with answers -- often to the wrong questions. Ask an actuary what the chances are of a particular borrower repaying a particular loan, and they give you a credit score. Today, depending on this one number, the borrower gets it. Or more likely, not.
But every loan has at least one other component the actuaries ignore: The lender.
In my hometown in Central New York, a small regional bank was acquired by a bigger bank, which in turn was acquired by an even bigger bank. Soon after, defaults on loans from the original bank rose by 40 percent.
We have seen AIG, Lehman Brothers and others collapse, seemingly without notice from the actuaries. They were not wrong. They just were not looking.
I'm not saying we should get rid of the actuaries and all their credit scoring tools. But we do have to recognize that credit scores are just that: tools. They were always meant to be just a part of the way banks lent -- and recovered -- their money.
Every day I see people with lousy credit scores that are far more credit worthy than someone with a credit score much higher.
At the company I co-founded, we write bonds and issue working capital for smaller contractors doing government work. A year ago, Joe, a painting contractor, applied for a bond.
A bond, of course, is how a government agency guarantees that if the contractor cannot finish a job, the bonding agency will. The bonding company then can turn around and recover the money from the contractor. So it is really a line of credit, not an insurance policy.
Joe's credit score was 432: A medical emergency depleted his family's $200,000 medical insurance, and creditors were calling his house every day.
But for the last ten years, Joe had paid on time every payment for his house, car, electricity, taxes, everything. We checked. We knew he could do the painting job on time and under budget so we issued him a bond and working capital.
Contrast that to someone with a credit score of 790 -- but who does not work and has their bills paid by another person. That person is one heart attack away from losing their ability to repay any loan.
After we issued Joe his bond and working capital, our job was just beginning: We received the checks from his client, we paid his vendors, his employees, his taxes. The biggest risk on any business loan of this kind is the contractor using the money from one job to pay expenses on another.
We manage that risk every day for government jobs around the country.
This is what bankers used to do before before federal regulators turned them into box-checkers with no discretion.
Federal bureaucrats imposed these credit-starving regulations. They can take them away. Today.
Just ask an actuary.
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David J. Dunn, PhD: Great Lent: What Fasting, South Park and Your Inner Toddler Have in Common
As a brand builder and business owner, access to capital is oxygen for a company to grow. Right now, the system is severely broken and there is very little activity focused on fixing it. This will continue to be an issue with rebounding the economy.
The first is trust.
Do we trust our loan manager to have good judgement and make the call that a risk is worth taking?
Do we trust the borrower to live up to the commitment entailed?
Does the borrower trust the Bank and the Government?
Is the borrower trusted or going to provide a level of service and goods to their customers that will be trusted?
Without trust the deal is just a deal and so why not use forms and formula to determine worthyness.
After all there is nobody alive and at home inside the numbers.
In this world after ENRON and Water Gate and WAR built on lies it is understandable.
Trust is gone and it must return one brick at a time, one loan at a time, one honest answer at a time.
We have to build it again and it will hurt to do it.
The second issue is judgement.
Good judgment is hard to find on both sides of the table.
The lenders the borrowers and the ultimate customers all are out of practice and have lived for years without it.
We didn't need it as we could fill in the boxes on the forms and "know".
So get to it!
Build trust and judgment again and understand that everybody needs to stop being essentially selfish and start being CONNECTED instead.
The 99% understand this in their guts.
Can the 1% figure this out and then step up?
Outside of a financial crisis and the ensuing recession, there are a number of reasons why someone goes into foreclosure. But, the two most common were 1.) responsible primary residence owners who fell vitcim to medical bills 2.) Wanna-be Robert Kiyosake (e.g. Rich Dad Poor Dad) investors who bought as many homes as they could.
IMO, the people who fell into bucket #1 should not be treated the same as those who met the criteria for bucket #2. Plus, I know that I speak on behalf of many of the people who worked at the firm when I say that forelosing on people who legitimately got sick and were being gutted by the medical providers were the ones that really made us dislike our jobs. This was despite the fact that we were being told that what we were doing was a healthy component of capitalism.
The wanna-be Robert Kiyosakes were more likely to recover because they had the means to do the legal and financial wrangling to keep their machines going. I guess they hold the title of "investor," but were they really creating jobs? They created my job, maybe, but that was about it as far as I could tell.
Needless but important to say the slow and inept response to my situation by all three of the mortgage holders didn't help either.
Small business and even consumers are contained from an un realistic view of the "credit worthiness" solely based on some score defined by faceless people with a customer service crew outsourced to some country that their people don't speak the same language very well or so full of menu options it takes 20 minutes to talk to a live representative because none of the menu options handles your simple and obvious question left off the menu.
Thank so much for your post. Not bringing this up and fighting this is one of the huge failures of this administration to bring our economy back. I don't understand why Obama didn't want to fight for our economy from this standpoint that you so richly describe, but thanks so again for this great post. People everywhere really need to be made aware of this and the damage to our economy that's resulted.
Best,
Meredith
www.fundinggates.com/blog