Reputation under Regulation: The Fair Credit Reporting Act at 40 and Lessons for the Internet Privacy Debate, Cato Policy Analysis No. 690

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More than 40 years ago, Sen. William Proxmire (D-WI) guided the Fair Credit Reporting Act (FCRA) through Congress, seeking to improve the operations of the credit reporting industry. The complexities and tensions in a reputation system like credit reporting are formidable, however, and the FCRA has not satisfied consumergroup demands for accurate, responsive, fair, and confidential credit reporting. In fact, new problems have emerged, such as credit repair fraud and identity fraud. Credit reporting today is anything but the confidential service Proxmire hoped for. Passed in tandem with a financial surveillance law called the Bank Secrecy Act, the FCRA has been turned toward government and corporate surveillance, providing little or no privacy or control for consumers. As economic theory predicts, the credit reporting industry appears to have benefited from the ossifying effects of regulation. Though the information and technology environments have changed dramatically over the last four decades, the credit reporting and reputation marketplace has seen little change or innovation. A potential related market for identity services is also stagnant thanks in part to government policies. When Congress chose to preempt common law remedies for wrongs done by credit bureaus, it withdrew a tool that could have guided credit reporting toward better service to consumers and a more innovative and vibrant marketplace. With uniform national regulations, we cannot know how credit reporting might have evolved for the better.
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  Executive Summary  More than 40 years ago, Sen. William Proxmire(D-WI) guided the Fair Credit Reporting Act(FCRA) through Congress, seeking to improvethe operations of the credit reporting industry.The complexities and tensions in a reputationsystem like credit reporting are formidable, how-ever, and the FCRA has not satisfied consumer-group demands for accurate, responsive, fair, andconfidential credit reporting. In fact, new prob-lems have emerged, such as credit repair fraudand identity fraud.Credit reporting today is anything but the confi-dential service Proxmire hoped for. Passed in tandemwith a financial surveillance law called the Bank Se-crecy Act, the FCRA has been turned toward govern-ment and corporate surveillance, providing little orno privacy or control for consumers. As economic theory predicts, the credit re-porting industry appears to have benefited fromthe ossifying effects of regulation. Though theinformation and technology environments havechanged dramatically over the last four decades,the credit reporting and reputation marketplacehas seen little change or innovation. A potentialrelated market for identity services is also stagnantthanks in part to government policies.When Congress chose to preempt commonlaw remedies for wrongs done by credit bureaus,it withdrew a tool that could have guided creditreporting toward better service to consumers anda more innovative and vibrant marketplace. Withuniform national regulations, we cannot know how credit reporting might have evolved for thebetter.These 40 years of information regulation un-der the Fair Credit Reporting Act hold lessonsfor present-day debates. Foremost: legislators,regulators, and advocates lack the knowledge thatit takes to anticipate and guide the direction of technology, privacy, or the information economy.These things should be left to the people and busi-nesses who are together building the future.  Reputation under Regulation The Fair Credit Reporting Act at 40 and  Lessons for the Internet Privacy Debate by Jim Harper No. 690December 8, 2011  Jim Harper is director of information policy studies at the Cato Institute and author of  Identity Crisis: How Identification Is Overused and Misunderstood .  2 The Fair CreditReporting Actis a highly complex pieceof informationregulation. Introduction On January 31, 1969, Sen. William Prox-mire (D-WI) went to the floor of the U.S. Sen-ate to speak about legislation he was introduc-ing that day. His bill would address problemswith credit bureaus, the companies that collectinformation on individuals’ creditworthiness,character, or general reputation and dissemi-nate it to banks, credit card issuers, and others.He discussed his many concerns with creditreporting and his plan to solve them.“Perhaps the most serious problem in thecredit reporting industry,” Senator Proxmire said,“is the problem of inaccurate or misleading in-formation. There have been no definitive studiesmade of just how accurate is the information inthe files of credit reporting agencies. . . . Everyoneis a potential victim of an inaccurate credit report.If not today, then perhaps tomorrow.” 1 He called his bill the Fair Credit Reporting Act. It proposed a number of requirements forcredit bureaus meant to help ensure that theinformation in credit files would be accurate,relevant, and confidential. To inform peopleabout credit reports, users of them would haveto disclose to consumers when credit reportsformed the basis for adverse decisions. Creditbureaus would have to allow individuals tocorrect inaccurate or misleading informa-tion. Congress passed Proxmire’s bill late thefollowing year, and President Richard Nixonsigned the Fair Credit Reporting Act into law.More than four decades after Proxmire’sbill became a law, and after dozens of amend-ments to it, the Fair Credit Reporting Act isa highly complex piece of information regu-lation that appears not to have achieved itsgoals. According to consumer advocates, cred-it reports are still rife with errors, and creditreporting remains an obscure challenge formany consumers. The Federal Trade Com-mission is only part way through the study of credit reporting that Proxmire lamented nothaving in 1969. 2 And under regulation, creditreporting has become nothing like the “confi-dential” system that Proxmire sought. On thecontrary, regulated credit reporting facilitatescorporate and government surveillance.How is it that four decades of federal regu-lation have not achieved the goals Proxmiresought for credit reporting? Why is a fair andprivacy-protective credit reporting industry soelusive? The answers are not obvious, but ex-perience under the FCRA serves as a cautionabout regulating our information economy top-down from Washington, D.C. This is notbecause information collection, processing,and use are free of problems, but because regu-lation is ill-equipped to solve them.Credit reporting involves deep complexi-ties, including identification issues, contestednotions of relevance, and the surprisingly dif-ficult problem of arriving at “fairness.” Gov-ernment regulation of credit reporting has noteffectively solved these problems or reconciledthe conflicting values that drive them. Mean-while, the Fair Credit Reporting Act has likely protected the credit reporting industry fromcompetition, denying consumers the benefitsof innovation.When the Fair Credit Reporting Act pre-empted state common law remedies againstcredit bureaus, it foreclosed an option thatmay have resulted in better protection forconsumers and better results for the economy and society. Because Congress imposed a na-tional credit reporting rule, we cannot know how this industry might have developed had itbeen left free to experiment, subject to simplerules against harming consumers.The lesson of four decades under the FairCredit Reporting Act is that information reg-ulation—in the name of credit reporting fair-ness, privacy, or whatever goal—is complex and value-laden. Because the federal governmentlacks the capacity to foresee how technology,the economy, and society will evolve, it shouldnot regulate information practices. Deviatingfrom our nation’s founding principles of free-dom is as much a mistake in the informationarena as in any other.With an online world far more advancedand complex than the credit reporting in-dustry of 1969, it is worth examining care-fully what we know and what we do not know about the information environment. Despitefulsome good intentions, no expert group or  3 A credit bureauis a type of “reputationsystem.” legislative body has the capacity to dictate how the Information Age should take shape. Many in society do not yet understand that they areparticipants in an information economy, noteven the simple, contained part of it known ascredit reporting. What Is Credit Reporting?  A credit report is a record of a person’s fi-nancial activities intended for use in deter-mining creditworthiness, and also in someemployment and insurance decisions. It listscredit card accounts and loans, the balanceson those accounts, and how consistently a consumer makes his or her payments. It alsoshows if any action has been taken against a consumer because of unpaid bills. 3 Firms thatlend to consumers provide the data they havecollected to credit bureaus, who compile suchinformation from a number of sources, thendistribute those compilations back to “data furnishers” and to others.Credit reporting began in the late 1800swith local merchants pooling informationabout which customers failed to pay creditaccounts. 4 During this period, retailers didmuch business by extending their own credit,but nowadays credit cards have supplantedstore credit. Credit reporting allows retail-ers to refuse credit sales to deadbeats and tobetter serve the good credit risks among theircustomers. In the 1970s there were more than2,000 credit bureaus, but the inefficiency of their operating separately in an increasingly mobile society was becoming clear. Largecredit bureaus emerged in response to increas-ing mobility in American society and to takeadvantage of the economies of scale that new computing and communications technolo-gies were creating.Today there are three major credit bureaus:Experian, TransUnion, and Equifax. Every user of credit in the United States almost cer-tainly has a file with at least one credit bureau,and most probably have files at all three. Asof 2005 over two billion items of informationwere added to the files of the credit bureaus ev-ery month, coming from 30,000 lenders andother sources. Credit bureaus issued over threemillion credit reports every day. 5  Access to data on a large universe of creditusers helps lenders calculate the risk of defaulton unsecured consumer loans. With largeamounts of data, they can develop sophisti-cated algorithms that enable finer and finer judgments about borrowers. This intelligencelowers credit risk overall, meaning that creditcan be offered less expensively to most people,though, of course, the cost of credit may behigher for the relatively small number of peo-ple who appear at higher risk of defaulting onloans. 6 Credit bureaus srcinally provided only theraw data behind a credit decision, but they havecome to do analysis of the data—credit scor-ing—if the lender wants to purchase it. They do not make the final decision about whetheror not to lend or on what terms. Lenders makethose decisions. Credit Reporting as aReputation System Though nobody used such lingo in the1970s, a credit bureau is a type of “reputationsystem.” It is a tool that supports decision-making on a large scale or by a large numberof users.Every individual has a reputation withinhis or her social circle, family, and work en- vironment, of course, but these individualreputations are not useful in remote transac-tions or in transactions with large, impersonalinstitutions. The idea of systems that providereputation information on a large scale hascome into its own over the last few years as anadjunct to mass, remote transacting. 7 Creditreporting is probably the srcinal and longest-standing large-scale reputation system.Reputation systems outside of credit re-porting include things like eBay’s FeedbackForum, where buyers and sellers rank eachother and comment on past transactions. 8  This helps future buyers and sellers gaugethe risks of dealing with one another and  4 Determiningwhat goes into abiography that is“right” or “fair”implicates a hostof social valuesand norms. encourages good behavior. EBay users know that the transactions available to them and theprices others will pay them may shrink if they misbehave by misrepresenting the goods they sell, paying slowly, and so on. A reputation system is a complex socialmechanism. It combines two separate con-cepts, identity and biography, each with itsown difficulties.Take identity. Figuring out precisely whopeople are is hard to do on a mass scale. Overthe last century, changing circumstances havemade names like “John Smith” indistinct andobsolete for use as identifiers. 9 There are morepeople, communications have improved, andmobility has increased. This makes it morelikely that two people in the same (now morepopulous) place will have the same name. Evenunusual names may be repeated several timesin a country with tens or hundreds of millionsof inhabitants. Growth in the size, scope, andcomplexity of organizations has likewise in-creased the chance that they will encounterduplication among names.The response has been to turn to uniformidentifiers like the Social Security number.These help institutions such as credit bureaussort among millions of consumers, the index-ing system in the institutional “mind.” Butthe Social Security number is a weak identi-fier that is not fixed to any individual. 10 It isrelatively easy for a person to adopt another’sSSN for the purposes of identity fraud. AndSSNs are often misreported or incorrectly transcribed, leading to errors in tying data tothe right identity.Then there is biography. Biography wouldsimply be connecting factual information toan identity, but the relevance of given facts togiven decisions can be contentious. Determin-ing what factual information goes into a biog-raphy that is “right” or “fair” implicates a hostof social values and norms.What is “fairness”? Every child learns aboutthe concept of fairness on the playground, butit remains a complex and elusive concept. Themanifold values that go into making any par-ticular decision “fair” are beyond all but themost careful philosophers.One might say that fairness is some assur-ance that each person will get his or her due,but that begs the question of what is due.Fairness can include, in different measures,the absence of wrongful bias, consistency of rules, honest administration, and so on. Fair-ness is not a guarantee of correct decisions inevery instance. Fulfilling that goal would raiseadministrative costs in many decisionmakingsystems beyond the value of deciding. Mostdecisionmaking systems essentially punt. Incourts of law, for example, a “fair” trial is onethat is merely well calculated to produce thecorrect outcome. It is not a trial process inwhich the right result is reached every singletime. 11 Fairness often involves giving the affectedparty some opportunity to participate in a de-cision. Thus, constitutional fairness includesgiving a criminal defendant a right to partici-pate in his or her trial and to cross-examinewitnesses. 12 Important decisions that are notproduced with at least some input from anaffected party are often rightly criticized asarbitrary. This is not only because a person’sparticipation will favor a correct result. Partici-pation fulfills the ideal that an individual hasa measure of autonomy even when he is theobject of another’s decision.The question of what is fair and unfair incredit reporting is a matter of ongoing con-troversy. A single-minded statistician wouldmine every piece of data about every person todetermine the relevance of each item of biogra-phy to creditworthiness. The privacy advocatewould object to having so much data available,regardless of the purpose. Those who believein redemption think it is unfair for informa-tion from the distant past to haunt one’s pres-ent. Redistributionists might pursue rules forcredit reporting that help people get creditwho otherwise wouldn’t, making up for somedifficulty society has laid before the consumer. All of these interests are represented in thedebate about credit reporting.With all these conflicting dimensions,credit reporting fairness is hard to administeron a mass scale. Challenges come from identi-ty issues, judgments about biography, and the
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