TABLE OF CONTENTS I. Introduction II. Background: Credit Reporting Agencies in the United States A. The Consumer-Credit-Reporting Industry B. Credit Reports and Credit Scores C. CRAs, Clients, and Consumers: Relationships and Incentives 1. Inaccuracies in Credit Reports 2. Information Is Provided with No "Permitted Purpose" Under the Law 3. Identity Theft 4. Fertile Ground for Manipulation Through Marketing Lists D. Regulatory Efforts for Consumer Protection 1. The Fair Credit Reporting Act 2. The 1996 FCRA Amendments 3. The Gramm-Leach-Bliley Act 4. The Fair and Accurate Credit Transactions Act III. A Weak Link in the Current Regulatory System: Consumers' Cognitive Limitations A. The Misconception of the Consumer as Homo Economicus B. Unawareness and Financial Illiteracy C. The Status Quo Bias D. Self-Control Problems E. Overoptimism IV. The Implications of Consumers' Irrationality in the Credit-Reporting System A. Unawareness of Rights Under the FCRA 1. Unawareness of the Right To Receive a Free Credit Report 2. Unawareness of the Right To Dispute Errors for Free B. Exploiting Biases Through Marketing Lists V. Consumer-Protection Mechanisms A. Consumer Protection Under the Policy of Libertarian Paternalism 1. The Policy and Its Benefits 2. "Nudging" the Credit-Reporting System a. Disclosure and Framing i. The Problem with Excessive Information ii. Disclosure of Right To Opt out and Right To Dispute Errors iii. Unlimited Access to Credit Reports and Credit Scores b. Defaults B. Consumer Financial Education 1. Why Is Education in the Credit-Reporting System Appealing? 2. The Limitations of Consumer Education a. Doubtful Efficacy b. Predominant Biases c. Costs VI. Conclusion I. INTRODUCTION
Consumer credit availability in the United states has grown dramatically throughout the twentieth century. The significant increase in the number of consumer transactions, along with the expansion of information technology, has resulted in the creation of massive amounts of detailed information on an individual's purchasing and credit history.
Consumer credit reporting agencies (CRAs) play an important role in the financial information market. (1) These agencies collect, process, and analyze financial information received from various furnishers to create consumer reports and credit scores. such consumer reports assist, among others, lenders, retailers, employers, and landlords in assessing consumers' creditworthiness. Major CRAs also offer personalized and demographic data to their clients for marketing purposes.
The credit-reporting system has significant economic benefits. It renders various financial and purchasing opportunities--such as credit, employment, housing, and insurance--more available and affordable to consumers. (2) CRAs have a tarnished reputation, however, as far as consumer protection is concerned. While making their business out of gathering, compiling, and analyzing consumers' information, CRAs generally do not have privity of contract with those very same consumers. Thus, CRAs have little or no incentive to protect consumers' privacy and ensure the accuracy of every single credit report. (3)
This lack of incentive has caused numerous problems for consumers, including major inaccuracies in credit reports and erroneous credit scores; infringement of consumers' right to privacy by providing information with no permitted purpose under the law; contribution to the prevalence of identity theft; and the creation of a fertile ground for consumer manipulation through targeted marketing lists. (4) These problems can cause severe damage to consumers, who may be denied credit, employment, housing, and insurance. The situation is also potentially detrimental for lenders, who may extend underpriced credit to a consumer or reject a creditworthy borrower. Finally, the lack of CRA incentives to protect consumers' privacy and ensure reporting accuracy can generate a series of larger negative externalities, affecting the economy as a whole.
Since 1970, various regulatory efforts have been made to address these problems without undermining the voluntary nature of the credit-reporting system. Such regulatory attempts to protect consumers include, inter alia, entitling all consumers to one free annual credit report, implementing a dispute-resolution process to investigate and correct errors, and endowing consumers with the right to opt out of marketing lists. (5) Yet, despite these regulatory efforts, CRAs have failed to maintain accurate files, identity theft continues to be a growing phenomenon, and many consumers have been tempted to accept offers for excessive or unnecessary borrowing by prescreened solicitations. (6)
This Article suggests that the current regulatory system has been captivated by the misconception of the consumer as a homo economicus. Existing regulations have given consumers a significant role in facilitating the production of more accurate credit. The current system envisions rational, vigilant, and alert consumers, who regularly monitor their credit reports, dispute errors, and opt out of marketing lists. At the heart of this approach is the notion that consumers know their own credit history and are able to determine its accuracy at the lowest costs. (7) Moreover, rational consumers can decide whether it is worthwhile to incur the costs associated with monitoring credit reports and disputing errors. Studies have shown, however, that consumers' rationality in the decision-making process is in fact questionable, and so too is the justification for imposing monitoring responsibilities on consumers. (8)
My objectives in this Article are twofold. The first objective is to challenge the economic-regulatory approach through the behavioral-economic approach--a relatively new model that aspires to explain relevant features of human behavior absent in the standard economic framework. (9) Research in behavioral economics has shown that people's preferences and decision-making processes are often different from the rational behavior expected from the homo economicus. Consequently, people sometimes fail to act in their own best interests and do not maximize their utility. (10) Part III will introduce three types of judgment errors that people are inclined to make. Part IV will explain how these errors are reflected in the credit-reporting industry, harming consumers, lenders, and the economy as a whole.
The second purpose of this Article is to explore different solutions that may fit into the behavioral-economic framework. Part V will analyze two potential consumer-protection mechanisms: (11) applying psychological tools, such as framing and defaults, for a better-designed system ("libertarian paternalism" (12)), and enhancing consumer financial literacy. This Article is the first to employ the behavioral-economic approach with respect to the credit-reporting system.
Because CRAs are a substantial part of the United States' society and economy, the debate over their operation is of utmost importance. (13) I hope that this Article will offer new insights into problems that may affect every consumer in the United States in the contemporary information age.
BACKGROUND: CREDIT REPORTING AGENCIES IN THE UNITED STATES
The Consumer-Credit-Reporting Industry
The first consumer CRAs in the United States emerged in the late nineteenth century, in the wake of the country's expansion and the subsequent increase in trading transactions. These private, for-profit firms commoditized borrower information and made it available to anyone for a price, whereas it was previously only available to members of closed networks. (14) CRAs applied the information they collected to consumers' credit histories to assist lenders in evaluating credit risk, reducing the problems of adverse selection and information asymmetry between borrowers and lenders. (15) Simultaneously, the transparency of consumers' credit histories reduced consumers' "moral hazard," because delinquency with one lender could result in sanctions by other lenders as well. (16)
CRAs replaced the traditional letters of recommendation and other forms of gossip with standardized criteria for creditworthiness. (17) At their inception, in the absence of information pertaining to past financial behavior, CRAs relied on borrowers' characteristics, such as "honesty," "extravagance," and "energy," to determine creditworthiness. (18) This system was eventually accepted as useful by the end of the nineteenth century, despite initial misgivings about what many Americans perceived was an inquisitorial method of assessing creditworthiness. (19)
Consumer credit availability in the United States grew dramatically throughout the twentieth century. Barron and Staten attribute broader access to credit products to four factors: "[l]egal rules that permit the collection and distribution of personal credit data"; "[d]ramatic reductions in data processing costs and ... improvements in the speed of data retrieval"; "[t]he development of statistical scoring techniques for predicting borrower risk"; and "[t]he repeal of legislated interest rate ceilings that had limited the ability of creditors to price their loan products according to risk." (20)
Indeed, the significant increase of consumer transactions and the expansion of information technology have resulted in the creation of massive amounts of detailed information about individuals' purchasing and credit histories. In this market of extensive financial information, CRAs play an important role. Information is provided to CRAs on a voluntary basis from sources such as: lenders of all kinds (including banks, credit card companies, mortgage companies, and retail stores), employers, medical insurers, landlords, governmental agencies, and court records. Interestingly, this voluntary system evolved with almost no regulatory interference with regard to its main functions. (21)
Today, at least one credit report exists for every...