There was a very interesting article here on the Real Estate Dispatch last week. It was by Tom Koziol on the topic of consumer credit scoring models (article). I found it interesting because just one day earlier I was speaking to a friend of my who is an independent auto broker. She was telling me about several clients of hers who were having trouble obtaining auto loans despite stellar credit history and substantial income.
It’s not unusual to see credit scores drop dramatically even though the borrower has never missed a payment, borrowed more money, or made any significant changes at all. What has happened is that the percentage of credit utilization has changed.
Imagine a scenario where Joe Customer has a FICO score of 720 and a $25,000 credit line from ABC Bank with an outstanding balance of $5,000. That’s a credit utilization ratio of 20%, a healthy number in the eyes of a lender. Now ABC Bank, concerned about the risk in their credit portfolio, decides to cut Joe’s limit down to $10,000. Joe isn’t concerned because he had no intention of borrowing more from them anyway. What Joe doesn’t realize is that his credit score has dropped because his credit utilization is now 50% and his ability to borrow on favorable terms has been impacted.
An economy is nothing more that money in motion. When the money stops moving the economy stagnates. It is also a closed circle in normal times. A consumer makes a purchase, a manufacturer supplies the product that a worker is paid to produce, the worker uses his pay to become a consumer and the cycle starts again. Outside forces can act on the normal operation of that circular machine. One force would be the Government pumping money into the economy to stimulate it. However the tightening of credit acts to pull money out of that circle and slow it down.
It makes perfect sense that the banks would want to reign in reckless borrowing by those who are irresponsible. However denying credit to your best and most responsible borrowers is pure insanity and, ultimately, economic suicide.