Wednesday, April 30, 2008

The New Value of Value Consciousness

Which is easier: trying to make healthy food choices when you’re surrounded by people who value nutrition and find creative ways to enjoy food, or trying to make healthy choices when you’re in the midst of folks who binge on transfats and disdain calorie counts?

It takes a lot of effort to moderate our desire for gratification – not just with food but in all areas. It helps when our efforts are seen as positive, valuable, and are reflected by others in our social context.

This is why it is so interesting to me how the media has pivoted lately in their coverage of personal finance stories. People have been in financial distress for years. Years. The unsustainable rises in housing prices, coupled with massive amounts of consumer debt and student loans have been akin to a thin person with 90% blocked arteries. Just because you can fit into a size 2 doesn’t mean you’re healthy, darling.

It’s hard to put yourself on a debt diet when you feel like you’re the only one who has to watch what you spend. But now that we are in a recession, budgeting and frugality suddenly have positive social value. I see evidence of this in how the media has begun to favor stories about efforts to manage family costs over pro-consumption pieces. Open the paper or watch the news, and you will see article after article about how generics are beating name brands and the top ten hot new ways to save.

If you agree that the economic trouble is not new, then how do we explain the new frame?

I think there are two major forces in play. Number one, the problems have reached critical mass. Denial can no longer protect us from being aware of threatening material without great damage to the collective self. What kind of society would we be if we didn’t pay attention to the record number of foreclosures and utility shut-offs? It would seem callous and insensitive to celebrate free-wheeling spending when thousands of people are in crisis.

Number two, when the challenges are external and commonly felt, then the locus of the problem shifts. The experience is no longer framed as “I struggle with the price of gas (because I personally have no money)” but rather “The price of gas is a problem.” When the cause is externalized the ego can still preserve the self as good, and thus activities of problem-solving are seen as good as well. Living on a budget goes from being ego dystonic to being ego syntonic.

This shift in how our media frames the issue may seem incidental to how we as individuals experience it, but it is actually of profound significance. In modern society media serves as the closest thing we have to a collective voice. When that voice does not reflect – with sympathy and affirmation – the individual’s struggle, then the struggle becomes a source of shame and steps to resolve the struggle are usually inhibited.

I think that we as a nation are ready to embrace the ideals of economic contraction. I want to be careful here. I do not suggest in any way that any person enjoys financial distress. Economic troubles are painful and the crises are real. Rather, going back to the point I made earlier I believe these troubles have been present for a long time and it has been a source of unconscious frustration that they’re been rather ambivalently acknowledged. For the past five years at least, people’s anxiety about the economy has been met with encouragement to go out and spend more or to just find another credit product to tide them over until… something (that part was never quite answered).

A brief sidebar – the growth of the Green Movement, especially among the higher income strata, constitutes an interesting complement to the rise in value consciousness. Because the movement promotes conservation as part of ecological stewardship, even those who don’t experience personal economic strain can still demonstrate support of activities of sustainable (lowered) consumption.

In a way, I think people are a bit exhausted by the prolonged pressure to consume. Deficit spending is anxiety-producing, and the individual members of society have been containing those feelings in isolation for too long. Being value conscious is suddenly the thing to be, and I am glad of it.

Wednesday, April 23, 2008

MyFICO, Myself

I’m going to go out on a limb here and say that some people need to stop worrying so much about their credit scores. When did credit scores become an obsession? If I see one more article about how people spend hours each month trying to “game” the model to drive their score up a few points, I am going to tear my hair out.

Look, I understand that a higher credit score can save thousands (or tens of thousands) over the course of a major loan such as a mortgage. I’m not saying that the number is unimportant or that we should ignore it.

My point is that I feel like people have a tendency to become overly distracted by their credit score. This distraction can constitute a relatively benign waste of time or may range all the way to financial paralysis or even self-destructive behavior.

For example, I’ve met with several people who have been under terrible duress with their credit cards: late payment fees, default interest rates in the 30-percents, collection calls coming non-stop. But these people are too afraid to take action (contacting a credit counseling service about a debt management plan or even learning more about bankruptcy protection) because they’re irrationally concerned about the effect these actions might have on their credit score.

At the other end of the spectrum there are people like Jeffrey Sheldon (from the credit score article referenced above), a 36-year-old systems administrator in Virginia, who is taking great pains to bring his 740 credit score even higher in hopes of qualifying for the best terms on a planned home refinance:

When Mr. Sheldon was shopping for an auto loan last fall, he first compared rates online. Then, he allowed only two lenders to pull his credit report because he knew that lots of inquiries could drag down his score. Now, he’s making extra payments so that he can pay off the five-year loan in 3 ½ or four years. He figures the lower debt level will boost his score, which is already near the upper end of … the range.

I applaud Mr. Sheldon for doing what he can to save money and reduce his debts. But I see a lot of people who go through these same efforts who are not even planning to take out a major loan in the near future. They want a higher score simply because they see it as some sort of personal validation.

The credit score is tantalizing because it pushes specific psychological buttons. It is seen as completely empirical measure of our behavior (ha!) that provides feedback about our actions. It presents an individual “score” (double ha!) based on that behavior. The score categorizes and ranks us. Additionally, there is the reward for a good score that comes in the form of better terms on loans and therefore saved money (just tell that to all of the borrowers with good credit scores who still got subprime loans).

Let’s take a minute to address these assumptions. First of all, the credit score is not a measure. It is a model. It compares specific financial behavior against the behavior of others in order to predict the likelihood that a person will default on a payment. Period. It doesn’t measure how “good” or “bad” you are with credit – it simply lets lenders know how they can best make money off of you. If you get a high “score” (I’m going to force myself not to put that word into quotes for the rest of this piece even though I’m tempted to – indulge me just this once) lenders know they can make money off of you slowly over a long period of time. If you have a low “score” (okay, I promise that’s the last time) then they need to make money quickly before you are statistically likely to have trouble making the agreed-upon payments.

Why are credit scores so commonly misunderstood? Why are they so broadly applied outside of what the model is designed to capture?

I think people get distracted by their scores because humans are social creatures and thus hard-wired to crave feedback and validation from external sources. Credit scores can seem like the ultimate measure of all the things adults strive to be– mature, trustworthy, and responsible.

A high credit score can also serve as a psychological balm during insecure times or when facing a daunting challenge. It’s as if you say to yourself, “See – Fair Isaac Corporation thinks that I’m going to be financially stable enough to make these payments for the next 30 years. I’m going to believe that, too.”

The reward that we get for having a high score can indeed be of significant monetary value. But the more we try to game the score the more we pervert the validity of the model. This touches on the Observer Bias, where people change their behavior when they know they’re being watched. The Observer Bias can skew the results to the point where the validity of the measure (model) is ruined and must be revised.

Overemphasis on score is also problematic when people focus on the number to the exclusion of the good behavior it is supposed to measure. When we don't take the actions that we need to (such as accepting a short-term dip in score in order to address a pervasive debt problem) or when we lose significant amounts of time or quality of life in order to game the system, then I think we have lost sight of what's important.

Remember that the actual scoring algorithm is kept completely confidential so at the level of specific action we can't even know for certain how our behavior will change the score. For the vast, vast, vast majority if we just pay our bills on time, live within our means, only take out the amount of credit that we can manage, and check our credit reports for errors, then our scores should reflect that we are capable financial stewards without any more self-conscious forms of management.