Experiment #2: In the Back Door

Nathans sold Just The Facts in 1996, and wound up working as a consultant at the big accounting firm Price Waterhouse. But he just couldn’t get this contradiction out of is mind:

- There are 50 million renters who can’t build credit by paying the rent.

- There are banks and other lenders desperate to find more trustworthy borrowers.

Surely there must be a way to knit these two facts together and solve both problems.

“So yeah, this is the bee in my bonnet,” he says.

Working at Price Waterhouse, Nathans developed the idea of creating his own credit bureau. Meanwhile Fannie Mae and Freddie Mac, the government-backed mortgage giants, had problems of their own. Both were created to help low- and moderate-income people by houses.

But in the early 2000s both companies’ underwriting systems were being accused of racism. That’s because both systems were automated, and looked at credit reports to decide whether someone should get a loan.

It wasn’t that African-Americans and Hispanics had bad credit. It was that a disproportionate number of them had little or no credit at all. When faced with such applications, Fannie and Freddies’ computer systems simply spat them out.

“They were being treated as though they had bad credit, when in fact they had no credit,” Nathans says. “And maybe they were being responsible by not buying things on credit.”

So Nathans pitched his solution to Fannie and Freddie: Let’s create a new credit bureau that allows people to actively report their on-time payments of things like rent and utilities. Merging that data with traditional credit scores would help low- and moderate-income people, including African-Americans, build better credit.

“They loved the concept because they were getting a lot of political heat on this,” Nathans says of Fannie and Freddie.

With financial support from Fannie, Freddie, I.B.M., Citibank and the Ford Foundation, Nathans founded Pay Rent, Build Credit (later shortened to PRBC) in 2002. It was the first credit bureau that allowed consumers to take an active role in credit reporting, and file information that as missing from their traditional credit reports.

PRBC also was a small company, with little money and a small staff, trying to do a big job. “PRBC struggled for years with capitalization,” says Craig Watts, spokesman for FICO. “They were always underfunded.”

Working with the National Credit Reporting Association, PRBC would physically verify lines of credit that traditionally don’t appear on credit reports. That meant calling landlords to independently check whether loan applicants actually had current leases and were current on rent payments. It meant calling utilities and cell phone companies to check payment histories, and loading all that data into forms that are easily combined with credit reports from the three big credit unions – Transunion, Equifax and Experian – to determine a more accurate FICO credit score.

“Our members have called, faxed, emailed, checked public records,” says Terry Clemans, executive director
of the National Credit Reporting Association. “That way the lender would know that the data they’re receiving, even though its not coming from the big three [credit bureaus], that it is legitimate and verified.”

There were problems, however. The most important was cost. Running down all that information cost lenders about $65 per loan applicant, Nathans says.

That’s a significant investment, especially if the applicant fails to qualify even after all the new information is added to their credit score. And even if the added information helps the applicant qualify, it doesn’t help the lender. It may simply win the borrower a lower interest rate, which means lower fees and lower profits for the lender.

“If you stop and think about the lending model, what lender in their right mind is going to pay extra for an additional credit report,” Nathans says, “particularly if it means they have to charge the applicant less?”

There was a second problem, of course. As Nathans was trying to get PRBC off the ground, many lenders employed loan officers who deliberately forged loan documents and inflated applicants’ credit scores just to win the fees from selling more loans.

In short, while Nathans was trying to convince lenders to spend money on verifying credit the right way, they were making billions by not verifying credit at all.

“Michael was competing against many of the mortgage lenders, whose only financial interest was in closing the loan and had no recourse for fraud,” Clemans says. “So they were creating trade lines that didn’t even exist.”

Nathans was forced to concede defeat. He sold PRBC in 2008.

“Everybody said it was a great idea,” Nathans said. “Well that and $2.75 will get you a cup of coffee.”

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Tagged as: credit bureau, credit reporting, PRBC

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Christopher Maag Contributing writer for Credit.com, Chris graduated with honors from the Columbia University Graduate School of Journalism, and has reported for a number of publications including The New York Times, TIME magazine and Popular Mechanics. Reach Chris via email at chris@credit.com.