CFPB has the right problem but wrong answer on medical debt proposal

Bloomberg News

I set my wristwatch ten minutes fast. I don't know when I started doing it or who gave me the idea, but I think it started when I was a teenager and had a problem of being chronically late to important things like class. If I set my watch ten minutes early, then when I showed up ten minutes late for something as usual I would have tricked myself into showing up on time. 

I'm not chronically late to things anymore, and whether it's because of this trick or just because my prefrontal cortex finished developing I'll never know. But what I do know is that I've fully internalized the idea that my watch is ten minutes fast — which can sometimes create precisely the problem I thought I'd solved, because I'll look at another clock and assume I have time to run and grab a coffee and/or cake pop before that meeting when in fact I do not. The point is that there is an objective reality of what the correct time is that exists independent of my ability to manipulate what time my watch says it is, and that manipulation only sometimes yields an intended result.  

I thought of this when I read about the Consumer Financial Protection Bureau's proposal — and creditors' predictable outcry in response — to bar medical debt from consumer credit reports. But before going any further, I want to say there is considerable merit in more deeply interrogating the role medical debt plays in a borrower's ability to repay. 

Medical debt isn't the same as credit card debt or a home mortgage for a lot of reasons, not least of which is that in many if not most instances, medical debt is not debt assumed by choice or through the fault of the borrower. Medical debt can also be very large — as anyone who's ever seen a hospital bill can tell you — but can also be the subject of lengthy adjudication between insurance companies, clinics, hospitals and the patient. So when CFPB Director Rohit Chopra said medical debt has "little predictive value in credit decisions," he's probably right — whether you can afford this house or not probably does not hinge on whether you dropped a hammer on your foot three years ago.

But whether a borrower ought to have medical debt or not — or whether a borrower's medical debt will ultimately be assumed by themselves or someone else — is a different question than whether it exists and whether its existence has a material effect on a borrower's ability to repay. Because the proposal deals not with the debt itself but with credit bureaus' ability to see that debt, I fear the net effect will be an erosion of credit scores as a viable proxy for a borrower's creditworthiness and lead lenders to seek other, perhaps less fair metrics to make credit decisions.

Part of the problem here is that the CFPB doesn't have jurisdiction over insurance companies — that's an explicit carveout in Dodd-Frank. If they did, I suspect the bureau would tackle issues of medical billing and collections head-on rather than indirectly by way of credit reports. But the law is what it is, and barring some unfathomable event that makes Congress eager to give the CFPB more power, it's not likely to change. 

Regulation and compliance

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One might argue that this proposal is a positive innovation for the consumer even if it is not as holistic as would be ideal, but I'm not so sure that's the case. As I said before, credit reports are a tool intended to give lenders an apples-to-apples comparison of one borrower to another in terms of their willingness and ability to repay debts. If credit reports instead give lenders an apples-to-apples comparison of one borrower to another except for the $80,000 in medical debt that one borrower has that the other doesn't, then the tool becomes considerably less valuable. 

If lenders can't see medical debt that they know is out there, if only in the aggregate, then they are left with the challenging problem of trying to ascertain that information through other means. That could mean including questions on credit applications about medical debt, or it could mean just being more conservative across the board about offering credit — or just relying less on credit reports at all in making underwriting decisions, and thus denying borrowers credit for worse reasons. For the marginal borrower for whom these differences are most consequential, this is not the reform you are looking for.

Credit bureaus are at least conceptually on board with the idea that medical debt is different and should be treated differently than other debt — Equifax, TransUnion and Experian earlier this year removed paid medical debts from credit reports and opted not to include medical debts under $500 from reports for precisely this reason. 

Making those changes mandatory, and even raising that no-show medical debt threshold to $1,000 or $2,000 might do more to reduce medical debt noise from credit reports while still alerting lenders to the kinds of massive debts that they would want to know about. A more painstaking approach might be to attempt to differentiate between medical debts in adjudication or elective medical debts in credit reports. 

There's a robust debate to be had about whether consumers should have medical debt in the first place — again, it isn't a great determinant of creditworthiness — but that's a matter for another column in another publication. But right or wrong, the proposal as currently drafted is more likely to muddy rather than clarify a consumer's creditworthiness to lenders, and that's never a good thing.