Law in the Internet Society
-- JoseFuentes - 12 Dec 2008 Second Paper

The Absence of Privacy and How It Led to the Recession of 2008

Few Americans care about their privacy. Well they care, but just not enough to do anything about it, like rejecting loyalty reward programs. But surely they care about their financial information, which is “some of the most sensitive, personal information imaginable.” Yet most consumers are surprised that “most companies actually rent or lease customer data to third parties . . . .” Although the Gramm-Leach-Bliley Act provides consumers with “some minimal rights to protect (their) financial privacy, . . . the burden is on (them) to assert (their) rights” through an opt-out mechanism. Unfortunately, it “appears that although consumers are generally concerned about the loss of financial privacy, only about 5 percent have taken the low-cost step of opting out.

So why should Americans care about the loss of their privacy? Aside from incurring personal costs (like price discrimination at, the absence of privacy externalizes costs to the American community. Indeed, this article argues that the absence of privacy contributed to U.S. recession of 2008 (the “Recession”). For the sake of brevity, I won’t describe the details of what caused the Recession. It suffices to say that many commentators agree that the sub-prime mortgage crisis triggered the Recession. (See also and

The sub-prime mortgage crisis was caused by the absence of privacy because it: (1) is necessary for securitization and (2) allowed mortgage originators, using aggressive marketing, to sell mortgages to people who couldn’t afford them.

Economists have argued that the mortgage crisis was fueled by the advent of securitization. Previously, mortgage originators made money on the borrower’s ability to repay the loan plus interest. But through securitization, originators could sign up anyone, even risky borrowers, and resell the loans in a secondary market. These mortgage-backed securities exist and are tradable because entities can price the security. Pricing consists of evaluating the borrowers’ default risk – the probability that the borrowers will be able to pay their mortgage on time. This risk is measured by analyzing borrower data collected by a credit bureau. In other words, a credit bureau “collects information from various sources” to produce the credit score that is sold to the mortgage originator.

This presents a significant privacy issue, for “credit bureaus collect and collate personal information, financial data, and alternative data on individuals from a variety of sources called data furnishers . . . . Data furnishers are typically creditors, lenders, utilities, debt collection agencies and the courts . . . that a consumer has had a relationship or experience with.” The credit bureaus, leveraging all of the data, create massive databases that describe a consumer’s creditworthiness. Without the ability to attach a credit score to a particular borrower, MBSs would be impossible since investors could not properly value the security.

Admittedly, the Fair Credit Reporting Act (“CRA”), 15 U.S.C. 1681 et seq., regulates the collection of consumer credit information by providing guidelines for data furnishers. But these guidelines are not strict with respect to what kinds of consumer data can be reported. The only privacy concession the statute makes is a restriction on the collection of medical data. 15 U.S.C. 1681a(d)(3).

  • The argument here is flawed by the position that if securitization made possible the financing practices that were disastrously mismanaged, therefore prohibiting securitization is (a) possible and (b) desirable. You didn't justify the position that making possible the better management of risk in the financial industry necessarily causes catastrophic risk mismanagement. And you didn't explain either how to prevent people who want to borrow money from giving real, knowledgeable and effective consent to the sharing of information needed to establish their credit, or how to regulate what we learn and teach about facts in the world, including who pays their bills regularly, without destroying the principle of freedom of inquiry and freedom of speech.

As for the second effect, the absence of privacy allowed financial institutions to peddle more credit products through aggressive marketing, which led to debt traps. Once the consumers were stretched to their spending limits, they began defaulting on their mortgages. As mentioned earlier, the sudden and widespread defaults caused the sub-prime mortgage crisis.

The debt trap was created by extracting consumer surplus via “(l)enders (who) found new ways to squeeze more profit from borrowers. The extraction was facilitated by sophisticated marketing tactics (and) gathering personal financial data to tailor their pitches to the consumer . . . .” The lenders knew who to target and how because they had consumers’ financial data. “(B)usinesses comb through an array of sources, including bank and court records, to create detailed profiles of the financial lives of more than 100 million Americans. They then sell that information as marketing leads to banks, credit card issuers, and mortgage brokers, who fiercely compete to find untapped customers. . . .

Unsurprisingly, a consumer getting back from the hospital would find mail to this effect: “Can’t afford your hospital bill? Take a loan to pay it off.” The elderly, too, were targeted by sophisticated direct mail programs telling them to “Live Richly” and get a home equity loan. Ironically, the lenders even targeted people who just exited bankruptcy by offering special credit lines for people with “less-than-perfect credit.”

Furthermore, the lenders spent “hundreds of millions of dollars on advertising campaigns that (made) debt sound desirable and risk-free.” For instance, Mastercard’s “Priceless” campaign was meant to “eliminate negative feelings about indebtedness.” Other commentators point to the recent attractiveness of second mortgages (which were renamed as “home equity loans” to sound more pleasant). Previously, the second mortgage was a desperate tool but now has become universally accepted due to “ubiquitious ad campaigns from banks.

  • Untargeted advertising cannot be part of your argument, and adducing irrelevant evidence this way tends to create an impression of overargument that you should be trying carefully to avoid.

In sum, the absence of privacy – the consumer’s inability to keep a lid on his transactions –enabled the credit bureaus and marketers to collect hordes of data about consumers. The data was parsed so that statistical inferences could be made about the consumers’ creditworthiness. This ability to predict the default risk resulted in MBSs and the tremendous expansion of sub-prime mortgage market. Simultaneously, the data was sold as marketing leads to financial institutions, which aggressively pushed more credit products on consumers. Maxed out, the consumers defaulted on their loans. The mortgage industry finally failed in 2007, triggering the recession of 2008.

It bears mentioning that the U.S. recession could have been averted with more stringent privacy practices. For example, the debt trap could have been avoided if consumers’ data were not saleable. “European countries, . . ., have far stricter laws limiting the sale of personal information. Those countries also have far lower per-capita debt levels.

  • I suspect you don't disagree that you are offering a rather confined view of the causes of the global financial crash. Even granting your position that trouble in the sub-prime mortgage market in the United States touched off the crash, causal analysis built around that one component would be like describing the causes of the First World War by concentrating primarily on how Bosnian terrorists planned the murder of a Habsburg non-entity visiting Serbia.

  • So a broader focus on the information flows in the global credit markets would have been appropriate, and would have showed as much support for privacy (as unregulated hedge funds and private equity operations as well as proprietary trading within the investment banks took more and more of the rich peoples' money out of the range of traditional financial regulation) as opposition, the tendency being always to enhance the privacy of the rich at the expense of the poor. Which reinforces the general and probably unsurprising conclusion that when information is conceived as property, the property distributions are certain to be radically unjust and the movement to be in the direction of further injustice.

  • Which shouldn't be used to obscure the fact that credit became more equitably distributed in the US over the last generation, not least because securitization enabled the sort of broad market competition that deprived the local banker of the power to determine who got it and who didn't. Equitable access to credit is not shown here or anywhere to be a cause of undersaving or overborrowing, and is not the reason that systemic risks were poorly managed. Even those homeowners who are now being castigated for being in over their eyeballs weren't leveraged at thirty to one: no one in the world would have lent them that kind of money.


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r4 - 09 Feb 2009 - 17:32:11 - EbenMoglen
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