Spurred by polls showing that the public is concerned about maintaining personal privacy, federal and state legislators have proposed a blizzard of legislation. In Congress, many of these bills would require explicit consent from customers before their financial information could be transferred to a third party. A law like this sounds reasonable to many people, and it would certainly protect privacy, but at great cost to consumers.
Our current credit system relies on the routine collection and dissemination of information to credit agencies and financial institutions. The fact that collection is routine makes the information complete, and because it is complete, it is likely to be reliable. If you've ever bought a car after spending half an hour with a dealer's credit officer, become eligible for a credit card by signing a one-page form, or received a department store discount on a day's purchases for opening a credit account at the store's cash register, you have been the beneficiary of a system in which your transaction history has rewarded you with convenient and inexpensive access to credit. Many consumers take this system for granted, but it was not always so.
To the extent that laws might be changed to forbid the routine dissemination of credit information, financial institutions would not be able to distinguish between good credit risks and bad--even for those people who chose not to place limits on how their financial information might be used. If a substantial number of people failed to give permission, either by action or--more likely--inaction, the entire data base would become suspect. Financial institutions would not know whether the data they were getting was a true picture or only what the applicant wanted them to know.
In this environment, the people who paid their bills would have less access to credit and would have to pay more for it, and the people whose credit standing was weak would be able to avoid the consequences of their acts. Since consumers then would have to furnish large amounts of data to get credit, they would have a strong incentive to stay with the same lender for future loans, reducing competition among financing sources. The credit system used to work in this way, and laws that broadly limit the use of financial information could take us back there.
A Crucial Distinction
Why do legislators want to tinker with our current system, which delivers so much value to consumers? One answer may be that they think of privacy in terms of government snooping and have not bothered to make the crucial distinction between the dangers posed by government's collection of information about individuals and the dangers of collection and use by private institutions.
We should recall that government must be controlled by sweeping laws because it has the power--and sometimes the will--to coerce and intimidate. Its interest, after all, is to gain compliance with its rules. Banks and other financial institutions do not have the same kind of authority or interests. They are trying to separate good credit risks from bad or to sell products and services. When they collect and disseminate information, as in the case of financial reporting, there is the possibility of misuse, but not misuse in the same league as government snooping.
When individuals express concerns about the privacy of their financial affairs, they may be afraid that their private information--in the wrong hands--will be used to harm them. These are legitimate concerns, but they must be answered with specific legislation. We must develop laws or regulations that address particular harm, like unwanted solicitations, identity theft, or the dissemination of information to people who have no legitimate reason to obtain it. The Fair Credit Reporting Act, for example, permits credit information to be released by credit agencies only for limited and legitimate purposes. Focused laws like this make sense.
The restrictive legislation that has been introduced in Congress and in many states strays into dangerous territory far beyond what is necessary to protect individuals against harmful use of their private financial information.
Peter J. Wallison is a resident fellow at AEI.