Max Moran
The American Prospect, October 7, 2019

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The Wall Street Journal reported recently that Freddie Mac, the government-sponsored mortgage giant, is testing underwriting software from fintech firm ZestFinance. A creation of ex-Google executive Douglas Merrill, ZestFinance claims to use machine learning and artificial intelligence to spot trends in a borrower’s record that traditional lending models miss. This supposedly allows more credit to flow to borrowers who need and can afford it, allowing Freddie to issue more mortgages.

Here’s what the Journal didn’t report: ZestFinance is currently entangled in a class action lawsuit for dodging state-imposed limits on exorbitant payday lending interest rates. This is at least its second time in court over these issues. The Journal also neglected to note how one of the company’s venture capital backers has direct ties to President Donald Trump’s American AI Initiative, which could allow taxpayer dollars to flow through ZestFinance back into his pocket.

Press coverage of ZestFinance has barely discussed these salient facts. That’s why the House Financial Services Committee needs to conduct an oversight hearing of the company’s new relationship with Freddie Mac.

Merrill, ZestFinance’s founder, claimed in puff pieces over the years that he started his company after his sister-in-law struggled to get a loan to buy emergency snow tires. Seeing how difficult it was for people with poor credit scores to get a fair deal, Merrill heroically quit his comfy position as Google’s chief information officer—from which he helped engineer the company’s IPO—and set to work building a new kind of lender. He planned to apply lessons learned from working on Google’s algorithms to the credit-underwriting business. Under Merrill’s leadership, machines would look past the staid, old creditworthiness metrics and find new ways to get people a fair loan.

But that altruistic version of the story doesn’t scan with the company’s practices, especially in its early days. ZestFinance originally ran a direct-lending platform called Zest Cash, where it lent to people whom Merrill calls “subprime” (read: low credit score) borrowers. One of its partners was BlueChip Financial, a corporation founded by the Turtle Mountain Band of Chippewa Indians in 2012. But according to an ongoing lawsuit, ZestFinance used BlueChip Financial as a front for dodging payday lending regulations.

This is a common tactic used by online payday lenders, known as a “rent-a-tribe” scheme. Because BlueChip is technically based in Chippewa tribal territory, it’s outside of the jurisdiction of interest rate cap laws in certain states. That means a nontribal company that funnels its business through a tribal corporation like BlueChip can exploit low-income borrowers with high interest rates without fearing oversight. Tribal businesses could also claim exemptions from federal consumer protection laws.

According to the lawsuit, BlueChip, the tribal company, issued more than 500,000 loans in partnership with Merrill, but only 1 percent of the company’s profit went to the tribe. The rest went to ZestFinance and other nontribal groups. These loans had interest rates as high as 490 percent.

One plaintiff on the current case, Gwendolyn Beck, filed an individual suit against ZestFinance one month before the class action. Beck’s case ultimately settled out of court, according to a public document search. Her suit stated she’d taken out two loans from ZestFinance—one with a principal of $400, which ended up costing her $1,116.23, and one with a principal of $600, which ended up costing her $2,884.45.

A year before Beck’s suit, Merrill and ZestFinance faced another case with identical allegations that they used BlueChip to offer extractive loans and evade state usury limits. ZestFinance tried to kill that case through mandatory arbitration, but the defendant argued that the company was maneuvering around state and federal laws. The judge ruled in the defendant’s favor, but ZestFinance appealed. Ultimately, the case settled out of court.

Today, ZestFinance is out of the direct-lending game, but Merrill remains the company’s leader and public face. Instead, it offers its machine learning and AI tools to other financial institutions that want to use them for underwriting purposes. That’s why Freddie Mac is now working with the company.

Even this merits further oversight, though. ZestFinance is a startup, meaning it survives off of investment money from venture capitalists. One of its backers is the private equity firm Fortress Investment Group, which holds major stakes in national payday lending companies, according to a report from Americans for Financial Reform (where I worked as an intern) and the Private Equity Stakeholder Project.

Another prominent ZestFinance backer is Peter Thiel, the radical far-right libertarian behind Palantir, the surveillance company whose ICE contracts progressive activists are currently fighting to undo.

Thiel is Trump’s most outspoken supporter in Silicon Valley, who spoke at the 2016 Republican National Convention. He has written that he turned his back on democracy once women gained voting rights and low-income people gained government aid. But he’s also an early Facebook investor who is well respected in venture capital circles. Thiel invested $20 million in ZestFinance in 2013 through the most secretive of his funds, Thiel Capital, whose website is only a logo.

Why does it matter that Thiel is a ZestFinance backer? Because Thiel also installed an associate of his as the highest-ranking technology official in the Donald Trump White House: Michael Kratsios, who used to be the principal and chief of staff at the aforementioned Thiel Capital.

Kratsios is now the chief technology officer of the United States, and his major project has been the American AI Initiative, which is pumping taxpayer dollars into AI research while deregulating the industry. Kratsios bragged at a panel this month that because of this initiative, the Trump White House was calling for $1 billion in nondefense AI spending across the government for the FY2020 budget. That surge equals the amount appropriated for all AI spending (defense and nondefense) in FY2016.

ZestFinance is an AI company. It is now working with a quasi-governmental entity in Freddie Mac. It is possible that taxpayer funds directed by Thiel Capital’s former chief of staff will now flow to a Thiel Capital company, putting more money in Peter Thiel’s pocket.

Then again, perhaps not. This is speculation based on available public information. But answering questions like this, and exposing shady businesses before they harm the public through government-owned enterprises like Freddie Mac, is why Congress has oversight powers.

All of these issues—fintech, payday lending, Freddie Mac—fall squarely within the jurisdiction of the House Financial Services Committee, chaired by progressive champion Maxine Waters. She should call Merrill in for an oversight hearing and subpoena documents about his and other ZestFinance staffers’ interactions with Kratsios, Thiel, and Thiel Capital.

This wouldn’t be Merrill’s first time in front of the committee: He testified before its AI Task Force in June about how machine learning causes AI to function as a “black box,” meaning that it’s difficult to trace why machines make the decisions they do. Merrill claimed ZestFinance’s models were better at explaining such decisions than others. Now that we know Freddie Mac is employing ZestFinance’s technology, he ought to defend his company’s models again and more clearly. But more importantly, he must answer for the rent-a-tribe allegations and the possibility of financial connections to Thiel to demonstrate that he merits the public’s trust.


Max Moran is a Research Assistant at the Revolving Door Project at the Center for Economic and Policy Research.