It is universally accepted that market competition and consumer choice are not only beneficial but also quite necessary in a modern economy. In some cases, however, settling on a single standard is a far better option. We would not want, for example, competing standards for the electrical outlets in our homes, nor reams of paper to come in a vast array of sizes.
The tension between a set standard and increased competition is now in the forefront of the mortgage industry, with far-reaching implications for consumers. The Federal Housing Finance Agency (FHFA), an independent entity that regulates Fannie Mae, Freddie Mac, and the eleven Federal Home Loan Banks is considering whether to allow these Government Sponsored Enterprises (GSEs) the option of allowing lenders to use alternative credit scoring models for home buyers.
Given the current state of the economy, with its skyrocketing home prices and record-setting inflation, introducing new scoring models into the housing market would be a big risk with no identifiable benefits. Supporters claim it creates competition in the credit scoring industry but what it truly offers is unnecessary risk when we can least afford it.
Alternative scores would surely benefit the companies promulgating them, but consumers have no choice which model scores them. Further, there is no evidence these models offer any new innovation or improvement that would help credit worthy homebuyers qualify for loans. FHFA has confirmed this repeatedly over the years in semi-regular assessments of scoring models for their predictive accuracy and thoroughness in scoring borrowers through countless carefully weighted data points. Models that fall short of the current FICO score in accurately assessing risk for lenders do not improve the safety or soundness of our housing market, which must remain paramount.
There is also an issue of added cost. Our nation’s lending infrastructure is heavily standardized through software, banking protocols, and financial verifications. The mortgage lending chain, from the GSEs down to lender institutions, would be required to invest in complex and costly modifications to accommodate an alternative model, costs that would certainly be passed on to borrowers.
Lack of market stability is at the heart of introducing alternate scoring models. Credit score models are built on empirical data, but different models would in most cases yield different scores, and by definition different assessments of risk. Lenders would, of course, choose to use the more favorable score to nudge the applicant toward approval. This is good for profits, but it transforms lending into a subjective exercise which invites the risk of increasing the number of bad loans, a mistake we certainly do not want to repeat.
Increased risk of default in housing is certainly something understood by Sandra Thompson, currently head of FHFA, and upon whose shoulders this decision largely rests. Ms. Thompson spent several decades at the Federal Depositors Insurance Corporation (FDIC) and had a front-row seat to the 2008 market crash caused by sub-prime lending. Ms. Thompson is wisely taking a very careful and thorough approach, inviting input and actively listening to industry voices and stakeholders to assess the best path for consumers and to ensure a financially sound and stable housing market. This wise path emphasizes safety, security, and minimizing risk in mortgage lending, which should be applauded.
The bottom line is that data does not play favorites. Currently all mortgage applicants are evaluated objectively through precise and proven risk modeling that has served as the backbone of America’s mortgage lending for decades. The risk of including new and alternative scoring models in the housing industry is in sight, while the benefits are not.
