The underlying cause of stunted home sales volume and sticky pricing may be the epidemic of floundering Fair Isaac Corporation (FICO) scores during the Lesser Depression, according to a recent FICO study.
Roughly 50 million American consumers experienced a FICO score drop of at least 20 points in 2008-2009 following the housing bust and financial crisis. 21 million of those who experienced a dip in their FICO scores lost more than 50 points and many others suffered losses in excess of 100 points.
FICO score averages on government-guaranteed loans during the same period show that as millions of consumers were becoming less creditworthy per FICO ratings, lenders were increasing their underwriting standards. The average credit score for Fannie Mae- and Freddie Mac-backed loans soared to a seemingly unattainable 760. Although the Federal Housing Administration (FHA) will back borrowers with scores as low as 620 (lower in some cases), the average for borrowers who qualified through FHA-participating lenders was above 700.
The repercussions of the downward spiral in FICO scores seem to be dire. 33% of agents surveyed have reported a killed deal due to insufficient buyer FICO scores, according to a survey recently released by the national real estate trade union.
first tuesday take: The combination of weakened creditworthiness and stricter qualifying standards looks to be a knife in the back of a hanged housing market.
There is decidedly nothing wrong with stricter underwriting from lenders — lax lending standards are perhaps what got the market into the mess it’s in now. The problem is overreliance on the “all-powerful” FICO score. The FICO score is an improper outsourcing of lender judgment to a corporation using mathematical abstraction to arbitrarily determine creditworthiness. It is too heavily relied upon as a standard of creditworthiness (read: cause for rejection) when it bears no rational connection to a homebuyer’s ability to perform. [For more information on the virtues of strict underwriting, see the July 2011 first tuesday article, Strict lending is good for you and the economy.]
California in particular is now populated with a sizable contingent of strategic defaulters due to a lack of other means for getting rid of excessive debt due to the flagrant lending practices of the Millennium Boom. Many of these individuals still have jobs, earn sufficient wages and are willing to make regular mortgage payments on their homes as long as they are not throwing their dollars at a black hole asset. By and large, those who have strategically defaulted have done so out of sound financial sense — an unemotional analysis and business-like decision. [For more information on the savvy of strategic defaulters, see the July 2011 first tuesday article, Strategic default smarts.]
Thus, the hit they have taken to their credit scores does not reflect the likelihood of default due to inability to pay, but rather reflects an unwillingness to be swindled. This is the true threat the increasingly more financially literate homebuyer poses to lenders in the new real estate paradigm; this is the threat the credit rating agencies are patently colluding with lenders to mitigate.
The same collusive scenario took place in the run up to the financial crisis, only in the reverse. Credit rating agencies colluded with investors on the secondary mortgage market in order to turn quicker profits by vouching for mortgage-backed bond (MBB) pools that we now know were overflowing with junk. How can anyone trust these private institutions any longer when it comes to determining the course of what is perhaps the single most crucial market to U.S. domestic prosperity?
To paraphrase William Henry Harrison, the insistence on the necessity of an institution is the eternal argument of all conspirators. [For more information on the FICO sham, see the June 2010 first tuesday article, The FICO score delusion.]
re: “Lower credit scores slow housing recovery by thwarting sales” from the Los Angeles Times