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
Gentlepersons, Your views, well stated, I’ve agreed in parallel since the inception of FICO – which for all practical intent terminated “character” lending. THANKS for staying on trac with credible points of view
Steven….you are right. Wake up folks… The Federal Reserve is not what we have been lead to believe…..it is privately owned and operated.
The loan agreement was a contract. Either party could take advantage of the contractual provisions. The borrower obligated to make payments only if they wish to keep the property. Not making payments is an option in the contract, as was sacrificing the property if payments were not made. Furthermore, the lender is not obligated to take the property if payments are not made. In the business situation, if clearly making the decision to stop making payment is the best option for the borrower, that decision makes more sense than bankrupting themselves, or pursuing a failed investment. Hasn’t anyone ever heard of a business closing their doors when it no longer can make a profit, or an investor selling an asset when it declines in value? Strategic default is an inaccurate tag, the action should simply be named an “intelligent, well-informed, pragmatic, empirical business/family/life decision”.
Wow you guys are way off base. THE AMERICAN PEOPLE ARE BEING PLAYED.
Over and over and over ,then over again. Search on Google the Federal Reserve Audit 2011. ALL YOUR QUESTIONS will be answered and you will know who pulls the strings on interest rates, Rates go up. prices usually drop. On this see saw the Fed raised rates from 3% to 6.75 in summer 2006, by 2008 wall street banks came asking for more fed money, Make your own mind up after reading about the checks the fed wrote to themselves, is is $53,333 for every US Citizen, we got the bill but they get to LOAN it BACK to Us….HUH? Raise gasoline prices to 20 bucks a gallon & see how the US economy does then//////same thing with housing…Smiles MERRY CHRISTMAS time to make $$$$$ in 2012
I agree with the author of the article. Only a fool would continue to follow thru on a financial deal that went bad because of issues outside their control.
The banking industry has been paid over & over for the loans in default. They sold them so many times no one really knows who owns them. Just read up on all the investor lawsuits and they are not suing the homeowners but the banks. In many cases it would have been better for the investor and homeowner to have modified the terms of the loan. However, the servicing companies (banks) do not make as much profit that way so they have chosen to foreclose. This cycle pads the banks but continues to drag down the home prices and at some point a homeowner has to say enough is enough and walks.
I don’t see how you can possibly justify the actions of strategic defaulters or portray them as people “unwilling to be swindled”. They borrowed hundreds of thousands of dollars, willingly signed the contracts with the banks, have the ability to repay and you condone their action of walking away??
How were they being swindled? No bank has ever promised that property values would always go up. No bank has any clause in their notes that say if the value decreases you are off the hook. The banks don’t want the defaults any more than anyone else.
You say the FICO scores are not accurate in these cases because they don’t reflect a borrowers true ability to pay. Especially when it comes to the well heeled strategic defauter. Well one thing is certain, they do correctly portray the fact that people chose not to pay and that is just as bad a credit risk as those who can’t pay. Who is to say that in the future a strategic defaulter won’t make the same choice again and simply walk away from an obligation because it’s convenient and stick a bank with the bill again?