Competition for FICO would foster a more sustainable housing system
James B. Lockhart III
8 April 2019
OPINION — Housing policy is suddenly back in the news. The Senate Banking Committee held hearings on housing finance reform recently and the Trump administration wants federal agencies to draft reform plans for mortgage securitization giants Fannie Mae and Freddie Mac. But after 10 years in conservatorship, winding down these government-sponsored enterprises and restructuring the mortgage market will be herculean tasks.
We can start by revisiting a proposed regulatory rule on credit scoring.
Fannie Mae and Freddie Mac require institutions that either sell them loans or service their purchased loans to use credit scores produced by the Fair Isaac Corporation, or FICO. These scores provide a metric to predict borrower loan performance. The Federal Housing Administration also requires lenders seeking their mortgage insurance to use FICO scores, effectively creating a credit-scoring monopoly for nearly every mortgage application in the United States.
While FICO was once widely relied on as the only provider in town, alternative credit scores are on the rise. Some include rental housing, utility and other payment data, resulting in more credit information and, for many consumers, potentially higher scores.
The Federal Housing Finance Agency, as Fannie and Freddie’s regulator and conservator, has long been exploring the use of such alternatives. After decades studying newer scores (and a major housing crisis), there must be something better. Congress thought so. To end the existing monopoly and hasten the use of newer models, Congress passed a law last spring that included a provision with a simple and straightforward title: credit score competition.
Regretfully, FHFA ignored Congress’ intent in its proposed rulemaking, currently out for comment. The agency proposed restrictions that would effectively preserve the current outdated models and a government-sanctioned monopoly, including the prohibition of “an Enterprise from approving any credit score model developed by a company that is related to a consumer data provider through any common ownership or control, of any type or amount.” This restriction effectively put the brakes on FICO’s main competitor, VantageScore, although they compete in other credit categories.
In all my years of federal service, I have never seen a regulation, or even a proposed rule, that presumed to dictate such targeted exclusion from what should be a competitive market.
There are and will be other financial technologies that will want to enter the mortgage credit scoring market. Yet the proposed rule’s overly restrictive business assessment requirements, coupled with a strange statement that the selected scoring model will not be reviewed for seven years, may prevent more predictive and inclusive models in the future.
FHFA didn’t just ignore Congress — it also snubbed the Treasury Department, which serves on the agency’s advisory board. In 2017, the Treasury released a major report noting the potential for these new approaches “to meaningfully expand access to credit and the quality of financial services.” Of course, adopting these new models will require time and money from Fannie, Freddie and other market participants. There are serious implementation and operational challenges to overcome that should not be taken lightly.
However, Fannie Mae and Freddie Mac’s key missions are to provide liquidity and stability to the mortgage market and to promote affordable housing. New credit score models and competition could lead to more consumers with scores, safely expanding access to credit. With more granular data, new models may also more accurately assess one’s ability to repay mortgage debt.
Mortgages for affordable housing must be sustainable. A decade ago, the failure of Fannie and Freddie caused hardships and foreclosures for millions of Americans. The newer models should help to guard against these mistakes of the past by empowering lenders with more accurate and predictive measures of loan performance.
It’s time for a fresh start on many fronts, which includes ending the conservatorships of Fannie and Freddie and restructuring the mortgage market. An easier but effective move is to withdraw this misguided proposed rule. FHFA needs to write a new rule that truly promotes innovation and competition in credit scoring to foster a more sustainable housing system.
James B. Lockhart III was the first director of FHFA and is now a senior fellow at the Bipartisan Policy Center.
The Bipartisan Policy Center is a D.C.-based think tank that actively promotes bipartisanship. BPC works to address the key challenges facing the nation through policy solutions that are the product of informed deliberations by former elected and appointed officials, business and labor leaders, and academics and advocates from both ends of the political spectrum. BPC is currently focused on health, energy, national security, the economy, financial regulatory reform, housing, immigration, infrastructure, and governance. Follow BPC on Twitter or Facebook.
The Las Vegas area was hit especially hard by the housing crisis a decade ago. Innovation and competition in mortgage credit scoring can foster a more sustainable housing system, Lockhart writes: