Credit scores: Flawed system...or Scapegoat?

Posted by: Dean Foust on February 20, 2008

creditontheedge.jpgI wrote a story recently in the print edition of BusinessWeek on a topic that I thought had been largely ignored in all of the coverage of the mortgage mess: The degree to which mortgage lenders, and the Wall Street firms that bundled mortgages into bond-like securities, replied on FICO and other credit scoring systems in their underwriting process. You can read the story by clicking here.

The story generated a fair bit of feedback from readers, as you’ll see in the comments at the bottom of the story. I was struck by the degree to which readers lambasted me and my partner in the project, Aaron Pressman, for blaming FICO and, with it, absolving the banks of any responsibility for making bad loans. That wasn’t my intent.

Granted, we point out in the article that FICO has its flaws, it can be "gamed" by unscrupulous mortgage brokers and self-styled "credit doctors," and its creator, Fair Isaac, hadn't overhauled the scoring system to keep pace with the innovation in the mortgage business.

But we also intended to show how banks and other lenders were using a scoring system in a manner for which it wasn't originally intended. In other words, relying so heavily on FICO was a mistake to begin with. But readers didn't see it that way. They felt we were simply swallowing the banks' line that FICO wasn't all that Fair Isaac promoted it to be, and the banks were wronged. Didn't intend it that way. But read the story and tell me what you think, either on this blog or the "comments" section of the original article.

Reader Comments

Rose

February 25, 2008 10:42 AM


I guess they would call my husband and I subprime borrowers. but we didn't go after houses that we could'nt aford or our dream house. We got what we could aford. We have made every paymnt on time (We thank the lord for that)We are aware that any thing can happen but we were not going after something that look good just because. and that its were the problem lay with people bitting off more then they can chew. I am gratefull that We had a lender that looked at our score but also looked at everything else. they truly use their underwriting skills. At times it was difficult and it did'nt seem like we were going to get approval they kept asking for so much paperwork. but we were approved with a credit score of 579 and did I mention we haven't missed a payment or been late (thank you jesus!!

Michael

February 26, 2008 8:37 PM

Dean,

I read your original article with interest. Having worked in both the USA and other markets (Australia, New Zealand, and the UK) scoring and its use remain varied by lender.

Some lenders not only use it blindly as THE decision maker, but probably worse, do not monitor the tool's performance or portfolio results sufficiently to know when issues arise or adjustments are required.

A poor craftsman often blames his tools. Whilst finance companies do not 'own' the FICO score, they will always be accountable for the degree to which they use it. Saying "I was dooped" - in my view - is proof positive that the lender was not doing their part.

That said FICO - like nearly all monopolies (or near monopolies) - became lax and over confident. The fact that much of the issue can be traced to activities designed to be deceptive (piggybacking etc) regardless of whether or not they are illegal or not is sad. But that is the reality of the world today - and so must be something that all involved must stay on top of.

Looking forward...
Fixing the situation could actually make things worse - which could easily happen if those who do not know how to properly use scoring are allowed to develop a "fix" - either out of legal proceedings or worse via some ill advised industry regulation.

Credit scoring has great potential to HELP deliver a consistent and reliable outcome for lenders and borrowers - but like any tool in the hands of the un-skilled it can, as it has in this situation - cause grave damage.

Finally - I was only able to see one comment posted in response to your article (from Rose) if there are others I would greatly appreciate you sending them to my email address.

frank

March 3, 2008 2:33 AM

Over the last 25 years I have had about
30 loan transactions with a bank. These were a combination of RM & CM deals..
Years ago i used to go to my loan officer at the local branch.. he knew me and how i conducted my biz.. loans were no problem, i just signed a note. Pretty soon he got promoted and i got a kid from yale... he could have cared less about previous preformance.. all he wanted was ASSETS!!.. so no assets no loan.. So i get used to this yallie.. then the bank gets merged.. and i get a Havard guy..
all he wants for a loan is to know who was my grandfater.. If he wasn't born on the right side of the tracks.. then no loan!! go figure??
In summary the last 25 years of bank consoladation has been a failure... potential great loans have been denied and other "PC" type loans have been expedited.. the bank loses; the economy loses; the borrower loses; and worst of all the ass-ole.. Harvard MBA get's promoted...jmo frank

julie Mealo

June 15, 2008 11:52 AM

Your article was dead on. I have worked in lending 25 years, pre fico worship days, and actually assessing the full credit report is the only way to accurately assess risk. Some old fashioned lenders, like local savings banks, still do it the old way and have far less problems than those lenders that relied on Fico alone.

Many of the protesters that criticized your article most likely come out of a background in which fico has always been used, so they don't know the difference and don't understand the principals of prudent manual underwriting.

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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