Washington Inflates Credit Scores and Another Housing Bubble
Why is the Trump administration continuing the Biden push for ‘inclusive’ credit scores?
By Allysia Finley
Matt Rourke/Associated PressA wrong-headed political drive in Washington to make housing more affordable fueled the 2000s housing bubble, which burst into the 2008-09 financial crisis.
Now we’re seeing history rhyme as federal housing regulators create perverse incentives that are sure to lead to inflated credit scores that will let riskier borrowers take out lower-interest mortgages.
Like many Washington blunders, this one has its roots in rent-seeking.
The story began in 2006, when the three major credit bureaus—Equifax, TransUnion and Experian—stood up a credit-scoring competitor to the dominant Fair Isaac Corp., or FICO.
The three firms collect credit records on borrowers, though their data repositories somewhat differ.
They pay FICO royalties and use its proprietary algorithm to generate credit scores based on the data in a borrower’s file.
These fees are small—only about $5 to $10 for each score when a mortgage lender pulls a borrower’s credit file.
By creating a jointly owned competitor, VantageScore, the firms aimed to reduce royalties they have to pay to FICO and boost their margins.
VantageScore advertised its credit-scoring model as more “inclusive” than FICO because it used utility, rent and telecom payments.
That meant borrowers who had never used credit cards or taken out loans could score relatively high.
“By scoring more individuals from minority and lower-income backgrounds, VantageScore 4.0 can help bridge a homeownership gap that has persisted for decades,” the company claimed.
But VantageScore struggled to gain acceptance among home lenders because Fannie Mae and Freddie Mac—the government-sponsored enterprises that stand behind half of single-family mortgages and set lending standards for the industry—required them to use FICO.
The credit bureaus complained that Fannie and Freddie were stifling competition.
They also accused FICO of abusing its monopoly to charge excessive fees, which they claimed raised mortgage costs.
It was a nice story that resonated with politicians, but it wasn’t true.
FICO receives about $30 from the $100 in costs when a mortgage lender pulls a borrower’s credit records, which is less than 0.3% of the cost to originate a mortgage.
In the aftermath of the housing crisis, the Federal Housing Finance Agency, which oversees Fannie and Freddie, sought to keep them on a tighter leash, at least for a time.
No more adjustable-rate mortgages and liar loans to subprime borrowers.
VantageScore had a scant track record of predicting mortgage defaults during times of stress.
During the Biden presidency, VantageScore pressed the FHFA to let mortgage lenders use its score when underwriting mortgages.
In October 2022, the FHFA agreed.
Curiously, two months earlier, VantageScore announced that it would eliminate unpaid medical debt from its scoring model—a policy priority for progressives in the Biden administration.
FHFA records that the nonprofit Housing Policy Council obtained recently through a Freedom of Information Act request—first submitted in July 2023—showed that officials at Fannie and Freddie had opposed allowing lenders to use VantageScore.
So did the FHFA jawbone the housing godzillas into accepting VantageScore?
It’s unclear, since the housing regulator redacted nearly 200 of the 318 pages of documents it produced on the grounds they included privileged information.
Why would FHFA Director Bill Pulte, appointed by President Trump, shield his Biden predecessors?
Perhaps because he shares their political goal of expanding homeownership by easing underwriting standards.
At least the Biden FHFA required lenders to submit to Fannie and Freddie both a FICO and VantageScore for all loans.
Mr. Pulte, however, announced last summer to much fanfare that lenders would be allowed to choose which score to use when underwriting mortgages.
The end of this story writes itself.
Lenders will always choose the higher score so they can make more mortgages to risky borrowers—and at lower rates.
Fannie and Freddie charge higher fees to insure mortgages for borrowers with lower credit scores.
That means Fannie and Freddie will guarantee riskier mortgages and charge less for doing so.
Chesapeake Risk Advisors’ Clifford Rossi estimates that severe-delinquency rates could increase by 18%.
The consulting firm Milliman predicts default rates will rise by some 30%.
The American Enterprise Institute’s Ed Pinto, Tobias Peter and Sissi Li estimate guarantee fees will fall by 10% to 13%, putting taxpayers at greater risk.
“Because FHFA exlicitly allows ‘score shopping,’ lenders, realtors, and borrowers could simply choose the more favorable score, leading to more approvals, looser credit, and greater default risk, while leaving vulnerable borrowers with unsustainable debt.
Score providers, in turn, may lower their criteria to win more business,” the AEI researchers explain.
Who doubts that FICO and VantageScore will begin competing for business by tweaking their models in ways that inflate credit scores?
Such perverse incentives flow from the government’s vast mortgage backstop.
If not for this, lenders would choose the credit-score model that they think better captures a borrower’s risk, since they would have to bear the costs of defaults.
Instead, lenders and credit firms can foist the costs onto taxpayers.
Privatized gains and socialized losses, just as America experienced 20 years ago.
Mr. Pulte was a teenager during the inflation of the 2000s housing bubble.
Still, you’d think America’s chief housing regulator would be familiar with this history.
Ms. Finley joined The Wall Street Journal in 2009 after graduating from Stanford University with a bachelor’s degree in American Studies. During college, she edited the opinions section for The Stanford
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