Methods and models for credit scoring, which help determine a borrower’s ability to pay in full and on time, may seem like dry topics. But as NTU has often shown, they actually matter a great deal to taxpayers. If those methods and models are inaccurate, untested, or worse, subject to manipulation for unrelated policy goals, trillion-dollar government lending programs quickly pile up unnecessary risks and liabilities. Recently, taxpayers have been reminded of this danger as the Federal Housing Finance Agency (FHFA) begins an implementation process for new credit score models that Fannie Mae and Freddie Mac will use to provide loan liquidity in the housing sector.
Following legislation and a final rulemaking from FHFA last year, in March 2023 FHFA, Fannie and Freddie unveiled the “Enterprise Credit Score and Credit Reports Initiative,” among the biggest procedural overhauls in the history of the two Government-Sponsored Enterprises (GSEs). One major element is requiring lenders to provide two credit scores instead of one – the new FICO 10T and VantageScore 4.0 – for each loan they seek to qualify for underwriting by Fannie and Freddie.
Unfortunately, a recent letter from four House Members on the Committee on Financial Services to FHFA would chart a risky course, as it urges Director Sandra Thompson to micromanage the implementation process so that one model (VantageScore 4.0) jumps to the head of the line in the implementation phase..
Asking Director Thompson to play favorites in this manner rather than allowing implementation to unfold organically would violate the pledges she made in her May 2023 testimony to the very same House Committee on which the four lawmakers sit. As she noted:
FHFA and the Enterprises anticipate a multiyear transition and are committed to working with stakeholders to ensure a smooth process towards the use of the new credit score models and the new credit report requirements in a manner that avoids unnecessary costs and complexity. The transition timeline must be flexible enough to incorporate testing and unexpected events, but also efficient enough to ensure that consumers, the Enterprises, and others benefit from the more accurate credit score models.
Furthermore, the point of FHFA’s final rulemaking (for which NTU offered both caution and hope) was that no artificial advantages or disadvantages would be conferred on any of the companies whose models provide scores for GSE-backed housing loans. Government agencies routinely get it wrong when, in the name of “competition,” they simply put their massive thumbs on the economic scales to obtain what they believe will be a “fairer” outcome.
Equally troubling, the Representatives who wrote Director Thompson – Brittany Pettersen (D-CO), Vicente Gonzalez, Jr. (D-TX), Zach Nunn (R-IA), and Young Kim (R-CA) – have echoed a complaint from a trade association that the fees for credit reports that go into borrowers’ scores must come down before Fannie and Freddie are permitted to use one of the new models, FICO 10T. Unfortunately, the market structure in this area of lending is more complex than the association’s complaint suggests, involving credit reporting agencies, the entities that own the credit score models, the housing GSEs, and certainly not least, private-sector lenders who must navigate a maze of regulations and procedures.
For example, while FICO does collect royalties from the three credit reporting agencies, those agencies, in turn, actually set the fees for access to the data that is eventually used in the credit score. Given that the three credit reporting agencies (Experian, TransUnion, and Equifax) created VantageScore in 2006, calls for FHFA to further elevate VantageScore’s model would, to many observers, ring strangely contradictory to traditional notions of competition.
Indeed, supporters of having the government punish one credit score model to promote another should be careful of what they wish for. Allowing FHFA to oversee and supervise competing models in service to “an improved view of risk,” as Director Thompson put it in her testimony, is one thing. Asking FHFA to become a competition regulator is quite another. One inconvenient outcome could be scrutiny as to whether there remains enough daylight between VantageScore and its parent credit reporting companies so as not to present a problem of vertical integration. This type of government fishing expedition is, in NTU’s view, already far too common and meddlesome today.
How should FHFA unravel this latest conundrum over credit score competition? From NTU’s perspective, the agency shouldn’t even try doing so. By staying true to the principles expressed in her May testimony to Congress, Director Thompson and FHFA should facilitate, rather than dictate, exactly how the Enterprise Score and Credit Reports Initiative translates from theory to practice. A timely reminder of this principle comes from 17 trade associations effectively representing the entire universe of private-sector firms interacting with Fannie and Freddie. Their comment letter to FHFA urged a “recalibrated timeline [for the initiative] that accommodates both data analysis and modeling as well as a stakeholder engagement process that considers the costs, complexity, consumer impact, and policy implications of the transition.”
September 6 marked the 15th anniversary of Fannie’s and Freddie’s “conservatorship” – a polite term meaning that taxpayers explicitly back the trillions in liabilities of both institutions due to oversight failures NTU had long predicted. Because of these failures, FHFA’s statutory mission statement was unambiguously defined, to NTU’s applause: “Ensure the regulated entities fulfill their mission by operating in a safe and sound manner to serve as a reliable source of liquidity and funding for the housing finance market throughout the economic cycle.” This remains the proper focus for FHFA.
Fair competition among thoughtfully, consistently tested credit scoring models could contribute to more accurate measurement of borrowing risks in taxpayer-backed lending programs. On the other hand, propping up the illusion of competition, or making business decisions about which competitor gets a leg up in the process, can increase those borrowing risks. Sophisticated taxpayers recognize this difference; here’s hoping government safety and soundness regulators will do so as well.