Credit Rating Agencies, Writ Small

As a long-time lender, I would always trade off fico for equity.

email from Angelo Mozilo, Countrywide CEO (now charged with civil fraud), to a lieutenant

What exactly is Mozilo talking about?

Sub-prime lenders’ growing concerns, circa 2006, that the size of a borrower’s down payment was a much better predictor of their loan quality than their credit score as calculated by the Fair Isaac Corp. (now called “FICO”).

As the housing boom wore on, such scores came to loom increasingly large in mortgage origination decisions — much like the Triple-A ratings parceled out by Standard & Poor’s and Moody’s effectively became the “Good Housekeeping Seal of Approval” for trillions in mortgage-backed securities.

Unfortunately, the calculations made by both FICO and the credit rating agencies rested on the same, fatally flawed — and for a time, very lucrative — assumption: namely, just because something had never defaulted in mass numbers, it never would.


With respect to mortgage-backed securities, the prevailing mindset was that the risk of default to investors, always historically negligible, could be reduced even further by segregating the highest risk securities into discrete groupings or “tranches.”

In FICO’s case, the decision-making was at the level of the individual mortgagor (or borrower).

The fatal assumption? That consumers who had never defaulted on their debts, never would.

As now seems obvious, there’s a big difference between paying your utility bills on time and owing, say, a couple grand on a few credit cards, and owing several hundred thousand (and perhaps much, much more) on a mortgage. On a house that’s worth less than you owe. That you’ve got no equity in (and indeed, never did). When you’ve maybe lost your job, or are afraid you might. You get the idea . . .

Not surprisingly, the foregoing proved to be an especially combustible mix.

Lenders: ‘Show me the money’ (downpayment)

So now what?

At least at the moment, everyone’s “back to basics”:

–Only lend against good collateral, conservatively valued;
–Require borrowers to have some “skin in the game” (a sizable down payment);
–Carefully vet the borrowers’ income and assets.

As Mozilo and other long-time bankers know — and always knew, deep down — it is those principles that are the foundation for high-quality mortgages — not a third party’s flawed, seal of approval such as FICO scores.

Mozilo’s been called lots of things, but “dummy” isn’t one of them (unless you count leaving behind incriminating emails).

About the author

Ross Kaplan has 19+ years experience selling real estate all over the Twin Cities. He is also a 12-time consecutive "Super Real Estate Agent," as determined by Mpls. - St. Paul Magazine and Twin Cities Business Magazine. Prior to becoming a Realtor, Ross was an attorney (corporate law), CPA, and entrepreneur. He holds an economics degree from Stanford.

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