Blaming FICO for the meltdown: Time to back off

06.09.09
By John Ulzheimer

In their Friday, June 5th Money section, USA TODAY published several emails written by Angelo Mozilo, former CEO of Countrywide. The Securities and Exchange Commission, who has filed a civil complaint against Mozilo accusing him of defrauding investors, released these emails. And while I’m sure the trial will be entertaining, I was more interested with the content of one of the emails.

In an April 2006 email from Mozilo to David Sambol (Countrywide’s former president), he wrote: “In all my years in the business I have never seen a more toxic product (subprime 80/20 loans). It’s not only subordinated to the first, but the first is subprime. In addition, the FICO’s are below 600, below 500 and some below 400…”

Surely that was a typo? What lender in their right mind would ignore FICO credit scores as low as below 400, let alone below 600 and 500? I guess we know the answer to that one. So pack up the trucks, dump out the garbage, and settle your final bill. All of you critics of the FICO score can take your road show home. You’re no longer allowed to blame the tool if you ignored the tool.  

The fact of the matter is we all knew this was happening. Mortgage lenders were not only ignoring FICO scores; those lenders were, and still are, using score optimization services to artificially boost FICO scores just to get their deals done so they can get paid. FICO scores were viewed more as a small hurdle to getting a deal approved rather than a risk alarm that screamed louder and louder as the scores went lower and lower. Still, these alarms fell upon deaf ears.

What this email does is it validates the practice. And Countrywide wasn’t the only mortgage lender doing this. This process of overriding a low score, hence the term “low side override”, became a mortgage lender’s ticket aboard the gravy train.

Surely FICO was thrilled with the evidence that their core offering, which has been beaten soundly by many in the press, was still doing its job to warn lenders away from risky borrowers. I wanted to break their senior executive, Dr. Mark Greene, away from his metaphorical champagne and ask a simple question, which he graciously accepted…     

My question was the following: What risks do mortgage lenders like Countrywide take by overriding or ignoring FICO scores?

Dr. Greene responded, "Each lender makes its own decisions about its underwriting practices, the level of risk it is willing to take in making loans, and the terms it will offer to balance that risk, in keeping with its own lending strategies. For years we have encouraged lenders to use all available information, including FICO scores, in every credit decision. It’s noteworthy that lenders who have followed our recommended best practices for using credit scores have continued to thrive, including those in the U.S. mortgage market."

Let’s be very clear about what Mark Greene is saying here. It’s not a criticism of any lender nor should it be taken as such. It’s the most basic and simple truth about the application of credit scoring. It is a tool to be combined with other tools and policies to determine risk. The problem for Countrywide is that the FICO score is to lending as a foundation is to a home. It’s unwise to ignore the FICO score just as it’s unwise to ignore a home’s foundation.  

We all know what’s happened to Countrywide. We all know what’s happening to other mortgage lenders and homeowners. What we don’t know for certain is how many other mortgage giants decided that little 3-digit number wasn’t so important. I guess we just need to keep our eyes on the crime blotter for ex-mortgage-CEOs to figure that one out.  

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Mortgage lenders viewed FICO scores as a hurdle rather than a risk alarm that screamed louder and louder as scores went lower and lower.