The pain of the subprime lending crisis has spread beyond borrowers and lenders to, among others, the debt rating agencies, which face regulatory inquiries and the threat of fines and lawsuits for having failed to foresee the troubles. Shares of Moody’s Corp. lost half their value between May 23 and December 31, when they closed at $35.70.
Fair Isaac Corp., a 52-year-old data services company best known for creating the FICO score that underlies consumer creditworthiness ratings, has also seen its share price fall — to $32.15, from $40 in early July. But the Minneapolis-based company has not faced attacks on its reputation like those suffered by the corporate raters. If anything, Fair Isaac’s data from the front lines of consumer lending provides evidence of out-of-control underwriting practices, says CEO Mark Greene. Lenders “went to individuals with very sophisticated [adjustable-rate mortgage] products that had teaser rates followed by a significant reset,” says Greene, who joined Fair Isaac in February after 12 years with IBM Corp., most recently as vice president of sales and distribution for the financial services industry. “It was perhaps a product the borrowers didn’t fully appreciate, and probably a product that they knowably could not afford to repay once the reset occurred,” he adds. “That was often coupled with a low-doc or no-doc discipline that caused origination and underwriting policies to be quite different from what they had been in the past.” Greene, 53, a onetime Federal Reserve Board economist, spoke last month with Institutional Investor Staff Writer Dan Freed.
1 Have borrowers behaved as expected in this crisis?
We’re seeing funny things happen, including changes in what’s called the payment hierarchy. It used to be that borrowers paid their mortgages first, and then credit cards, car loans, etc. We see evidence now that those classes are all being affected, but maybe in different orders. The one that seems to be comparatively okay is automobile loans. That may be because people understand a car is easily repossessed if you don’t stay current.
2 Why have home loans become a lower priority?
Perhaps homeowners didn’t expect to be in the house when rates reset, or maybe they viewed housing as a temporary asset and moved more frequently. We’re not sure, but we’re seeing changed consumer behavior, and not just in the U.S. I just returned from seven cities in Europe, and they’re seeing the same phenomenon there.
3 Who is to blame for the crisis?
There’s evidence that some banks were a bit ambitious in seeking to penetrate the subprime market, and they undertook some transactions that I think in retrospect they wish they had not. Frankly, the FICO scores probably told them not to. I think that’s the origin: a failure to properly use the scores in conjunction with sound underwriting practices.
4 Are there concerns about the accuracy of FICO scores?
You see some concerns reported in the press about whether the scores have been as accurate in the subprime space as they historically had been. We think they have been. The FICO score is designed to assess consumers’ past ability to meet payment obligations. Even in subprime over the past year or two, FICO scores seem to have done that quite well.
5 Do you believe that the securitization model ultimately lowers risk?
In normal times it does. There’s an issue, though, in the separation of origination, servicing and risk management. Banks used to do all this under one roof. They knew the customer from the cradle to the grave. With the specialization of the mortgage industry, origination, servicing and risk management were split among at least three different entities. Nobody truly knows the customer anymore, and that as much as anything has been the root cause of the current mortgage issue.
