While putting away some of the leftovers from dinner the other night, I pulled a dish out of the cupboard, and before I knew it, it fell to the floor and broke.
I’m pretty sure it was FICO’s fault. (You read that right, FICO — as in the Fair Isaac credit score).
Why was it FICO’s fault? Well, I figure since everybody else seems to be blaming FICO for all the troubles in the world, I might as well, too.
First came BusinessWeek, which wrote “the once-vaunted FICO credit scoring system is now being blamed for failing to flag risky home-loan borrowers.” Then the folks over at Gonzo Banker wrote:
For all the high levels of rocket science and statistics deployed, it’s clear that lenders have been lulled into underwriting laziness by the FICO score….By relying on automation to create credit scores which rely on historical patterns in a person’s credit file, a tremendous amount of credit was granted to people that, quite simply, could not and cannot afford it.”
My take: FICO is not only responsible for the credit crunch, it’s the cause of world hunger, poverty, and my dropping a dish. OK, just kidding.
What rankles me is the piling on by Biz Week, Gonzo, and other observers against the same FICO score that many of them heralded as the best predictor of everything from loan creditworthiness to P&C insurance policy-worthiness to even future job success.
Let me see if I have this straight: A few years ago, many consultants urged financial services firms to use the FICO score to automate more of their lending decisions to cut costs and speed up cycle time. As common wisdom held, not only would they make decisions faster, but they would attract more apps because of their superior cycle time. But, according to many of these same consultants, thse financial firms that did this are at fault for spurring the credit crunch by relying on automation?
[Note: I’m really not trying to take a swipe at the folks over at Cornerstone, who write the Gonzo Banker site. I have a lot of respect for Steve Williams and his colleagues there. For all I know, Cornerstone was not one of the firms urging FIs to automate using the FICO score.]
Blaming the FICO score is misplaced. According to the Business Week article:
The average FICO score of borrowers who stopped making home-loan payments was 589 in 2001, compared with 620 for those who were paying on time—a 31-point difference that pointed to FICO’s predictive ability. By 2006, as subprime loan volume was surging, the gap had closed to just 10.”
Let me introduce a new term to some in the financial services community: Calibration. If you have a scale, and you find that it’s consistently 2 ounces off, you recalibrate it to adjust for the skewing. There’s no reason why FIs couldn’t have recalibrated, and adjusted their policies to account for the closing gap.
I’m a lot more inclined to agree with Jeremy Siegel, professor at the University of Pennsylvania, who wrote in Kiplingers:
…it was the free-market zeitgeist, which encouraged the creation of easy-money mortgages and their enthusiastic purchase by yield-hungry investors, that ultimately led to the credit fiasco.”
And I would have fully agreed with him if he would have added “consumers who knowingly and willingly borrowed way beyond their means.”
The point that Dr. Siegel makes (in my opinion), is that the credit crunch is not a simple situation with a simple cause and effect dynamic. It’s a complicated problem, caused by many factors, few of which are easily controlled.
The comments from the Business Week and Gonzo Banker point, however, to a bigger issue: The inability for people to take the blame for their own mistakes.
Spill a cup of coffee on yourself? Sue the place that sold it to you! Drive too fast and crash your car? Blame it on the car manufacturer for making a car that goes too fast! Made too many loans to people who can’t pay because you relaxed your credit policies to capitalize on the strong demand for home loans? Blame it on FICO! I’m sure it’s the score’s fault — after all, it made me break a dish.
3/14 UPDATE: For an excellent follow-up to this, see Bhupendra’s post.
Technorati Tags: Marketing, Banking, FICO, Gonzo Banker
Ron Shevlin's Marketing Whims 
You should check out the book “Credit Scores & Credit Reports” by Evan Hendricks. It really opened my eyes to how shady the credit agencies and Fair (hah) Issac really are!
Ok, you’ve touched a button here and I have to respond.
First off, the banks and lender’s should look no further than their own doorstep for blame on the credit crisis. Variable Rate, interest only loans to people who can barely afford the current rate is just plain poor underwriting. Your point about the inability to accept blame is dead on.
The bigger issue with the credit crisis and the economy in general is that the policy makers seem to be making more short term decisions than long term decisions. Inflation is rapidly rising, and yet our interest rates are still artifically low…I could go into an econ lesson here, but I’ll refrain. This is not the point I wanted to make.
The calmer voice in me prevailing now, what this really points out to me is the dangers of using a single score (like FICO, or say, ummm Net Promoter Score) to drive your business decisions. Whether you are making underwriting decisions, marketing decisions, strategic decisions or any other types, you should be looking into multiple points of information to make that decision.
A simple example of this comes from one of my first jobs out of college. I was a loan officer in a small community bank specializing in consumer and home equity loans. Our underwriting decisions at that time included a look at the credit report, with a scoring algorithm, a debt to income ratio (not lending to anyone spending more than 22% of their income on the first mortgage and nor more than 35% of income on all total debt including the expected payment), a debt to equity ratio on the home (we wouldn’t exceed 80% loan to value) and we also looked at other liquid assets in making the underwriting decisions.
The point being, it wasn’t just the FICO score that determined whether or not we lent the money. I’m sure that the lenders are looking at multiple factors, but it makes me wonder how strict the underwriters were on the B & C credit individuals were in sticking to the other guidelines.
Now, as a marketer, I never utilize a single metric to drive decisions. My world is rarely that simple…maybe I’m doing something wrong.
If we’re talking about mortgage lending (which seems to be the root of most current economic woes), in my experience, not a single mortgage lender relied solely on a FICO score. In fact, the most important factor was that the borrower had enough equity in the home to make the loan seem like a good idea.
If home values are inflated, almost everyone in some states (such as Calif) seemed to have enough equity. In many cases (of course subprime), people were qualifying for refinance loans even if their FICO score was dismal.
So, to blame the current situation on FICO is ridiculous. But, I guess it makes for easy-to-digest news stories…
Now, I can’t say for certain that FICO is not responsible for the dish breaking. I’m thinking it probably is 🙂
@Jeff: Your comment helped me realize a key point that I didn’t really get across in the post: The importance of testing and validation.
It’s kinda like the “eggs in one basket” saying: If you’re going to put all your eggs in one basket, you better REALLY watch over that basket.
Translation: If you’re going to use one number to make decisions, you better make sure that number is “right”. By saying “right” I don’t mean “make sure someone’s FICO score really is 580” but “make sure 580 is as good a predictor of creditworthiness as you think it is”.
As I think about this more, I really believe the root of the problem is NOT the over-reliance on a single number (whether its FICO or NPS), but the lack of testing and validation.
And Jeff, for some reason, I’ve got to believe that if I buy you some drinks someday, you’d be able to tell some stories about your firm’s clients that got themselves into hot water by not testing adequately. 🙂
Ron –
After 15 years in Database and Direct Marketing, I have more than one story to share about both good and bad performance.
A drink someday sounds like a great plan. We have a few friends in common if you need to look me up.
If I haven’t said it, I really enjoy your blog.
– JPH
Ron – Excellent point about the testing and validation. If I remember correctly, using FICO scores was a key method for pricing loans when everyone got into “risk-based pricing”. I’d be curious if any of those institutions have actually monitored their “A” vs. “C” paper and found higher delinquencies in the higher-priced loans.
Great Article Ron. I agree with all your points.
I have my response to your post in my blog.
http://analyticsbhups.blogspot.com/2008/03/blame-fico-for-sub-prime-crisis.html
Bhupendra
Credit scores are hugely important. They should have considered that more when giving out loans years ago however. But FICO scores are extremely important now.
Great FICO related info. FICO scores are hugel and need to be considered at all times now.
The problem with FICO is that in 4 months people can totally SCREW their score but it takes like 7 years and a whole lot of magic dust to fix it.
Stacy… I agree with you completely! What’s messed-up is if a person makes one (1)(Uno) payment, then, your right, it takes a very long time for the FICO’s people to adjust it back. You can loss 20-40 points just from that alone. I still have a couple of accounts that I paid and closed about four months ago, and they still show that they are open. What is wrong with these F@#$%’s people?
The FICO score just may be the best kept secret yet. Heck, even the colonels chicken and coca cola have had some pretty good copy cats, but not FICO. The only weapon we have to use against them is the FCRA – Fair Credit Reporting Act and use every loophole, tactic, and trick in the book to get stuff off our credit reports, whether the items are legitimate or not. Dispute, dispute, dispute, but with care using laser targeted reasons. We teach you this at http://www.AttractiveCreditSecrets.com Whether it’s adding positive credit or disputing negative items. We got it covered. Free ebook for checking us out.