Coyote Blog

From Edward Pinto at the American

Fannie and Freddie entered into agreements accepting responsibility for misleading conduct discovered by the SEC, including:

1.    As of June 30, 2008, Freddie had $244 billion in subprime loans, while investors were told it had only $6 billion in subprime exposure.

a.    Freddie knew it was inadequately compensated for the risks it was taking. For example, it was taking on “subprime-like loans to help achieve [its] HUD goals” that were similar to private fixed-rate subprime, but the latter typically received “returns five to six times as great,” says the complaint.

b.    Freddie had concerns about risk layering on loans with an LTV >90% and a FICO <680. (Yet, in Freddie’s disclosures it only noted risk layering concerns on loans with an LTV >90% and a FICO <620. This is a major difference since only 10 percent of its loans fell into the LTV >90% and a FICO <620 category, while nearly half fell into the LTV >90% and a FICO <680 one.)

2.    As of June 30, 2008, Fannie had $641 billion in Alt-A loans (23 percent of its single-family loan guaranty portfolio), while investors were told it had less than half that amount ($306 billion, or 11 percent of its single-family loan guaranty portfolio).

3.    The SEC complaint disclosed that Freddie had a coding system to track “subprime,” “other-wise subprime,” and “subprime-like” loans in its loan guaranty portfolio even as it denied having any significant subprime exposure.

These suits are important because they demonstrate that Fannie and Freddie “told the world their subprime exposure was substantially smaller than it really was … and mislead the market about the amount of risk on the companies’ books,” said Robert Khuzami, director of the SEC’s Enforcement Division.

This is pretty incredible.  It's like the last two years didn't even happen.

A national consumer coalition plans to file a series of landmark federal fair housing complaints beginning Dec. 6, challenging a widespread practice by banks and mortgage lenders: requiring borrowers who apply for FHA loans to have FICO credit scores well above the 580 minimum set by the FHA for qualified applicants with 3.5 percent down payments....

Because FHA insures lenders against losses from serious delinquency or foreclosure, there is "no legitimate business justification" for rejecting applicants solely on the basis of FICO scores that are acceptable to FHA, the complaints contend.

Subprime mortgage customers are generally defined as those under a credit score of 620.  I am surprised that anyone in this environment is offering 3.5% down to any buyer  (though here is the government actually advertising the fact).  But giving 3.5% down to subprime borrowers?

Even with the FHA guarantee, banks have learned that the cost of default for them is not zero.  Only someone who has been in a cave for two years could somehow ascribe this action to discrimination rather than an obvious reaction to the ongoing mortgage crisis.  The government is still out acting irresponsibly, and when private institutions (who actually have to live with the cost of their decisions) try to behave like adults, they get hauled into court.

By the way, this sure does seem to bolster the argument that community banking standards and the pressure from the government and community groups to drop lending standards played a large role in the housing crisis.  If we are seeing this kind of pressure even after the housing disaster, what kind of pressure was at work, say, in 2005?

Via Mark Calabria, who has more

Update: Flashback

"In 1995, HUD announced a National Homeownership Strategy built upon the liberalization of underwriting standards nationally. It entered into a partnership with most of the private mortgage industry, announcing that "Lending institutions, secondary market investors, mortgage insurers, and other members of the partnership [including Countrywide] should work collaboratively to reduce homebuyer downpayment requirements."

The upshot? In 1990, one in 200 home purchase loans (all government insured) had a down payment of less than or equal to 3%. By 2006 an estimated 30% of all home buyers put no money down.

"The financial crisis was triggered by a reckless departure from tried and true, common-sense loan underwriting practices," Sheila Bair, chair of the Federal Deposit Insurance Corporation, noted this June. One needs to look no further than HUD's affordable housing policies for the source of this "reckless departure." If the mortgage finance industry hadn't been forced to abandon traditional underwriting standards on behalf of an affordable housing policy, the mortgage meltdown and taxpayer bailouts would not have occurred."

Several observers, including Megan McArdle, said that I was too harsh when I wrote this in a post about pre-employment screening:

I understand that this is exactly what the Left is shooting for "“ an environment where the competent have no advantage over the incompetent.  If employers are resorting to FICO scores, it just demonstrates how all the other reasonable avenues of obtaining information have been closed to them.

Unreasonable?  Perhaps.  Or perhaps not.  From the US EEOC site:

There is no Federal law that clearly prohibits an employer from asking about arrest and conviction records. However, using such records as an absolute measure to prevent an individual from being hired could limit the employment opportunities of some protected groups and thus cannot be used in this way....

Even if the employer believes that the applicant did engage in the conduct for which he or she was arrested that information should prevent him or her from employment only to the extent that it is evident that the applicant cannot be trusted to perform the duties of the position when

• considering the nature of the job,
• the nature and seriousness of the offense,
• and the length of time since it occurred.

...

Several state laws limit the use of arrest and conviction records by prospective employers. These range from laws and rules prohibiting the employer from asking the applicant any questions about arrest records to those restricting the employer's use of conviction data in making an employment decision.

This means that a company cannot, according to the EEOC, maintain a blanket policy of, for example, never hiring anyone convicted of murder or bank robbery.  Just take that as your happy thought for the day next time you are snuggling up for bed at night in some hotel, wondering if you are in a state where the hotel was allowed to screen its night-time employees for felonies.

My sense is that the Left is shooting for employment based on paper qualifications rather than perceived capability.   I wrote before that the Left has cheered on tort actions that have almost shut down the provision of job references.  Or look at civil service or schools.  Hiring is based on minimum qualifications (e.g. possessing the correct teaching degree) rather than ability.  Promotion is based on seniority rather than performance.  Every grievance system ever invented makes it almost impossible to fire employees even for cause, much less for performance shortfalls.

Megan McArdle writes:

There was a great deal of back-and-forth in the left half of the blogosphere this weekend over employers who use FICO scores as a way of weeding out job candidates.  In a sort of peculiarly American fashion, our nation seems to have decided that one's credit history is a good proxy for one's worth as a human being, and thus should be used to determine eligibility for everything from employment to excellent rates on car insurance.

I have no trouble believing that the FICO score is often a proxy for what some researchers call conscientiousness; I've certainly had roommates and others around me who had terrible credit because, well, they didn't bother to pay their bills, and regarded rent as something optional that could be turned in if no more exciting commercial opportunities immediately presented themselves.

That said, it's going to be at best a weak proxy.  It's also a proxy for things that, as a society, we may not want employers to consider, like a past history of depression.  And for things that have nothing to do with your job performance, like a car accident that left you with huge medical bills and no job, or a sudden job loss.  Looking at our national savings rate, lots and lots of Americans live very close to the edge of their paychecks; they can't all be terrible employees.

I have never really even considered asking employees for their FICO score, in part because all small business people hate these scores as, even with perfect credit records, our scores tend to be smaller than people with similar income and history due to the constant credit checks made on us by vendors and other partners.

That being said, as someone who has 500 service employees working for me, I understand the insatiable desire for information on employee reliability and conscientiousness.  A large number of our employees we hire who interview well tend to get released within 60 days of their hire.  I can't tell you how many people who seem totally normal and friendly turn out to be raving maniacs in stressful customer contact situations.

The elephant in the room that neither McArdle or folks like Kevin Drum mention is that businesses are starved for reliability information on potential employees.  It used to be the best source was to check job references.  Nowadays, though, very few employers will give a honest job reference, or will provide any information at all.  I know I am guilty of that -- my company does not allow any manager to give out performance data on past employees.  I only needed to be sued once over somehow interfering with someone's living by giving honest information about that employee's reliability to change my behavior.

I understand that this is exactly what the Left is shooting for - an environment where the competent have no advantage over the incompetent.  If employers are resorting to FICO scores, it just demonstrates how all the other reasonable avenues of obtaining information have been closed to them.

The only saving grace in this country is that employment is still mostly at-will, meaning we can fire our hiring mistakes and move on.  Of course the Left wants a European-style system where it is impossible to fire anyone too -- this is the system the post office has, and one can see how well it works out.  If they are victorious on this final front, I will be forced into a game of Russian Roulette, where I can't find out anything about those I hire, I can't fire the incompetent people I do hire, and I am infinitely legally liable for any mistakes any of these employees make.