7 Reasons and False Assumptions that Caused the Housing Crisis - False Assumption 2
False Assumption 2: Existing Systems for Risk Management, such as FICO Scores and Rating Agencies, Are Adequate.
To a large extent, the current housing market downturn is the consequence of exceptionally lax lending standards that amidst ample liquidity resulted in the creation of a housing bubble. The bubble burst once the unsustainable and artificially-inflated prices eroded affordability and the economic slowdown caused many borrowers with weak credit quality to default on their mortgage payments. The problem with the housing market was thus a reflection of a systematic failure of the credit system that overemphasized certain elements of risk management, such as FICO scores and risk-based models for credit rating, and ignored other factors that determine the capacity of mortgage borrowers to finance their obligations.
Before the bubble burst, many mortgage lenders focused primarily on quantitative risk indicators, such as FICO scores, when making their lending decisions. Yet, they failed to account adequately for other factors that influence borrowers' capacity to service mortgage debt, such as down-payments, incomes, or future interest rates, and all current local variables which represent the flow of businesses, jobs, people, and capital, which influenced future price trends and movements that directly affect local markets and credit risks. Exposing the limitations of FICO scores, a recent study by Fair Isaac and the bond rating agency DBRS found "that a borrower with a high credit score is just as likely to default on a no-money-down mortgage as is a lower-scoring borrower who puts down as much as 40%." And this is primarily because if future price movements trend downward, the borrower will be upside down very quickly. Once inadequate risk management for credit rating purposes is added to this slew of misconceived lending practices, it becomes clear why the credit markets collapsed, sending mortgage loan delinquencies and charge-offs to the highest levels in nearly two decades.
These lending practices proved inappropriate for making prudent decisions about lending. They ignored various risks affecting borrower's creditworthiness, which, however, have an impact on borrowers' debt servicing capacity and therefore on default risk. Unlike these models, the Home Value Predictor takes into account various economic factors, such as future interest rates, local employment and household income growth, when making predictions about trends in home prices.
For more information, visit http://www.HomeValuePredictor.com and click the link to purchase my book titled "The Missing Keys to Thriving in Any Real Estate Market."
To a large extent, the current housing market downturn is the consequence of exceptionally lax lending standards that amidst ample liquidity resulted in the creation of a housing bubble. The bubble burst once the unsustainable and artificially-inflated prices eroded affordability and the economic slowdown caused many borrowers with weak credit quality to default on their mortgage payments. The problem with the housing market was thus a reflection of a systematic failure of the credit system that overemphasized certain elements of risk management, such as FICO scores and risk-based models for credit rating, and ignored other factors that determine the capacity of mortgage borrowers to finance their obligations.
Before the bubble burst, many mortgage lenders focused primarily on quantitative risk indicators, such as FICO scores, when making their lending decisions. Yet, they failed to account adequately for other factors that influence borrowers' capacity to service mortgage debt, such as down-payments, incomes, or future interest rates, and all current local variables which represent the flow of businesses, jobs, people, and capital, which influenced future price trends and movements that directly affect local markets and credit risks. Exposing the limitations of FICO scores, a recent study by Fair Isaac and the bond rating agency DBRS found "that a borrower with a high credit score is just as likely to default on a no-money-down mortgage as is a lower-scoring borrower who puts down as much as 40%." And this is primarily because if future price movements trend downward, the borrower will be upside down very quickly. Once inadequate risk management for credit rating purposes is added to this slew of misconceived lending practices, it becomes clear why the credit markets collapsed, sending mortgage loan delinquencies and charge-offs to the highest levels in nearly two decades.
These lending practices proved inappropriate for making prudent decisions about lending. They ignored various risks affecting borrower's creditworthiness, which, however, have an impact on borrowers' debt servicing capacity and therefore on default risk. Unlike these models, the Home Value Predictor takes into account various economic factors, such as future interest rates, local employment and household income growth, when making predictions about trends in home prices.
For more information, visit http://www.HomeValuePredictor.com and click the link to purchase my book titled "The Missing Keys to Thriving in Any Real Estate Market."
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