Taxpayers remember all too well the history of massive financial bailouts. Rarely have these huge liabilities wound up on the federal balance sheet by some single monumental miscalculation. Rather, as NTU has long observed, they are the product of seemingly modest policy choices that accumulate over time like dark clouds, whose danger is not evident until they combine to create the perfect storm that floods Washington in red ink.
This is not an apocryphal tale in the case of the housing finance giants Fannie Mae and Freddie Mac, now well past a decade in government (and taxpayer) conservancy. Despite NTU’s repeated warnings, years of casual moves at these Government-Sponsored Enterprises (GSEs), under complacent oversight, created a near-$200 billion disaster. This is why the Federal Housing Finance Administration, the taxpayers' "storm watcher" over Fannie and Freddie, has such a vital role with its imminent decision over whether to create uncertainty in the credit scores that inform numerous taxpayer-backed lending programs. And FHFA's own "weather charts" show what's ominously looming on the horizon.
At issue is an agency rule, born of a congressional directive, to methodically test and evaluate whether to allow the use of alternative, competing models for generating credit scores factoring into the loans that Fannie Mae and Freddie Mac facilitate by providing liquidity. NTU supported this careful, data-backed approach, which balances the principle of competition with financial security. After all, an untested scoring model could produce inaccuracies leading to billions in bad loan debts that taxpayers would have to cover.
After considering the testing of the current score model along with possible new entries, FHFA has announced it is examining four decision options:
1. Keep current policy that Fannie and Freddie require and utilize only one score for each borrower in evaluating loans;
2. Require that lenders provide borrowers’ scores for all approved score models on every loan;
3. Allow lenders to choose any one of the approved score models in submitting each loan to Fannie and Freddie for evaluation;
4. Create a “waterfall” in which a primary and secondary core model is allowed for each borrower, and whichever qualifies for approval for Fannie or Freddie’s portfolio “wins.”
FHFA’s internally prepared estimates of the potential disruption to the public and private sectors from options 2-4 are alarming in their own right. According to a chart in the agency’s own opening remarks at a “listening session” on the credit score models, the estimated compliance cost for the multiple score options was between $374 million and $614 million, with an implementation period of 2-2 ½ years. Buried in those costs was $54 million attributed to Fannie and Freddie themselves. FHFA’s data raises a number of important considerations. Is this really a burden that the private sector, still recovering from recessionary, COVID-related, and now inflationary shocks, can easily handle right now? Will these additional expenses for Fannie and Freddie affect their own financial condition, as the volume of discourse over a new “housing bubble” gets louder? How will investors here and abroad react over any impacts on the attractiveness of holding Fannie and Freddie’s mortgage-backed securities?
Last month, NTU had the opportunity to provide comments during the FHFA listening session with dozens of stakeholders, including businesses that created the scoring models under examination, affordable housing advocates, and financial institutions. We carried the flag, however, for the largest stakeholder group of all: taxpayers. Among our points:
- Federal finances overall have the least capacity in modern history to absorb another fiscal shock from the housing GSEs. As NTU Foundation’s Demian Brady noted in a recent in-depth analysis, gross federal debt now exceeds 130 percent of Gross Domestic Product – a danger sign for even well-capitalized economies in the developed world.
- Recently tightened capital standards for Fannie Mae and Freddie Mac, which NTU supportedas a protective measure against future infusions of taxpayer cash, are being reconsidered. The impact of new compliance burdens from multiple scores on both GSEs’ financial positions becomes especially important, if FHFA is moving in the direction of eased standards.
- As NTU noted in a 2019 study, the range of other federal programs relying in some fashion on credit scores is broad, extending to the Federal Housing Administration, the Department of Veterans Affairs, and even the Small Business Administration. All told, the study estimated that some $7 trillion of programs connected to taxpayers are likewise connected to credit scores. If the agencies administering these ventures follow the lead of Fannie and Freddie with multiple scores, the costs and risks to taxpayers will multiply.
- In any case, the compliance tab for a multi-score regime will likely be higher than estimated. While FHFA’s own range of as much as $614 million is bad enough, NTU’s experiencewith paperwork burden estimatesfrom tax compliance suggests that the actual tab for the private sector could be much higher. For example, a Treasury proposal allowing the IRS to peer into millions of bank accounts with more than $600 of annual churn would impose heavy retooling expenses on the private sector, likely amounting to much, much more than $614 million over 24 to 36 months. Multiple scores, while not the same, would still involve not entirely dissimilar problems, including reprogramming application systems, additional recordkeeping, retraining existing employees and hiring “compliance personnel,” and new information security measures.
The final point in NTU’s “listening session” presentation also had to do with facing another simple but stark reality. Many federal entities serve to boost affordability and inclusion in housing, such as the Department of Housing and Urban Development, the Federal Housing Administration, the Department of Veterans Affairs, and the Department of Agriculture. Congress, meanwhile, is proposing all kinds of legislation in this area of policy, good and bad. An FHFA decision on credit scores that reflects prudence would not shut down opportunities to meet housing goals in other ways.
On the other hand, FHFA is the only agency specifically designed to serve as the front line of warning and defense against another major storm against the housing finance system. This role requires an outlook reflecting an abundance of caution and an appreciation of how seemingly calm conditions can quickly converge and flare up.
The FHFA’s official mission statement, crafted in 2008 when the newly-created entity had to replace the ineffective and conflicted Office of Federal Housing Enterprise Oversight, says: “Ensure the regulated entities fulfill their mission by operating in a safe and sound manner to serve as a reliable source of liquidity and funding for the housing finance market throughout the economic cycle.” As NTU can attest with its work on other agencies, too, the mission statement is more than a few words – it is intended to be the lodestar by which a federal agency navigates.
At FHFA, safety and soundness are not only supposed to come first, they’re supposed to come foremost. Taxpayers are hoping and counting on FHFA’s new leadership to remember this foundational, fundamental principle in coming days, as the agency faces a crucial test on credit score models.