The American Enterprise Institute’s (AEI) latest opinion piece (“FICO is not the issue. A untimely two-score system is”) challenges an almost unanimous market conclusion: VantageScore 4.0 is a extra predictive credit score rating for mortgages than Classic FICO. Tobias Peter and Sissi Li’s critique tells yesterday’s story. VantageScore 4.0 is about tomorrow, and the market agrees.
While Peter and Li’s analysis paper claims that “each VantageScore 4.0 and Classic FICO are efficient in figuring out high-risk loans, with solely marginal variations between the 2,” VantageScore’s evaluation tells a clearer, verifiable and extra quantitatively exact story. Their evaluation rests on misunderstandings, outdated assumptions, selective omissions, and a basic refusal to acknowledge what’s coming subsequent for mortgage finance: the top of a decades-old monopoly and the beginnings of helpful competitors in credit score scoring.
READ MORE: Fannie Mae updating disclosures to pave means for VantageScore
At its core, the AEI research and editorial criticize VantageScore for analyzing mortgages inside a selected rating vary, claiming the method introduces “bias.” But that criticism misses the purpose. Effective stress testing depends on a rigorous examination of the segments most weak to default. By concentrating on debtors who’re traditionally extra susceptible to stress, analysts can see whether or not a mannequin actually separates high-risk from low-risk customers.
We can study some latest examples. During the COVID-19 pandemic, historic default patterns made it clear which teams carried the best publicity. Focusing on these populations is important in a stress check. If a threat mannequin cannot maintain up underneath scrutiny the place the exposures are highest, it is not strong. That’s precisely why the inhabitants in query was not solely justified however is important to proving the mannequin’s capacity to differentiate credit score threat.
Interestingly, the AEI’s white paper admits that, even after performing their very own recalculation and eradicating what they take into account to be methodology flaws, VantageScore 4.0 nonetheless demonstrates predictive enchancment and captures extra defaults within the riskiest decile: figuring out 32.9% of defaults versus 32.0% for Classic FICO.
Instead of highlighting this efficiency benefit, the AEI’s researchers brush this discovering off as a “modest 3% elevate.” However, when this predictive elevate is utilized to the trillion-dollar GSE portfolio, a 3% benefit is gigantic. Tens of 1000’s of defaults recognized earlier might imply billions in averted losses. To dismiss this achieve as a “modest” elevate is akin to dismissing a security function that stops 1000’s of accidents a 12 months.
Classic FICO was the one rating utilized in mortgage originations in 2008, when deficiencies in stress testing led to a deterioration in underwriting requirements that finally resulted within the collapse of the housing market, in accordance to the St. Louis Federal Reserve.
The American Enterprise Institute research additionally refers to the truth that the mortgage launched dataset solely consists of loans that FICO allowed available in the market. That is true, however this “survivorship bias” (as they name it) solely creates a bonus for Classic FICO.
Independent research that analyzed the identical dataset and concluded that VantageScore 4.0 is “higher” than Classic FICO in mortgage are ignored by the AEI white paper. These analyses embody analysis from JPMorgan Chase, Bank of America, Bloomberg Intelligence and credit standing company KBRA.
Additionally, even the 2 unbiased analysis research (by the Urban Institute and Milliman) cited by AEI’s editorial and white paper verify that whereas each fashions are predictive, VantageScore 4.0 is stronger in figuring out high-risk debtors on the decrease finish of the credit score spectrum.
Moreover, the piece avoids partaking with the total breadth of VantageScore’s personal revealed white paper (“VantageScore 4.0 and Classic FICO: A Comparison”). Our findings present proof of VantageScore 4.0’s predictive superiority over your entire span of ten years of efficiency information, for various borrower varieties and timeframe slices throughout pre- and post-COVID intervals. If AEI’s critique had benefit throughout these broader datasets, one would count on them to handle these outcomes straight. Their silence speaks volumes.
Forward-looking credit score scoring issues, and VantageScore’s fashions stand up to essentially the most intense scrutiny. The AEI editorial makes an attempt to defend the established order by nitpicking methodology and downplaying outcomes that present clear benefits for VantageScore 4.0. However, this isn’t solely about mannequin accuracy; it’s about whether or not we maintain propping up an outdated system or embrace one designed for the longer term.
VantageScore 4.0 is not only a comparable mannequin; it’s the future: a extra inclusive, trendy, forward-looking, and risk-sensitive credit score scoring mannequin that strengthens the housing finance system and expands entry to accountable credit score.
