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Author: Cooley, Scott
Date published: March 1, 2011
Journal code: MOB
Lost in all of the wrangling over what to do with Fannie Mae and Freddie Mac is what I perceive as an equally important issue of what to do with Fannie's Desktop Underwriter® (DU), Freddie's Loan Prospector® (LP) and the other various technologies developed by the government-sponsored enterprises (GSEs). As! have long said, the housing bubble was created in large part because of the automated underwriting systems (AUSes), with their ability to easily modify the types of loans the GSEs would accept. Without DU and LP, the underwriting of all prime mortgages couldn't have become so egregious in the years that followed their introduction.
It was in May 2004 that I wrote in a similar column for this very magazine that I feared a real estate bubble was inevitable, and at that time called out the GSEs and their AUSes for their dramatic role in such a bubble. I said then about the AUSes, "To rely on them so blindly could become a recipe for disaster."
In discussing the very dangerous and liberal underwriting guidelines of the times, I stated, "AUSes are approving far more borrowers. than ever before." I summed up what was going to happen with the housing economy as it "looks like the perfect storm" and "the longer the party, the greater the hangover." Sadly, the predictions were dead-on, and in fact, the perfect storm continued to build for three more years before finally destroying the very foundation of our housing industry.
As nefarious as these systems proved to be, they were just technological tools. It took programmers, underwriters and, most Importantly, management teams to build and modify these tools to reap enormous profits at the ultimate expense of the U.S. taxpayer, consumers, banks, and others.
These complex systems are very powerful, and they now have incorporated many years of refinement and experienee. They are certainly not evil by themselves and, in fact, continue today to approve very viable loans. They do so efficiently and accurately. In fact, they are far better tools than the older underwriting guidelines used throughout the 1980s and 1990s (though use of the older rules would have likely prevented the housing bubble in the first place).
Now we are at a point where we must ask ourselves as an industry: What should we do with DU and LP?
I propose that there are two parts to the AUSes that need to be dealt with. The first part is the underwriting rules themselves. Desktop Underwriter and Loan Prospector are decisioning engines and require people to decide just what the rules should be for underwriting prime mortgages. These underwriting rules should not be loosened as defaults improve or tightened as defaults increase.
To prevent future housing bubbles and busts, the rules should remain fairly consistent over time. Yet, they should also allow some modification as we gain experience with different classes of borrowers who prove themselves worthy of a prime mortgage.
They also have to change as consumers' financial behaviors change over time. I do believe the AUSes can prevent future housing bubbles. I have previously proposed underwriting formulas where in any particular ZIP code, down payments would be increased whenever homeprice appreciation becomes frothy. It's a fairly simple formula, and we know now just how important such an addition could be to the AUSes.
Through the use of AUSes, there are many ways to
prevent future housing bubbles and busts. Who controls these rules is at the core of our future housing industry. This is a weighty issue and mustn't be taken lightly.
I propose that if the U.S. government is to continue to explicitly support the mortgage market through its full faith and credit backing, then the AUSes should only be modifiable by a government-backed entity (similar to the Federal Housing Administration [FHA], which currently creates its own similar underwriting rules).
On the other hand, if, as some recommend, our government exits from the mortgage industry altogether, then these automated underwriting rules will need to be modified by private enterprise, in either case, it is my strong belief that the veil of the black boxes (DU and LP) should be lifted. The publication of the loan underwriting rules should go back to the way it was before the advent of DU and LP, and be widely available to all lenders and underwriters.
The second component of the AUSes that must be addressed is the technology engines themselves, (t's important that these tools remain available to all in the industry that rely on them. I feel the best solution is to spin these technologies (along with the systems and staff that support them) out to private enterprise.
The fees that are charged for their use could support two independent and competing companies. Congress could take the step of taking bids for these products (DU and LP). Further, because the AUS rules will become public, other firms could create competitive systems. Even more important, large lenders can add the rules to their existing loan origination systems (LOSes).
Clearly, efficiency and productivity has been hampered by the forced use of DU and LP throughout the industry during the past 15 years. As the rules followed by these automated underwriting systems become open, lenders could best determine if they would like to continue to use DU and/or LP or to place the rules into their own systems.
I have spoken with many information technology (IT) managers in the industry over the years, and they have long derided the GSEs for not allowing them to build the prime mortgage underwriting rules into their own systems. For example, the CLUES system developed by Countrywide Financial Corporation (later acquired by Bank of America) was a phenomenal system that would have really benefited by the lifting of the curtain around the rules within DU and LP.
The GSEs have invested many millions of dollars into their respective AUSes. These are highly complex systems that have had about 15 years of experience (good and bad) behind them. There are teams of programmers that support these systems and some really smart people who keep them going. These are highly valuable assets of the GSEs and, should they be sold, they would certainly carry a high price tag. I would only suggest that they not be sold to a lender, because other lenders then would be hesitant to use them.
While Congress tries to determine the future of the GSEs1 more consideration needs to be given to the future of their technology investments. Even beyond the AUSes, other technology components of the GSEs are valuable, and consideration needs to be given to their future as well. We can't underestimate the importance of the automated underwriting engines to the future of our industry, We must also diligently plan their role going forward.
Scott Cooley is an independent mortgage technology consultant, analyst and author based in Los Gatos, California. He can be found at www.scooley.com.