Passion Party #159 - Computers Run Amok
As we move forward in time, past the Banking Crisis of 2008
and the Great Crash of 2009
it is becoming clear that a root cause of the mess we're in stems from faulty computer models that made people (and banks and investors) believe that a risky transaction would become risk-less if it were sliced and diced enough to become unintelligible to mortal man.
Faulty computer model #1
The Fair Issacs Company (FICO) uses computer models to create a risk-based credit score that banks take as gospel in creating loans. As The Market continued on its frothy way in the early 2000s, FICO discovered an amazing "fact" - that people with a very high credit score historically never default on a home loan, even if they borrow 100% of the purchase price to buy the house.
Viola! 100% financing for "qualified" borrowers ("qualified" at this point equaled a high FICO as the banks had already accepted computer models that allowed them to do "stated income" loans, rather than dealing with those pesky tax returns).
Then somehow, a few months AFTER real estate prices started to drop in 2007, FICO retracted this idea. It seems the computer model was flawed. They discovered that with NO equity in a house, a person with perfect credit had as much likelihood of defaulting as a person with bad credit that put 30 - 40% down to buy a home.
Of course, this was a severe case of "closing the stable door after the horse has bolted".
100% financing had snared many folks into a belief that borrowing money was a way to riches
as opposed to a way to be in debt up to their eyeballs.
(to be continued...)