FICO's New Strategic Default Predictor: Closing the Barn Door After the Horse Is Gone

FICO's discovery that strategic defaults tend to be carried out by people with excellent credit is not fresh news.* What is bizarre is that they publicized it, since reporters poked into their whitepaper, and now there are hundreds of articles online which provide road maps to getting maximum benefit from a strategic default.

From the Washington Post:

[Strategic defaulters] know their credit scores will take a hit after they fall behind on their mortgages, so they tend to open new credit cards in advance of defaulting....

Yes, and some of them have guessed that their credit card limits will be slashed after the strategic default hits their credit reports. They're maxing out those new credit cards as you read this.
The Washington Post continues:

... the numbers are tough to tease out because "strategic defaulters have all the incentive to disguise themselves as people who cannot afford to pay,"....

Right. The Washington Post readers may not have known the term "asset protection" a week ago, but with this help from FICO, they'll figure it out soon. (Asset protection is why the rich are hard to sue; most of their money is not in their name, or is offshore.)

There is an even stranger twist to the plot, embedded in the full report (signup required to download). While the FICO news release touted its new formula as a tool for lenders to act "proactively" to prevent strategic defaults, the main scenario offered in their more detailed paper is to actually contact the borrowers before they miss any payments.

If I were a bankster, I would have a really, really bad feeling about this idea. In an example phone call to the Smith family:

"Hi, this is John from Big Bloated Bank! We notice that your home is underwater, and were wondering if you had any plans to strategically default? If so, we'd be glad to work with you!"

"Well ... no, we didn't have any plans to default...."

"Well, that's great! But please be sure to call us if you do! Have a nice day!" (hangs up phone)

"Who was that, honey?"

"It was Big Bloated Bank, asking if we had any plans to do a strategic default, since our home is underwater.... Had you ever thought about strategic default?"

"Well, not until now. But now that you mention it, the Joneses stopped paying their mortgage and they've been living rent-free for 14 months now. In fact they had money to vacation in Hawaii this year."

"But how about when they have to move?"

"Haven't you been following rents? A house the size of this one rents for half what we pay in mortgage."

"Gee, honey, it was great of the bank to give us a call!"

After a few minutes thought, the Smiths may decide that this is a good time to be keeping up with the Joneses.

* The fact that people with good credit ratings are more likely to carry out a strategic default has been known since 2009 -- in fact, it's the definition of the term. For further analysis of this FICO report, please see my forthcoming article in the Huffington Post, "FICO Report Recommends 'Concierge Service' for Well-Off Strategic Defaulters." (Link to come when the article is posted.)

by Nicholas Carroll