FHFA's "Good Credit Penalty": The Fannie Mae LLPA Change

Nothing New Under the Sun

Fannie's LLPA grid always involved overcharging people with good credit and undercharging people with bad credit, namely, charging people with good credit more than is needed to cover their default risk and those with bad credit less. This LLPA change just increased the size of that subsidy: It is not introducing any fundamentally new policy. Interestingly, this change to the LLPA grid has awakened the public to the fact that Fannie Mae is, essentially, a wealth redistribution scheme. It redistributes wealth from the upper middle class to the lower middle class. However, the public is wrong if it thinks there is anything new here. It was always like this.

Unless you thought that a government-run enterprise was inherently more efficient than private industry, a basic understanding of economics should have made you expect that subsidies were at play: How else does a corporation expand home ownership? Even their cheaper access to credit involved an implicit risk transfer from home buyers to the taxpayer, in this case, from city dwellers (some of whom may be poor) and the very rich to the middle class. Subsidies were always part of the game.

If you look at the old LLPA grid and divide the LLPAs from the worst credit buckets by those in the best, you can see that the ratios don’t scale with the risk. The LLPA for a 780+ borrower in Fannie’s highest LTV bucket was only half that of a 680 borrower, but does anyone who has experience with credit scores believe a 680 is only half as likely to default? A little common sense is enough to realize that Fannie was always overcharging borrowers with good credit.

Some of the articles may have led you to believe that Fannie is actually charging those with good credit more than those with bad credit. But, if you look at the LLPA grid, that is clearly not true. What has happened is those with good credit are seeing their LLPAs increase, and those with bad credit are seeing them decrease relative to what they had been: People with good credit are still paying a smaller fee overall. As I said, it is not charging those with good credit a higher fee than those with bad credit pay---just a higher fee than they used to pay.

This policy change is not exactly what the media is making it out to be. It isn't anything new. In fact, this policy is the norm throughout the insurance industry: It even has a name, cross-subsidization. Do you really think that a 30-year-old isn’t paying some portion of the 80-year-old’s health care costs when he pays for health insurance?

In fact, I will let you in on a secret: The exact same game is played with LTVs. Those with lower loan to value ratios subsidize those with higher—both through the base g-fee and through the LLPAs.