The Lending Standards Red Herring

I'd taken a hiatus from talking about the role -- or more precisely, lack of a role -- of lending standards in bringing down the economy, but a couple of developments today pull me back to it.

In his speech today on the need for more action on preventing preventable foreclosures, Bernanke repeated the claim that declining standards share a large part of the blame for the current mess:

...no real or financial asset can provide an above-normal market return indefinitely, and houses are no exception. When home-price appreciation began to slow in many areas, the consequences of weak underwriting, such as little or no documentation and low required down payments, became apparent.

But a new paper released by the Fed itself seems to contradict this statement. From Fed economist Shane Sherlund:

Credit scores predict default and prepayment well, with higher credit scores defaulting less and generally prepaying more often. This suggests that borrowers with higher FICO scores were generally lower default risks ex post. Fully documented loans default less often, but not to a statistically significant degree.

Sherlund concludes, like many others, that the primary reason for the rise in defaults was (and is) home price depreciation. Getting this point right is really important for the next administration: We shouldn't give priority to regulating originators in lieu of dealing with the much more important problems with securitization (why did so many come to trust subprime securities?) and the pitiful performance of the ratings agencies (this might have had something to do with it). More later.