The Guru Is In
Algorithmic Morality
By David A. Smith
5 min read
Those who say you can’t put a price on virtue have never worked in the capital markets. Although people say they value many things, what they actually pay for is what they truly value. Increasingly, that is virtue, or the appearance of virtue, now manifesting itself in the availability, terms, security and risk-adjusted yield of debt or equity instruments. For a couple of decades, what constitutes ‘virtue’ has been rapidly evolving and expanding with few signs of settling down. The rise to prominence of what is now called climate resilience created a base of advocacy that soon colonized ESG and is making rapid inroads with DEI (the acronym that everybody knows today).
As it does, the intellectual infrastructure of quantifying virtue has grown apace. Starting a few years back, algorithmic morality arrived in affordable housing, with a series of tentpole debt issues by large market-leading nonprofit sponsors, up to $100 million apiece in long-term low-fixed-rate unsecured Sustainability Bonds. Now our behemoth duopoly is entering the arena, led by Fannie Mae’s January announcement of its Social Bond Framework and related issuance of Social Mortgage-Backed Securities.
Not Social Impact Bonds, mind you; for all its potential as a breakthrough approach to tackling seemingly intractable problems, the pay-for-success model remains as elusive as it was ten years ago. No, these are straight-ahead loans, underwritten with those same great credit standards you’re used to, bundled in curated subsets for extra virtue:
Our Single-Family Social Bond programs will offer investors the ability to invest in single-family MBS featuring high concentrations of loans made consistent with our Mission Index. In turn, investor demand for these MBS may result in lenders focusing more on lending to these populations, with loans underwritten to the Enterprises’ strong credit standards.
Naturally, such a product comes with:
- A catchy handle. Originally titled the Single-Family Social Index, now with a ‘refreshed name’ – the Mission Index.
- An upper-crust endorsement. Blessing was bestowed by a Second-Party Opinion from Sustainalytics, itself a renamed company. Founded in 1992, it has grown substantially both organically and through acquisitions (plus a renaming) before itself being 100 percent acquired by Morningstar in 2020 as part of the latter’s strategic push into becoming the rating agency of choice for socially virtuous capital.
- A buzzword-salad description. Viz:
The Fannie Mae Social Bond Framework is robust, transparent and in alignment with the four core components of the Social Bond Principles 2023. The use of proceeds will contribute to the advancement of the UN Sustainable Development Goals 10 [Reduced Inequalities] and 11 [Sustainable Cities and Communities]. Additionally, Sustainalytics considers that Fannie Mae has adequate measures to identify, manage and mitigate environmental and social risks commonly associated with eligible mortgages.
Whatever that actually says, it sure sounds good:
Prying the lid off the evaluation methodology reveals that, as might be expected from a methodology created by those being rated by it, there are many ways to win. A pool of loans qualifies if it passes two tests:
1. Each loan meets the ‘Mission Criteria Share’ by checking one of ten boxes in three categories:
- Two on income – low-income borrower or affordable rental.
- Three on household – first-time homebuyers, living in underserved markets, or targeted by a special program.
- Five on location – disaster area, low-income area, manufactured housing, high-needs rural or minority tract.
2. The whole pool averages two out of three of the categories.
The sub-definitions, all thoroughly enumerated, are likewise generous. ‘Affordable rental’ includes many under-served subcategories: ‘restricted affordable’ (LIHTC and Section 8), unrestricted affordable (NOAHs), special public purpose (state or local customization of ‘workforce housing’) and ‘self-imposed restrictions’ (voluntary special purpose).
As Fannie and Freddie acknowledge, the Mission Index is an aggregated repackaging of previous Duty to Serve elements.
While the name is new, the underlying concept is not. [It] reflects direct feedback from investors, highlights that this is an Enterprise-specific disclosure and helps investors better understand how our mission activities support U.S. housing.
Coming from any other organization, that would sound sheepish.
In truth, after hearing of the unveiling of Social Bonds, I came to snark but stayed to ponder as I delved more. The impact being an elusive djinn who muggles claim to pursue, investors need metrics as its proxies – and the more cogently expressed, the better.
As time passes, the catchphrases and proxies consume the purpose…but if the proxies are well designed, less important than the starting low bar at inception is the value of observing, measuring and incentivizing the bar to rise over time.
When first launched, the Hubble telescope was mocked for foggy glasses: today the images it brings back are upending cosmology. The 2006 launch of Zillow was derided as wildly inaccurate: yet it vaporized real estate brokerage mercantilism, as just a few days ago the National Association of Realtors waved the white flag on the hallowed six percent fixed commission. Better transparent measurements evolve better behavior, and better behavior evolves
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