The Continued Importance of Fair Lending in the Age of Obama

Housing discrimination continues to plague the market, as does the myth that the housing crisis resulted from extending homeownership and home mortgage credit to historically underserved groups: minority families. Even with the Obama administration's Homeowner Affordability and Stability Plan and, within that, the Making Home Affordable program, minority groups continue to suffer ongoing discrimination and fair housing violations. By Nandinee Kutty

For some people who have seen minorities rise steadily to the ranks of the nation’s middle class and have witnessed an increase in diversity in what were once exclusively white residential neighborhoods, concerns about housing discrimination and segregation now seem like yesterday’s news. But for many Americans, housing and lending discrimination, and a lack of access to neighborhoods of their choice still make for harsh realities.

Census data reveal that segregation has, in fact, declined in the United States on some measures, and while much of the recorded decline in segregation is due to a decrease in the proportion of exclusively white neighborhoods, the share of predominantly black neighborhoods has remained virtually unchanged since 1980. Where segregation has declined, generally speaking, it has been in relatively small Sun Belt communities with small black populations. In older Northeastern and Midwestern industrial communities, traditionally high levels of segregation persist. The National Fair Housing Alliance estimates that four million fair housing violations occur each year.

But still for some Americans, the election of Barack Obama represents a final and definitive end to discrimination in our society, allowing for some to deem unnecessary continued fair housing enforcement. Moreover, we keep hearing that old resilient myth that the current home foreclosure crisis is the result of extending homeownership and home mortgage credit to historically underserved groups—minority families. According to this argument, a broad range of policies aimed at expanding homeownership opportunities and fair lending contributed to the present crisis. In reality, these policies, which include the Community Reinvestment Act (CRA), the affordable housing goals of the government sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac, and the expansion of homeownership in minority communities, are not responsible for the foreclosure crisis.

There are several places where we can look to find the real culprits in the current economic crisis. They include the decades of housing and lending discrimination that led to the exponential growth in abusive subprime loans; the lack of adequate regulations in the mortgage lending sector; the deregulation in the financial sector including the mortgage lending sector; the failure to enforce existing consumer protection laws; the 2000 law that ensured that credit default swaps would remain unregulated; the 2004 SEC decision to allow the largest brokerage firms to borrow more than 30 times their capital; the unchecked close relations between rating agencies and companies packaging mortgages and selling securities; and the failure of the SEC to oversee the brokerage firms as they got further invested into subprime debt. These are the culprits of the economic crisis.

There is enough evidence that the current crisis is the result of misbehavior by brokers, lenders, servicers, and the mortgage-backed securities industry that even former Federal Reserve Chairman Alan Greenspan said in a 2007 Newsweek interview that the “big demand” for subprime mortgages “was not so much on the part of the borrowers as it was on the part of the suppliers who were giving loans which really most people couldn’t afford.” Handsome profits were made at each level of the supply chain, not least of all by investors on Wall Street, who became the prime drivers for expanding high-cost unconventional home mortgage loans.

And despite the evidence and arguments refuting the notion that expanding homeownership in minority communities caused the foreclosure crisis, the myth continues, and might influence the actual behavior of lenders and policy makers. The reason for its persistence is that it lies near the germ of truth, even though the myth is false. The germ of truth about the housing crisis is that abusive lending targeted at minority communities was the precursor of this crisis. And it is the lax regulatory environment surrounding such lending that allowed ever more abusive practices to be developed and expanded.

A Spike in Lending Discrimination

There is reason to be concerned that the growing foreclosure crisis will lead to a return to the old days of outright credit denial to minority families and minority neighborhoods. Equally qualified minority applicants are now more likely than white applicants to find their loan applications turned down because of a popular perception that they are risky borrowers.

Recently, even since President Obama’s election, you still hear that we shouldn’t force banks to make loans that they are not comfortable making—language echoed in March by then-Treasury Assistant Secretary Neel Kashkari in his testimony on Capitol Hill. There, Kashkari said that the government “must not attempt to force banks to make loans they are not comfortable with, nor should we try to direct the lending from Washington.” He added that bad lending practices were the root causes of the crisis and that “returning to those practices will not help end the turmoil.” Kashkari, a Bush administration holdover upon request of Treasury Secretary Timothy Geithner, ran the $700 billion Troubled Asset Relief Program up until April, when Fannie Mae Chief Executive Herb Allison was tapped by the Obama administration to take over.

Moreover, the Washington correspondent for Forbes magazine, Josh Zumbrun, said on C-SPAN’s “Washington Journal” recently that “we don’t want to do too much to force the banks to make loans they are not comfortable making—they are already losing tons of money . . . so you don’t want to force them into taking out loans that could potentially make their situation worse.”

Although these speakers did not mention lending to minorities (Mr. Zumbrun had earlier referred to people with low credit scores and low incomes), it is worth asking the question: “What groups, historically, have banks been uncomfortable making loans to?” Whether one wants to go back 75 years or 25 years, we know that banks have been uncomfortable making loans to minority neighborhoods, to minority households, and to lower income households in general.

We’re seeing a climate where the enforcement of fair lending laws may be viewed as “forcing” banks to do something they don’t want to do, and thus a risky maneuver in the midst of a banking crisis. Fair lending is the law; it’s not optional, or practiced only when it’s convenient or when banks are financially healthy and profitable. We are where we are because of decades of housing and lending discrimination.

A Brief History

Real estate and home mortgage professionals openly discriminated against racial minorities in housing sales, home insurance, and mortgage finance in the early decades of the 20th century. Neighborhoods were redlined, while others formed neighborhood associations replete with specific provisions that enforced racially- and ethnically-restrictive housing. Groups subjected to these covenants have included African Americans, Hispanics, Jews, Chinese, Eastern Europeans and others. African Americans were the most common group to be excluded from white neighborhoods. Douglas Massey and Nancy Denton document this history in their important book, American Apartheid: Segregation and the Making of the Underclass.

The Home Owners Loan Corporation (HOLC), established by the federal government in 1933, gave concrete form to these discriminatory practices and institutionalized them. In the words of Massey and Denton, “it lent the power, prestige, and support of the federal government to the systematic practice of racial discrimination in housing.” The Federal Housing Administration and the Veterans Administration that were set up soon afterwards adopted the practices institutionalized by the HOLC. Thus, redlining became an officially recommended practice and the industry norm during this period of unprecedented expansion of homeownership through federally assisted mortgages.

The period of blatant credit denial and housing discrimination against minorities and minority-neighborhoods continued unabated until sporadic legal challenges and the legislation that came about as a result of the civil rights movement in the 1960s made discrimination in housing illegal. The Fair Housing Act of 1968 banned discrimination in home mortgage lending. And the Equal Credit Opportunity Act of 1974 (ECOA) banned discrimination in any aspect of a credit transaction, including home mortgage lending. However, even through the 1970s and 1980s, housing and lending discrimination persisted, practiced in covert forms and varied guises in an industry known for being conservative and resistant to change.

Reverse Redlining

In 1980, Congress liberalized usury laws for home mortgages, making it possible for lenders to make high-cost loans. In 1982, Congress passed legislation to allow adjustable-rate mortgages, interest-only loans and balloon payments. Conditions were now ripe for the growth of high-cost subprime lending that came in an array of complex products that were difficult to understand. The subprime industry—then an industry dominated by small, independent mortgage companies—grew steadily in the early 1990s. In this phase, subprime lending was primarily targeted at minority neighborhoods and families—those who were still denied prime credit and any lending from mainstream institutions. The elderly and women were also in the targeted group. Precisely the same types of neighborhoods that had been redlined in the past were now subject to ‘reverse redlining’—they were solicited for subprime loans on abusive terms. This lending came to be known as predatory lending, and thrived in the subprime sector of the home mortgage market.

We all know what happens next: huge profits earned in the subprime sector caught the attention of large national banks and large independent lenders then entered this sector and quickly became the dominant players. The subsequent explosion of irresponsible lending between 2000 and 2006 is what led to the current housing crisis where about one in eight U.S. homeowners with mortgages are in foreclosure or behind on mortgage payments. Now the crisis is a much graver situation where recession-induced foreclosures are starting to dominate the abusive products-driven foreclosures. Abusive lending in the U.S. has created havoc in the global economic system through its exposure to U.S. mortgage-backed securities.

Well-respected experts have recognized the link between discriminatory lending practices and the current economic crisis. According to the former HUD Secretary Henry Cisneros, who co-chaired a bipartisan commission on fair housing, “the serious problems of housing discrimination and segregation…have now helped to lead us to our current financial crisis, due in part to poor enforcement of our fair housing and civil rights laws.”

Home Mortgage Policies Under Obama

Looking at the Homeowner Affordability and Stability Plan, and within that, the Making Home Affordable program, we see $200 billion of additional support to Fannie Mae and Freddie Mac to enable a healthy level of activity in their secondary market operations and to keep the flow of home mortgage credit going for new home purchases and refinances. It also includes a $75 billion loan modification program and a refinancing program for homeowners underwater; both programs are voluntary. The loan modification program is expected to assist four million homeowners, and the refinancing program some five million homeowners. Furthermore, judicial modifications of mortgages might be possible through bankruptcy courts if the legislation to change the bankruptcy law passes.

The 2010 budget proposed by the administration has increased funding for the U.S. Department of Housing and Urban Development to combat home mortgage fraud and predatory practices, and for fair housing enforcement. However, these are fairly modest proposals.

In addition, mammoth interventions by the government in the financial sector are expected to keep borrowing costs low, including mortgage interest rates. Under the financial rescue plan (or TARP), certain real estate mortgage-backed securities will be bought, and the government also plans to help private investors buy these toxic assets (now known in this administration as “legacy assets”).

A series of “shock and awe” measures from the Federal Reserve Board, such as its decision to purchase long-term U.S. Treasuries bonds (for the first time in more than 40 years), are also expected to bolster the flow of credit in the economy and keep borrowing costs low. Such measures will indirectly help some homeowners to refinance to more affordable rates and also encourage new home buying.

A main drawback of the Obama housing plan is that it’s a one-size-fits-all approach and does not get to the heart of the reasons why a homeowner might be in foreclosure. While it acknowledges “dishonest lenders who acted irresponsibly,” and lenders who distorted facts, the plan does not show any special accommodation to homeowners who were victims of fraudulent lending practices, such as those whose homes were overvaluated by appraisers whose interests were closely aligned to those of the lender or broker. In these cases, a sound housing plan would take these homes’ principal values and automatically reset them to reflect the correct market value at the time of the home purchase. Subsequently, the current refinancing program parameter of 105 percent of current market value may be applied. (Under the refinancing program, homeowners can refinance if their outstanding mortgage debt is no more than 105 percent of the current of the home).

In addition, the Obama housing plan makes no mention of anti-fraud prosecutions against lenders, brokers and servicers, and it should. Vigorous anti-fraud prosecution and seeking compensatory and punitive damages from the offending parties needs to be an important part of a sound housing plan. While such prosecutions can be launched at the state level by state attorneys general, the federal plan needs to forcefully stipulate that this is one strategy for providing relief to homeowners in distress. A federal program could help provide immediate relief to the victims of fraud, while the court cases are pending.

The Obama housing plan does not offer any guidelines to specifically help lower income families and families who were victims of lending discrimination. In the absence of such guidelines, it’s reasonable to expect that a good deal of “creaming” will occur following the program’s implementation, i.e., increased eligibility for loan modifications for better-off homeowners, because the program parameters favor higher income families. It is obvious that the 31 percent standard for the loan modification part of the housing plan (lenders will receive a subsidy if they can bring down the monthly payments to that level) can be more easily achieved for higher income homeowners; hence, they might be the ones who receive the most workouts under the plan. Also, homeowners who are only modestly underwater or not yet underwater will be helped by the refinancing provision, and not those whose home values have fallen far below the value of their mortgage. Only loans backed by Fannie Mae and Freddie Mac are eligible for refinancing under the Obama plan and this will leave out most of the subprime loans affected by plunging home values.

The housing plan lacks progressivity in the subsidy it offers, and only its full implementation will reveal how regressive it might turn out to be.

The Kirwan Institute’s john powell has suggested using a policy of targeted universalism in public policy; that is, even as programs are specified in universal terms, there should be a targeting of each program that takes into account the “differential situatedness” of groups in American society. In the case of a government rescue plan for homeowners at risk of foreclosure, a strong case can be made for targeting victims of abusive lending practices because these practices contributed to the mortgage delinquencies in the first place. The negligence of Congress to enact new legislation and of government agencies to enforce existing regulations to curb abusive and irresponsible lending over the past 10 years is palpable. This provides another rationale for targeting the housing rescue plan to victims of abusive lending practices.

It will be important for the government to track the flow of TARP funds and any new credit creation to minority neighborhoods and to other historically underserved groups. At the time of this writing, there has yet to be an announcement from the administration of a plan to engage in such tracking. Housing policy and civil rights advocates must demand this. Surprisingly little is known about the uses that the TARP funds have been put to. It is not clear how much of the funds have been applied for, creating new credit flows and in which sectors. We don’t know if the financial institutions receiving the monies from the government will agree to track actual households (by minority status) and regions that these funds will flow to. The Kirwan Institute has provided a model for tracking the flow of the economic stimulus funds to communities of color. Tracking households and neighborhoods can be done using GIS mapping techniques.

According to a range of experts, including professionals who work in the field with home mortgage-seekers, the flow of mortgage credit has slowed down in recent months, and new lending is largely available only to borrowers with unblemished credit, those who make a sizeable down payment, and those with steady income. Professionals from the field also report that minority households and minority neighborhoods are the hardest hit when they seek home mortgage loans because they encounter a presumption of being risky borrowers. In other words, we may already be seeing a return to the old-fashioned lending discrimination in the form of outright denial of loan applications for equally qualified minority applicants.

The current housing and economic crisis has occurred because abusive lending practices were allowed in home mortgage markets. When the victims of these practices were predominantly minority families, Congress failed to curb these abusive practices about which it had received detailed testimony on multiple occasions. The federal regulations during this period had intervened to prevent states from enforcing their own consumer protection laws that would have prevented some of the abusive lending. Now the problems have spilled over to non-minority communities, as well as into the prime lending sector. Dr. Martin Luther King, Jr. said that the quality of justice is indivisible and “injustice anywhere is a threat to justice everywhere.” These words ring so true in the present context. The unjust lending practices could not be restricted to certain segments—they are in all sectors, and pose a threat to justice everywhere.

Moving forward, we have to work to prevent market misbehavior even if we feel that it can be contained within a particular segment of the market. The rest of America must not look the other way, when credit card companies, mortgage brokers and lenders, and other actors are fleecing particular consumers in the financial system. Recent history has taught us that such misbehavior, when proven to be highly profitable, eventually finds its way to other segments of consumers as well, and becomes a threat to everyone.

Dr. Nandinee K. Kutty is an economist and a policy consultant. She is an editor and contributor for the book Segregation: The Rising Costs for America (Routledge 2008). She is the author of numerous research papers published in peer-reviewed journals of economics and public policy. Dr. Kutty was formerly a professor at Cornell University. Her published research papers and op-eds are currently on the reading lists for courses taught at various universities in the U.S. Her e-mail address is nndkutty@aol.com.

Published by the National Housing Institute