President
Obama says the Occupy Wall Street protests show a "broad-based
frustration" among Americans with the financial sector, which continues
to kick against regulatory reforms three years after the financial
crisis.
"You're seeing some of the same folks who acted irresponsibly trying
to fight efforts to crack down on the abusive practices that got us into
this in the first place," he complained earlier this month.
But what if government encouraged, even invented, those "abusive practices"?
Rewind to 1994. That year, the federal government declared war on an
enemy — the racist lender — who officials claimed was to blame for
differences in homeownership rate, and launched what would prove the
costliest social crusade in U.S. history.
At President Clinton's direction, no fewer than 10 federal agencies
issued a chilling ultimatum to banks and mortgage lenders to ease credit
for lower-income minorities or face investigations for lending
discrimination and suffer the related adverse publicity. They also were
threatened with denial of access to the all-important secondary mortgage
market and stiff fines, along with other penalties.
Bubble? Regulators Blew It
The threat was codified in a 20-page "Policy Statement on Discrimination in Lending"
and entered into the Federal Register on April 15, 1994, by the
Interagency Task Force on Fair Lending. Clinton set up the little-known
body to coordinate an unprecedented crackdown on alleged bank redlining.
The edict — completely overlooked by the Financial Crisis Inquiry
Commission and the mainstream media — was signed by then-HUD Secretary
Henry Cisneros, Attorney General Janet Reno, Comptroller of the Currency
Eugene Ludwig and Federal Reserve Chairman Alan Greenspan, along with
the heads of six other financial regulatory agencies.
"The agencies will not tolerate lending discrimination in any form," the document warned financial institutions.
Ludwig at the time stated the ruling would be used by the agen cies
as a fair-lending enforcement "tool," and would apply to "all lenders" —
including banks and thrifts, credit unions, mortgage brokers and
finance companies.
The unusual full-court press was predicated on a Boston Fed study
showing mortgage lenders rejecting blacks and Hispanics in greater
proportion than whites. The author of the 1992 study, hired by the
Clinton White House, claimed it was racial "discrimination." But it was
simply good underwriting.
It took private analysts, as well as at least one FDIC economist,
little time to determine the Boston Fed study was terminally flawed. In
addition to finding embarrassing mistakes in the data, they concluded
that more relevant measures of a borrower's credit history — such as
past delinquencies and whether the borrower met lenders credit standards
— explained the gap in lending between whites and blacks, who on
average had poorer credit and higher defaults.
The study did not take into account a host of other relevant data
factoring into denials, including applicants' net worth, debt burden and
employment record. Other variables, such as the size of down payments
and the amount of the loans sought to the value of the property being
bought, also were left out of the analysis. It also failed to consider
whether the borrower submitted information that could not be verified,
the presence of a cosigner and even the loan amount.
When these missing data were factored in, it became clear that the
rejection rates were based on legitimate business decisions, not racism.
Still, the study was used to support a wholesale abandonment of
traditional underwriting standards — the root cause of the mortgage
crisis.
For the first time, Washington's bank regulators put racial lending
at the top of their checklist. Banks that failed to throw open their
lending windows to credit-poor minorities were denied expansion plans by
the Fed in an era of frenzied financial mergers and acquisitions. HUD
threatened to deny them access to Fannie Mae and Freddie Mac, which it
controlled. And the Justice Department sued them for lending
discrimination and branded them as racists in the press.
"HUD is authorized to direct Fannie Mae and Freddie Mac to undertake
various remedial actions, including suspension, probation, reprimand or
settlement, against lenders found to have engaged in discriminatory
lending practices," the official policy statement warned.
The regulatory missive, which had the effect of law, advised lenders
to bend "customary" underwriting standards for minority homebuyers with
poor credit.
"Applying different lending standards to applicants who are members
of a protected class is permissible," it said. "In addition, providing
different treatment to applicants to address past discrimination would
be permissible."
To that end, lenders were directed to "make changes in marketing
strategy or loan products to better serve minority segments of the
market." They were also advised to "change commission structures" to
encourage brokers and loan officers to "lend in minority and low-income
neighborhoods" — a practice Countrywide Financial, the poster boy of the
subprime scandal, perfected. The government now condemns the practice
it once encouraged as "predatory."
FDIC warned banks that even unintentional discrimination was against
the law, and that they should be proactive in making "multicultural"
loans. "An ounce of prevention is worth a pound of cure," the agency
said in a separate advisory.
Confronted with the combined force of 10 federal regulators, lenders
naturally toed the line, and were soon aggressively marketing subprime
mortgages in urban areas. The marching orders threw such a scare into
the industry that the American Bankers Association issued a
"fair-lending tool kit" to every member. The Mortgage Bankers
Association of America signed a "fair-lending" contract with HUD. So did
Countrywide.
HUD also pushed Fannie and Freddie, which in effect set industry
underwriting standards, to buy subprime mortgages, freeing lenders to
originate even more high-risk loans.
"Lenders should ensure that their loan processors and underwriters
are aware of the provisions of the secondary market guidelines that
provide various alternative and flexible means by which applicants may
demonstrate their ability and willingness to repay their loans," the
policy statement decreed.
"Fannie Mae and Freddie Mac not infrequently purchase mortgages
exceeding the suggested ratios" of monthly housing expense to income
(28%) and total obligations to income (36%).
It warned lenders who rejected minority applicants with high debt
ratios and low credit scores to "be prepared" to prove to federal
regulators and prosecutors they weren't racist.
"The Department of
Justice is authorized to use the full range of its enforcement
authority."
It took a little more than a decade for the negative effects of the
assault on prudent lending to be felt. By 2006, the shaky subprime
mortgages began to default. In 2008, the bubble exploded.
Clinton's task force survived the Bush administration, during which
it produced fair-lending brochures in Spanish for immigrant home-loan
applicants.
And it's still alive today. Obama is building on the fair-lending infrastructure Clinton put in place.
As IBD first reported in July, Attorney General Eric Holder has launched a witch hunt vs. "racist" banks.
"It's a more aggressive fair-lending enforcement approach now," said
Washington lawyer Andrew Sandler of Buckley Sandler LLP in a recent
interview. "It is well beyond anything we saw during the Clinton
administration."
Tom Perez, assistant attorney general for civil rights, recently
testified that his division "continues to participate in the federal
Interagency Fair Lending Task Force." And he and the task force are
working with the newly created Consumer Financial Protection Bureau to
"enhance fair-lending enforcement."
The fair-lending task force's original policy paper undercuts the
notion the financial crisis was all about banker "greed," though it
certainly played a role after the fact. Rather, it offers compelling
evidence that the crisis evolved chiefly from government mandates and
threats to increase lending to applicants who could not afford them.
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