Reverse Redlining

During the semi-annual report of the Consumer Financial Protection Bureau before the House Financial Services Committee on January 28, Democrats and Republicans expressed concerns about credit availability for minorities and the less creditworthy. Representative Brad Sherman (D., Calif.), for example, fretted about the impact of fair-lending enforcement, observing that those with lower credit scores and income paid more.

Alternately fawning and testy exchanges between committee members and bureau director Richard Cordray highlighted the chasm between Democrat and Republican views on government’s role in consumer credit. Democrats praised Cordray and the Bureau. Republicans questioned its legitimacy, accountability, and impact on credit availability and innovation.

Chairman Jeb Hensarling (R., Texas) set the Republicans’ tone, remarking that “when it comes to credit cards, auto loans, and mortgages of hardworking taxpayers, the CFPB has unbridled, discretionary power not only to make them less available and more expensive but to absolutely take them away.” Cordray’s exchanges with Republican representatives Shelley Capito (Va.), Scott Garrett (N.J.), Robert Pittenger (N.C.), and Bill Posey (Fla.) were testy. Representative Steve Pearce (N.M.) charged that “it’s a war on the poor being conducted by you and this administration,” provoking an otherwise generally even-keeled Cordray to anger.

Credit markets dynamically allocate capital from savers to consumers and investors, enabling maximum sustainable growth and consumer satisfaction. Profit-seeking financial institutions lend to borrowers, who, absent fraudulent intent, plan to repay. In voluntary credit transactions, both parties think they’ll be better off.  

Increasingly Newspeak shrouds credit discussion. Community activists, politicians, and regulators beat tom-toms for “responsible lending” — by which they mean more credit on easier terms for politically favored, less-creditworthy constituencies — and hurl incendiary accusations of racial discrimination at banks. A dozen major cities have enacted Orwellian “responsible lending” ordinances requiring banks doing business with them to provide more credit in low-income neighborhoods.

The Community Reinvestment Act is a nationwide “responsible lending” program and potent weapon that activists and regulators use to force banks to make risky loans. A study by economists Sumit Agarwal, Efraim Benmelech, Nittai Bergman, and Amit Seru concluded that banks made riskier mortgages during CRA examinations, from baselines certainly already elevated by the CRA. The CRA’s whole point is to force banks to make riskier loans.

Genuinely responsible lending sets terms based on value and risk, with the expectation, though not certainty, of profit. For progressive activists however, “responsible lending” means forcibly allocating and stealthily subsidizing credit to riskier borrowers. Such politicized misallocation of credit reduces wealth and job creation. If it’s a city’s condition of business, it’ll be priced in, and taxpayers will end up paying the subsidies. Meanwhile, in America’s credit markets, government is making a mockery of Martin Luther King Jr.’s dream that in America individuals would be judged on their merits.

Washington embraces a noxious disparate-impact doctrine, insisting that any credit results not mirroring the population’s ethnic mix constitute illegal racial discrimination. Every lender is at risk. Few if any walks of American life exactly mirror the proportion of different ethnic groups in the larger population. Whites are underrepresented in the NBA and NFL. Indian Americans own half of America’s independent motels. Credit scores, incomes, assets, and credit appetite, and consequently credit consumption and terms, are not distributed evenly across ethnic groups. 

The aggressively trumpeted fiction of widespread racial credit discrimination is politically useful and guaranteed to cow bank management. Wielding disparate-income doctrine, the Department of Justice mau-maued Wells Fargo and Ally Bank.  

In 2012 the DOJ and Office of the Comptroller of the Currency pried $125 million from Wells Fargo to settle a disparate-impact suit in which its wholesale-mortgage brokers were accused of discriminating against minorities. 

In 2013 the DOJ and CFPB bludgeoned Ally Bank into paying $98 million to settle charges that its indirect auto-lending business discriminated against minorities. The only evidence: Borrowers whom regulators guessed were black paid on average 29 basis points more than those they guessed were white. But neither Ally nor its regulators knew the borrowers’ race! Regulators used proxies such as census tracts and names to guess race, a practice resembling redlining, which is illegal. No evidence was presented to establish that the creditworthiness of the different borrower pools was comparable or that there was intent to discriminate.

Indirect auto lending was one of the few areas where Democrats worried about the CFPB’s approach to enforcing fair-lending law. Representative David Scott (D., Ga.) pressed Cordray on the impact that the CFPB’s fair-lending guidance and enforcement has on auto dealers, expressing concern that it would raise costs and push the marginally creditworthy out of the market.

If regulators wanted to test for actual racial discrimination, they could manufacture sets of otherwise identical black, white, and Asian applicants and compare responses. But they don’t want to because they would find nothing. Any lender offering worse terms for noncommercial reasons would lose out to competitors.

Credit scores were the last century’s greatest consumer-credit innovation, objectively ranking creditworthiness and enabling Americans to obtain credit, sight unseen, in seconds. That’s not good enough for disparate-impact dogmatists, whose logic requires allocating credit by race.  

Disparate-impact doctrine patently violates the Constitution’s Equal Protection Clause. Therefore, the Obama administration has worked relentlessly to keep the Supreme Court from reviewing the doctrine. Three cases presented an opportunity for the Court to drive a stake through the heart of this profoundly un-American legal concept. Two are dead.

The administration successfully pressured St. Paul, Minn., to withdraw its case in Magner v. Gallagher. In December, weeks before oral arguments were scheduled to be heard, the township Mt. Holly, N.J. (the plaintiff in Township of Mt. Holly v. Mt. Holly Gardens Citizens in Action), settled — conveniently for the administration. Administration allies had a hand in it. The Ford Foundation, George Soros’s Open Society Foundation, the National Fair Housing Alliance, and Self-Help Community Development contributed money to TRF Development Partners, which is building homes called for in the plaintiff’s plans for demolishing and rebuilding in the Mt. Holly Gardens neighborhood.

The Supreme Court, however, may yet have a chance to weigh in. Judge Richard J. Leon of the U.S. District Court for the District of Columbia has restarted the third suit, in which the American Insurance Association and National Association of Mutual Insurance challenge a February 2013 HUD regulation permitting disparate-impact claims. It had been on hold pending the Mt. Holly case.

This administration has an unhealthy race obsession. Chief Justice John Roberts rightly wrote that “the way to stop discrimination on the basis of race is to stop discriminating on the basis of race,” but racial discrimination is required by the administration’s disparate-impact-doctrine.  The only way lenders can shield themselves from disparate-impact complaints is to separate credit origination and underwriting standards by race. That, however, would discriminate against individuals who were more creditworthy but of the wrong racial profile.

During the CFPB hearing before the House Financial Services Committee, Bill Huizenga (R., Mich.) noted that one-third of black and Hispanic applicants wouldn’t meet the CFPB’s debt-to-income ratio of 43 percent. Complying with the CFPB’s ability-to-repay and qualified-mortgage-standards rule exposes lenders to the risk of violating disparate-impact-doctrine, despite a statement to the contrary issued by the CFPB, OCC, Federal Reserve, FDIC, and National Credit Union Administration: Absent “other factors,” they “don’t anticipate” a problem. But does anyone doubt that, with hyper-political President Obama, Attorney General Holder, and their camarilla, “other factors” might include bringing disparate-impact suits to boost African-American voter turnout in November’s midterm elections?

Separate credit standards for different ethnic groups is repugnant. It offends the American precept of judging individuals on their merits. It also makes society poorer. If regulators really want to subsidize riskier borrowers based on ethnicity, let them do so openly, so voters can judge the policy and its costs.

— Eric Grover is principal of Intrepid Ventures, a consultancy serving the financial services and payments industries.