Justice Department’s Witch Hunt Against Banks Will Harm Economy

by Hans Bader on July 11, 2011

in Deregulate to Stimulate, Economy, Legal, Regulation

The Justice Department is now extorting multimillion dollar settlements from banks, by accusing them of racial discrimination because they use traditional, non-racist lending criteria that minority borrowers are, on average, less likely to satisfy, such as having a high credit score, or being able to afford a substantial downpayment. Its Civil Rights Division chief, Tom Perez, “has compared bankers to Klansmen.” The “only difference, he says, is bankers discriminate ‘with a smile’ and ‘fine print,’” calling their lending criteria “every bit as destructive as the cross burned in a neighborhood.”

As Investor’s Business Daily notes in “DOJ Begins Bank Witch Hunt,”

In what could be a repeat of the easy-lending cycle that led to the housing crisis, the Justice Department has asked several banks to relax their mortgage underwriting standards and approve loans for minorities with poor credit as part of a new crackdown on alleged discrimination, according to court documents reviewed by IBD.  Prosecutions have already generated more than $20 million in loan set-asides and other subsidies from banks that have settled out of court rather than battle the federal government and risk being branded racist. An additional 60 banks are under investigation, a DOJ spokeswoman says. Settlements include setting aside prime-rate mortgages for low-income blacks and Hispanics with blemished credit and even counting “public assistance” as valid income in mortgage applications. In several cases, the government has ordered bank defendants to post in all their branches and marketing materials a notice informing minority customers that they cannot be turned down for credit because they receive public aid, such as unemployment benefits, welfare payments or food stamps.  Among other remedies: favorable interest rates and down-payment assistance for minority borrowers with weak credit. . .

Such efforts risk recreating the government-imposed lax underwriting that led to the housing boom and bust, critics fear. “It’s absolutely outrageous after what we’ve just gone through,” said former Rep. Ernest Istook, a Heritage Foundation fellow. “How can someone both be financially stable enough to merit a mortgage at the same time they’re on public assistance? By definition, you don’t have the kind of employment that can support such a loan.” . .

In the new prosecutions, Justice acknowledges in every case it did not prove charges of intentional discrimination, while banks have denied any wrongdoing. Many, in fact, earned outstanding ratings from anti-redlining regulators enforcing the Community Reinvestment Act.  Istook calls Holder’s crusade an “egregious overreach by the government.” He says many of the targets are smaller banks without the resources to fight a protracted legal battle. . .

As part of settlement deals, prosecutors have required banks to sign “nondisclosure agreements” barring them from talking about the methods used to allege discrimination. Bank lawyers contend the prosecutors are trying to hide the shaky legal grounds on which the cases are built. “It’s horrible what they’re doing at the civil rights division,” said Reginald Brown, a partner at Wilmer Hale in Washington, who has represented banks in connection to recent race-bias investigations. “They don’t have any proof, just theories.” He added, “They want you to sign something saying you agree, under the condition of any settlement with them, that you won’t disclose what their theories were. That’s because their theories are loopy and wouldn’t stand the light of day.” One such theory — “disparate impact” — holds that merely a difference in loan application outcomes is enough to prove racial discrimination — even if no intent exists on the part of loan officers to contrast based on the color of applicants, and even legitimate business factors — such as credit scores and down payments — help explain disparities in loan outcomes between white and black applicants.

We wrote earlier about how the Obama administration is supporting lawsuits based on a “disparate impact” theory even in circumstances when the Supreme Court has said that the theory cannot be used, using such lawsuits to pay off liberal special-interest groups and trial lawyers with millions of dollars of taxpayer money.

The Investor’s Business Daily story illustrates two outcomes of this pressure to avoid “disparate impact”: lenders will make loans to people with bad credit — increasing future default rates and harming banks’ ability to stay afloat — and will make loans to minorities on preferential terms, engaging in racial discrimination.

Such lower lending standards can have disastrous results. A recent book co-authored by The New York Times‘ Gretchen Morgenson chronicles how federally-promoted lower lending standards spawned the financial crisis, and put minority borrowers into homes they could not afford.

“This is a story, the authors say, ‘of what happens when Washington decides, in its infinite wisdom, that every living, breathing citizen should own a home.’  Encouraged by politicians to expand home lending—not least to minorities and to households with few assets—[government-sponsored mortgage giant Fannie Mae] ignored reasonable standards of underwriting and piled up fugitive profits almost as fast as it increased risk to taxpayers.  The disaster is now measured in the hundreds of billions of dollars. As for the borrowers who were supposedly to benefit from Fannie’s mortgage-industrial complex, Ms. Morgenson and Mr. Rosner write that home ownership ‘put them squarely on the road to personal and financial ruin.’”

Banks and mortgage companies have long been under pressure from lawmakers and regulators to give loans to people with bad credit, in order to provide “affordable housing” and promote “diversity.” That played a key role in triggering the mortgage crisis, judging from a story in the New York Times. For example, “a high-ranking Democrat telephoned executives and screamed at them to purchase more loans from low-income borrowers, according to a Congressional source.” The executives of government-backed mortgage giants Fannie Mae and Freddie Mac “eventually yielded to those pressures, effectively wagering that if things got too bad, the government would bail them out.” Clinton-era affordable housing mandates were a key reason for the risky lending. A recent study by Peter Wallison, who had prophetically warned about Fannie and Freddie, found that two-thirds of all bad mortgages were either “bought by government agencies or required to be bought by private companies under government pressure,” a finding echoed by other recent studies. Another law designed to prod banks to make loans in low-income communities, the Community Reinvestment Act, also contributed to the financial crisis, say the Wall Street Journal, Investor’s Business Daily, bankers, and economists. Yet Obama has sought to expand its reach.

But there is another way for banks to eliminate such perceived racial “disparities”:  Refusing to make loans to whites who would otherwise receive them, curtailing the flow of available credit. Given a choice between making bad loans to minorities, and  refusing to make a few good loans to whites, a bank may choose the latter, since profit on a good loan is smaller than the loss on a defaulted loan. This, too, causes economic harm.

Cutting off the flow of credit to businesses can deprive them of capital needed to operate and expand, causing a recession and mass unemployment. For example, the Roosevelt Recession of 1937 is linked by some economists to the Federal Reserve’s increase in reserve requirements, which left banks with less money to lend, causing a contraction in the money supply and drying up the flow of credit for businesses that otherwise would have employed people. (That recession was also the product of  Supreme Court rulings that upheld anti-business measures passed during the New Deal, like the National Labor Relations Act, which had previously been struck down by lower courts, but which the Supreme Court upheld beginning in 1937 in cases like NLRB v. Jones & Laughlin Steel Corp.)

Unemployment is already very high, thanks to Obama administration policies.

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