The Department of Justice has new ideas on fair-lending.
Veterans expect Justice Department to bring more energy to fair lending, including new targets—among them, loan modifications
By Steve Cocheo, executive editor,
The opening bars of the Obama Administration’s fair-lending enforcement overtures have a somewhat familiar air to them, to Paul Hancock. That shouldn’t be surprising. Hancock played a big part in the composition of the Department of Justice’s approach to fair-lending.
Hancock was Chief in the Housing and Enforcement Section of the department’s Civil Rights Division, and his signature was among those on the complaint and consent decree of the very first federal mortgage-related fair-lending case pressed under the Equal Credit Opportunity Act. The allegation in U.S. v. Decatur Federal Savings & Loan case was that the thrift had applied stricter underwriting standards to African-Americans than to white applicants. The $1 million settlement reached in the 1992 case resonated throughout the home-lending industry, and was the first of a string of federal settlements between banks and Justice.
While many trace the roots of aggressive federal fair-lending enforcement to the Clinton years, Hancock and his colleagues brought the Decatur case during the Administration of George H.W. Bush.
Now, with a Democratic President very focused on the mortgage mess, and equal rights; an Attorney General who has left no room for doubt where he stands; and a nominee for Assistant Attorney General for Civil Rights who is a former civil rights prosecutor coming off major involvement in the foreclosure crisis, Hancock reaches an inescapable conclusion.
“We’ll have aggressive enforcement of fair lending in this Administration,” says Hancock, now partner in the Miami law offices of K & L Gates LLP. Hancock and other experts interviewed believe that banks will see increased attention not only on the bread-and-butter issues that the government has stressed for decades, but also on new wrinkles brought about by the mortgage crisis—including, somewhat paradoxically, the effort to refinance or modify troubled mortgage borrowers. (For an update of last month’s Compliance Clinic on loan modifications, see http://tinyurl.com/LoanModClinic)
Scoping out fair-lending changes
While the basic theme of federal fair-lending enforcement will be the same, the approach will differ in some ways from the past, experts predict. Banks both large and small have lent their names to a string of fair-lending cases. More will join them, the experts say, as cases that have been pending at the Justice Department for years will be moved forward and very publicly pursued.
“There’s a bunch of live cases over there,” especially those based on referrals by banking regulators, when they find a pattern or practice of discrimination, says Lucy Griffin, a compliance attorney and consultant with extensive experience at multiple Washington agencies and ABA, and ABA BJ contributing editor. She is president, Compliance Resources, Inc., Reston, Va.
There will be another shift that bankers will need to watch, and prepare for, as well. Thus far in its history, fair-lending enforcement has concerned exactly that—lending. The main focus has been on the up-front elements and errors of the lending process: redlining, marketing, pricing, loan decisionmaking, etc.
In today’s circumstances, Hancock and others predict, the servicing end of the process, especially in the mortgage arena, will feel the heat of the spotlight.
Institutions modifying loans independently or under the Obama Admini stration’s special programs, will need to do so carefully. Indeed, experts interviewed warn that dangers lurk in credit in general where lenders try to apply the lessons of today’s debacle to future decisions.
Bush years reconsidered
To assess where the Obama years may take fair-lending issues, one needs to examine the recent past. Typically, the George W. Bush Justice Department’s efforts in fair-lending get painted as a failure.
A particularly damning statement was made by the bipartisan Report of the National Commission on Fair Housing and Equal Opportunity in December:
“Litigation by the Department of Justice challenging lending discrimination has … been seriously reduced, which may have contributed to the worsening of the foreclosure crisis. During the 1990s, fair-lending enforcement was ‘ramping up.’ A total of 14 fair-lending cases challenging discrimination in real-estate-related lending were brought from 1992-2000, many of which challenged discriminatory predatory activities. But since 2001, fair-lending enforcement has been greatly reduced. DoJ has brought only five fair-lending cases dealing with residential lending, four that attacked redlining practices, and one that attacked discriminatory pricing practices for manufactured homes. None has concerned predatory lending practices despite extensive research demonstrating the discriminatory patterns so prevalent in the subprime market.”
While acknowledging that private plaintiffs, state attorneys general, and some municipalities have stepped into the perceived gap, at times, the report held federal DoJ muscle as critical to litigate cases to provide “meaningful redress.”
Andrew Sandler, a veteran banking attorney, defended and advised many banks in fair-lending matters while at the Skadden Arps firm. He thinks the inaction of the Bush years has been overplayed.
“While the Department of Justice pursued fewer fair-lending cases in the Bush years, the federal banking regulators, especially the FDIC have been more aggressive over the last few years in their enforcement and their efforts to refer potential cases to the Justice Department,” says Sandler. He recently started a new law firm of his own called BuckleySandler LLP, where he is co-chair.
In the last five years, says Sandler, since Home Mortgage Disclosure Act data were expanded to include mortgage pricing information, “it’s been all about pricing and statistics, with a major assault on discretionary pricing, especially at the FDIC.”
“It is my impression that a lot of what we’ve seen out of the FDIC is being driven from the top,” points out Sandler. Further, he believes the regulators are pursuing some bases for their referrals on some questionable legal standards.
DoJ will not dominate
“The Fed is taking a more radical approach to its statistical analysis in assessing loan pricing,” says Sandler.
“Fed examiners are focusing on loan rates that diverge from the bank’s stated rate sheet without proper regard for risk factors such as credit scores and loan-to-value ratios.” While this would appear to be missing half the picture of a loan pricing decision, Sandler describes it as what’s happening. The attitude appears to be that if a borrower qualifies for a loan, there should be no difference in prices.
Sandler isn’t sure what has caused the shift. But he thinks that a different team of Fed economists has been working on fair-lending issues in recent months.
Overall, Sandler says this is symptomatic of the broadening of fair-lending enforcement, discussed earlier. Much of the direction “used to come from the Justice Department.” Now, he says, the individual government entities appear to be taking their own directions.
Going forward, he sees at least part of this split in focus continuing. “The new Department of Justice will do its own thing,” says Sandler. He suspects that the federal banking agencies, the Department of Housing and Urban Development, the Federal Trade Commission, and other federal players with pieces of the fair-lending duty will begin to work more closely again.
However, overall, Sandler says he expects “continued atomization of fair-lending enforcement, with each enforcement agency continuing to pursue its own agenda. The reinvigorated DoJ fair-lending enforcement program will not be able to reestablish DoJ primacy in setting a unified government fair-lending enforcement program.”
Private fair-lending cases are, and will remain, something of a wild card, it seems. K&L’s Hancock notes that a large number of private class-action suits arising from fair-lending grounds have been filed in recent years. The majority of these cases, says Hancock, have been filed on the basis of the “disparate impact” legal theory of fair-lending enforcement in which the same, seemingly neutral treatment can be proven to be discriminatory to protected groups, due to differing results.
(This is as opposed to the more mainstream “disparate treatment” issue, where a lender is accused of treating whites and a protected group or groups differently.)
Hancock says it will be interesting to see how the new players at Justice feel about the disparate impact argument.
Foreclosure adds to complex issues
Fair lending has always been a complex area of banking law and regulation, and with the return of an aggressive, publicized Justice Department effort in a time of massive foreclosures and troubled borrowers, affairs will only grow dicier.
Thomas Perez, awaiting Senate confirmation for the post of top civil rights prosecutor, made it clear in the confirmation process that he intends to continue his efforts to address the foreclosure issue, expanding from his home turf of Maryland to a nationwide viewpoint.
Perez indicated that his first take in looking at foreclosure-related cases would be to consider if the particular credit granted was selected on a discriminatory basis. He added that, “if there is not sufficient evidence of discrimination, but it appears that borrower may have been defrauded or that a lender/broker/ servicer may have violated other federal statutes, the [Civil Rights] Division would refer homeowners to the other agencies with jurisdiction.”
Pricing challenges continue
The playing field for mortgage brokers has been evolving, and the relationship between brokers and primary lenders who buy their production has evolved as well. But there will be much old business coming within range of Justice’s radar.
K&L’s Hancock says one issue that may be addressed is how much responsibility a lender bears for the fees charged by mortgage brokers representing them. There have been inconsistencies in how Justice evaluates pricing issues, says Hancock, and this may come to a head on Attorney General Holder’s watch.
The inconsistencies involve such issues as whether controls should be used when evaluating loan pricing. In their absence, Hancock explains, there is more likelihood that market-based pricing decisions will look discriminatory.
Hancock doesn’t think Holder will push the envelope on such evaluations the way some private plaintiff attorneys have. But Holder, Hancock notes, in this and other areas, won’t be reasoning alone. “A lot will depend on the posture taken by the Assistant Attorney General for Civil Rights,” presumably Perez, he says.
Andrew Sandler is convinced that Perez’ fair-lending record makes it clear that he believes in “enhanced” fair-lending enforcement, and that having an advocate for enforcement at Perez’ level will be a sea change compared to the recent Bush years. BJ
Six critical fair-lending pressure points to review now
Overall, the experts interviewed for the main article recommend not only continuing the internal fair-lending monitoring that banks have long done, but expanding it to new areas including loan processing and servicing. They offer this advice:
1. Consider “foreclosure scores” carefully. Consultant Lucy Griffin of Compliance Resources, Inc., says there is a concept in the field now that new mortgage lending decisions should incorporate a “foreclosure risk score.” Griffin cautions that basing part of the loan decision on the foreclosure record of the geographical area where the property is located may lead to discrimination.
Merely going along with what Fannies and Freddie say they will buy won’t necessarily secure any protection, warns Griffin. First, she says, the lender is always the one responsible for how it makes loans, not any third party. Second, she says, both GSEs have long maintained the position that they set secondary market standards, not primary mortgage market standards, and thus that their rules are not intended as a fair-lending safe harbor.
2. Don’t wrap your bank in an Obama program security blanket. As pointed out in “10 steps to defusing loan mod bombs,” the May edition’s Compliance Clinic by Griffin and fellow contributing editor Nancy Derr-Castiglione, there are many ways to get into compliance trouble while trying to do good.
True, there is some protection for “special purpose credit programs,” points out Griffin. Section 202.8 of the Equal Credit Opportunity Act is the relevant rule.
Griffin says that disparate impact is permissible in the context of a special program so long as an institution’s actions fall in line with the structure and goals of the program. She warns, however, that even those institutions that sign onto the Obama mortgage program must proceed with care.
Griffin advises banks to carefully monitor who gets what kind of relief and how much of it, in the course of refinancing and modifying under the program.
“Down the line,” says Griffin, “someone is going to be asking that question.”
And even though there is protection, it is not airtight. “All of the fair-lending marketing and outreach issues attach to this,” says Griffin. So there has to be consistency in who is notified and how they are notified, for instance. (A relevant case, she says, is 1994’s U.S. v. First National Bank of Vicksburg.)
3. If you’re “getting religion” on credit, be careful. Now that reality has hit the credit markets, there is an emphasis on sound underwriting, and demonstrating same to examiners. Griffin cautions that banks must be sure that all factors they add back into the loan decision relate to credit performance, and nothing that can be later construed as a discriminatory barrier to credit availability or to fair pricing of credit.
4. Look for gaps in your credit program’s compliance logic. An issue already raised in the past several years concerns differing treatment of married and unmarried co-applicants for credit. In the 2007 Justice case, U.S. v. Compass Bank the government alleged that unmarried co-applicants were charged higher rates for auto loans made through the Birmingham, Ala., bank’s dealer network than did married co-applicants. The $1.75 million settlement began with a Federal Reserve Board referral to Justice in 2003.
Griffin says she suspects that there are similar cases pending at Justice now, and adds that there are other situations where inconsistent application of policies will trap unwary banks.
For instance, she asks, how does your bank treat temporary unemployment of a borrower? If treatment of blacks and whites in such straits can be shown to be different, fair-lending trouble won’t be far away.
5. Don’t drop self-testing for compliance. A long-standing concern is whether a bank’s efforts to test itself for fair-lending compliance potentially put a loaded gun in the government’s hands, if troubles are located. Even in the absence of a clear view of all of the Administration’s fair-lending policies. banking attorney Andrew Sandler urges bankers to continue such efforts, and to adopt them if they haven’t been self testing.
“Not doing that is a red flag,” warns Sandler.
6. TARP banks have some special issues. The wrinkle never before seen in the fair-lending arena is the issue of government ownership of banks, through TARP and related federal programs. Will a bank desiring to fight Justice Department allegations, or a referral made by bank examiners to Justice, be able to be its own master? Or, poses Sandler, will a federal part-owner pressure or require the institution to settle right away?
“That remains to be seen,” say Sandler. “There’s an inherent conflict of interest between government as investor and government as regulator.”
—Steve Cocheo, executive editor