A Different Standard

Housing regulation would encourage risky lending, critics say

February 19, 2013

A new rule from the Department of Housing and Urban Development could lead to another housing market crash like the one that nearly crippled the economy in 2008, legal and financial experts say.

The rule would establish a controversial standard for determining if discrimination was taking place in mortgage lending. Critics say such a standard would lead to more lending by banks to borrowers less able to repay their debts.

The debate over discrimination in lending revolves around two different standards. The first, known as disparate treatment, holds that one must intend to discriminate against borrowers in order to be legally liable.

The other standard, disparate impact, holds that any lending standard that yields different results for different racial or ethnic demographics is in itself discriminatory even if the lender has no intent to discriminate and applied lending standards equally to all applicants.

HUD is attempting to institutionalize the disparate impact standard in a rule finalized this month.

The rule would classify as discrimination any lending practice that results in a racial disparity in the makeup of borrowers, critics say. If a bank’s lending standards result in a larger share of Asian borrowers than Hispanic borrowers, for instance, those standards would be illegal, even if the bank had no intention to discriminate.

According to the Washington State Asset Building Coalition, blacks and Hispanics are significantly more likely to have lower credit scores than Caucasians. A lending policy based solely on one’s credit score would have a disparate racial impact, not due to any intent to discriminate but due to the varying creditworthiness of potential borrowers in different racial demographics.

"This is a foolish policy that will punish lenders for totally neutral, nondiscriminatory credit standards and policies," said Hans von Spakovsky, a senior legal fellow at the Heritage Foundation and a former attorney in the Justice Department civil rights division.

The HUD rule "will impose racial quotas on lenders of the same type that previously led to the mortgage crash," Spakovsky said in an email.

Critics note that the HUD rule is similar in intent to a 1977 law called the Community Reinvestment Act, which aimed to reduce racial discrimination in lending.

That law "led to riskier lending by banks," according to a study by the National Bureau of Economic Research. The study found positive correlations between CRA compliance and the rate at which banks tended to lend as well as the delinquency rates of their loan portfolios.

The HUD disparate impact rule may lead to more risky loans and more defaults, observers warn.

The American Banking Association released a statement urging "regulators to refocus their fair lending supervision on potential differing treatment of borrowers with similar circumstances and creditworthiness, rather than applying statistical quotas."

An ABA spokesperson declined to elaborate on the group’s objections to the rule.

Roger Clegg, the president of the Center for Equal Opportunity, also voiced concerns about HUD’s "politically correct" approach to mortgage regulations.

There is "a lot of evidence" that the rule would lead to more risky lending practices, Clegg said.

Clegg expressed doubts about the HUD rule legal grounding. The department cited "eleven federal courts of appeals that have ruled on this issue" and agreed that the disparate impact standard is the appropriate application of the Fair Housing Act, the law that governs lending discrimination.

However, Clegg noted, the Supreme Court has been cool to such an argument. The court was slated to consider the question of disparate impact last year in a case brought by the city of St. Paul, Minn.

The Justice Department, in a deal a number of lawmakers alleged was an improper "quid pro quo," agreed to drop an unrelated False Claims Act case against the city if it withdrew its Supreme Court complaint.

"I don’t think that DOJ would dispute that it doesn’t want the Supreme Court to decide the issue" or that "they pressured the city of St. Paul" to drop the case, Clegg said.

Hans Bader, senior attorney and counsel for special projects at the Competitive Enterprise Institute, which filed a brief in the St. Paul case, said the HUD rule "would pressure banks to engage in the very same risky practices that led to the 2008 housing collapse such as mortgage lending to non-creditworthy borrowers. Thus, it could contribute to a future financial crisis, and it will help spawn future mortgage meltdowns."

HUD did not respond to a request for comment.