Did Racism Help Cause the Mortgage Crisis? Conclusion

copyright © 2008 Ralph Brauer. The Strange Death of Liberal America

The quest for a culprit in the financial mess continues to occupy the press and financial analysts. “How,” they ask again and again, “Could America have gotten itself into this mess?” Much attention has focused on the institutions and CEOs who are at the center of the current crisis. The feeling is growing that providing bailouts to financial giants and CEOs such as Citi and Sandy Weill is to reward those who engaged questionable and even illegal behavior.  

The Inability of Fines to Stem the Practice

The previous three essays laid out the case that the mortgage crisis began with discriminatory lending and redlining during the post World War II housing boom. What was one of the greatest mass social movements in history, one that made home ownership a reality for millions of Americans, unfortunately came with a heavy price,for it shut out people of color.

Wide swaths of America were segregated by race. This was not merely due to the prejudices of local home builders or lending institutions but came from the FHA and the federal government. It was a national policy. In systems terms people of color faced two restrictions that served to reinforce each other–they could not move from where they were which left them at the mercy of those who controlled both lending and real estate and they had no access to the government programs that were available to whites and when they did they found the price was often too high.

This influenced the growth of loansharking or what people have relabeled predatory lending or subprime lending. Which terms you use does not really matter because the results were the same: people of color faced exorbitant terms, shady practices such as Sandy Weill’s tactic of coupling insurance with loans and “closed book” closings, and finally just old-fashioned ripoffs.

We have seen in the history of loan sharking that many of these firms paid fines for their illegal practices, but the threat of fines apparently did little to stem the practice. In many cases the fines were so small that corporations easily paid them off. In other cases they became part of the balance sheet of doing business. Sandy Weill, for example, bought a company that already had been fined for deceptive lending and yet instead of ceasing such practices Weill continued them into the next decade culominating with the huge fine levied against Citi in 1999. Other companies were undaunted by the fine levied against Citi and continued to engage in loansharking resulting in this year’s judgment against Bank of America which will far surpass the fine levied against Citi.

A Civil Rights Issue

Given that racial discrimination lies at the heart of these illegal practices, perhaps a heavier stick is needed to curb them.

South Carolina Representative James Clyburn, one of the deans of the Black Caucus, has testified:

We must now begin to address predatory lending practices that overwhelmingly affect blacks by instituting laws that will make what are already unethical practices illegal. If not, the government will continue to be a partner in yet another tragic black land takings saga.

Section 804b of the Fair Housing Act states:

It shall be unlawful to discriminate against any person in the terms, conditions, or privileges of sale or rental of a dwelling, or in the provision of services or facilities in connection therewith, because of race, color, religion, sex, familial status, or national origin.

Section 805 begins:

It shall be unlawful for any person or other entity whose business includes engaging in residential real estate-related transactions to discriminate against any person in making available such a transaction, or in the terms or conditions of such a transaction, because of race, color, religion, sex, handicap, familial status, or national origin.

While the Act provides only monetary civil penalties, thus far those have been used mainly against organizations and not individuals. But what if the individuals who sanctioned such acts were prosecuted?

There needs to be in inquiry into who took part in loansharking, but not merely for financial misdeeds but also for violation of Civil Rights laws. If a Sandy Weill or some other CEO or former CEO could be indicted on a civil rights violation it would send a clear message about the roots of this crisis.

It is interesting that the way our current Civil Rights laws are written, someone can go to jail for burning a cross in someone’s front yard, but not for predatory lending that has the impact of stealing that front yard from the homeowner. Also it is criminal to lie on a loan application but not to lie about the loan itself (i.e. “closed folder” closings). The National Consumer Law Center has drafted model legislation aimed at the business of predatory “payday loans,” but what it says in the final paragraph of the model legislation could just as easily be applied to home mortgages:

Criminal penalties are an important deterrent to lender abuse. Any knowing violation of the act is a misdemeanor and subjects the violator to a $1,000 fine or imprisonment not to exceed six months or both.

A few states have begun to institute criminal penalties for predatory lending. Last year my home state of Minnesota passed a bill prohibiting what it termed “residential mortgage fraud.” It provided:

Whoever violates this section shall be sentenced as provided in section 609.52, subdivision 3, based on the aggregate economic loss suffered by any person as a result of the violation. However, the maximum sentence of imprisonment for the offense may not exceed two years. A person convicted of a violation of this section shall be ordered to pay restitution to persons aggrieved by the violation. Restitution shall be ordered in addition to a fine or imprisonment but not in lieu of a fine or imprisonment.

Yet there still is no similar federal statute. Until there is the people involved will have the fines paid by their corporations and retire on their golden parachutes. Sandy Weill is leading a comfortable retirement. Before he retired, Forbes ranked the man who owes his fortune to predatory lending at 377th in its survey of the richest people in the world and 162nd in the United States.  Today he is worth around $1.5 billion and owns a $42 million dollar penthouse that includes more than 2,000 square feet of terraces.

Zeroing in on Glass-Steagall

Another remedy is that no one associated with the repeal of Glass-Steagall shall have a role in the upcoming administration. For many Americans, Barack Obama represents a new hope that business as usual will end. Having someone involved with the repeal of Glass-Steagall in his administration will send the wrong message.

The answer to the question “How did we get into this?” is quite simple. The warning signs were there as long as a decade ago in reports and investigations by people like Hudson, the Woodstock Institute and others.  But then the subprime crisis was primarily a problem for people of color and like many problems for people of color this one was ignored or downplayed.

You would have thought that Katrina would have taught us the error–if not the immorality–of such thinking, but it did not. As long as whites and the high rollers still believed the playing field was level for them they did not care about the unlevel playing field that had existed for half a century and more in communities of color.

The fatal mistake came with the repeal of Glass-Steagall, for suddenly formerly segregated loans became all mixed up as loansharking morphed into the more respectable-sounding euphemism of subprime. Financial threads became so entangled that no one could unravel them, not even the so-called wise men such as Robert Rubin, who continued to provide Citi with advice even as it expanded its loansharking operations.

The repeal of Glass-Steagall ironically accomplished what people of color had been attempting since before Dr. Martin Luther King served time in that Birmingham jail–it irrevocably tied the fates of white and black America together. The last time that happened on such a scale is when a grizzled old Southern firebrand named Edmund Ruffin had the honor of lighting the fuse on the first cannon that fired on Fort Sumter.

There are already more proposals on the table to solve the current crisis than the already fragile legs of the table can hold. We’ve had a so-called bailout which some banks used to buy other banks and continue business a usual.  Three banks are in violation of federal law prohibiting them from controlling more than 10% of the market. We’ve even heard proposals for mortgage relief, but those have been met by cries that if people got themselves into a mess it’s their own fault and they should not expect any help.

The Final Judgment

According to State of the Dream by United for Fair Housing, in the quarter century from 1970-2006, white home ownership increased from 65.4% to 75.8% while African American home ownership increased only from 41.6% to 48.4%–or less than half the white rate. This is not merely a national embarrassment but an indictment of American social policy. It is the single greatest policy failure of the post World War II era.

From it stem a host of interrelated problems that definitively prove that discrimination rots the very foundation of democracy–the idea of the level playing field. According to a report released in 2004 by the Corporation for Enterprise Development, the government spends $335 billion on asset-building policies that:

Disproportionately benefit those who already have assets. Analysis of the largest spending categories shows that over a third of the benefits go to the wealthiest 1% of Americans-those who typically earn over $1 million per year. In contrast, less than 5% of the benefits go to the bottom 60% of taxpayers.

In his last book, Dr. Martin Luther King, jr. wrote:

Now we realize that dislocations in the market operation of our economy and the prevalence of discrimination thrust people into idleness and bind them in constant or frequent unemployment against their will.

A case cited by Mike Hudson provides an illustration. It involves an elderly African America woman with a sixth grade education whose vision was so bad she could hardly see the documents. The company’s attorney asked her:

“Did you tell him that you couldn’t understand basic sentences in the English language well enough to make decisions about it?” She acknowledged she hadn’t, but said the loan officer should have explained things better. “He should have did right,” she said.

“He should have did right.” Those words now echo across America not merely in the concrete canyons of the inner city but in cul-de-sacs in neighborhoods that sport “For Sale” signs among the crabgrass that is reclaiming what used to be golf-course lawns. Just as no one wants to talk about the elephant in the room, no one wants to talk about the solutions.

The financial crisis grew from redlining and racial discrimination and only when redlining and its evil stepchild, loansharking, are suspended will we have rooted out the cause of the crisis. Right now what the experts are proposing is a bit like trying to rid a lawn of dandelions by pulling on their tops. These solutions may get rid of the visible problem, but not the roots. Until we dig them out for good we can expect that after some time the weeds will grow back–only this time they will be more resistant because the roots will have grown deeper.

So the solution is quite simple: the time has come to put home ownership on a level playing field. That does not mean valuing an inner city home the same as a suburban McMansion or not applying the same qualifying standards to everyone. It does mean no more “closed folder closings,” no more 40% APRs, no more ingeniously-worded contracts, no more unnecessary insurance or other costs and no more redlining.

This series began with a painting of the signing of the Constitution. While many of the gentlemen whose names are on that document were unrepentant slave holders, the words they wrote and the government they created have endured precisely because they have transcended the human frailties of those who founded this nation.

They may not have fully honored the ringing preamble with its immortal words:

We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.

Yet the words are still there–especially “establish justice.” As America prepares to inaugurate its first African American President we need to remember that when he takes the oath of office to uphold and defend the Constitution, he does so on behalf of all of us. For we are not a dictatorship but a democracy and in a democracy all of us must see to it that those words mean what they say.

Crossposted: My Left Wing

Did Racism Help Cause the Mortgage Crisis? The Bubble Bursts



Carter Glass

copyright © 2008 Ralph Brauer. The Strange Death of Liberal America

In 1997 the FDIC published an imaginary interview with Carter Glass that predicted what would occur with the repeal of the Glass-Steagall Act two years later.

Banks lent their names, prestige, and tradition of sound banking operations to these affiliates, and on that basis did people invest and transact business with them. When calamity struck, not all bankers felt a responsibility to the citizens they had enticed.

This imaginary interview would prove especially prescient about people of color.

With Glass-Steagall out of the way, mainstream banks began getting into the loansharking business in a big way. In a paper for the St. Louis Federal Reserve System, Souphala Chomsisengphet and Anthony Pennington-Cross point out:

The market share of the top 25 firms making subprime loans grew from 39.3 percent in 1995 to over 90 percent in 2003. Many firms that started the subprime industry either have failed or were purchased by larger institutions.

A 1999 article “Banks Take  Over Subprime” in National Mortgage News captures how the repeal of Glass-Steagall changed the market:

Among the top 25 sub prime lenders in the third quarter of 1999, ten are owned by either a bank or thrift.  A year ago, just three of the top 25 were owned by depository institutions.

The myth persists that the victims of this boom in loansharking ended up in that position because they could not have qualified for other loans. Yet data from a 2002 Fannie Mae report dispels this notion. It found:

Credit quality alone therefore does not fully explain the extreme reliance of black households on the subprime market. Further research by Freddie Mac reports that as much as 35 percent of borrowers in the subprime market could qualify for prime market loans. Fannie Mae estimates that number closer to 50 percent.

There are others who have confirmed that the myth is false, most notably the Wall Street Journal, whose analysis of credit scores is one of the most widely-used sources. Authors Rick Brooks and Ruth Simon reported that the study of more than $2.5 trillion in subprime loans made since 2000 showed:

In 2005, the peak year of the subprime boom, the study says that borrowers with such credit scores got more than half — 55% — of all subprime mortgages that were ultimately packaged into securities for sale to investors, as most subprime loans are. The study by First American LoanPerformance, a San Francisco research firm, says the proportion rose even higher by the end of 2006, to 61%. The figure was just 41% in 2000, according to the study.

The repeal of Glass-Steagall did not change one fact–the prime victims of predatory lending remained people of color. A 1999 Woodstock Institute Report on lending in Chicago noted:

The restructuring of financial services industries and the failure of federal and state regulators to respond to these changes have increased the ability of certain lenders and brokers to exploit homeowners, particularly in minority and modest-income communities.

In October 2002, ACORN (Association of Community Organizations for Reform Now) released “The Great Divide,” a report on 2001 national loan data for 68 metropolitan areas. The report found continuing and even growing racial and economic disparities in home mortgage lending. Nationally, African-American mortgage applicants faced rejection 2.31 times more often than white applicants, and Hispanics were denied 1.53 times more often than whites.

For those who hold an economic or class-based analysis of the subprime market targeting people of color, the ACORN study is an eye-opener, for it found income made little difference. ACORN notes in Chicago African-Americans earning more than $84,600 had 2.06 times more likelihood of being turned down than whites earning less than $28,450.  The report said:

The rise in subprime and predatory lending has been most dramatic in minority communities. Subprime lenders account for half, 51 percent, of all refinance loans made in predominantly black neighborhoods, compared to just 9 percent of the refinance loans made in predominantly white neighborhoods. Subprime lending, with its higher prices and attendant abuses, is becoming the dominant form of lending in minority communities.

The Community Reinvestment Association of North Carolina adds their study to the evidence:

In North Carolina, the incidence of high cost loans originated by African-American borrowers are more than four times (4.15) greater than for whites in North Carolina.

Foreclosed: State of the Dream 2008 by United for a Fair Economy has a graph that shows the pattern

The study goes on to point out:

We estimate the total loss of wealth for people of color to be between $164 billion and $213 billion for subprime loans taken during the past eight years. We believe this represents the greatest loss of wealth for people of color in modern US history.

The banking industry has tried to explain these figures in a variety of ways, the main one being the old dodge of shifting the argument from race to class, but the North Carolina study and others refute this theory.

We also staunchly argue that continuing discrimination and corporate practices are a factor in the loan pricing disparities by race. The history of racism in finance continues to play a role in access and cost of credit.

In 2007 testimony before the House Financial Services Committee Jim Campen, Executive Director Americans for Fairness in Lending, reported on results of an ongoing study his group is conducting in the Boston area:

The black/white denial rate ratio, which averaged about 2.0 during the 1990s, was 2.34 in 2005, while the Latino/white denial rate ratio, typically about 1.5 during the 1990s, was 2.07 in 2005.

In the highest income category, consisting of borrowers with incomes above $150,000, black applicants experienced a denial rate of 25.9%, almost triple the 8.9% denial rate experienced by their white counterparts; the 20.7% denial rate for Latinos with incomes above $150,000 was 2.3 times greater than the white rate.

I have focused my analysis on mortgage lending in Massachusetts, with particular emphasis on the city of Boston and the Greater Boston area, but I believe that a detailed examination of mortgage lending patterns in other cities and states would reveal qualitatively similar findings.

Again, a chart tells the complete story. Note what is essentially a flat line as income increases. The message to people of color is clear: not matter how much you make you will face discrimination in getting a mortgage.

In short, not only did the repeal of Glass-Steagall open the floodgates for banks to enter into loansharking, after the repeal the discrimination against people of color became worse!

Another graph from the Center for Responsible Lending shows the impact of discrimination:

Michael Hudson found that Citi was right in the middle of this:

In 1999, the company agreed to pay as much as $2 million to settle a lawsuit accusing Commercial and American Health & Life of overcharging tens of thousands of Alabamans on insurance. Beasley, Allen, claim[ed] nearly 1,500 clients in Alabama, Mississippi, and Tennessee who had Commercial Credit or CitiFinancial loans.

In 2002 Citi bought Associates First Capital, a sleazy Texas firm that had paid over $33 million in settlements to Georgia and North Carolina lawsuits. Martin Eakes of North Carolina’s Self-Help Credit Union even directly challenged Citi head Sandy Weill at a stockholders’ meeting in April 2001:

No company that values its good name would have bought Associates.

In the fallout over the merger and Citi’s own subprime branch CitiFinancial (which had been created from the original Weill loansharking operation), Citi agreed to a $240 million settlement with the Federal trade Commission. Hudson noted that despite all the big numbers, each victim ended up with an average of $120 and the cost to Citi was two week’s profits.

Jodie Bernstein, director of FTC’s Bureau of Consumer  Protection, said Citigroup’s newly acquired  affiliate-Associates First Capital-engaged in a wide variety  of deceptive practices:

They hid essential information from consumers,  misrepresented loan terms, flipped loans and       packed in  optional fees to raise the costs of the loans.

And where was Robert Rubin during all this?

The True Impact

This essay has featured an unusual number of quotes, charts and statistics, which at times march down the page one after the other. There are editorial and rhetorical reasons for this: editorially I have always believed in quoting directly from the source when writing on the web so readers can see what someone said and rhetorically I wanted readers to feel the weight of this evidence piling up.

For that is exactly the situation people of color find themselves facing. The real implications of the mortgage crisis press down on families and communities,  suffocating dimensions of life that white suburbanites take for granted–good schools, easy access to shopping, and, most of all, choices.

We need to remember that behind the numbers lie people. Their personal experiences testify to the real consequences of the problem. One story comes from Michelle Allison of the NAACP’s Merced Branch in California, who was locked into a prepayment loan and now owes $100,000 above what she initially requested:

It’s like being over a barrel. I just wanted to be treated fairly and receive the best service. I was not given options or enough information for me to make an alternate decision. I want to get back to where I was financially before I received my loan.

The AARP has another story:

Betty Cooper was an older, wheelchair-bound African-American widow, living on a monthly pension. She experienced a bait and switch of her interest rate that resulted in unaffordable monthly payments. In addition, she was charged a hidden broker fee that cost her a steep 8 percent of the mortgage, and an unexplained balloon mortgage payment.

Multiply stories like these by the numbers in the statistics above and you have some idea of the trail of misery that has been left by loan sharking in communities across the country.

The Web of Deceit

The real shock is that many of these studies data back to as long as a decade ago, with each subsequent study piling on more evidence to support the previous ones.  After much time spent reading all this evidence you begin to wonder if anyone else has read it. Yet some of the studies such as the North Carolina one were inserted into the Congressional Record where they lie today, largely unknown to the general public.

This is evidence of discrimination on a scale resembling the mountain of evidence marshaled for Brown v Board or the abuses of Reconstruction or the evils of slavery. In 1944 Gunnar Myrdal referred to the problem of race as an “American dilemma.”  Sixty years later the dilemma has become quite simply one of economic survival and with it the survival of our democratic society.

Sandy Weill built a financial empire on loansharking. Even long after Citi had merged and acquisitioned its way to the very top of the American financial industry, Citi continued to engage in loansharking. And they are far from alone. Bank of America recently agreed to a settlement that will probably be the largest in history over the loansharking activities of its subprime affiliate, Countrywide.

Weill could not have done this alone. Instead he had help at the highest levels, including the three Congressmen whose names are on the bill that repealed Glass-Steagall to then Secretary of the Treasury Robert Rubin to the many economists and policy wonks who were gung-ho for securitization in all its manifestations. Rubin joined Citi shortly after leaving Treasury to become one of its most trusted advisors. Did he know about the loansharking or was he looking the other way?

Given the huge increase in subprime mortgages and the role they played in Citi’s portfolio along with the mountain of evidence showing their disproportionate impact on people of color it is hard to believe anyone in the financial industry from regulators to bankers was not aware of this. Yet they chose not merely to look the other way, but to allow it to continue until the elephant in the room became too big to ignore.

This is what researchers mean when they speak of “structural racism,” for it is not merely a matter of personal prejudice. Many of the people involved–including Sandy Rubin–would vehemently deny that they are racists. The ugly reality of structural racism is that like termites infecting a house it gnaws away at institutions until they weaken and threaten to topple.

Right now the entire American economy may topple because it is infected with the termites of structural racism. In a recent paper Rick Cohen writes:

The subprime crisis carries the seeds of structural racism not from discriminatory intent, but from ostensibly racially benign or supposedly ameliorative policies and programs. This is a difficult message for the nation to hear. The pushback has been strong.

Jim Campen agrees:

The enormous racial disparities in mortgage lending and the dramatic shrinkage of the portion of total mortgage lending that is subject to evaluation by bank regulators under the provisions of the Community Reinvestment Act (CRA) indicate the need for major changes in public policy toward the mortgage lending industry.

The final installment of this series examines some of these policy changes.

Crossposted: My Left Wing

Did Racism Help Cause the Mortgage Crisis? Part One

I am honored to present the work of Ralph Brauer.  For some time I have marveled as I read his research and reflected upon his work.  Today, this author of note shares with readers at BeThink.  I welcome Ralph Brauer.  May I invite you to peruse his prose.  Please ponder; then share your thoughts.

copyright © 2008 Ralph Brauer. The Strange Death of Liberal America

There is an elephant in the room no one wants to mention when you bring up the housing crisis.  It is the same elephant that has occupied the room since the very beginning of this nation.  Yes, it was there that hot Philadelphia summer when they drafted the Constitution.  Maybe that is what Ben Franklin is gazing at as he sits in the center of the famous painting of the signing of the Constitution by Howard Chandler Christy that hangs today in the House of Representatives east stairway.  Certainly the elephant had haunted Franklin much of his life causing him to call it “a constant butchery of the human species” in an anonymous letter written in 1772.  That elephant that haunted Franklin and continues to haunt us today is racism.

The economic crisis we face today has produced countless essays analyzing its origins and proposing all manner of cures, but almost no one has dared to mention the elephant in the room.  As I researched this topic I found only one person who seemed to be on to it: John Kimble, who wrote an excellent op ed piece in the New Orleans Times Picayune in October that should be required reading for everyone.  One sentence gets to the heart of the matter:

What few today remember is that one of the government’s central goals in undertaking mortgage market reform was to segregate American cities by race.

That such a piece should come from New Orleans does not surprise me; that few have sought to connect what to me seem rather obvious dots is more of a mystery to me.  But that is the power of that elephant in the room.

Perhaps now with an African American President we will finally have more open discussion of the elephant in the room and that discussion should begin by acknowledging that the elephant played a significant role in causing the mortgage crisis which in turn has toppled financial giants as if they were a row of dominoes.  To understand why we need to go back to the years immediately after the Second World War when the housing boom began.

The Creation of the Suburb

The discussion of the role of racism in America should begin by confronting the most important social, cultural and political reality of the past half century: the American suburb is largely a creation of racist loan policies that came from none other than the federal government.  The suburban migration stands as one of the largest freely-undertaken, government-subsidized mass social movements in history.  It accomplished by democratic means what dictators over the ages have tried to accomplish by force: alter the physical, economic, and social environment to create a unique culture.  As Kenneth Jackson writes in Crabgrass Frontier, his history of the American suburb:

Suburbanization was not an historical inevitability created by geography, technology, and culture, but rather the product of government policies.  (p. 293)

Through a variety of government subsidies, the creation of the suburbs allowed people of modest means to attain what real estate ads have christened the American dream.  The immensity of this achievement is only beginning to dawn on us, for it constituted the kind of land and social reform that governments everywhere still try to accomplish.  Kenneth Jackson notes:

Single family housing starts in this country rose from 114,000 in 1944 to 937,000 in 1946, 1,183,000 in 1948, and 1,692,000 in 1950.  (p. 233)

The federal government financed this growth through the Federal Housing Administration, an agency created during the New Deal to help spur the growth of home construction.  During the postwar housing boom Jackson points out:

The main beneficiary of the $119 billion in FHA mortgage insurance issued in the first four decades of FHA operation was suburbia.

Drawing the Color Line

A half century before the creation of suburban America, W.E.B. DuBois had written in the very first sentence of The Souls of Black Folk the immortal and prescient words:

HEREIN lie buried many things which if read with patience may show the strange meaning of being black here at the dawning of the Twentieth Century.  This meaning is not without interest to you, Gentle Reader; for the problem of the Twentieth Century is the problem of the color-line.

Little could DuBois have predicted that the color line would become a red line drawn around the American suburb by none other than the FHA.  The name redlining actually dates back to the 1930s when the FHA first began using color codes to designate areas where they should not invest.  Red areas were off-limits.  Jackson states:

FHA also helped to turn the building industry against the minority and inner-city housing market, and its policies supported the income and racial segregation of suburbia.

Even as the suburbs mushroomed across the American landscape, a few were asking questions.  In 1955 Columbia Professor Charles Abrams charged:

From its inception, the FHA set itself up as protector of the all white neighborhood.  It sent its agents into the field to keep Negroes and other minorities from buying houses in white neighborhoods.  (Jackson, pp. 213-214)

In what has become the classic source on FHA discrimination, The Politics of Exclusion, Michael Danielson quotes an FHA underwriting manual:

If a neighborhood is to retain stability, it is necessary that properties shall continue to be occupied by the same social and racial classes.  A change in social or racial occupancy generally leads to instability and reduction in values.(p. 203)

FHA policies also required appraisers to determine the probability of people of color moving into a neighborhood and even forced homeowners to agree not to sell their property to someone of another race.  According to one commentator,

“[T]he most basic sentiment underlying the FHA’s concern was its fear that property values would decline if a rigid black and white segregation was not maintained.

With the rise of the Civil Rights movement in the 1960s, the FHA began to make some attempt to right these wrongs, but with the election of Richard Nixon in 1968, the so-called “Southern Strategy” soon put a stop these efforts.  Chris Bonastia documented Nixon’s dismantling of FHA’s residential integration efforts in his paper, “Hedging His Bets: Why Nixon Killed HUD’s Desegregation Efforts.” Nixon’s refusal to back HUD’s reform efforts would have an impact on American society that ranks right up there with the decision by President Rutherford B. Hayes to abandon the South to the segregationists, essentially ending Reconstruction.

Yet to see one man and one decision as a historical lynch pin is to take an outmoded view of history, for the truth is that by 1968 the die had already been cast and DuBois’ color line had been drawn like a moat around the suburbs designed to keep people of color from entering. It would have taken considerable political will–and perhaps even federal law enforcement–to desegregate the suburbs by then.  Dr. Martin Luther King, jr.’s infamous march into the Chicago suburb of Cicero, where he was met with bricks and catcalls, showed the depth of that moat. There is a moment in the video of that march when you hear what sounds like a shot and King turns suddenly as if wondering where the shot came from.

This does not excuse Nixon’s actions, which at best were misguided and at worst cowardly and racist. While historians debate how much Richard Nixon personally bought into the Thurmond catechism, his elevation of Thurmond aide Harry Dent to the White House staff after the election sent a clear signal of his alliance with Thurmond. Dent was the one who sat outside the Senate chamber with a pail in case Thurmond needed a quick bathroom break during his record-setting filibuster. Nixon himself put it bluntly:

I am not going to campaign for the black vote at the risk of alienating the suburban vote.

For the federal government to go further than the law, to force integration in the suburbs, I think is unrealistic. I think it will be counter-productive and not in the interest of better race relations. [quoted in Charles M. Lamb, Housing Segregation in Suburban America Since 1960, p. 4, p. 9]

Still, as Lamb would point out in a footnote, two decades later a University of California study found that 44% of white Americans favored encouraging African Americans to move to the suburbs.

The Creation of the Subprime Market

Yet the FHA did not just discriminate against people of color who sought to live in the suburbs, it also made  it more difficult for them to obtain loans, period, by refusing to insure loans in areas with high concentrations of people of color.  The systemic impact of this is still reverberating through America’s inner cities.  Without FHA insurance, no reputable bank would issue a home loan to someone living on the other side of the “color line.” This in turn had a host of social and cultural impacts, from resource-poor schools to lack of jobs because businesses would not build where the FHA would not write loans.

You don’t need to be a systems modeler to see how each of these came to feed on each other. In the last decade scholars have begun to refer to this as “structural racism,” by which they mean a convergence of forces and policies that conspires to sustain the color line. Just imagine one systemic loop: you cannot get a good job because you live in a neighborhood with substandard housing and were educated in a substandard school and so you cannot qualify for a loan for better housing which in turn further reinforces the substandard housing. Structural racism is also not a bad metaphor, either, for it suggests the immense weight of these multiple factors that presses down on people living inside those red lines drawn by the FHA.

Where legitimate businesses and institutions are prevented from entering, illegitimate ones will grow. Since regular banks would not lend to people of color in inner city neighborhoods and FHA policies kept them from lending to the few people of color who could afford suburban housing, there obviously was a need for someone to supply these loans and so we have the growth of the so-called subprime market, only back in those days they were known as loan sharks and other unprintable words and had reputation to rival check cashing operations, greedy landlords and take and bake furniture renters. Anyone who has grown up in the inner city can tell stories not only about price-gouging home loans, but high-priced loans for everything from cars to buying furniture or clothes on credit.

What Is Subprime Lending

Subprime lending is a mixture of old-fashioned altruism and blatant thievery with an American twist. Some entered into the business of making loans to people of color because they genuinely believed people deserved an equal opportunity, others saw a chance to make a quick buck. The reality of the situation was that without FHA insurance even the most well-meaning lenders still had to charge more than they would have for a white suburban home-buyer.

A 2003 study for the Lawyers Committee on Civil Rights Under Law reported:

While red-lining has served to exclude poor and minority residents from the benefits of mainstream mortgage lending, purveyors of predatory lending (or so-called “reverse red-lining”) practices have targeted many of the same poor and minority households that traditional lending institutions have ignored or excluded.

In testimony before the House Committee on Banking and Financial Services in 2000 Bill Brennan of the Atlanta Legal Aid Society outlined how subprime lending works for lenders:

Here is what these companies do, the predators. They overcharge on interest and points, they charge egregiously high annual interest and prepaid finance charges, points, which are not justified by the risk involved, because these loans are collateralized by valuable real estate.

Since they usually only lend at 70 to 80 percent loan-to-value ratios, they have a 20 to 30 percent cushion to protect them if they have to foreclose. They usually always buy at the foreclosure sale and pay off the debt and sell the house for a profit.

As for those taking out the loans, Gary Gensler, Undersecretary for Domestic Finance at the treasury Department, told the same Committee:

Borrowers in these markets often have limited access to mainstream financial services. This leads to two things, as the Senator said earlier. Some borrowers who really would qualify for prime loans-we estimate anywhere between 15 and 35 percent of the subprime market could qualify for prime and cannot get that prime loan. Second, the rate and term competition is limited. Subprime lenders don’t tend to compete as much on price.

Beyond preying on vulnerable populations, beyond the limited access to mainstream financial services, is that abusive practices tend to be coupled with high-pressure sales tactics, whether by a mortgage broker, a home improvement contractor, sometimes a lender themselves in the local community.

Perhaps the most extensive and longest longitudinal study of predatory lending practices has been the Woodstock Institute’s periodic reports on Chicago.  It’s 1999 report “Two Steps Back” was among the earliest to blow the whistle on predatory lending.  They found:

Documented cases of abuse include fees exceeding 10 percent of the loan amount, payments structured so that they do not even cover interest (resulting in increasing principle balances), and flipping a loan numerous times in a couple of years.

At the same time, lending to lower-income and minority communities is often viewed as an isolated line of business, in which the focus is on the short term transaction and associated fees. Lenders active in such communities tend to be mortgage and finance companies subject to much less regulation than banks and thrifts. The increased scale of the subprime industry itself has resulted in a larger number of abuses. Moreover, there has not been a proportionate increase in regulation or regulatory resources devoted to this new industry.

As usual, graphs and tables tell the story in black and white:





The date on the graph may be a little difficult to see. It is 1998. On the first table, the percentage of subprime loans going to African American communities is 53%. Only 9% went to predominantly white communities. The Woodstock study went on to deal with the obvious question: is it race or income that is the strongest determinant of who receives a subprime loan? They found it was the former:

Thus, whether a neighborhood is predominantly African-American explains the greatest amount of variation in subprime lending,

The Final Results

In 1997 Bill Brennan could tell the New York Times:

We have financial apartheid in our country. We have low-income, often minority borrowers,  who are charged unconscionably high interest rates, either directly or indirectly through the cover of added charges.

Three years later Census data would confirm Brennan’s charge. The Lawyers Committee on Civil Rights Under Law found:

The typical white person lives in a neighborhood that is overwhelmingly white, with a few minorities (80.2% white, 6.7% African American, 7.9% Hispanic American, and 3.9% Asian American), the typical African American lives in a neighborhood that is mostly black (51.4% black, 33.0% white, 11.4% Hispanic American, and 3.3% Asian American). By comparison, the typical Hispanic American lives in a neighborhood that is more evenly Hispanic American and white (45.5% Hispanic, 36.5% white, 10.8% black, and 5.9% Asian American); and the typical Asian American lives in a neighborhood that is mostly white (17.9% Asian American, 54% white, 9.2%  black, and 17.4% Hispanic American).

In a study released this year by United for a Fair Economy, the authors note:

According to federal data, people of color are more than three times more likely to have subprime loans: high-cost loans account for 55% of loans to Blacks, but only 17% of loans to Whites.

This is a decade after the Woodstock study identified a similar pattern in Chicago.

Reflections

This history makes you wonder what kind of country we might have become had racism not pervaded the home mortgage market. The United for a Fair Economy study puts it eloquently:

While the housing crisis has affected all sectors of society, it has disproportionately affected communities and individuals of color. For them, the dream that Martin Luther King, Jr. once spoke of has been foreclosed.

Now the injustices white America heaped on black America for half a century have come home to roost. The sobering thought to ponder is that what you have read so far is merely the very tip of a rather large iceberg, for there are literally dozens and dozens of books and countless articles on racism and housing. If you enter “racism” and “housing” in Google you will find over four million entries. Yet despite over half a century of studies, reports and papers about discriminatory lending, little was done about it.

The most damning piece of evidence in this entire story is not that racism fostered predatory loans, but that like organized crime going from petty bootleggers and drug dealers to big time operators, the practice of predatory loan sharking expanded and went mainstream– moving from being the providence of small-time shady operators to mainstream banks. Essentially, loan-sharking cast off its sleazy past and the bigger it became the more people looked the other way.

That is until it suddenly threatens to take down the entire American economy. Now like the figures in that painting of Constitution Hall, fingers are pointing and people are staring.

If racism played a big role in creating the mortgage crisis, the solution to our current problems will prove tougher to deal with than what the so-called experts have been telling us. We could be witnessing the fourth American revolution. The first was the war for independence, the second the Civil War, the third the Great Depression and now the present crisis which combines the themes of the previous two–race and economics.

The next essay in this series focuses on how we got here and why, for only by understanding that journey can we see a way out of the current morass. What is clear so far is that this crisis is not merely the fault of a few misguided CEOs, but rather the culmination of decades of discrimination in which all of us are culpable.

Now the time has come to stop pretending there is no elephant in the room and deal with it.

Resources

For a good bibliography on the subject click here.

Crossposts: The Strange Death of Liberal America, My Left Wing, Progressive Historians, The Wild, Wild Left

Did Racism Help Cause the Mortgage Crisis? The Rise of Sandy Weill and Citigroup



Photo: United for a Fair Economy The State of the Dream

copyright © 2008 Ralph Brauer. The Strange Death of Liberal America

Sandy Weill’s story tells how racially-biased predatory lending lies at the center of the economic crisis.  A third-generation American, Weill grew up on the streets of Brooklyn where for some the road to success was a place whose name came from a structure built to protect the city from Indians, pirates and other invaders and whose die was cast when a small group of men met in secret under a buttonwood tree: Wall Street.

Like the hero of a Horatio Alger tale, Weill began his climb to success not in the proverbial mail room but as a $35 a week clerk, eventually clawing his way to become second-in-command at American Express. But Weill had an itch for more so he cashed in his chips and set about looking for his own business. In 1986 he settled on a Baltimore loan company named Commercial Credit that specialized in predatory lending.

The tale of how Weill would use Commercial to build the financial empire that became Citigroup is the story of the financial crisis and at the heart of that story is racial discrimination and predatory lending. In short, predatory lending made Citi into one of the nation’s largest financial institutions and now is responsible for its downfall.

The Beginnings of Citi

If Weill did any due diligence at all, he knew quite well he was buying a company whose entire existence was predicated on ripping off people of color. Commercial already had a shady reputation when Weill moved in on it. In 1973 the FTC had issued an order demanding Commercial cease using deceptive and hardball tactics to entrap those in search of a loan. In his article “Banking on Misery Citigroup, Wall Street, and the Fleecing of the South,” Michael Hudson  relates that Weill’s assistant, Alison Falls, was appalled at the idea of buying Commercial:

Hey guys, this is the loan-sharking business. “Consumer finance” is just a nice way to describe it.

After Weill bought the company did he seek to curb these practices? Quite the contrary, Commercial became even more aggressive. After all, Weill’s whole business plan was predicated on using Commercial to launch a larger company and in order to do that he had to get as much as he could out of Commercial, which meant squeezing clients even more.

Some of Weill’s former employees tell stories of being pressured into steering clients into dubious deals. Hudson quotes Sherry Roller vanden Aardweg, who worked for Commercial in Louisiana from 1988 to 1995. She agrees there was “a tremendous amount of pressure” to sell insurance: That insurance was issued by another Weill acquisition American Health & Life.

We kept adding insurance that we could offer. It just kept growing. It was beginning to get a little bit ridiculous.

Frank Smith, who worked for Weill in Mississippi, put a perspective on ripoffs such as “closed folder closings” in which documents adding to the cost of the mortgage were kept from the client:

They need the money or by God they wouldn’t be at the finance company. They’d be at a bank.

Weill used the money milked from Commercial’s clients to acquire insurance and finance company Primerica. In 1990 he acquired Barclay’s Bank. Meanwhile the stories told by African Americans victimized by Weill certainly sound like loan sharking. Two Mississippi clients of Commercial signed on for Annual Percentage Rates (APR) of 40.92 and 44.14. Another client paid $1,439 for insurance on a $4,500 loan.

Ripoffs like this attracted the attention of attorneys and law enforcement officials, especially in the South, where Commercial had a large presence. Hudson reports:

In 1999, the company agreed to pay as much as $2 million to settle a lawsuit accusing Commercial and American Health Life of overcharging tens of thousands of Alabamans on insurance.

Jackson, Miss., attorney Chris Coffer says he obtained confidential settlements for about 800 clients with claims against Commercial Credit or its successor, CitiFinancial.

How much money African Americans probably overpaid Commercial can be glimpsed from one study by the Community Reinvestment Association of North Carolina. Testifying before a 2006 hearing of the Federal Reserve in Atlanta, CRA-NC Community Organizer Richard Brown cited the findings of the study, Paying More and Getting Less: An Analysis of 2004 Mortgage Lending in North Carolina:

Our key finding is that disproportionately, by a ratio of more than 4 to 1, African Americans pay more interest on home loans than whites do in North Carolina.

Cultural Impacts

Like some modern plantation, subprime lending was built on the enslavement of African Americans, only instead of being field hands or sharecroppers their lives were indentured to loan sharks. Like the infamous overseers who ruled plantation life with the crack of a whip, the loan sharks ruled the lives of African Americans with whips woven together with words the way real whips are woven from strips of leather. While these words might not have inflicted the physical wounds overseers specialized in, the mental scars inflicted by the words woven into loan sharking mortgages were socially and psychologically devastating.

Like slavery, loan sharking helped to turn the African American family into a hot-button issue whose implications are still the subject of volatile debates within and outside the community. Yet while the particular sociological and cultural impacts of loan sharking may be the subject of some debate, there is agreement about the big picture: the impact rippled through families and communities like a rogue wave bringing misery and destruction. In the inner city and some rural communities, especially in the South, African American families faced two equally devastating choices when it came to housing: deal with the loan sharks or deal with the slum lords.

Loan sharking also rippled through American culture. Call it apartheid or something else, whatever label you assign to it the forced separation of whites and people of color is the number one issue of post World War II America. As surely as South Africa carved out “homelands” for its black citizens, so FHA and others carved out the equivalent through redlining.

In the South African Americans and whites lived together but interacted through the elaborate codes and rituals of Jim Crow, but in the North the races were physically separated so a white suburbanite could grow up without having much association with people of color. As a result, while white Southerners saw African Americans as inferior, white Northerners saw them as abstractions.

The 90s Boom in Subprime Loans

Meanwhile Sandy Weill continued building Citi through mergers and acquisitions. In 1993 came the controversial merger with Travelers followed four years later by Citi’s acquisition of Salomon Brothers. At the same Weill was building Citi, the mortgage market was undergoing some dramatic changes. Researchers began identifying a huge spike in the number of subprime loans. Loan sharking had come from back streets and low budget store fronts to the center of America’s financial empire: Wall Street.

A graph from the Woodstock Institute tells the Story:

This graph raises two obvious questions: what was fueling the growth and who was providing those new subprime mortgages? The first is still the subject of some debate among economists and others.  For example, some have tied it to an increase in interest rates. In its explanation accompanying the graph Woodstock states:

Despite increasing rates in 1994, 1995, and 1997, however, subprime lenders continued to increase their refinance volumes. This suggests that subprime refinancings are not driven by homeowners refinancing to save money during times of declining rates and that subprime lenders are aggressively marketing loans regardless of the rate environment.

In part, the growth of predatory activity stems directly from the development of an increasingly specialized and segmented mortgage market, especially for refinance and home equity loans.

What was in it for others is the same thing that was in it for Sandy Weill–profits. Forbes reported that in the boom of the 90s, subprime companies enjoyed returns up to  six times greater than those of the best-run banks.

United for a Fair Economy put it more bluntly:

The subprime lending crisis has occurred because a financial product intended for limited use by a limited number of people has been parlayed into another ill-fated bubble by some mortgage lenders lacking in integrity, foresight, and any vestige of civic concern.

What made this possible was the packaging and trading of loans, which goes under the fancy name of securitization.  A Federal Deposit Insurance Company report describes how this process works:

Thirty years ago, if you got a mortgage from a bank, it was very likely that the bank would keep the loan on its balance sheet until the loan was repaid. That is no longer true. Today, the party that you deal with in order to get the loan (the originator) is highly likely to sell the loan to a third party. The third party can be Ginnie Mae, a government agency; Fannie Mae or Freddie Mac, which are government sponsored entities (GSEs); or a private sector financial institution. The third party often then packages your mortgage with others and sells the payment rights to investors. This may not be the final stop for your mortgage. Some of the investors may use their payment rights to your mortgage to back other securities they issue. This can continue for additional steps.

As usual a graph tells the story of the growth of these new investment vehicles.

The FDIC goes on to explain how various pooling tactics package subprime loans, taking you into a thicket of acronyms like (MBSs), collateralized debt obligations (CDOs), and structured investment vehicles (SIVs)–all essentially are ways of spreading the risk of pooled mortgages. Notice that the initial upswing in MBS begins in the late 1980s. That was due to the tax reform act of 1986.

Ginnie Mae (Government National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) had been involved with MBS before the 1986 bill, but the Reagan Administration’s gift to the home mortgage industry introduced another acronym into the mix: REMIC–Real Estate Mortgage Investment Conduit, which is yet another tool for pooling and packaging mortgages. None other than Freddie Mac described the importance of the 1986 bill:

The REMIC law was passed as part of the Tax Reform Act of 1986 and marked the beginning of the growth of the CMO [Collateralized Mortgage Obligation] market.

Once financial institutions began to catch on to this and entered the thicket of securitization in a big way, there was no turning back. The American economy would never be the same.  Put the two graphs above together and you have the story: the initial growth of the subprime market was enabled by the growth in MBS. There remained only one regulatory hurdle in place, one that had been there since the Great Depression.

The Repeal of Glass-Steagall

Had Carter Glass been alive in the 1990s it is doubtful any of this would have happened, but by the time he put his name on the Glass-Steagall Act during the Depression, Carter Glass was an old man. He had actually been a delegate to the 1896 Democratic National Convention when William Jennings Bryan gave his “Cross of Gold” speech and most of his political life he had a Bryan streak in him that included a distaste for banks. When he left Woodrow Wilson’s cabinet at the end of Wilson’s term he was already warning of the dangers of uncontrolled banking, particularly banks getting involved in the stock market and other financial dealings.

Carter Glass would not have liked Citi or Sandy Weill. Weill, in turn, had little use for what Glass had created, seeing it as an obstacle that stood in the way of his fulfilling his vision of the kind of “full-service” banking Carter Glass had feared.

The Glass-Steagall Act was designed to keep banks out of the securities business because Carter Glass and New Deal officials including President Franklin Roosevelt believed that one of the causes of the Depression was that banks had strayed too far from their original functions during the 1920s.  According to a paper by Jill M. Hendrickson:

in 1932, 36 percent of national bank profits came from their investment affiliates (Wall Street Journal 1933, p. 1).

Glass-Steagall built a wall between banking and other financial services and the ink on the paper was barely dry when the bankers and their allies in the Republican Party began howling.  Over the next half century there were numerous attempts to weaken or scuttle Glass-Steagall, but in the midst of the securitization boom the cries to tear down the wall of Glass-Steagall grew louder.  In 1990, the Fed, under former J.P. Morgan director Alan Greenspan, permitted guess who–J.P. Morgan–to become the first bank allowed to underwrite securities.

It would be none other than Sandy Weill who would put in motion the forces that ended Glass-Steagall when he essentially gave the federal government the equivalent of an upraised finger by proposing the most audacious financial merger in American history: he would merge one of the largest insurance companies (Travelers), one of the largest investment banks (Salomon Smith Barney), and the largest commercial banks (Citibank) in America. The problem was the merger was illegal in terms of Glass-Steagall.

Weill convinced Greenspan, Robert Rubin, and President Bill Clinton to sign off on a merger that was illegal at the time, with the expectation that Congress would repeal Glass-Steagall. That would happen with a big push from Sandy Weill. First, he spent over $200 million in lobbying fees to convince Congress to go along with his merger. It still ranks as the largest single amount spent by one firm on one bill over the shortest period of time in American history.

When the conference committee charged with reconciling the House and Senate versions of the repeal bill seemed stalemated, it was Sandy Weill who applied the final push needed to get the bill passed. Here is the now oft-quoted Frontline report of what happened:

On Oct. 21, with the House-Senate conference committee deadlocked after marathon negotiations, the main sticking point is partisan bickering over the bill’s effect on the Community Reinvestment Act, which sets rules for lending to poor communities. Sandy Weill calls President Clinton in the evening to try to break the deadlock after Senator Phil Gramm, chairman of the Banking Committee, warned Citigroup lobbyist Roger Levy that Weill has to get White House moving on the bill or he would shut down the House-Senate conference. Serious negotiations resume, and a deal is announced at 2:45 a.m. on Oct. 22. Whether Weill made any difference in precipitating a deal is unclear.

The Aftermath

With Glass-Steagall out of the way, Sandy Weill had his merger and the American financial industry now had a green light to enlarge on subprime lending. Some followed Weill’s model of consolidating loan and insurance companies as he had done with American Health & Life and Travelers, taking loan sharking to a level those who had engaged in it back when it was done in storefronts with peeling paint could have never imagined.

More money than any organized crime syndicate could have dreamed of flowed into the coffers of the subprime lenders. What had been an activity aimed mainly at people of color now became linked to complex financial instruments such as tranches and derivatives, that to an uninitiated mind resembled nothing so much as the old shell game. Where’s the mortgage? Under this fund? No. guess again. Inner city and suburb which had been separated by redlining became linked by acronyms–MBS, CDOs, CMOs. But as we shall see in the next essay, ripping off people of color would continue.

Postscript: The Revelations of Language

Some reading this essay might object to my linking loan sharking and subprime mortgages, but Sandy Weill from the streets of Brooklyn would get it. Subprime is perhaps one of the most misleading euphemisms ever devised, because it means exactly the opposite of what the term implies. The Investopedia offers a succinct definition:

A type of loan that is offered at a rate above prime to individuals who do not qualify for prime rate loans.

As for loan sharking, a definitive definition is a little more difficult to come by. Investopedia says it is anyone who charges above the legal interest rate (which is set by some states). Several others add that it also involves an implied or real threat to injure the person who doesn’t pay off.  As if to throw a ringer into that definition there are dozens of references to “legal loan sharking.” Perhaps the broadest definition is at Wiktionary:

Someone who lends money at exorbitant rates of interest.

These definitional niceties represent not merely semantic nit-picking, but in fact provide a vital piece to understanding the cultural shifts that have accompanied the economic crisis. One of the unspoken theses in this series of essays is that by clothing loan sharking in the more respectable term of subprime, it suddenly made it not seem so bad to lend money to people–especially people of color–at higher rates. It is reminiscent of the semantic games segregationists used to play with strategies like the “literacy law.” CNN even named “subprime” the word of the year. Can you see them doing that for loan sharking?

In a fascinating article, Ben Zimmer explains how subprime came to have its present meaning, noting that the earliest use of the term was in industry to describe something below grade while in the 1970s banks used it to refer to loans below the market rate.

Something happened to the word in the 1990s, however. Now it was the borrowers themselves who were being classified as “less than prime” based on their shaky credit histories. [My underline]

Zimmer is on to something when he says the term was applied to people, because as we have seen, a high percentage of subprime loans were aimed at people of color.  So the phrase about borrowers being “less than prime” has more meaning than Zimmer perhaps realized when he wrote that sentence.

At the same time that subprime underwent a shift in meaning it is quite clear that so, too, did loan sharking. The earlier references clearly have a criminal tinge to them. In old crime movies “loan sharking” was always thrown in with other nasty activities gangsters perpetrated on the innocent and not so innocent. Yet the recent references seem to take the gangster and the “enforcer” out of the term, so loan sharks just charge higher rates without threatening to break your legs or worse.

This linguistic convergence of loan sharking and subprime reflects an economic and social convergence, for it seems to date from about the time Sandy Weill first bought Commercial. So as Weill took what his own assistant termed a loan sharking operation to the pinnacle of corporate success, the financial industry adopted the euphemism of subprime just as it was getting into this type of lending.

In truth it is the financial industry itself which has helped to blur the distinction between conventional lending at a higher rate and the hardball, card-sharp techniques of the loan shark. That in turn has given rise to a new term “predatory lending” which has largely replaced loan sharking in our vocabulary, creating a living for economists and others who write papers dissecting the differences between the two as if they mattered to those who have to pay exorbitant rates.

As we plunge deeper into the financial crisis, two things are clear: it takes a pretty good lawyer to decipher the standard mortgage agreement and an even better wordsmith to explain if an agreement charging more than the standard interest rate is an innocent subprime mortgage or predatory lending. For me I will continue to use loan sharking with its connotations of shady activity until the financial industry cleans up its act.

Zimmer ends his article by observing:

Here’s hoping that in the not-too-distant future we can look back on the current usage of subprime as a quaint artifact of the late 20th and early 21st centuries.

Twenty years ago the mainstream financial industry would have nothing to do with subprime lending.  Now they are using language much like the defenses of the original loan sharks to defend it, talking about how they are performing a service for people who cannot get loans any other way.

In the next essay we will look at the consequences of the Glass-Steagall repeal, the fall of Sandy Weill and Citigroup, and the growth of so-called subprime lending. Then you can make up your own mind about whether to call it loan sharking or continue to use that other euphemism.

Crossposts:  The Strange Death of Liberal America, My Left Wing, Progressive Historians, The Wild, Wild Left

Did Racism Help Cause the Mortgage Crisis? Part One

I am honored to present the work of Ralph Brauer.  For some time I have marveled as I read his research and reflected upon his work.  Today, this author of note shares with readers at BeThink.  I welcome Ralph Brauer.  May I invite you to peruse his prose.  Please ponder; then share your thoughts.

copyright © 2008 Ralph Brauer. The Strange Death of Liberal America

There is an elephant in the room no one wants to mention when you bring up the housing crisis.  It is the same elephant that has occupied the room since the very beginning of this nation.  Yes, it was there that hot Philadelphia summer when they drafted the Constitution.  Maybe that is what Ben Franklin is gazing at as he sits in the center of the famous painting of the signing of the Constitution by Howard Chandler Christy that hangs today in the House of Representatives east stairway.  Certainly the elephant had haunted Franklin much of his life causing him to call it “a constant butchery of the human species” in an anonymous letter written in 1772.  That elephant that haunted Franklin and continues to haunt us today is racism.

The economic crisis we face today has produced countless essays analyzing its origins and proposing all manner of cures, but almost no one has dared to mention the elephant in the room.  As I researched this topic I found only one person who seemed to be on to it: John Kimble, who wrote an excellent op ed piece in the New Orleans Times Picayune in October that should be required reading for everyone.  One sentence gets to the heart of the matter:

What few today remember is that one of the government’s central goals in undertaking mortgage market reform was to segregate American cities by race.

That such a piece should come from New Orleans does not surprise me; that few have sought to connect what to me seem rather obvious dots is more of a mystery to me.  But that is the power of that elephant in the room.

Perhaps now with an African American President we will finally have more open discussion of the elephant in the room and that discussion should begin by acknowledging that the elephant played a significant role in causing the mortgage crisis which in turn has toppled financial giants as if they were a row of dominoes.  To understand why we need to go back to the years immediately after the Second World War when the housing boom began.

The Creation of the Suburb

The discussion of the role of racism in America should begin by confronting the most important social, cultural and political reality of the past half century: the American suburb is largely a creation of racist loan policies that came from none other than the federal government.  The suburban migration stands as one of the largest freely-undertaken, government-subsidized mass social movements in history.  It accomplished by democratic means what dictators over the ages have tried to accomplish by force: alter the physical, economic, and social environment to create a unique culture.  As Kenneth Jackson writes in Crabgrass Frontier, his history of the American suburb:

Suburbanization was not an historical inevitability created by geography, technology, and culture, but rather the product of government policies.  (p. 293)

Through a variety of government subsidies, the creation of the suburbs allowed people of modest means to attain what real estate ads have christened the American dream.  The immensity of this achievement is only beginning to dawn on us, for it constituted the kind of land and social reform that governments everywhere still try to accomplish.  Kenneth Jackson notes:

Single family housing starts in this country rose from 114,000 in 1944 to 937,000 in 1946, 1,183,000 in 1948, and 1,692,000 in 1950.  (p. 233)

The federal government financed this growth through the Federal Housing Administration, an agency created during the New Deal to help spur the growth of home construction.  During the postwar housing boom Jackson points out:

The main beneficiary of the $119 billion in FHA mortgage insurance issued in the first four decades of FHA operation was suburbia.

Drawing the Color Line

A half century before the creation of suburban America, W.E.B. DuBois had written in the very first sentence of The Souls of Black Folk the immortal and prescient words:

HEREIN lie buried many things which if read with patience may show the strange meaning of being black here at the dawning of the Twentieth Century.  This meaning is not without interest to you, Gentle Reader; for the problem of the Twentieth Century is the problem of the color-line.

Little could DuBois have predicted that the color line would become a red line drawn around the American suburb by none other than the FHA.  The name redlining actually dates back to the 1930s when the FHA first began using color codes to designate areas where they should not invest.  Red areas were off-limits.  Jackson states:

FHA also helped to turn the building industry against the minority and inner-city housing market, and its policies supported the income and racial segregation of suburbia.

Even as the suburbs mushroomed across the American landscape, a few were asking questions.  In 1955 Columbia Professor Charles Abrams charged:

From its inception, the FHA set itself up as protector of the all white neighborhood.  It sent its agents into the field to keep Negroes and other minorities from buying houses in white neighborhoods.  (Jackson, pp. 213-214)

In what has become the classic source on FHA discrimination, The Politics of Exclusion, Michael Danielson quotes an FHA underwriting manual:

If a neighborhood is to retain stability, it is necessary that properties shall continue to be occupied by the same social and racial classes.  A change in social or racial occupancy generally leads to instability and reduction in values.(p. 203)

FHA policies also required appraisers to determine the probability of people of color moving into a neighborhood and even forced homeowners to agree not to sell their property to someone of another race.  According to one commentator,

“[T]he most basic sentiment underlying the FHA’s concern was its fear that property values would decline if a rigid black and white segregation was not maintained.

With the rise of the Civil Rights movement in the 1960s, the FHA began to make some attempt to right these wrongs, but with the election of Richard Nixon in 1968, the so-called “Southern Strategy” soon put a stop these efforts.  Chris Bonastia documented Nixon’s dismantling of FHA’s residential integration efforts in his paper, “Hedging His Bets: Why Nixon Killed HUD’s Desegregation Efforts.” Nixon’s refusal to back HUD’s reform efforts would have an impact on American society that ranks right up there with the decision by President Rutherford B. Hayes to abandon the South to the segregationists, essentially ending Reconstruction.

Yet to see one man and one decision as a historical lynch pin is to take an outmoded view of history, for the truth is that by 1968 the die had already been cast and DuBois’ color line had been drawn like a moat around the suburbs designed to keep people of color from entering. It would have taken considerable political will–and perhaps even federal law enforcement–to desegregate the suburbs by then.  Dr. Martin Luther King, jr.’s infamous march into the Chicago suburb of Cicero, where he was met with bricks and catcalls, showed the depth of that moat. There is a moment in the video of that march when you hear what sounds like a shot and King turns suddenly as if wondering where the shot came from.

This does not excuse Nixon’s actions, which at best were misguided and at worst cowardly and racist. While historians debate how much Richard Nixon personally bought into the Thurmond catechism, his elevation of Thurmond aide Harry Dent to the White House staff after the election sent a clear signal of his alliance with Thurmond. Dent was the one who sat outside the Senate chamber with a pail in case Thurmond needed a quick bathroom break during his record-setting filibuster. Nixon himself put it bluntly:

I am not going to campaign for the black vote at the risk of alienating the suburban vote.

For the federal government to go further than the law, to force integration in the suburbs, I think is unrealistic. I think it will be counter-productive and not in the interest of better race relations. [quoted in Charles M. Lamb, Housing Segregation in Suburban America Since 1960, p. 4, p. 9]

Still, as Lamb would point out in a footnote, two decades later a University of California study found that 44% of white Americans favored encouraging African Americans to move to the suburbs.

The Creation of the Subprime Market

Yet the FHA did not just discriminate against people of color who sought to live in the suburbs, it also made  it more difficult for them to obtain loans, period, by refusing to insure loans in areas with high concentrations of people of color.  The systemic impact of this is still reverberating through America’s inner cities.  Without FHA insurance, no reputable bank would issue a home loan to someone living on the other side of the “color line.” This in turn had a host of social and cultural impacts, from resource-poor schools to lack of jobs because businesses would not build where the FHA would not write loans.

You don’t need to be a systems modeler to see how each of these came to feed on each other. In the last decade scholars have begun to refer to this as “structural racism,” by which they mean a convergence of forces and policies that conspires to sustain the color line. Just imagine one systemic loop: you cannot get a good job because you live in a neighborhood with substandard housing and were educated in a substandard school and so you cannot qualify for a loan for better housing which in turn further reinforces the substandard housing. Structural racism is also not a bad metaphor, either, for it suggests the immense weight of these multiple factors that presses down on people living inside those red lines drawn by the FHA.

Where legitimate businesses and institutions are prevented from entering, illegitimate ones will grow. Since regular banks would not lend to people of color in inner city neighborhoods and FHA policies kept them from lending to the few people of color who could afford suburban housing, there obviously was a need for someone to supply these loans and so we have the growth of the so-called subprime market, only back in those days they were known as loan sharks and other unprintable words and had reputation to rival check cashing operations, greedy landlords and take and bake furniture renters. Anyone who has grown up in the inner city can tell stories not only about price-gouging home loans, but high-priced loans for everything from cars to buying furniture or clothes on credit.

What Is Subprime Lending

Subprime lending is a mixture of old-fashioned altruism and blatant thievery with an American twist. Some entered into the business of making loans to people of color because they genuinely believed people deserved an equal opportunity, others saw a chance to make a quick buck. The reality of the situation was that without FHA insurance even the most well-meaning lenders still had to charge more than they would have for a white suburban home-buyer.

A 2003 study for the Lawyers Committee on Civil Rights Under Law reported:

While red-lining has served to exclude poor and minority residents from the benefits of mainstream mortgage lending, purveyors of predatory lending (or so-called “reverse red-lining”) practices have targeted many of the same poor and minority households that traditional lending institutions have ignored or excluded.

In testimony before the House Committee on Banking and Financial Services in 2000 Bill Brennan of the Atlanta Legal Aid Society outlined how subprime lending works for lenders:

Here is what these companies do, the predators. They overcharge on interest and points, they charge egregiously high annual interest and prepaid finance charges, points, which are not justified by the risk involved, because these loans are collateralized by valuable real estate.

Since they usually only lend at 70 to 80 percent loan-to-value ratios, they have a 20 to 30 percent cushion to protect them if they have to foreclose. They usually always buy at the foreclosure sale and pay off the debt and sell the house for a profit.

As for those taking out the loans, Gary Gensler, Undersecretary for Domestic Finance at the treasury Department, told the same Committee:

Borrowers in these markets often have limited access to mainstream financial services. This leads to two things, as the Senator said earlier. Some borrowers who really would qualify for prime loans-we estimate anywhere between 15 and 35 percent of the subprime market could qualify for prime and cannot get that prime loan. Second, the rate and term competition is limited. Subprime lenders don’t tend to compete as much on price.

Beyond preying on vulnerable populations, beyond the limited access to mainstream financial services, is that abusive practices tend to be coupled with high-pressure sales tactics, whether by a mortgage broker, a home improvement contractor, sometimes a lender themselves in the local community.

Perhaps the most extensive and longest longitudinal study of predatory lending practices has been the Woodstock Institute’s periodic reports on Chicago.  It’s 1999 report “Two Steps Back” was among the earliest to blow the whistle on predatory lending.  They found:

Documented cases of abuse include fees exceeding 10 percent of the loan amount, payments structured so that they do not even cover interest (resulting in increasing principle balances), and flipping a loan numerous times in a couple of years.

At the same time, lending to lower-income and minority communities is often viewed as an isolated line of business, in which the focus is on the short term transaction and associated fees. Lenders active in such communities tend to be mortgage and finance companies subject to much less regulation than banks and thrifts. The increased scale of the subprime industry itself has resulted in a larger number of abuses. Moreover, there has not been a proportionate increase in regulation or regulatory resources devoted to this new industry.

As usual, graphs and tables tell the story in black and white:





The date on the graph may be a little difficult to see. It is 1998. On the first table, the percentage of subprime loans going to African American communities is 53%. Only 9% went to predominantly white communities. The Woodstock study went on to deal with the obvious question: is it race or income that is the strongest determinant of who receives a subprime loan? They found it was the former:

Thus, whether a neighborhood is predominantly African-American explains the greatest amount of variation in subprime lending,

The Final Results

In 1997 Bill Brennan could tell the New York Times:

We have financial apartheid in our country. We have low-income, often minority borrowers,  who are charged unconscionably high interest rates, either directly or indirectly through the cover of added charges.

Three years later Census data would confirm Brennan’s charge. The Lawyers Committee on Civil Rights Under Law found:

The typical white person lives in a neighborhood that is overwhelmingly white, with a few minorities (80.2% white, 6.7% African American, 7.9% Hispanic American, and 3.9% Asian American), the typical African American lives in a neighborhood that is mostly black (51.4% black, 33.0% white, 11.4% Hispanic American, and 3.3% Asian American). By comparison, the typical Hispanic American lives in a neighborhood that is more evenly Hispanic American and white (45.5% Hispanic, 36.5% white, 10.8% black, and 5.9% Asian American); and the typical Asian American lives in a neighborhood that is mostly white (17.9% Asian American, 54% white, 9.2%  black, and 17.4% Hispanic American).

In a study released this year by United for a Fair Economy, the authors note:

According to federal data, people of color are more than three times more likely to have subprime loans: high-cost loans account for 55% of loans to Blacks, but only 17% of loans to Whites.

This is a decade after the Woodstock study identified a similar pattern in Chicago.

Reflections

This history makes you wonder what kind of country we might have become had racism not pervaded the home mortgage market. The United for a Fair Economy study puts it eloquently:

While the housing crisis has affected all sectors of society, it has disproportionately affected communities and individuals of color. For them, the dream that Martin Luther King, Jr. once spoke of has been foreclosed.

Now the injustices white America heaped on black America for half a century have come home to roost. The sobering thought to ponder is that what you have read so far is merely the very tip of a rather large iceberg, for there are literally dozens and dozens of books and countless articles on racism and housing. If you enter “racism” and “housing” in Google you will find over four million entries. Yet despite over half a century of studies, reports and papers about discriminatory lending, little was done about it.

The most damning piece of evidence in this entire story is not that racism fostered predatory loans, but that like organized crime going from petty bootleggers and drug dealers to big time operators, the practice of predatory loan sharking expanded and went mainstream– moving from being the providence of small-time shady operators to mainstream banks. Essentially, loan-sharking cast off its sleazy past and the bigger it became the more people looked the other way.

That is until it suddenly threatens to take down the entire American economy. Now like the figures in that painting of Constitution Hall, fingers are pointing and people are staring.

If racism played a big role in creating the mortgage crisis, the solution to our current problems will prove tougher to deal with than what the so-called experts have been telling us. We could be witnessing the fourth American revolution. The first was the war for independence, the second the Civil War, the third the Great Depression and now the present crisis which combines the themes of the previous two–race and economics.

The next essay in this series focuses on how we got here and why, for only by understanding that journey can we see a way out of the current morass. What is clear so far is that this crisis is not merely the fault of a few misguided CEOs, but rather the culmination of decades of discrimination in which all of us are culpable.

Now the time has come to stop pretending there is no elephant in the room and deal with it.

Resources

For a good bibliography on the subject click here.

Crossposts: The Strange Death of Liberal America, My Left Wing, Progressive Historians, The Wild, Wild Left