The Countrywide Settlement in Context: Discrimination and the Subprime Mortgage Meltdown
December 22, 2011
Yesterday, the Justice Department announced the filing of "its largest residential fair lending settlement in history to resolve allegations that Countrywide Financial Corporation and its subsidiaries engaged in a widespread pattern or practice of discrimination against qualified African-American and Hispanic borrowers in their mortgage lending from 2004 through 2008." In the settlement, Bank of America agreed to provide $335 million to compensate victims of lending discrimination.
Attorney General Eric H. Holder Jr. said the settlement showed that the Justice Department would “vigorously pursue those who would take advantage of certain Americans because of their race, national origin, gender or disability,” adding: “Such conduct undercuts the notion of a level playing field for all consumers. It betrays the promise of equal opportunity that is enshrined in our Constitution and our legal framework.” (New York Times)
In her book Reimagining Equality: Stories of Gender, Race, and Finding Home, Professor Anita Hill examines the problem of sub-prime lending, and how Countrywide and other institutions exploited these loans for financial gain:
By 2006 a number of major banks—including Bank of America, Countrywide, and Citicorp—and smaller banks that specialized in sub- prime loans were in this lucrative market. Over 25 percent of home purchase loans made in 2006 were subprime loans. And that same year, 31 percent of mortgage refinancing was made on subprime terms. (Anita Hill: Reimagining Equality, p 130.)
The Justice Department was not the first government entity to address discrimination in the lending market. In Reimagining Equality, Professor Hill looks at court cases in Baltimore, Illinois, and elsewhere that aimed to shine a light on these abuses and make communities financially whole. What follows is an adapted excerpt from the book that provides context for yesterday's settlement announcement.
As the mortgage meltdown went into full force, hundreds in Baltimore saw their American Dream vanish. Hundreds of homes went into foreclosure, and a host of associated costs began to pile up. Nevertheless, United States District Court Judge J. Frederick Motz viewed with skepticism the city leaders’ lawsuit aimed at recovering some of Baltimore’s losses. In January 2010, Motz, a Baltimore native, dismissed the claim, citing “other factors leading to the deterioration of the inner city, such as extensive unemployment, lack of educational opportunity and choice, irresponsible parenting, disrespect for the law, widespread drug use, and violence.” Judge Motz’s critics would attribute his remarks to his background in law enforcement or what many had long perceived as conservative, pro-business leanings. Over the course of his career in the legal profession, Motz had served as both assistant U.S. attorney and U.S. attorney for the District of Maryland. President Reagan had appointed him to the federal bench in 1985. As a judge, he had heard a number of high-profile cases involving the likes of the Microsoft and Wal-Mart corporations. His “probusiness” label came from a decision he rendered in favor of the latter in a case that challenged Maryland’s legislative attempt to require large employers to provide health care for their employees. Motz’s choice of language in the Wells Fargo case echoed the political rhetoric of the man who put him on the court. The federal judge concluded that the bulk of the problems alleged in Baltimore’s litigation against Wells Fargo Bank were due not to the bank’s actions but to flawed government policies (“lack of educational opportunity and choice”), individual neglect (“irresponsible parenting”), or criminal activity (“widespread drug use, and violence”).
Judge Motz’s observations can’t be chalked up to politics entirely. As a prosecutor and a judge, he was perfectly positioned to observe what happened in the city. Frederick J. Motz had lived in Baltimore most of his life. For eight years, during some of the city’s most troubled times, he had been a member of the advisory commission for the City of Baltimore’s Department of Social Services. Judge Motz, like The Wire creator David Simon, portrays a city that few could love.
Judge Motz had concluded that the collapse of the housing market in the city was the inevitable result of years of urban decline. Motz’s words amounted to a sweeping pronouncement that Baltimore’s black neighborhoods were destined to fail. Indeed, for decades prior to the subprime era, many Baltimore neighborhoods were notorious for high crime rates and communicable disease outbreaks. Some would declare them dysfunctional. Yet they had never completely collapsed as they did under the weight of the mortgage meltdown. Was it realistic to believe that such massive disintegration could be attributed to preexisting conditions in a few neighborhoods? Presumably, homeowners held titles to structures with some market value; landlords still collected rents; and the city continued to assess taxes on the properties in even the most troubled areas. And neither any of the city’s leadership problems nor the decline in Baltimore neighborhoods should have given Wells Fargo a free pass to exploit Baltimore’s residents.
One might read Judge Motz’s assessment as an attempt to distinguish blighted neighborhoods from other Baltimore communities that still had some chance of weathering the foreclosure storm. Taken in this light, in giving the city leave to refile against the bank after dismissing the first complaint, Judge Motz may have been engaging in a bit of ju- dicial triaging, encouraging the city’s legal counsel to narrow its claim to neighborhoods whose circumstances were less notorious. But in its second amended complaint, the city chose another route. In essence, the new pleadings alleged that Wells targeted poor black men and women in distressed communities because they were in the throes of crisis and were individuals desperate for credit. The attorneys set about to convince the court that Wells Fargo had siphoned off the equity left in the residences of down-and-out neighborhoods and left those communities to perish along with the rest of the municipality.
The City of Baltimore’s attorneys reasserted that “Wells Fargo’s discriminatory practices, and the resulting unnecessary foreclosures in the city’s minority neighborhoods, [had] inflicted significant, direct, and continuing financial harm on Baltimore.” This time the city’s claims were more circumspect, but its allegations of deliberate bank wrongdoing directed at black neighborhoods were still detailed and damning. Baltimore introduced into the record statements from former bank employees about training they had received that helped them sell loans in poor, primarily African American neighborhoods throughout Maryland. One New York Times article quoted a Wells Fargo bank officer, Elizabeth Jacobson, describing the bank’s “emerging-markets unit that specifically targeted black churches, because it figured church leaders had a lot of influence and could convince congregants to take out subprime loans.” In her affidavit submitted by the City of Baltimore in its amended complaint, Ms. Jacobson attested to a consistent pattern of steering black loan applicants to subprime loans, even though they may have qualified for conventional loans at lower interest rates. Jacobson even admitted that loan officers would tell the bank’s underwriting department that applicants who had been steered to subprime loans did not want to file proper documents that would qualify the customers for prime rates.
In the heat of the meltdown, commentators would question what kind of individuals enter into potentially disastrous loans, loans that they could not possibly repay once teaser rates expired. As I read the allegations in the Baltimore suit, I began to ask what kind of persons would market these kinds of products to homeowners. But that approach puts undue emphasis on the individual participants. Although it is admittedly tempting to demonize Jacobson and her fellow agents, the problems that led to the lawsuit were systemic. The more revealing inquiry looks into the atmosphere that existed inside banks and the banking industry as the subprime crisis brewed. The environment was one that, from top to bottom, fostered detachment. And my conclusion is that there were agents who were given financial incentives to make high-risk loans while simultaneously being encouraged to disengage from borrowers and the neighborhoods in which the borrowers lived. Reportedly, Wells Fargo also gave lavish gifts and trips to successful subprime loan officers.
Parts of Jacobson’s declarations and those of Tony Paschal (another Wells Fargo employee) read like instructions for how to marginalize cus- tomers based on where they live and skin color. The two reported that “subprime loan officers described African-American and other minority customers by saying ‘those people have bad credit’ and ‘those people don’t pay their bills,’ and by calling minority customers ‘mud people’ and ‘niggers.’” Paschal reported hearing fellow employees refer to “loans in minority communities as ‘ghetto loans.’ ” Elizabeth Jacobson was an extremely productive lender: in a span of three years, she reportedly sold more than fifty million dollars’ worth of subprime loans in Baltimore’s black communities.
Wells Fargo also relied on brokers, who would take loan applications from potential borrowers and shop the papers to a number of lenders. These independent brokers sometimes earned as much as $15,000 in com- mission on $130,000 loans. Even when brokers knew the borrowers or knew the neighborhoods, they rarely had any idea of the terms the lenders ultimately offered Baltimore residents. Brokers never evaluated borrowers. Their job was to fill out the forms, and Wells Fargo exercised stunningly little oversight over how they accomplished that task.
And just what were the consequences of the bank’s purported “sub- prime lending spree”? According to the lawsuit filed by the city, subprime loans led to foreclosures, and foreclosures led to abandoned properties. Baltimore’s housing department has had to board up scores of vacant homes, stabilize properties that threatened public safety, and condemn some others that could not be boarded and stabilized. The crisis has strained public safety resources, as police and fire departments have had to step up efforts to respond to incidents related to unoccupied homes. It is clear that the fallout is citywide, not limited to geographically or racially distinct neighborhoods, when public safety costs and losses in tax revenues attributed to the foreclosures are taken into account. Although Baltimore was once nicknamed Charm City, if the projection of nearly half a million home foreclosures is correct, its lure may be a long time re- turning. And sometimes lost in the talk about lost tax revenues and police and fire department expenditures are the individuals who had no part in the subprime market debacle but are left behind in impacted neighbor- hoods. Some remaining residents are at the mercy of squatters who take up residence in foreclosed and unsellable properties as close as next door.
Beginning to See a Pattern
Skeptics might conclude that the situation in Baltimore was an anomaly. And even with the evidence against Wells Fargo, it’s uncertain exactly what part of the problem in Baltimore was the fault of that one lender. Judge Motz dismissed the City of Baltimore’s second complaint against Wells Fargo too. “Theoretically, the city does have viable claims if it can prove property specific injuries inflicted upon it at properties that would not have been vacant but for improper loans made by Wells Fargo,” he wrote. “ In the interest of justice,” Judge Motz gave the city “leave to file a third amended complaint.” Nevertheless, the dismissal casts doubt on whether Wells Fargo will ever be held liable for the problems in Baltimore.
But when other public officials began raising claims, questions about Wells Fargo’s behavior got more intense. Were the practices alleged in the Baltimore lawsuit the product of rogue loan officers, or of local—or even headquarters—Wells management, or were they the way business was done throughout the industry? In March 2008, Illinois attorney general Lisa Madigan gave two lenders, Countrywide and Wells Fargo, a chance to explain what she described as the “alarming” disparities “between the home loans sold to white borrowers and those sold to African American and Latino borrowers.” Madigan’s investigation looked into disparities in the issuance of “high-cost” loans—those that were three percentage points above the U.S. Treasury standard—which performed in ways similar to subprime loans. The attorney general had been tipped off to the problem by an investigation conducted by the Chicago Reporter, a monthly investigative news magazine. In a study of loans issued in 2003, the Reporter found that African Americans, even those with six-figure salaries, were far more likely to get subprime loans than whites or Asians and that the preponderance of those loans were given out in black and Latino neighborhoods. High-cost loans made up 64 percent of all the loans Wells Fargo made to blacks and 50 percent of the loans Countrywide gave to blacks. Comparable figures for Wells Fargo’s and Countrywide’s white borrowers were 17 and 20 percent, respectively.
In October 2008 Madigan’s office settled with Countrywide, which by then had been bought by Bank of America. The State of Illinois was granted both injunctive and prospective relief, including an agreement that qualifying borrowers might have their loans modified. In July 2009 the attorney general announced a lawsuit against Wells Fargo Bank. The bank was once again accused of targeting black communities. And in the Illinois case, Latinos were also allegedly preyed upon for subprime loans. “As a result of its discriminatory and illegal mortgage lending practices, Wells Fargo transformed our cities’ predominantly African- American and Latino neighborhoods into ground zero for subprime lending,” said Madigan. “The dreams of many hardworking families have ended in foreclosure due to Wells Fargo’s illegal and unfair conduct.” This lawsuit continued even after Madigan’s office settled another claim against Wells Fargo over allegedly deceptive marketing of extremely risky loans. The costs of foreclosures in Chicago specifically are social and economic, with borrowers, their neighbors, local businesses, and the city all paying a price.
Where the complaint in the Baltimore suit gives one a sense of sub- prime lenders’ predatory assaults on the African American community, the Illinois complaint does that and more. It chronicles the growth of sub- prime lending practices nationwide and the parallel expansion of Wells Fargo’s role in it. Madigan’s filing gives insight into how the subprime mortgage market grew—both because of larger immediate returns and because bankers assumed that securities backed by subprime mortgages would perform in the same way as those backed by prime mortgages. The court documents state that Wells Fargo undertook an aggressive growth strategy and, according to one bank employee, “wanted to be the number one lender in all markets it served and wanted to serve all markets.” One employee maintained that Wells Fargo’s goal was to have the subprime lending division cover the fixed costs of all the bank’s operations.
In time, as the company vigorously pursued its fast-paced growth, the market for subprimes grew. According to the Illinois complaint, subprime mortgage lending increased from $35 billion to $625 billion between 1994 and 2005. By 2003 Wells Fargo’s subprime lending totaled $16.5 billion, and by 2007 Wells was the eighth largest subprime lender, by loan volume, in the nation. At roughly the same time, Wells Fargo was the Chicago area’s second-largest lender by volume, making over twelve thousand high-cost loans. The complaint suggests a culture inside the bank that was dominated by subprime loans. The bank set quotas for the number of sub-prime or high-cost loans “every area had to close” and “kept scorecards” that recorded managers’ subprime loan tallies.
In 2009 the City of Memphis filed a suit against Wells Fargo Bank. Allegations mirror those in the cases coming out of Baltimore and the State of Illinois. Wells Fargo denies the allegations of the plaintiffs in these suits. In addition to existing urban woes, they blame the foreclosure problem on borrowers themselves.
Indeed, by 2000 a number of cultural and economic factors had fueled a passion for home ownership among single black women. In the popular press, Essence magazine ran a campaign for home ownership. Even the Economist, a magazine that caters to middle-class and business readers, promoted owning a home as a way for black women to live the Ameri- can Dream. In fact, since the mid-1990s, even the gap between black and white unemployment rates, a historically persistent and seemingly intractable problem, had been shrinking. Apparently unaware of the dramatic rise in subprime lending, the Economist reported:
The growth in home ownership both drives and feeds off continued gains in wealth. The University of Georgia’s Selig Center for Economic Growth says that black buying power has increased steadily across the country, from $318 billion in 1990 to $723 billion in 2004 and a projected $965 billion in 2009. At a time when every American seems to be paying for his credit-card debts with home-equity loans, blacks have (for better or worse) joined the party, helped partly by the fact that many mortgage firms now rely more on color-blind computers than on sniffy clerks to check up on applicants.
But when lenders began targeting black and Latino communities for subprime loans, the positive effect of computerized processing went out the window. Race and ethnicity were reembedded in the process in a way that no computer could deflect.
In 2006 Corey Booker, the dynamic and popular mayor of Newark, New Jersey, advocated home ownership as “a critical step, especially [for] those [families] headed by a single parent, in breaking the cycle of violence and poverty.” Not-for-profit agencies set up seminars in Newark to show women how they could make home ownership a reality despite high interest rates and poor credit ratings. And why not? At the end of an era when the political message to those in poverty was to take personal responsibility, how better to evidence responsibility than to invest in their own neighborhoods and put a roof over their children’s heads. In the mid-1990s President Bill Clinton had used the rhetoric of personal responsibility and economic prosperity in reforming welfare and in his National Homeownership Strategy, which was introduced by a document subtitled “Partners in the American Dream.” Following in Clinton’s footsteps, President George W. Bush and Alan Greenspan, the longtime Federal Reserve chairman, also promoted the idea of home ownership in both rhetoric and policy. In 2003, when housing prices were beginning to spike, Bush introduced the American Dream Downpayment Initiative, promising that the law would help Americans realize the dream of home ownership and help close the gap between “minority households and the rest of the country” in that regard.
Nevertheless, none of the leaders, conservative or liberal, seemed aware of what was happening in the financial industry. Bush and lenders encouraged potential purchasers to “buy high” with the promise that housing values would continue to climb. Builders and developers responded. The average size of new single-family homes increased from around 2,000 square feet in 1992 to 2,241 square feet in 1999, then to over 2,500 square feet in 2006. Understandably, buyers spent more on new homes. The average-size home in 1999 cost $195,600. By 2006, in order to get the average home a buyer would have to come up with $305,900. Average household income enjoyed some growth, but it wasn’t steady and didn’t keep pace with the cost of housing. During this period of steeply rising home costs and inconsistent income growth, the number of sub-prime and high-cost loans spiraled upward.
Whether Baltimore or Memphis or the State of Illinois will be able to prove that Wells Fargo or any other bank targeted minority neighbor- hoods and violated fair housing laws remains to be determined. Nevertheless, the U.S. Department of Housing and Urban Development’s analysis of data available under the Home Mortgage Disclosure Act (HMDA) suggests that in the late 1990s, a potentially calamitous situation existed in black neighborhoods. HUD’s analysis of the situation in Baltimore, for example, pointed out the following facts:
1. As reported in HMDA, the number of subprime refinance loans originated in Baltimore increased over ten-fold between 1993 and 1998....
2.Subprime loans are seven times more likely in low-income neighborhoods in Baltimore than in upper-income neighborhoods. . . .
3.Subprime loans are six times more likely in predominantly black neighborhoods in Baltimore than in white neighborhoods. . . .
4.Homeowners in middle-income predominantly black neighbor- hoods in Baltimore are almost four times as likely as homeowners in middle-income white neighborhoods to have subprime loans. . . .
5.The findings are similar when borrowers (rather than neigh- borhoods) throughout the Baltimore metropolitan area are examined. . . .
6.Like originations, the subprime share of foreclosures is highest in low-income and predominantly black neighborhoods.
In the HUD’s own words, Baltimore’s African American residents bore an “unequal burden” of the burgeoning high-cost and subprime mortgage product market. Baltimore’s attorneys have filed for the third time in the suit against Wells Fargo in an effort to persuade the court of the merit of the discrimination claim. Will the numbers ultimately speak for themselves? An attorney in both the Baltimore and Memphis suits explained to a Memphis newspaper why the data reveal disparities that are, absent racial targeting, hard to explain: “Wells [Fargo] is getting it eight times more wrong in the black community than in the white community [in Memphis]. . . . That just can’t happen in and of itself. What it means is they’re making loans they know at the time can’t succeed. Or they’re pricing people beyond their means or too high.”
Countrywide photo by Neubie on Flickr. Used under Creative Commons.