Since the financial crisis of 2008, a defining question has been how to rein in Wall Street’s most reckless practices. In the face of the Dodd-Frank Act, a nascent Consumer Financial Protection Bureau and some impressive legal settlements against banks involved in securities fraud and abusive loan servicing, Wall Street has not been shy about taking countermeasures.
After lobbying furiously against financial reform, the financial industry has worked to defang the new regulatory regimes where it can. For the most part, this response has aimed at rolling back reforms put in place following the 2008 financial crisis. But the backlash against regulation has not been limited to attacking new financial reforms.
Over the last several years, Wall Street has joined a coalition of groups in a litigation campaign to dismantle a crucial regulatory bulwark: federal civil rights protections against discriminatory lending. Pressing this litigation effort is a good investment for Wall Street. It provides a low-profile path to advance its deregulatory agenda. Under the guise of a technical debate over legal doctrine, this litigation campaign aims to radically roll back an indispensable legal constraint on reckless financial practices. In the process, it would tear down a vital pillar of civil rights law, making it much harder to mount legal challenges to discrimination throughout the housing and lending markets.
A Pillar of Civil Rights Law
Discrimination was one of the engines of the financial crisis. Unscrupulous lenders designed their entire business models to serve Wall Street’s bottomless appetite for loans to be packaged into securities. The most effective way to feed that appetite was to exploit long-standing patterns of discrimination and residential segregation, which had the effect of funneling African-American and Latino borrowers into hyper-risky loans that put borrowers on a path to foreclosure.
As a result, some of the most important legal actions against the banks have involved discrimination claims under the Fair Housing Act (FHA). Many of those claims have relied on a long-standing pillar of civil rights law: The principle that the FHA prohibits housing practices that have a discriminatory effect – or, in the language of legal doctrine, a “disparate impact” – on the basis of race, sex, religion, disability or other protected characteristics. Disparate impact claims provide a way for judges to enforce anti-discrimination laws without forcing them to get inside the heads of decision-makers to determine whether discrimination was intentional.
The alternative, a regime in which one must prove intent, would create giant obstacles for the enforcement of anti-discrimination laws. That’s because, in the modern era, even people who operate from a perspective of racial bias generally know better than to broadcast that intent. The disparate impact standard thus helps to “smoke out” stealth discrimination. Perhaps more importantly, it also provides a way to attack neutral governmental or business conduct, unjustified by any legitimate interest, that perpetuates unequal conditions arising out of past discrimination. Disparate impact can break the gridlock of entrenched discrimination.
For that reason, disparate impact claims under the FHA have been at the forefront of the legal response to the financial crisis. Several of the nation’s biggest banks have been sued for using subprime lending practices that systematically led to black and Latino borrowers receiving costlier or riskier loans than white borrowers with comparable credit profiles.
For example, many subprime lenders maintained policies that gave brokers discretion to ratchet up the cost of a loan beyond what would be justified by credit considerations. This led to systematically higher rates – accompanied by higher risk of default or foreclosure – for minority borrowers. In other words, minority borrowers were getting less favorable loans, but those differences could not be explained by differences in credit profiles.
This is why the disparate impact framework has landed in the crosshairs of the financial services industry. Along with its allies, the industry has mounted a concerted campaign in the courts to abolish disparate impact claims under the FHA. If successful, this campaign of deregulation could have vast consequences for enforcing fair housing and civil rights laws.
The legal doctrine of disparate impact originated in a 1971 Supreme Court case involving the federal statute barring employment discrimination. Before long, that framework migrated to the FHA, where it has held sway for 40 years. Eleven of the 12 federal courts of appeal have ruled on the question of whether disparate impact claims are available under the FHA; they’ve all answered in the affirmative. Similarly, the Department of Housing and Urban Development – the federal agency with primary responsibility for the FHA – has long applied a disparate impact standard in its enforcement of the statute. In 2013, HUD issued a regulation formalizing that longstanding position and laying out the procedures for assessing disparate impact claims.
In other words, it is well settled law that the FHA protects against discriminatory effects in the housing arena. What that means in practice is that if a civil rights plaintiff shows that a housing-related practice disproportionately hurts a protected group, the defendant has to prove that the practice advances a legitimate business need. If the defendant can do so, then the plaintiff will only win if she can show that the defendant could have used less discriminatory alternatives in pursuit of that legitimate business aim.
This shifting burden of proof is a rigorous standard. Simply showing a statistical disparity does not win a lawsuit. What disparate impact doctrine recognizes, however, is that a practice that exacts a disproportionately negative effect based on a protected characteristics, like race, should at least have to be justified by some valid purpose. If no sufficient justification is put forward, that is precisely the kind of discrimination that the civil rights law should seek to eliminate.
Predatory Lenders Swarm the Most Vulnerable
Disparate impact claims ensure that the FHA can be a meaningful tool in the face of shifting forms of housing discrimination. Those claims became especially crucial over the last decade because of the intensely racialized dynamics around the subprime lending boom and resulting foreclosure crisis.
Subprime lending and race were inextricably linked from the outset. Discriminatory practices made it easier for subprime lenders, and the Wall Street banks that backed them, to ramp up their focus on dangerous loans. They piggybacked on a long and dismal history of residential segregation and lending discrimination, leading predatory lenders to swarm underserved minority communities.
Discrimination in subprime lending caused massive disparities in foreclosure rates. By 2010, African Americans and Latinos were 47 percent and 45 percent more likely than whites to face foreclosure.
This is why the Fair Housing Act has become an important element of post-crisis regulation, including through disparate impact claims. Though its provisions had long prohibited discriminatory lending, the law has assumed special stature in the current regulatory landscape. It provides a way to hold major banks accountable for harm caused by discriminatory lending. All of which explains why Wall Street would love to see the disparate impact standard on the chopping block.
Wall Street Shoots for the High Court
Over the last several years, the Supreme Court has signaled that it may be willing to unsettle the legal understanding that has prevailed under the FHA for the last four decades. Seeing an opening, the financial services industry has jumped into the fray and moved aggressively to bring about a judicial reordering of the FHA’s reach.
In 2011, the court accepted review of a case from St. Paul, Minnesota, putting in play the question of disparate impact under the FHA. The case before the court was not about lending or financial services, but those industries took notice. One brief submitted by the American Bankers’ Association and similar groups took aim generally at the disparate impact standard, but also argued that, even if the Supreme Court ruled that disparate impact claims are available for other FHA violations, it should carve out an exemption for lending. Another banking industry brief attacked the disparate impact standard more directly, with an almost startling degree of candor. That brief, submitted by the American Financial Services Association and others, argued, “Lending standards, by their very nature, have differential impacts that could be correlated with factors, such as race, that are listed in the Fair Housing Act as prohibited bases of discrimination.”
Though the bankers’ brief recognized that disparate impact doctrine doesn’t impose liability on the basis of a mere “differential impact” if the underlying policy can be justified, it asked the court to shield lenders from claims involving racial disparities, no matter how stark or how disconnected from legitimate lending criteria, except where plaintiffs can prove discriminatory intent. Before the court issued a decision, however, the city of St. Paul agreed to withdraw its petition for review, thus taking the case off the court’s docket.
In 2013, the court once again agreed to consider the question of whether the FHA authorizes civil rights plaintiffs to bring disparate impact claims. The financial industry joined the chorus of right-wing political groups filing friend-of-the-court briefs urging the demolition of the disparate impact standard. Once again, the Supreme Court never ruled on the issue, because the parties settled.
Opponents of the disparate impact standard are eager to get another shot in front of the Supreme Court. The financial services industry has led the charge. Nearly simultaneously, two industry groups representing property insurers filed lawsuits challenging HUD’s 2013 rule codifying the disparate impact standard. One of those lawsuits purports to aim narrowly at preventing the rule from applying to property insurance, despite a well-documented history of racial discrimination in how insurance is issued. The other case goes farther, arguing that the FHA shouldn’t be read to allow disparate impact claims and, if it does, it violates the Constitution.
In both cases, the insurance groups echo the arguments of the lending industry. They assert that disparate impact claims are a radical innovation that would undermine the availability of property insurance, even though the industry has been subject to disparate impact enforcement for decades and, in any event, is not liable for policies supported by a valid business justification. Both cases are being litigated by well-known Supreme Court specialists, telegraphing the industry’s intent to drive this issue back to the high court.
The mortgage bankers have filed briefs in those cases as well, insisting that disparate impact claims will hinder their lending businesses. In one of the insurance cases, the Chamber of Commerce has weighed in with its own brief. The financial industry, in other words, is gearing up for a fight. Its objective: shut the door on disparate impact claims.
Discrimination Poisons Everything
A strong anti-discrimination regime is a multilayered safeguard with widely shared benefits. Most obviously, it’s crucial for the individuals and communities that have been most severely harmed by predatory lending. Neighborhoods and families across the country have been hit hard, but the impact on communities of color has been different in kind.
A 2011 study showed that following the crisis, the racial wealth gap between white and black households skyrocketed. It’s now 20:1, the highest since Pew began surveying such data in 1984. And because real estate ownership is a major component of the wealth passed from generation to generation, the racial justice consequences of subprime-era abuses may play out for decades to come.
But scaling back anti-discrimination law in the area of lending doesn’t just threaten the communities who may be the direct targets of discriminatory practices. Indeed, this is one of the great lessons of the subprime fiasco: Race discrimination accelerated the worst lending practices, but the contagion quickly spread beyond minority communities and affected the entire economy. Discrimination, in other words, poisons the whole system.
This is one reason the litigation campaign against disparate impact is so pernicious. If Wall Street wants to make the political case that banks and lenders should be less regulated than they were during the subprime bonanza, it should do so. In its various legal briefs, the financial industry has argued that the disparate impact standard poses a radical threat to reasonable financial practices. But the FHA’s disparate impact standard has been around for decades. To the contrary, it’s Wall Street’s manufactured story that masks a radical deregulatory agenda. Deregulating discrimination would be a gift to Wall Street, one the courts should not be in the business of giving.