Race and the Housing Bubble

While we wait to see if the second Obama administration will do anything new to help homeowners hit by the lingering mortgage crisis (finally replace Bush-holdover Ed DeMarco at FHFA to make way for debt relief?), there’s time to review a recent development that didn’t get the full attention it deserved.

I am referring to a lawsuit, Adkins v. Morgan Stanley, filed in the Southern District of New York in October by the ACLU. We don’t usually associate the ACLU with consumer protection in mortgage finance, and not surprisingly, it has brought a fresh perspective on the abuses that led to the housing bubble, highlighting race disparity in subprime originations.

Together with the National Consumer Law Center, the ACLU has brought a class action against Morgan Stanley charging that it financed a major subprime mortgage originator, dictated the nasty terms offered, and bought up a big portion of the resulting junk to feed its securitization maw.  The originator was New Century Mortgage Corp., which filed in bankruptcy in 2007.

The plaintiffs are African-American homeowners in Detroit who were sold New Century mortgages and who have ended up facing foreclosure. Also joining as a plaintiff is Michigan Legal Services, which has been swamped with mortgage cases in foreclosure ground zero, Detroit.

The legal theories used include the Fair Housing Act and the Equal Credit Opportunity Act, which are promising because these federal laws cover purchasing loans and also make disparate racial impact sufficient to make out a discrimination case. The 71-page complaint presents data that Detroit-area African-American customers of New Century were 70 percent more likely to end up in subprime loans than white borrowers with similar financial characteristics. The suit seeks a jury trial and disgorgement of ill-gotten gains, among other relief including appointment of a monitor (a good idea given the constancy of race discrimination in US housing finance practices).

A class action lawsuit like this one of course faces many challenges, but it is potentially a strong tool to get relief to the minorities who were hurt by racially disparate lending practices used in the boom years 2004-2007.  It could be a model for similar efforts against other securitizers in other parts of the country.

As a result of the mortgage crisis and ensuing economic crisis, minority wealth has declined dramatically in the US.  A Pew study found that median wealth of white households has grown to 20 times that of African American households and 18 times that of Latino/Hispanic households. Minority households have tended to have more of their wealth in their homes, so they were the hardest hit by the crisis, likely continuing intergenerational disparities in wealth by race.

At the core of the mortgage crisis is a problem of race discrimination in mortgage credit, one that has gone on for generations in different forms.  In the 1950s, post-war federal homeownership programs deliberately focused on racially homogenous neighborhoods. Financial institutions engaged in redlining, refusing to lend in minority communities.  This set up the conditions for reverse-redlining, targeting minority communities for subprime loans in the 1990s, a practice that revved up during the bubble.

Plenty of white people got subprime loans, too, but the race disparity was pronounced.  Race discrimination thus significantly contributed to a dynamic that put the entire economy at risk. A government report in 2000 found that subprime refinancings were five times more likely in African American neighborhoods than in white ones. Minorities are significantly more likely to be sold mortgages than to seek them out.

The crisis hit minorities hard. African Americans and Latinos have been much more likely than whites to face foreclosure.

Government efforts concerning the mortgage crisis first focused on shoring up the safety and soundness of financial institutions. Efforts on behalf of homeowners at risk have been much weaker. In the delayed blame game, there has been more focus on bad servicing practices than on even worse origination problems, although the Justice Department did bring two race discrimination cases against Wells Fargo and Bank of America, resulting in settlements totalling half a billion, small change given the scope of the problem.

The ACLU suit goes after the Wall Street middlemen that created the whole house of cards. Morgan Stanley made huge profits on fees when it put together securitizations. Those left holding the bag were the borrowers and the investors, the parties at the beginning and end of the securitization pipeline. The practices involved have been called “pass the trash,” and they made it possible for securitizers to avoid holding the risk of default. 

One of the named plaintiffs in the case brought by the ACLU is Rubbie McCoy, a single mother who was sold an adjustable rate mortgage with an initial rate of over 12% that could not fall below 10.74%. In addition to being high cost (the interest rate could go as high as 17.75%!), her loan had other characteristics common in New Century subprime originations purchased by Morgan Stanley, such as a very high loan to value ratio and prepayment penalties. The loan left Rubbie with a high debt to income ratio. The broker inflated her income in the loan documents and the appraiser inflated the appraisal of her home’s value.  See her talk here about the stress of living in the shadow of foreclosure while keeping her kids on track at school. 

This will be one to watch.