Were Big Banks Guilty of Racial Discrimination in the Housing Crisis?
In the years leading up to the housing crash, public data suggest that black would-be homeowners in Detroit were 70 percent more likely than white borrowers to receive a risky subprime loan from the now-defunct lender New Century Mortgage Company. This is the central statistic embedded in a 70-page lawsuit filed Monday in New York against Morgan Stanley, the investment bank that went on to purchase a large share of those loans for repackaging in mortgage-backed securities.
The suit, filed by the ACLU and the National Consumer Law Center, alleges that a kind of "reverse-redlining" became the norm in Detroit. Fifty years ago, discriminatory housing policies prevented many blacks from obtaining home mortgages. Barely five years ago, this suit suggests that a different kind of racial discrimination was taking place in Detroit: Predatory lenders couldn’t approve enough high-risk loans to black borrowers, increasing Morgan Stanley’s profits and disproportionately leaving many of these black homeowners in financial ruin.
In a twist on the ever-expanding legal fallout from the housing crisis, this case – filed on behalf of five Detroit borrowers with the hint of thousands more to come if this turns into a class-action lawsuit – accuses for the first time an investment bank elbow-deep in the housing bubble of violating federal civil rights laws.
Investment banks like Morgan Stanley have been the subject of lawsuits before over their handling of mortgage-backed securities (just this month, New York State Attorney General Eric Schneiderman sued JPMorgan). But many of those suits have been brought on behalf of jilted investors, not homeowners, and none of them has alleged racial discrimination. Such claims have been made before about local banks and brokers, the mortgagees writing loans in a given community. This Detroit lawsuit, though, takes aim at Wall Street banks, not Main Street ones.
“You have to ask yourself: Why would the local banks engage in reverse-redlining? Why would they target these communities? What was in it for them?” asks Stuart Rossman, the director of litigation for the National Consumer Law Center. “What is unique and ground-breaking to this case is that we’re answering that question. New Century was engaged in reverse-redlining in Detroit, and the reason why they were engaged in reverse-redlining in Detroit was because of their relationship with Morgan Stanley.”
Morgan Stanley, the suit alleges, pushed New Century to issue large volumes of high-risk loans in exchange for financing. Rossman analogizes the relationship this way: "Think of this the Wizard of Oz," he says. "Toto is pulling back the curtain, and a voice says 'Don’t look at the man behind the curtain, ignore the man behind the curtain!'"
In response to the suit, Morgan Stanley released this one-sentence statement: “We believe these allegations are completely without merit and plan to defend ourselves vigorously.”
And so, for now, we have only the evidence the ACLU and NCLC have compiled. Rossman acknowledges that they’re advancing a novel theory, and that this case won’t be an easy one precisely because no one has ever tried to make this argument before. The lawsuit doesn’t allege that Morgan Stanley knowingly discriminated against blacks by targeting them for bad loans. It argues that the bank was reckless in failing to recognize that its policies effectively produced that result anyway.
As a legal question, Morgan Stanley’s intent isn’t really the issue. The plaintiffs don’t have to prove that the bank intentionally discriminated. The federal Fair Housing Act, however, says that banks can’t have policies that lead to a disparate impact on minorities. This means, in practice, that a policy may effectively discriminate against blacks even if it never explicitly mentions "minorities," "blacks" or "race." In one famous 1971 employment discrimination case, the Supreme Court ruled that the Duke Power Company violated the Civil Rights Act by requiring employees to hold a high-school diploma and certain intelligence test scores – a policy that had little to do with their job performance but that, in practice, excluded minorities.
Rossman has no doubt that the exact same thing occurred in other communities, with other banks. But Morgan Stanley is still standing five years after the housing bubble collapsed, unlike many of its contemporaries. And Rossman and the ACLU were able to follow a paper trail into Detroit, a city that also happens to have a long and well-studied history of housing discrimination.
The Massachusetts attorney general’s office had previously investigated the relationship between Morgan Stanley and New Century. New Century turned up a long public record when it went bankrupt in 2007. Morgan Stanley employees had previously testified before Congress on the bank’s subprime practices. And data filed under the Home Mortgage Disclosure Act helped support the statistical analysis that blacks were disproportionately given such loans (that 70 percent figure cited above controls for other factors related to creditworthiness).
As the lawsuit states, "not all subprime loans are predatory, but nearly all predatory loans are subprime." And as New Century ramped up its volume of subprime loans from 2004-2006, allegedly at Morgan Stanley’s request, blacks were increasingly on the receiving end. It is an added irony to this story that some of these borrowers had never been given the chance to own a home before because of the city’s history of housing discrimination. "They were ripe for the picking," Rossman says, "because they had been ignored for 40 years."
Clearly, this is not quite what equal housing advocates have had in mind. And it’s an odd twist that anti-discrimination laws once used to protect minority access to housing loans may now be used to defend them from lenders pedaling bad ones.
"What this lawsuit is saying is that these banks were adopting these policies, were profiting enormously by these policies, and they didn’t care to check what impact they were having, they didn’t care to check who was being hurt," Rossman says. "What this lawsuit will hopefully establish is that they have a duty and a responsibility to do that."
More fundamentally, this lawsuit also suggests that racial discrimination in housing is no relic of the 1960s. "There is no doubt in my mind that all that’s happened is that it’s evolved," Rossman says. "Instead of having a sign in the window that says ‘no blacks or Jews need apply,’ it’s manifesting itself in this more subtle type of racial impact."