Answer to Racquel RE: Red Lining Tactics

As having had a little experience in the field, I’d like to comment on an earlier post made by Racquel regarding home financing for African Americans.

She asks about the process of Red Lining, what the status of this practice is, and what can be done to prevent it.

Much has changed since the government secretly adopted this practice in the middle of the 20th century. But at the same time business is also, in a sense, carrying on as usual. It’s just a little more complicated and hard to detect now.

As an employee of a mortgage lending department it is mandatory (via a strictly enforced FDIC regulation) for me to receive annual training regarding discriminatory lending practices - along with my colleagues and anyone in the bank remotely connected to extending customers any type of credit.

Here’s info from the official speech our auditors give us during training: Red lining, as described in Rothenberg, was officially banned in 1968 by the Fair Housing Act (FHA)– part of a package of progressive "New Era" Civil Rights legislation pushed through Congress by the Johnson administration just days after Martin Luther King’s assassination. While legally banned, the practice of Red Lining continued unabated by many home financing institutions well into the 1980’s. To recap, Red Lining (at least the internal variety) is when you circle an undesirable minority neighborhood and make it your policy never to lend money or market your services there – you simply ignore it outright.

A lot of institutions considered it an unnecessary risk to lend in the predominantly minority neighborhoods they excluded because minorities were perceived as bad creditors. Plus a waste of time and effort cause lenders essentially make a percentage on the total dollar amount of any housing transaction - and a percentage of a low value property is a low value commission.

Other fair lending legislation followed to beef up the FHA including the Equal Credit Opportunity Act (bans discriminatory practices in all forms of lending – not just housing-related) and the Community Reinvestment Act – mandates and rewards institutions for serving the credit needs of all of their surrounding neighborhoods. These passed in the 1970’s, but it wasn’t until the late 1980’s with the passage of the Home Mortgage Disclosure Act (HMDA), that anti-discriminatory lending began to see strict enforcement. HMDA mandates that lenders collect sex, ethnicity, and race info regarding applicants for any major type of personal financing – including housing (but not, significantly, requests for business-related financing).

The government collects this info from all lenders across the country and makes it available in public (see here: http://www.ffiec.gov/hmda/) tables. They then analyze the data to verify compliance with anti-discrimination laws and can tell pretty quickly now (based on how high a percentage of minorities are turned down for credit – denials must be reported) if a lender is cheating.

It wasn’t until the Clinton administration required top of the line analysis and enforcement that HMDA was used to its full extent, though. When it was, a large number of very big industry players were found to be discriminating. Massive class action suits followed (remember this is more than 25 years after the FHA was passed in the first place!).

Most institutions now feel the risk of getting fined outweighs any benefits and comply as best they can. That doesn’t mean cheating doesn’t happen (there’s ways around everything) but it certainly has gone down. There’s still a big settlement from time to time, of course. See here for a basic timeline of fair credit laws and their enforcement: http://www.ffhsj.com/fairlend/timtest.htm

Personally, I can attest to HMDA and the other laws being carefully observed where I work. First of all, we spend a great deal of time (money) collecting and thinking about race/sex/ethnicity data, complying with, and submitting reports required of HMDA. And when a minority application does comes in it’s often treated like a hot potato. This means we’ll do everything in our power to grant credit. Most lending decisions are pretty bread and butter. Do some simple math (45% total debt to income is one big benchmark) and if the person qualifies, they’re good to go. If they don’t meet the mathematical criteria - tough luck.

But in cases where the numbers are shaky and on the fence, I’d have to say minorities get more benefit of the doubt. This is not for altruistic reasons, however. Banks are terrified of state and federal regulators who pay frequent checkup visits. These guys are absolute pros. All they have to do is take a 2 minute peek at your HMDA report (must be accurately maintained/subject to inspection at all times) and they can tell right away if your breaking the rules. I’ve seen them in action and it makes you sweat.

So that’s good but not the complete story.

First of all, any institution does a good bit of relationship-building reaching out/bending-the-rules for wealthy customers they’d like to attract or keep in hopes that they, in turn, will attract even more wealthy customers. Guess what color their skin is?

Secondly, a bank (very conservative) is only one of the many types of lending animals out there these days. The lending business has mushroomed lately for many underlying economic/market-driven reasons.

First off, with home prices far exceeding most salaries like never before, lenders have had to dream up all sorts of clever new products to let you have the house you can now barely afford. Including loans that have sky-high interest rates and other punishing features (rates that adjust on a periodic basis, or eat into your equity, or fancy lines of credit that operate like Master Cards secured by your house are the biggest examples) to offset any risks borrowers with not a lot of income power might present.

These risky products are referred to as sub-prime (literally “beneath the best deal”) and I’m sure you’ve heard the recent news stories. They are peddled by aggressive companies (a bank that’s in it for the long haul is too conservative to sell these) that make their money by doing a high volume of transactions and don’t hang on to the underlying debt equity. Instead, they wash their hands of the risk by packaging the debt up in bulk and selling it to an ever growing market of quick-return-hungry investors.

Bottom line is there are a lot of extremely pushy companies out there who make their money by selling risky loans to low income people (often minorities and blue collar workers) who don’t truly understand what they’re getting into. Most bankers don’t even appreciate the risks – I see it every day. Think of it this way: a lender sees a dozen transactions every day as a normal, routine part of going to the office. A typical consumer does one or two transactions in their lifetimes. Who do you think has the information advantage?

A good salesman knows a million ways to make a rotten deal sound fantastic too. And often people are willing to take them at their word cause they need the money bad. Always remember that the person on the other end of the phone is making a percentage of the total deal amount. The higher the amount, or the worse the terms, the bigger their commission (and vacation/boat/fancy SUV).

Remember also that the most unscrupulous companies make their money through high volume (calling/marketing to tons of people in media/telphone blitz campaigns) + ill-informed consumers. In fact, many deals are specifically designed so that the payment will balloon after a year or so of a low “teaser rate”. Meaning the customer will be forced to come back and pay to renegotiate another deal again and again and again. Fantastic! More commission for the lender! And with credit reports that can now measure how much debt you can take on to the penny, lenders know just how much to try and hit you up for.

Here’s a common tactic: they start by offering you a terrible deal (often that has uneccesarry insurance associated with it you don’t need but they make you feel is mandatory – they make money off this too), knowing in all likelihood you’ll say no at first. Then they keep “sweetening” the deal until you say yes. Often by lopping off unnecessary features bit by bit. In reality you wind up in the bad deal they’d intended to stick you in all along – but you think you’ve done some hard and successful bargaining.

The upshot is, now, the worst companies are preying on the minority and low income neighborhoods they once wouldn’t touch with a ten foot pole. They see these as big cash cows. Just look at the “lower your monthly payment today – we say yes!” commercials on TV. Often they’re aimed at and feature minorities and blue collar workers. These make me absolutely sick, by the way. If you understood the fine print you’d know that each and every one of these deals is financial suicide.

When the economy/rates are good, everything’s fine because people can usually keep up payment on even the worst of deals. But what happens when the job market or rates are shaky? Miss a couple payments on your crap deal or don’t have enough cash on hand to pay them for renegotiating and guess what happens? The lender’s got the house you’ve put your life savings into. It’s the biggest scam ever. I don’t know what’s worse – denying minorities credit or giving them false hope while luring them into a deal concocted to pocket everything they have. Just look at foreclosure stories or statistics and you’ll see minorities are “over represented” to an insane degree.

So what’s the best protection against scam artists? I’d say knowledge and closing that info gap. Never be afraid to ask lots of questions (salesmen prey on people’s reluctance to “appear educated” and not question), and put the lender to the test by comparison shopping.

The best resource I can recommend is the following Web site: http://www.mtgprofessor.com/. This guy is a Wharton professor and impartial consumer advocate dedicated to tipping the info scales and giving people the knowledge they need to make wise choices and protect themselves. Most of the stuff anyone would need to know (and lender’s don’t want you to know) is in his FAQ’s - written in a style easy for anyone to understand.

Finally, if you ever feel you’ve been ripped off or denied credit unfairly, there’s a phone book of laws you may not even know of, designed to protect you. There are many consumer advocacy groups dedicated to helping people out. Reach out to them!

The official government agency for this is the Department of Housing and Urban Development (HUD). Their only job is to protect people and they’re very easy and understanding to work with. Get in touch with them (http://www.hud.gov/). They have excellent trial lawyers whose reason-for-being is to sue the pants off con artists. When HUD gets on your case a business will get scared and often settle. And that’s what your taxes pay for. So use ‘em!