March 26, 2013

Lenders, Beware! You Might Be Discriminating and Not Even Know It! (HUD Announces Disparate Impact Rule)


In late February, the U.S. Department of Housing and Urban Development (HUD) published final rules that could result in banks being punished for lending discrimination if a lending policy has a different result on one group than another, regardless of whether anyone within the bank actually intended to discriminate.  It is a legal theory called "disparate impact" and it has been highly controversial.

Photo Credit: Håkan Dahlström / Foter.com

The Fair Housing Act (technically Title VIII of the Civil Rights Act of 1968, as amended) prohibits discrimination in the financing of a home loan on the basis of race, color, religion, sex, disability, familial status, or national origin. HUD, which is given the responsibility for interpreting and enforcing the Fair Housing Act, has the authority to promulgate rules implementing the Act.   

For years, HUD has interpreted the Fair Housing Act as prohibiting any lending practice that results in a different effect on one racial or ethnic group (a disparate impact), regardless of whether there was any intent to discriminate.  The policy or practice may, on its face, seem neutral and fair, but HUD, and a majority of federal circuit courts, are still willing to hold the lender liable.

The disparate impact theory operates by shifting the burden of proof from the plaintiff to the defendant-lender so that the defendant-lender must actually prove itself innocent.  Under this test, the plaintiff must only show that a practice results in, or could be predicted to result in, a discriminatory effect on a protected class (e.g., racial minority group). If the plaintiff can show merely this fact, the burden of proof shifts to the defendant prove that the lending practice is "necessary" to achieve a substantial, legitimate, nondiscriminatory goal. This is a difficult burden to overcome, because the lender must prove more than mere good intentions or commercial reasonableness; it must prove that the practice is a necessary aspect of doing business.  If a defendant can clear this high hurdle, the burden of proof will shift back to the plaintiff to show that the lender's goal could have been achieved by a practice that has a less-discriminatory effect. If the plaintiff can come up with a creative alternative that would achieve the same goal with less disparate impact, the defendant-lender will lose and be liable for damages (both compensatory and punitive) and penalties.

In finalizing the disparate impact rules, HUD concluded that the rule will not have a "chilling effect" on lending, as some commenters on the proposed rule have suggested.  Furthermore, despite an Executive Order requiring HUD to consider the compliance cost on small businesses and perform a cost-benefit analysis on the new rule, HUD declined, concluding (without any evidence) that the rules will "not have a significant economic impact on a substantial number of small entities."  (Some community bankers might beg to differ with these conclusions.)


To illustrate how the disparate impact theory applies in the real world, consider the case of California-based Luther Burbank Savings Bank.  The federal Department of Justice alleged that Luther Burbank violated the Fair Housing Act and the Equal Credit Opportunity Act by setting a policy that had a "disparate impact" on minorities.  Luther Burbank had very tight lending standards and only made jumbo loans.  It required a minimum $400,000 loan amount, had an average 680 FICO score, and an average loan-to-value ratio of 67%.  From 2006 and 2011, a disproportionately small percentage of Luther Burbank's single-family mortgage loans were made to African-Americans and Hispanics as a result of these policies that were racially neutral on their face.  As a result, Luther Burbank was sued by the U.S. Department of Justice.  The Department of Justice did not allege or present any evidence of intentional discrimination... because there wasn't any.  Rather than risk a devastating judgement, Luther Burbank Savings Bank settled with the Justice Department in late 2012 by agreeing to dramatically alter its business model by reducing its minimum loan amount to $20,000 and pledging to give $2.2 million to local community groups, "consumer education programs," and a specialized lending program.  

In sum, now that HUD as made its disparate impact model the law of the entire United States, a lender will need to be able to demonstrate that any policy or practice that results in a disparate impact, or is likely to result in a disparate impact, is necessary to achieve a substantial interest and that no less-discriminatory alternative exists.  

Remember the old saying: "The road to hell criticism, damages and penalties is paved with good intentions."


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