Suing the Bankers

Related to the foreclosures issue (and, of course, The Wire) it seems that Baltimore is suing Wells Fargo Bank "contending that its lending practices discriminated against black borrowers and led to a wave of foreclosures that has reduced city tax revenues and increased its costs." It's possible, of course, that this is a good idea but one needs to be very careful in this territory. The last thing a struggling city like Baltimore needs to do is create a situation where banks just figure they'd rather not lend anything to anyone in the city for fear of lawsuits if things don't work out.

It's by no means a policy book, but one thing that comes through loud and clear in Sudhir Venkatesh's Off The Books is that inability to secure formal, legal credit from proper banks is a big obstacle for inner-city underground entrepreneurs who'd like to take their successes above-board. Meanwhile, however bad the terms a real bank may offer a person in a sketchy neighborhood, you're way better off with the bank than with the loan shark or the checks cashed guy or the payday loan emporium.

Comments

Well, it's true that formal, legal credit is a good thing. But if that's what Baltimore wants, it's better off continuing to sue Wells Fargo and seeding some Credit Unions than just ignoring corrupt lending practices.

Posted by Meh | January 8, 2008 1:28 PM

Startups are at the mercy of banks everywhere. My brother started a successful restaurant in a mediocre mostly-white area, but he can't gain any equity because he took on some high-interest (non-loan-shark) loans. He'd be doing very well if it weren't for the interest he's paying, but as it is he's just surviving while the banks milk him.

Posted by John Emerson | January 8, 2008 1:30 PM

Louis C.K. said it best:

"If you're rich, they just give you more money. They go, 'You're so rich, why don't we just give you more? Here's some more money! Hey, take this guy's $10, he's not doing anything with it.'"

Posted by Reality Man | January 8, 2008 1:33 PM

I wonder how much of these problems have exacerbated somewhat recently?

Back in the It's a Wonderful Life days, everyone saved money in banks and S&Ls who would lend the money out to small business folk etc. Nowadays everyone wants to invest in the market (in part because, thanks to all the bad mouthing of social security, they are afraid they won't have enough to retire -- as FDR might have put it: "the only thing we have to fear is fear itself" -- unless they have a lot of high yield investments), which doesn't serve to capitalize our entrepreneurs.

Is there a policy mechanism by which we can encourage investment in accounts used to lend money to community small businesses and would-be home owners, rather than trying to securitize those loans and sell them off wherein someone gets left holding a piece of what Prof. Atrios calls big shitpile, instead of having a situation where the loan gets renegotiated and, while nobody wins so much money, nobody has to deal with the foreclosure process (and the investor doesn't loose everything when the market tanks from foreclosures, etc)?

Posted by DAS | January 8, 2008 1:44 PM

Re Matthews comment "you're way better off with the bank than with the loan shark or the checks cashed guy or the payday loan emporium. "
--------
Are you Sure?

Posted by Don Williams | January 8, 2008 1:45 PM

In or around late 2006, Illinois passed a law that basically said that loan applicants had to be provided with certified credit counseling if (1) their credit scores were below a certain level and (2) they were buying property is a handful of low income Chicago ZIP codes. The penalty for making a loan without evidence of certified counseling was that the bank's lien was null and void.

The result was entirely predictable. Banks simply stopped loaning in those ZIP codes, regardless of credit score (too difficult to check immediately before closing, which is the time at which the score mattered), and regardless of certification (too easy to forge). Heck, I had friends who went under contract prior to the law (with good credit) and were therefore exempt who had to threaten to sue to force the closing because the bank simply did not want to do business in those ZIP codes.

The law was repealed within a matter of months.

Posted by Joe | January 8, 2008 1:46 PM

BTW ... to what degree are banks actually being stupid?

I think the banks figure that a person in category X has a Y% chance of defaulting, so they should charge the person sufficient interest so their expected profit would be positive, given the Y% chance they won't even get all the principle back. But do they actually account for the fact that the chance of default itself depends on interest?

If banks really are operating in the manner that does ensure them the most profit, you can't fault them too much for being good business-folk, even if you can point out how the market fails to deliver what is needed (capital) to where it is actually needed (c.f. the Louis C.K. quote above).

OTOH, if even banks, whose business is money, can't even correctly account for risks and profits, what does that say about the ability of markets to even function in a theoretically optimal manner considering that people are simply not capable of maximizing even their self-interest?

Either way, the whole thing shows the soft-underbelly of neo-classical econs theory, doesn't it?

Posted by DAS | January 8, 2008 1:50 PM

Welcome to the slums.

Posted by Sean Kingston | January 8, 2008 2:08 PM

> The result was entirely predictable. Banks
> simply stopped loaning in those ZIP codes,
> regardless of credit score

The only problem with that story is that "banks" (that is, major banks and financial institutions) stopped lending in those zipcodes in the early 1970s and except for a few show loans around the time of charter renewal never restarted - the money was too good in the suburbs. It was only the few local savings-bank type places that still existed that loaned in those regions, and the regulation you describe wouldn't have been much different from their vetting process anyway.

Cranky

Posted by Cranky Observer | January 8, 2008 2:29 PM

DAS,

To answer your first question: yes. I work for one of the largest lending institutions in the country, and trust me, we have analyzed the bajeebus out of this. By and large, given any set of terms, location, and credit history, we can give you a pretty good estimate of how likely the customer is to default. And yup, it's optimized to bring in the most profit for us. (Whether it's best for our customers is an entirely different matter.)

Also, just some food for thought: the federal regulations governing fair lending practices are EXTREMELY tedious. Of course it's illegal to blatantly discriminate, but what a lot of people don't realize is that it's also illegal to decide lending eligibility based on a policy that's based entirely in hard financial data but has the EFFECT of being discriminatory. For example: we know that if a person has a reverse mortgage on their home, they are an order of magnitude likelier to default on another loan than a person of very similar financial position (except for the reverse mortage). However, we are prohibited from using this fact in any type of decisioning, because reverse mortages tend to be held almost exclusively by the elderly, and denying a loan based on whether the person has a reverse mortgage would have the effect of discriminating on the elderly.

Posted by Gheby | January 8, 2008 2:31 PM

Baltimore may just be the worst urban city in America. Have you tried living there? Yes there is some upscale and high-end living being put up downtown and around Johns Hopkins Univ. but the rest is a nightmare. Five people were murdered within a kilometer radius of my apartment before I left and I lived in one of the few managable areas where the police actually did their job and patrolled.

Don't delude yourself into thinking these guys who lost their homes weren't in on the scam too. They saw cheap (at least in their minds) money and ran with it.

Posted by neil | January 8, 2008 2:39 PM

Baltimore may just be the worst urban city in America. Have you tried living there? Yes there is some upscale and high-end living being put up downtown and around Johns Hopkins Univ. but the rest is a nightmare. Five people were murdered within a kilometer radius of my apartment before I left and I lived in one of the few managable areas where the police actually did their job and patrolled.

Don't delude yourself into thinking these guys who lost their homes weren't in on the scam too. They saw cheap (at least in their minds) money and ran with it.

Posted by neil | January 8, 2008 2:40 PM

Baltimore may just be the worst urban city in America. Have you tried living there? Yes there is some upscale and high-end living being put up downtown and around Johns Hopkins Univ. but the rest is a nightmare. Five people were murdered within a kilometer radius of my apartment before I left and I lived in one of the few managable areas where the police actually did their job and patrolled.

Don't delude yourself into thinking these guys who lost their homes weren't in on the scam too. They saw cheap (at least in their minds) money and ran with it.

Posted by neil | January 8, 2008 2:41 PM

I live in Baltimore City. Admittedly, I reside in one of the two exceptions you provide (pretty close to JHU's Main Campus) but it's not as if *everything* else in the city is a disaster.

Unfortunately there are some very, very bad parts of town that tend to get a lot of press. And the city government isn't the most responsive or efficient one out there.

But it's incredibly, ridiculously cheap compared with DC.

Posted by Answer Guy | January 8, 2008 2:47 PM

Neil, I'd like to issue you a formal invitation to come down and visit us here in New Orleans.

Posted by nolaboyd | January 8, 2008 2:58 PM

"contending that its lending practices discriminated against black borrowers and led to a wave of foreclosures that has reduced city tax revenues and increased its costs."

This is almost contradictory in view of the current credit situation. It is essentially suggesting that Wells Fargo wasn't making enough loans by discriminating against black borrowers but that it also made too many loans to people who can't pay and are now in foreclosure.

Technically it isn't a logical necessity that those be exactly the same people, but in practical reality, the city is talking about the same people getting too many loans and not getting enough loans.

Posted by Sebastian | January 8, 2008 3:13 PM

But the subprime mess shows that lenders weren't charging poor people high enough interest, so the obvious effect of trying to crack down on banks is that no poor person will be able to borrow money. Then, five years from now, we'll all read articles wondering why no one will lend to people in poor zipcoed.

This is a prime example of a seemingly good-intentioned policy that will end up screwing the pooor.

Posted by JAD | January 8, 2008 3:16 PM

Hmm, apparently it is a combo plate complaint. Part of the allegation is that minorities were charged higher fees. That part of a 'discrimination' complaint is not logically contradictory at least. Of course the fact that these loans apparently represent a 4X greater likelyhood of forclosure even according to the city, suggests that the fees might have been justified by a greater likelyhood of default.

Posted by Sebastian | January 8, 2008 3:21 PM

I haven't followed the Baltimore story at all, but the larger issue with Wells Fargo is that certain parts of the entity - WF Bank and WF Home Mortgage - make most of their loans in whiter and wealthier communities while they leave another division, WF Financial, to serve poorer and more heavily minority communities.

Since WF Financial charges higher fees and rates as a standard practice, working class people pay higher costs as a result of where they live, regardless of the quality of their credit.

The higher costs charged on these predatory loans (easily hundreds of dollars per month for individual homeowners) are responsible for a large share of the surge in foreclosures.

Posted by Chris | January 8, 2008 3:44 PM

Chris, no, working class people pay more for loans because they have worse credit/less assets. Again, the high unexpected default rates only shows that lenders were probably too loose with money (ie, they should have charged more). Also, no one was twisting these people's arms--if the loans were too expensive as you argue (ie, people can't afford the payments), then the solution is for people not to borrow the money when they can't afford to pay it back.

This problem should work itself out as lenders become more sophisticated in dealing with subprime risks, and as subprime borrowers better understand what they are agreeing to. The surest way to make sure poor people can never borrow money is to start putting all kinds of extra liability on banks when they lend to poor people.

Posted by JAD | January 8, 2008 4:14 PM

Chris, no, working class people pay more for loans because they have worse credit/less assets. Again, the high unexpected default rates only shows that lenders were probably too loose with money (ie, they should have charged more). Also, no one was twisting these people's arms--if the loans were too expensive as you argue (ie, people can't afford the payments), then the solution is for people not to borrow the money when they can't afford to pay it back.

This problem should work itself out as lenders become more sophisticated in dealing with subprime risks, and as subprime borrowers better understand what they are agreeing to. The surest way to make sure poor people can never borrow money is to start putting all kinds of extra liability on banks when they lend to poor people.

Posted by JAD | January 8, 2008 4:15 PM

As Matt suggests, some banks responded to all the discrimination lawsuits they faced simply by staying of minority neighborhoods, leaving them to the bucket shop predatory lenders.

Matt is gingerly touching on the little-discussed fact that a sizable chunk of the subprime crisis was created by the federal government's long anti-discrimination campaign to get more mortgages in the hands of minorities, which is a big reason why black and Hispanic default rates have been skyhigh lately.

Posted by Steve Sailer | January 8, 2008 4:18 PM

Back in the early 1990s, when the federal government was just gearing up for its massive campaign to force financial institutions to lend more to blacks, the default rates for minorities were the same as for whites, showing that the system was working rationally.

Today, blacks and Hispanics have higher default rates, showing that irrational pro-minority discrimination has been injected into the system by federal civil rights pressure.

Posted by Steve Sailer | January 8, 2008 4:22 PM

> Matt is gingerly touching on the little-discussed
> fact that a sizable chunk of the subprime crisis
> was created by the federal government's long
> anti-discrimination campaign to get more mortgages
> in the hands of minorities,

Google "mortgage quality maps" to learn just how far off base this is. "mortgage quality maps, campaign to destroy in government archives" might lead to even more interesting results, although there isn't much available on the web on that subject (see _Crabgrass Frontiers_).

Cranky

Posted by Cranky Observer | January 8, 2008 4:25 PM

One reason Baltimore is so awful these days is because so many whites, like Matt, and immigrants have been moving into Washington DC that lots of homeboys have been squeezed out of gentrifying DC by the higher cost of living. Baltimore is a natural place for them to go.

Posted by Steve Sailer | January 8, 2008 4:26 PM

That's a big reason, by the way, that the DC-NY elites are so much more pro-immigration than the public -- in the two rich and powerful cities, when immigrants move in, African-Americans move out, so the crime rate goes down. (For example, the number of African-Americans in New York City has been declining since 1979). What's not to love?

But the DC-NY elites assume, vaguely, that when immigrants come in, those troublesome African-Americans must be getting deported or something, because they just aren't around as much. In reality, they are just moving to places like Baltimore, but nobody they know lives in Baltimore ...

Posted by Steve Sailer | January 8, 2008 5:04 PM

Who says Baltimore is awful? The Wire is maybe the best TV show ever, but please don't extrapolate from the show's focus on crime and drugs to judge the overall quality of life in Baltimore. Even if I could by my current house in DC for the same $$ I'd stay in Baltimore. At least there is an organic culture here. There's nothing of the sort in DC that I'd want to be part of.

Posted by John I | January 8, 2008 5:06 PM

Steve...you have no idea what you're talking about. Census estimates suggest that Baltimore lost far more blacks than whites betweem 2000 and 2006, meaning that Baltimore is actually "whiter" per capita than it was in 2000.

Posted by Answer Guy | January 8, 2008 5:12 PM

"The only problem with that story is that "banks" (that is, major banks and financial institutions) stopped lending in those zipcodes in the early 1970s and except for a few show loans around the time of charter renewal never restarted - the money was too good in the suburbs. It was only the few local savings-bank type places that still existed that loaned in those regions, and the regulation you describe wouldn't have been much different from their vetting process anyway."

This simply isn't true, at least post-2002 or so (when the pool of homebuyers with good credit started to become insufficient to satiate the demand for CDO products). There is a reason why the Illinois legislature passed the laws it did -- lenders were praying on unsophisticated, lower income homeowners and homebuyers.

Posted by Joe | January 8, 2008 5:38 PM

Sebastian-

It is essentially suggesting that Wells Fargo wasn't making enough loans by discriminating against black borrowers but that it also made too many loans to people who can't pay and are now in foreclosure.

I think the desired policy was that they would lend more to black borrowers but also adopt less strict attitudes about ever getting any of their money back.

Posted by Glaivester | January 8, 2008 7:03 PM