Subprime Communities: Reverse Redlining, the Fair Housing Act and Emerging Issues in Litigation Regarding the Subprime Mortgage Crisis

Raymond H. Brescia* , Visiting Professor of Law, Albany Law School 

Subprime Communities: Reverse Redlining, the Fair Housing Act and Emerging Issues in Litigation Regarding the Subprime Mortgage Crisis originally appeared in the Albany Government Law Review and is available at 2 Alb. Gov’t L. Rev. 164 (2009).

       As the nation struggles to find its bearings in the current financial crisis and venerable pillars of Wall Street crumble, hundreds of billions of dollars will be spent to shore up the financial system and re-capitalize credit markets.  The spark that lit the blaze was the collapse of the subprime mortgage market, a daisy chain of inflated assets, speculative fervor, investor exuberance and unregulated and unchecked excess.  While the eyes of Washington are directed toward Wall Street, there is much talk of the need to prop up Main Street as well, and nowhere is this more apparent than in communities and neighborhoods across the United States that have felt the first wave of the financial crisis hit: home upon home of foreclosed properties, abandoned and neglected, their hollow silence hard to ignore.

       Many of these communities are communities of color.  Lured by the temptation of credit, an economic necessity all-too-often denied such communities in the past, many found themselves saddled with unaffordable loans and backbreaking debt.  Much of the rise in the homeownership rate in the United States over the past ten years was fueled by a rise in that rate among African-Americans and Latinos, a product of the expansion of the subprime mortgage market. As a result, as many subprime borrowers fall into delinquency and foreclosure, since a disproportionate share of such loans were made in communities of color, a disproportionate share of the foreclosures will also fall on such communities.  With that will come a parade of harmful consequences: abandoned homes, reduced property values, increased crime and a loss of equity and assets.

      Municipalities across the United States are trying to develop effective responses to the fallout in their communities from the collapse of the subprime mortgage market, funding housing counseling programs and foreclosure mediation and regulating the maintenance of foreclosed and abandoned homes. Another intervention that may prove promising is the prosecution of affirmative civil actions, designed either to punish lenders who allegedly engaged in discriminatory subprime lending practices or those failing to maintain their portfolio of foreclosed homes.  A case of the first type has been filed in Baltimore;3 cases of the second type have been filed in Cleveland and Buffalo.4

       In some ways, these cases are innovative.  They are brought by cities, rather than individual borrowers, to rectify or mitigate the harms caused by subprime borrowers in those cities’ constitutive communities.  In others, they are consistent with efforts of private actors to bring such litigation in this and other contexts.

       This article is an attempt to assess the challenges faced by litigants, including municipalities, when bringing actions to remedy acts of past discrimination in the subprime mortgage market.  The first case brought on behalf of a municipality as a whole was filed in early January 2008, by the Mayor and City Council of Baltimore, to remedy the impacts of what is alleged to have been discrimination in subprime lending within city limits. Baltimore, whose low- and moderate-income communities of neat row houses owned by working class homeowners have been ravaged by foreclosures generated by unaffordable subprime loans, has sued the largest lender in the Baltimore market, Wells Fargo, alleging racial discrimination in the marketing and selling of subprime home mortgages.

       This article reviews some of the emerging issues in discrimination law, as there is a growing body of lawsuits directed at “reverse redlining,” the practice of targeting borrowers of color for loans on unfavorable terms. As the following discussion shows, courts are struggling with the problems posed by reverse redlining and the challenges it raises to existing anti-discrimination jurisprudence.  A first wave of cases was filed in which allegations of reverse redlining were raised, and the courts’ handling of such cases attempted to develop a new approach to such allegations, one that departed from existing anti-discrimination approaches to lending discrimination in some significant ways.  A second wave of such cases, detailed below, appears to utilize, effectively, existing anti-discrimination jurisprudence in assessing the legality of reverse redlining practices.  The argument central to this piece is that this jurisprudence is useful to combat reverse redlining, and litigants and the courts should learn well from this second wave of cases that have been successful in addressing the unique challenges posed by reverse redlining allegations.  Although some tensions within anti-discrimination doctrine still exist, and these tensions are outlined in detail below, it is still the case that existing anti-discrimination frameworks are effective in combating reverse redlining and should be utilized to do just that.   

       This article is structured as follows: In Part I, I will describe the impact of the subprime mortgage crisis on municipalities across the country due to rising foreclosures and the increasing number of neglected and abandoned foreclosed properties within city limits.  This section will conclude with an overview of the impact of subprime lending on communities of color.  In Part II, I will describe the allegations and claims raised in the Baltimore litigation.  In Part III, I will describe the state of the law with respect to the Fair Housing Act’s ability to address the extension of loans on disadvantageous terms to borrowers of color and other protected classes.  In Part IV, I will assess emerging issues in anti-discrimination law with respect to the challenged lending practices, with a prescription for how courts can best address the Baltimore litigation and other, similar lawsuits that might be filed in the future, either by municipalities, state attorneys general or private litigants. Continue reading “Subprime Communities: Reverse Redlining, the Fair Housing Act and Emerging Issues in Litigation Regarding the Subprime Mortgage Crisis”

The Bailout Bluff that Saved Wall Street

Eric Schillinger, Editing Chair, ESchillinger@albanylaw.edu

In the wake of September’s now infamous banking collapse, New York State Governor David Paterson played an instrumental role in saving the world’s largest insurance company from bankruptcy and staving off a total collapse of the market. New York based American International Group (A.I.G.) nearly filed bankruptcy on September 15 after the declaration of bankruptcy by Lehman Brothers, and sale of Merrill Lynch to Bank of America for a price roughly half its estimated value twelve months ago. (1)  The market began dropping at a rate frightening to the average investor and high stakes financial planner alike. (2)  Paterson intervened, restoring a modicum of stability in the economy, and freezing the market before its downward spiral went out of control. (3)

Amazingly the bailout Paterson proposed was a bluff, halting the collapse, but not actually bailing out anything. Paterson’s “subsidiary restructuring” plan simply steadied the market’s invisible hand, buying time for A.I.G., while he devised a broad strategy to combat the harsh realities of a market suffocated by foreclosure. The bailout plan Governor Paterson proposed for A.I.G., would have allowed the insurance giant to collateralize its subsidiary holdings, in an effort to obtain needed loans and stave off bankruptcy. (4)  All in all, the deal would have unlocked over twenty billion dollars in capital for the insurance company, presently held by A.I.G. subsidiaries; essentially the governor suggested the state would allow A.I.G. to raid its subsidiaries for cash. (5)  Funds not previously available to A.I.G. would have been liquidized for use as collateral, putting A.I.G. subsidiaries on the line, but allowing the huge corporation to stay afloat. (6)

The substance of the plan was less important then the fact that a plan existed. By placing the state in the center of the collapse, the governor helped to slow down the downward spiral sparked by the collapse of Lehman Brothers. Patterson’s plan restored trust in the market, showing that, while the government might let the situation get bad, it would not stay uninvolved in the face of system-wide collapse. This action bought Paterson time, and with total disaster staved off for the moment, to move past his initial plan and draw the Federal Reserve into the mix. (7)  With the collapse at least on pause, the governor sent New York State Insurance Department Superintendent Eric Dinallo to negotiate with the Federal Reserve. Dinallo secured a Federal loan for A.I.G. totaling more than eighty billion dollars. ( 8 )  That loan would never have happened without the state first stabilizing the market. Just like private investors, the federal government was unwilling to throw money at a terminally ill market. (9)  Paterson put the market in stable but critical condition, and showed the Federal Reserve a capital injection would likely restore the market to relatively good health.

Amazingly, Paterson’s authority to “bailout” A.I.G under the proposed plan violated the State’s Insurance Law. (9)  The state bailout system presented by Paterson and Dinallo emphasized the fact that no tax payer money was going to A.I.G. (11)  Under the Paterson plan, capital would have been generated by A.I.G. restructuring itself to produce liquid funds. In effect, the state offered to allow A.I.G. to loot its own subsidiaries to stave off bankruptcy, in blatant violation of New York State Insurance Law § 1608. That section of the code states in part that:

The business operations, corporate proceedings and fiscal and accounting records of subsidiaries organized or acquired pursuant to this article shall be conducted or maintained so as to assure the separate legal and operating identities of the parent and subsidiary . . . . (12)

The bailout plan that Paterson proposed would have allowed A.I.G. to pull capital out of its subsidiaries solely for the purposes of generating collateral to borrow more money and keep the company running. Doing so would have obliterated the separate operating identities of the companies, as A.I.G. would have been reliant solely on its subsidiaries as a source of operating capital. With all the money mixed, the critical but sometimes fine line between parent corporation and subsidiary would have evaporated. However, the legal validity of the plan was of no consequence. Implementation took a back seat to involvement – by showing that the state was not going to let the market collapse without a fight, investors developed a restored sense of stability. With stability restored, Paterson had time to figure out another means of bailing out A.I.G. that was both legal and effective. The initial plan bought him time, and with that time he enabled the Federal Reserve’s involvement, eventually securing over eighty billion dollars in bailout money for the injured insurance giant. (13)

Essentially, the governor stalled the market’s collapse for one critical day by merely proposing a state-based regulatory bailout of A.I.G. With the market stabilized, Paterson bought enough time for Eric Dinallo to seek and secure federal aid. When eighty five billon dollars in aid from the Federal Reserve came down the pipeline, Paterson’s proposed plan became unnecessary. The legal issues surrounding it were mooted – A.I.G. never actually restructured its subsidiaries, instead they took a high interest loan directly from the federal government.

Paterson’s plan was successful because it was never implemented. The governor over-reached his authority in offering to allow A.I.G. to restructure itself and draw capital out of its subsidiaries, but in an amazingly frail market, a functional sounding but potentially illegal legal bailout plan saved the day. By demonstrating New York’s willingness to help prevent enormous corporate collapses, Paterson generated enough trust to create market stability when no other factors encouraged it. With the collapse frozen, Paterson had the time he needed to secure a functional and legal bailout of A.I.G. from the Federal Reserve. In effect, he offered a bluff of a bailout, holding the market at bay just long enough to get the federal government involved to save the day.

Robert Magee, _____________ editors.

____________________________________________________________________________________

1 – Andrew R. Sorkin, Bids to Halt Financial Crisis Reshape Landscape of Wall St., N.Y. TIMES, Sept. 15, 2008, at A1.

2 – Id.

3 – Posting of Irene J. Liu to Capital Confidential, http://blogs.timesunion.com/capitol/archives/8720 (Sept. 15, 2008, 12:48 EST).

4 – Id.

5 – Id.

6 – Id.

7 – Press Release, Boards of Governors of the Federal Reserve System, Federal Reserve Board, with full support of the Treasury Department, authorizes the Federal Reserve Bank of New York to lend up to $85 billion to the American International Group (AIG) (Sept. 16, 2008 ) (stating that the Federal Reserve was providing an $85 billion dollar bailout to A.I.G.) available at http://www.federalreserve.gov/newsevents/press/other/20080916a.htm.

8 – Michael Gromley, N.Y. Gov. Paterson Praises Insurance Chief Dinallo on A.I.G. Rescue, INSURANCE JOURNAL, Sept. 18, 2008 available at http://www.insurancejournal.com/news/east/2008/09/18/93807.htm.

9 – Liu, supra note 4.

10 – N.Y. INS. LAW § 1608 (2008 ).

11 – Liu, supra note 4.

12 – N.Y. INS. LAW § 1608 (a) (2008); see generally Counties of Warren & Wash. Indus. Dev. Agency v. Adirondack Res. Recovery Assocs., 283 A.D.2d 846, 849 (N.Y. App. Div. 3d Dep’t 2001) (discussing separate identities of corporate parents and subsidiaries).

13 – Federal Reserve Board, supra note 7.