Monday, August 27, 2012

It Just Isn't Fair....(What Disparate Impact Rulings Really Mean)

On July 12, Wells Fargo Bank, the nation's largest mortgage lender, agreed to pay $175 million to settle DOJ accusations that it had steered black and Hispanic borrowers into high cost subprime loans to earn higher points and fees.  The bank did not admit wrong-doing, but faced with the prospect of going to court against the DOJ's Civil Rights Division, the bank agreed to pay the settlement.  The next day, they announced the closure of their wholesale division which had allowed mortgage brokers to wholesale loans to the bank.

The DOJ's Civil Rights Division, led by assistant attorney general Thomas Perez, did not prove that Wells Fargo had intentionally discriminated against minority borrowers.  However, they did not have to prove such discrimination because they based their case on a legal theory called disparate impact. As opposed to policies that are designed to discriminate against minorities, policies that unintentionally discriminate or that have the unintentional effect of causing minorities to receive less favorable terms that non-minorities are covered under disparate impact rules.  In the Wells Fargo case, the government never proved that the bank had any policies in place which openly discriminated against minority borrowers or which encouraged others to so.  They didn't have to prove that.  All they had to do was take a random sampling of broker loans in high-minority population cities and determine that these loans--on the whole--featured higher interest rates and fees than non-minority loans in the same area, and then determine that Wells Fargo's policies overall had a disparate impact on minority borrowers, even though only 5% of Wells Fargo's loans were brokered so the sampling was far from representative of their overall portfolio. No other factors--for instance, borrower credit history--were considered in the disparate impact decision.  For an excellent description of the DOJ's philosophy of discrimination overall as well as their specific handling of this case read this National Legal and Policy Center paper on how the Civil Rights Division interprets discrimination.

The Consumer Financial Protection Bureau has also announced that it will be looking for examples of discrimination and taking action against cases of disparate impact. Further the agency will apply disparate impact standards to student loans and credit cards as well as mortgage loans. For more on this see

Those of us in mortgage lending are still feeling the fallout from the disparate impact settlement.  The primary issue in this case was whether brokers in certain areas were steering borrowers into subprime loans.  Since subprime no longer exists, this can no longer be an issue--right?  Wrong.  In an industry where more and more the federal government is dictating income, lenders are now having to look at their contracts with individual brokers to make sure that those contracts are indeed fair to the borrowers.  And in light of the disparate impact settlement, the only way to make the contracts fair is to make them uniform. 

In April of 2011, the Federal Reserve implemented a new loan originator compensation system which dictated that loan originators could be paid either by the borrower or by the lender but not by both. Further, in the interests of making sure that borrowers were not being steered into higher interest rate loans, the government mandated that each originator had to sign a contract with the lenders with whom he works establishing a pre-determined percentage of compensation for each loan he brokers for a set period of time. For example, if I want to broker loans to Lender X, I must have a contract which is usually in place for 90-120 days, stating that on each transaction on which I am paid by the lender, the percentage of payment I will receive will be X%.  That percentage cannot vary based on the terms of the loan--credit score, debt to income, etc.  Virtually all lenders have a cap which does not allow brokers to exceed 3% at most--in many cases compensation is limited to 2.5%, but many brokers have chosen smaller percentages so that they can remain competitive in their marketplaces.  Brokers are encouraged to set the same percentage of compensation with each lender they represent so that they cannot be accused of steering borrowers to higher interest rate loans.  Therefore, the theory goes, if you apply for a mortgage loan with me, and I am being paid exactly the same rate by each lender I represent, I do not personally benefit from sending you to one lender vs. another; and I must therefore be making my choices based on what is in your best interests.

The anti-steering provisions were designed to be "fair"--to make sure that all borrowers applying for a loan are treated equally.  The problem is, of course, that treating everyone equally only applies to each individual business where the borrowers have applied.  So if I see 10 prospective borrowers in a week, I will treat them all exactly equally since I am compensated at exactly the same rate for each loan that I close, and for each loan that I do not close I am not compensated at all.  However, if a borrower comes to me and gets a good faith estimate and then goes down the street to ABC mortgage and gets a good faith estimate with a different rate and different fees, even though ABC mortgage just happens to sell to the same lender I sell to, then according to the theory of disparate impact, the borrower has not been treated fairly.  I may treat each borrower who comes through my door exactly the same as every other borrower and ABC may treat each borrower who comes through their door exactly the same as every other borrower, but unless ABC and I treat each borrower exactly the same as each other, we and the lender we represent are guilty of "unintentional discrimination."

To address this problem, lenders are now changing compensation models so that rather than brokers determining the level of compensation they want or need to make in order to remain competitive in their markets, the lender sets the level of compensation it is willing to pay based on regions of the country.  For example, one of the lenders with whom I work is setting up regional compensation for brokers in the region covering Texas, Oklahoma and Louisiana.  This way all brokers working in this region will receive exactly the same pre-determined compensation from the lender.  Other lenders have announced that they will no longer permit borrowers to pay the broker directly--all pay must come only from the lender at the pre-set rate to insure that there is no disparate impact.

There are some obvious problems with this approach, however.  One of the most obvious is that the government can carry this issue of "fairness" and "unfairness" to whatever degree they choose.  For instance, who is to say that if lenders pay brokers in the New York/New Jersey region on a differing scale than those in the Texas/Louisiana/Oklahoma region that this differing pay has not had a disparate impact on the people in one of those regions? Further, why should borrowers be subjected to differing interest rates by different brokers representing competing lenders?  Isn't the job of the broker now to make sure that the borrower gets the best deal possible?  The borrower does not see the end lender until closing, so they are dealing only with the broker.  Why should some brokers be allowed to earn more more money than others just because they have relationships with lenders who are willing to pay them more?  Isn't that unfair? 

Because of the nature of disparate impact, the government never has to prove real discrimination; they have only to show through statistical data that actions produced differing outcomes for different groups of people, and this is a dangerous road to go down.  First, in order to correct these inequities, we can put the federal government in the position of setting and regulating private business agreements and private compensation.  This is particularly important at a time when Obama administration insiders have indicated that in his second term he wants to regulate private market compensation for people working in private industry based on the value of a job rather than what the market will bear. Using these standards, the government can set and cap compensation based on arbitrary standards of fairness.  Arguably, the janitor of a Fortune 500 company has a physically more difficult job than the CEO--certainly a more unpleasant job.  So why should the CEO be paid more and the janitor less?  Might it not be discriminatory to give higher compensation to people with more education, training and experience and less compensation to those who perhaps work very hard but have not had as many opportunities as their better-paid colleagues?  Why not pay everybody the same no matter where they work?

Ridiculous?  Yes, but it may not be that far from becoming reality.  The mortgage industry has been a proving grounds for some of the most radical invasions into private enterprise that our country has ever seen.  If the federal government can dictate how much we earn based on arbitrary standards of fairness, than ultimately it can apply those same standards to any industry and any employer.  The government can dictate the terms of private employment contracts, the costs of good and services, and even how much profit retail stores are allowed to earn.  In short, when "fairness" becomes the standard, there are no limits to the intrusions by the feds that are possible and even probable.

Life is not fair--outcomes are certainly not fair.  Attempting to guarantee that everyone experiences an equal outcome merely guarantees that no one has anything.  That is not the American system.  In a free enterprise system we believe in equality of opportunity but never equality of outcomes.  That takes away freedom of choice and freedom to make decisions--both of which are at the heart of a free society.

We have an election coming up in about 70 days.  That election is going to determine whether we restore the free enterprise system or we become more and more deeply enmeshed in a system where the federal government, in the name of fairness, dictates everything we are allowed to have, to earn and to keep.  Personally, I am counting the days until I go down to my local polling station and cast my vote for the Romney/Ryan ticket and against socialism.  I hope that at least 51% of my fellow Americans are willing to do the same.  Otherwise, we are going to wake up on November 7 in a country where capitalism and free enterprise are just distant memories and all of our decisions are subject to question by the arbitrary standards of Washington bureaucrats.

Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. Her newest novel, The Planner, about an out-of-control, environmentally-driven federal government, was released June 28, 2012. For more information, visit her website at
Frontier 2000.

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