CFPB, HUD Risk Litigation Over Fair Lending Enforcement

With regulators in blinders, lenders and lawyers are spooked, though. The SFFA decision raises questions as to whether, and to what extent, race should play a role in mortgage companies’ hiring and lending decisions. As an attorney representing independent mortgage banks (IMBs) and mortgage lenders in their negotiations with the Consumer Finance Protection Bureau (CFPB) and the Department of Justice (DOJ), Casseres says regulators are blurring the line between redlining allegations and demands for lenders to engage in race-based lending, either in defiance or ignorance of existing fair lending laws and June’s SFFA ruling.

Watch it on The Interest: A Complex Fair Lending Environment

Lacking guidance, lenders are trapped in the lobby, unable to exit regulatory revolving doors. 

Joshua Thompson, director of equality and opportunity litigation at the Pacific Legal Foundation (PLF), a public-interest legal organization that exclusively sues the government, believes federal agencies may soon have to defend their own race-based programs. “We’re in a day where we are experiencing the vestiges of sort of historical societal discrimination,” he says, “and I don’t think that those types of programs, if that is the sort of basis that the government is justifying race-based programs on, will survive after SFFA.” Fundamentally, generalized historical discrimination and ongoing racial disparities do not justify state-sponsored discrimination on the basis of race in any aspect of American life and business, says Thompson.

Meanwhile, Dan Morenoff, executive director of the American Civil Rights Project (ACR Project), a public-interest legal group that advocates for limited government and individual rights, says that he knows of “large lenders who have discriminatory programs that are being looked at quite actively.” Morenoff also says that “there are a whole lot of federal programs which treat races differently and those are, at the very least, problematic and subject to questioning.”

The cold, hard fact of the matter is, Casseres says, “It’s yet to be tested in lending.”

The Diversity Rationale

When people talk about the “overturning” of race-based affirmative action in college admissions, “our general rule that you cannot classify people on the basis of race and you cannot make racially based decisions,” explains Morenoff, “had this narrow exception out of deference to the educational expertise of the people running our institutions of higher education.” The June SFFA decision narrowed that exception for race-based affirmative action in college admissions even further, rendering the carve-out “overturned.” 

Legally, the “diversity rationale” upheld by the Supreme Court in the 2003 case, Grutter v. Bollinger, to allow for race-based affirmative action in college admissions, never provided a justification for race-based decision-making in other areas of business. Instead, the Grutter exception has been widely interpreted as a “generalized trump card for our non-discrimination laws,” Morenoff says. Those laws remain as in force as they ever were, he adds.

What the SFFA decision helps to underscore is how broadly entities across American politics and business have misread and misapplied that “diversity rationale.” In May 2022, the Hamilton Lincoln Law Institute, a public-interest law firm dedicated to protecting free speech, free markets, and limited government, filed an amicus brief in support of Students For Fair Admissions cataloging how that expansion has occurred, such as through race-based decisions outside of the admissions process at universities, the return of racial considerations when assigning students to K-12 public schools, and a diversity justification for the appointment of class counsel in federal courts.

“That’s not tenable now,” Morenoff claims. “Honestly, it wasn’t tenable before, but there were a lot of institutions that seemingly had accepted that there was this global exception to non-discrimination law, which was never actually there.” 

The Supreme Court’s SFFA decision serves as a reminder that the manner in which businesses and government entities pursue increased diversity matters. In SFFA’s aftermath, programs that violate equal protection clauses may find themselves under greater scrutiny. “Not only is the diversity rationale not a basis for an exception to employment law,” Morenoff says, but, “if you’re relying on it, you’re more or less admitting that you’re intentionally violating federal employment law.” 

Thompson agrees, citing actions taken by a number of elite U.S. law firms to remove mentions of race, gender, and sexuality from their DEI-oriented recruitment and advancement programs. “It’s a signal by the court and by litigants that we’re not going to tolerate this any longer. It’s their time to step up and hold these institutions to what the law requires them to abide by.”

Government Programs At Risk

Soon, the government may have to defend its own race-based programs, Thompson says. He strongly suggests that lenders do not thumb their noses at regulators but maintains that “we are sort of at the precipice of seeing a lot of these race-based requirements go away because they are unconstitutional.” Until that happens, however, the scrutiny of regulators can cripple lenders at a time when many have been in survival mode for eight straight quarters. 

In the SFFA decision, Thompson explains, the Supreme Court makes clear that only two state interests justify the government’s use of racial classifications: to stop race riots in prisons and to remedy specific instances of past racial discrimination. Presumably, those two state interests are the thresholds to pass anytime the government wants to discriminate on the basis of race.

How government funds are assigned and utilized also complicates the legality of race-based programs. In September 2023, the Department of Housing and Urban Development (HUD) awarded the City of Birmingham, Alabama, a $25.2 million loan guarantee under HUD’s Community Development Block Grant Program, Section 108, meaning funds are intended for “economic and community development projects that primarily benefit low- and moderate-income persons.” The City of Birmingham intends to use the loan pool for projects that will “support investments in communities and neighborhoods of color, and provide financing to Black, Indigenous, and people of color-led developers, businesses, and organizations.”

Remedy Disparities

Any race-based government programs that Thompson sees are not designed to remedy particular instances of past discrimination, but “to remedy disparities in lending practices or general societal discrimination that they view as more historical.” The extension of non-discrimination and fair lending laws to justify expansive, quasi-remedial, race-based programs is vulnerable to being questioned and litigated. Necessarily, Thompson thinks the burden should fall on the government, not markets or borrowers, to justify the existence of those programs in keeping with those laws allowing for narrow exceptions. 

Thompson calls it “perfectly sensible” that no one, no matter their racial or ethnic background, should want the government to enact racially discriminatory policies untethered to specific instances of discrimination, especially – and ironically, I’ll add – given the government’s long history of racial discrimination. “If the government is going to discriminate against people,” he concludes – and ironically, I’ll add – “it better have a damn good reason to do so.”

To those who argue that racial discrimination in the U.S. is not only historical but institutional, therefore systemic, and therefore ongoing, continuing to produce disparate outcomes for minorities in almost every corner of American life, society, and business, Thompson says, “the Supreme Court is pretty clear that that’s not enough to enact a race-based program.” To those who argue not all racial discrimination is identified or easily identifiable, especially by private dealings, Thompson says that a reliance on top-down government intervention only lets private actors who discriminate off the hook by “putting sort of a corollary discrimination on top of the discrimination that’s already ongoing.” 

Entities that discriminate should be made not to through the government’s enforcement of existing non-discrimination and fair lending laws, he says. However, a historical lack of guidance around existing non-discrimination and fair lending laws, particularly for non-bank lenders, is undermining regulators’ attempts to enforce those laws now, says Mitchell Sandler’s Casseres.

The Regulatory Revolving Door

Casseres is seeing an uptick in DOJ referrals for redlining and discriminatory lending practices, even just in the community of lenders she serves. Though redlining and racial discrimination are statutorily separate, she clarifies, between the SFFA decision and regulators’ increasingly aggressive enforcement actions, “one begets the argument for the other.” 

Ironically, though, Casseres sees regulators struggling to bring strong cases of redlining against non-bank mortgage companies. How and whether such companies, as non-depository institutions, should be examined for redlining remains up for debate.

Referring to the SFFA decision, Casseres explains, “If the Supreme Court has ruled that you can’t make decisions about where students attend school, where it really is like, ‘one person in, one person out,’ like somebody didn’t get that spot because you made a race-based decision, I don’t know how the government could step in and say, ‘Well, you have to make race-based decisions on lending,” not to mention decisions in hiring and marketing, as in the case of ongoing litigation between the CFPB and Townstone Financial Inc., an independent mortgage lender based in Chicago (see sidebar). 

The challenge facing these companies, Casseres says, is that “very few” are willing or financially capable of litigating against the federal government. Casseres expects “we will start to see a lot of settlements very soon in this space because a lot of IMBs, particularly now when the market’s not strong, would just rather settle it, and put it behind them than think about litigating against the United States government, with unlimited resources on the other side.” 

Which settlements, then, represent legitimate cases of redlining, and which represent government overreach? “I have been a part of very few investigations where I have actually seen documentation proving intentional redlining,” Casseres says. “There is, in the settlements, a lot of circumstantial evidence about the political views or potentially personal views of the individuals that are involved in sometimes loan origination, sometimes not even really dealing with borrowers. I have not seen documentation that, like, specifically points to the fact that, meant that they were intentionally avoiding trying to get business from any areas.” 

In fact, Casseres says she usually sees the opposite: most salespeople just want the sale, no matter where the loan comes from. 

“If there was documentation showing a prospective applicant was considering applying for a mortgage but didn’t apply because somebody made some sort of racial commentary to them,” Casseres posits, “I think that would be legitimate.” But, she continues, “I haven’t seen much of that, to be honest.” Instead, what she sees at IMBs are emails between employees with similar political views, or else, inboxes full of spam about controversial issues. Having employees with those views does not entail discriminatory lending or a discriminatory company culture.

Recently, though, Casseres is seeing more pushback from clients as regulators grow more aggressive. “People are just starting to get more emboldened about how to defend themselves,” she says, explaining the shift, “because somebody has to.” The SFFA decision portends a worrying spiral, though. Casseres expects pressure from regulators and the GSEs to lend in specific geographic areas to increase, “and potentially to even lend based on race or ethnicity.”

Where Does The Buck Stop?

With the SFFA decision in mind, it is “very possible” that the CFPB could “now come back and question race-based lending programs under this new light,” says Casseres. “There is nothing in the law that technically prevents them from doing that,” raising the question: are lenders liable for engaging in race-based lending if regulators encourage them to do so?

That legal question hasn’t been tested in lending. Direct liability for racial discrimination depends on which non-discrimination or fair lending law has allegedly been violated and the entity that brings the lawsuit, says the American Civil Rights Project’s Morenoff. A borrower could claim in a lawsuit, he says, that the regulatory carve-out for race-based, special purpose credit programs, allowed for under the ECOA, is unconstitutional. 

Alternatively, Morenoff says the mortgage industry should be paying close attention to “Section 1981” of the Civil Rights Act of 1866, which prohibits racial discrimination in contracting, such as for employment or loans. “If you are trying to avoid potential liability, you should not assume that you can engage in any race-based contracting, not internally, not externally.” 

Instead, lenders should adopt the standing presumption that all race-based decisions involving contracting are illegal, which would include contracts for employment and mortgage lending. Here, the regulatory carve-out that allows for race-based lending programs under the ECOA appears particularly vulnerable, says Morenoff.

The Fair Housing Act (FHA), administered by the Department of Housing and Urban Development (HUD), includes a blanket ban on racial discrimination in mortgage lending, which the ECOA reiterates with one important distinction: the ECOA has an exception that allows lenders to engage in race-based lending if regulators approve. This carve-out provides only the shakiest of foundations for the government to approve race-based lending, Morenoff thinks. 

He reads the ECOA exception like this: “You may put in writing a program to allow you to discriminate based on race if you think that it would improve the access of a group that would otherwise not be so good to credit, and you’re doing so not to get around the generalized prohibition on discrimination based on race. But, you’re only ever writing that because you’re creating a program to discriminate based on race.” As the regulation is written, “literally nothing” can qualify, he says. “Is that constitutional? There’s a very strong argument that it’s not.” 

Even more problematically, Morenoff adds, is how HUD administers the FHA by piggybacking off of the CFPB’s regulatory carve-out in the ECOA. He cites a guidance document published by HUD in 2021 that effectively hangs HUD’s regulatory hat on the CFPB’s statutory peg. “It’s very hard for me to imagine how that guidance document from HUD could possibly withstand scrutiny if that ever gets litigated,” he says. “But again, you have to actually have someone litigate it.”

Think Geographically, Not Racially

Until such issues are litigated, Casseres recommends that lenders pay attention to how regulators are thinking – and start to think like them. 

Casseres has recently been fielding questions from lenders about the legality of special purpose credit programs (SPCPs) in light of the Supreme Court’s SFFA ruling. She tells clients that SPCPs remain an effective way to penetrate markets that are historically underserved. “But, they may consider eliminating race and ethnicity as part of the program, and instead focus on a geography which will capture certain specific races and ethnicities.” 

Similarly, Casseres suggests that lenders who want to hire more diversely should think geographically, not racially. Geography often correlates to race, ethnicity, or religion, but it doesn’t have to. “It’s more inclusive than that,” she explains. Lenders who do 80% of their lending to Hispanic borrowers could consider recruiting within the geographic areas where that 80% of lending occurs, instead of thinking they need to hire more Hispanic loan officers. 

That’s easier said than done, though, because “pretty much every CEO” that Casseres talks to whose company has been the target of a redlining investigation says recruiting minority loan officers to serve underserved areas is the most challenging issue they face. 

“There are tools that you can use to figure out who’s doing the most loans in those areas,” independent of race or ethnicity,” Casseres says. By trying to target those loan officers, “more than likely,” she continues, “they will correlate to being Hispanic or Black loan officers.”

Casseres cautions lenders and regulators who think SPCPs are the silver-bullet solution for increasing lending to underserved groups in underserved areas. Assuming SPCPs are the most effective method leaves other tools underutilized and underfunded. Lender credits, down payment assistance programs, and inventory shortages are crucial areas needing attention. 

“I’m just not sure that all this back and forth, and all this agency enforcement is actually effectively getting people to lend more in these areas.”