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VOL. 125 | NO. 20 | Monday, February 1, 2010

House of Cards

How risky loans spurred the local foreclosure crisis – and a suit against Wells Fargo

By Andy Meek

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Attorneys Steve Barlow, Webb Brewer and John Relman are representing the city in a lawsuit alleging that Wells Fargo targeted minority neighborhoods for bad loans. Photo: Lance Murphey

It’s a little more than halfway through the first meeting of the state Senate’s Commerce, Labor and Agriculture Committee in 2009, in a nondescript hearing room in Nashville’s Legislative Plaza.

Four bank executives from around the state are seated at a table in front of a row of senators. A line of questioning is about to put the bankers on the hot seat.

Then-committee chairman Paul Stanley, a Germantown investment banker who resigned from the Senate last year in the wake of an intern sex scandal, had personally invited the bankers to attend. He wanted them to share why the U.S. economy very nearly sailed over a cliff a few months earlier.

As the hearing wore on, Stanley and at least one other senator began to hone in on what they thought might have contributed to banks around the country approaching the edge of ruin and subsequently getting billions in public money. Their culprit: a more than 30-year-old piece of federal legislation with an otherwise dull name, the Community Reinvestment Act.

What they wanted to get to the bottom of was whether banks had been strong-armed by Washington into writing mortgages and loaning money to every borrower – even questionable ones – who stretched out their hand. That discussion provides an intellectual framework for a major legal flap that’s unfolded in Shelby County over the past year. It, too, concerns the relationship between borrowers and lenders.

Neither a borrower nor lender be

At the end of December, attorneys representing Memphis and Shelby County governments filed a major predatory lending lawsuit in U.S. District Court.

In a more than 50-page federal complaint, both governments allege Wells Fargo, one of the largest U.S. banks by assets, targeted minority neighborhoods in Shelby County and steered high-cost, predatory loans to those areas.

In theory, that practice is a violation of the federal Fair Housing Act.

The city-county lawsuit paints Wells Fargo as the bad actor. Back in Stanley’s committee room, the discussion was over whether borrowers – and, ultimately, government officials who encouraged near-universal homeownership – bore the responsibility.

Attorneys for the city and county are gearing up to advocate their answer to that question. And they’ve drawn a clear line about which side of the argument they come down on.

While attending the 78th winter meeting of the U.S. Conference of Mayors this month in Washington, Memphis Mayor A C Wharton Jr. met with civil rights lawyers in the U.S. Department of Justice. Among them was Thomas Perez, assistant U.S. attorney general for the Justice Department's Civil Rights Division.

A dilapidated home at 575 Trigg Ave. is one of six Wells Fargo foreclosures within several blocks. Photo: Lance Murphey

Wharton told Perez the “American dream is turning into the American nightmare, and Memphis is a poster child for that.”

“I met with the assistant attorney general pursuant to an announcement that the Justice Department made a week or so ago that it was going to become involved in some of the reverse redlining lawsuits,” Wharton said. “It was my feeling that Memphis is a poster child for those lawsuits simply because of the stark difference between the foreclosure rate in loans made to black borrowers and white borrowers.

“Obviously, it would be inappropriate for me to say one way or the other what his responses were. But the meeting also was to emphasize to him that while I do believe our city and county governments have lost money on this … going forward, let’s try to work out something on a nationwide basis that protects consumers. That was the purpose of the meeting.”

In early 2009, PBS newsman David Brancaccio interviewed Wharton about the lawsuit. At one point, Brancaccio asked whether banks were doing a good thing by going into poor minority neighborhoods, pricing for risk and making loans when no one else was doing so.

Wharton could barely hide his disdain at that thought.

“Oh, how charitable,” Wharton said in response.

He went on to decry the ability of banks to turn a quick buck by writing subprime mortgages to susceptible borrowers and then selling those mortgages to someone else, removing the risk from the bank’s balance sheet.

During a hearing in Baltimore the same month Stanley’s committee summoned the quartet of bankers, lawyers for Wells Fargo were arguing the same issues in court – but from the opposite perspective.

The city of Baltimore in 2008 filed a suit nearly identical to the one pending in Shelby County. The Baltimore court action also targeted Wells Fargo. And Memphis and Shelby County governments are using the same Washington-based law firm of Relman & Dane to litigate the local suit.

Andrew Sandler, an attorney representing Wells Fargo in the Baltimore case, defended the company’s practices during that January 2009 hearing.

“What risk-based pricing is all about is discriminating on the basis of risk and charging risky borrowers more than you charge less risky borrowers,” Sandler said. “The facts of our society are that if you look at credit score, if you look at family wealth, cash to close, any of the things that go into a legitimate risk analysis, minority borrowers tend to disproportionately be in the higher risk element.”

Congress’ goal in passing the CRA was to ensure access to credit even among people in low- and moderate-income neighborhoods. But the Tennessee state senators wondered during Stanley’s commerce committee meeting whether that idea had morphed into an implied mandate from the federal government to loan money even to potentially risky or questionable borrowers.

“Part of my concern with that … is that financial institutions were basically told to loan to people you would not normally loan money to,” Stanley told the bankers in front of him.

A home at 491 Simpson Ave. is one of six Wells Fargo foreclosures within several blocks. Photo: Lance Murphey

Among the group was Tony Thompson, then-Nashville regional president for First Tennessee Bank.


First Tennessee is a subsidiary of Memphis-based First Horizon National Corp., which got $866 million in taxpayer bailout money near the end of 2008.

“Part of that was to try to stimulate people and get them into homes and try to help them out, but the underlying issue is can the borrower pay the money back?” Stanley continued. “How has that impacted (your) institutions?”

Thompson leaned toward his microphone and appeared to choose his words carefully. He alluded to section 802 of the CRA, which encourages banks to help meet the credit needs of their communities in a way that’s “consistent with the safe and sound operation of such institutions.”

“I think the crux of the Community Reinvestment Act is to make credit available to borrowers irrespective of race, color, creed,” Thompson said. “And so the – if we had a regulator here, they would tell you they would not ask you to make a loan to someone who could not pay it back. ... Simply make credit available, regardless of who’s walking into your bank, to those people who can demonstrate the ability to repay. That is the crux of the Community Reinvestment Act.”

Republican Sen. Dewayne Bunch, one of the Tennessee Senate’s most rock-ribbed opponents of government intervention in the marketplace, immediately pounced.

“Do you not already do that?” Bunch chimed in. “I mean, why does the federal government need to come in and tell you to make loans that you can make money on?”

Thompson agreed banks already were extending credit equally, regardless of the CRA. And he shied away from admitting to pressure from the government to make loans.

“So you all put yourself in this position with all these bad loans, then?” Bunch asked. “It’s either one or the other.”

The First Tennessee executive gently pushed back with an answer that appeared to lay the responsibility squarely on the shoulders of lenders.

“Well, if you make a loan, you put yourself in that situation,” Thompson said. “If bad loans were made, we’re the ones that made the decisions.”

That point gets to the heart of the matter in the city-county lawsuit against Wells Fargo, for which both governments have agreed to split the cost of litigating it up to a combined total of $250,000.

Filing the suit at the end of December was the culmination of more than a year of planning and strategizing about how to go about dragging lenders into court whose dubious practices may have worsened the area’s foreclosure problem.

Wells Fargo – A Far-Flung Enterprise

With $1.2 trillion in assets, more than 70 million customers and stock that as of Sept. 30 had a market value of $132 billion, Wells Fargo & Co. today is far removed from the company’s more humble origins.
It was founded in the 1850s, and the company name quickly became synonymous with the stagecoaches it sent thundering across thousands of miles of countryside carrying gold, valuables and a variety of other goods.
In the 1957 Broadway musical “The Music Man,” one character’s song is about whether the “Wells Fargo Wagon a-coming down the street” will bring “curtains or dishes or a double boiler” or “something special just for me.”
Financial innovation turned the page on the company’s past and brought it into the modern era. Today, Wells Fargo’s mortgage division alone serves all 50 states with more than 2,200 mortgage and Wells Fargo bank stores and had mortgage originations by the end of 2008 of $288.47 billion.
– Andy Meek

Starting in 2006, when some of the early warning signs of the housing bust were starting to appear, the number of Shelby County’s residential foreclosures rose about 18 percent from that point through 2008. That’s according to real estate information company Chandler Reports, www.chandlerreports.com. From 2008 to 2009, the number tapered off, falling from 6,209 residential foreclosures in 2008 to 5,539 last year.

As Stanley’s committee session shows, a broad philosophical debate has unfolded over what went so wrong among banks, lenders, homebuyers and others over the past couple of years.

That argument is bigger than the CRA. Because the housing boom was fueled, in part, by writing mortgages for people who could not afford to pay them back, it’s spurred a debate over who is at fault.

In retrospect, the red-hot housing market of even a few years ago now appears largely to have been a house of cards.

The floodgates

Wells Fargo was one of the top four mortgage lenders by volume in Shelby County in 2009, according to Chandler Reports. The city and county’s complaint against Wells Fargo says the company’s foreclosures are concentrated in minority neighborhoods.

The complaint is packed with page after page of statistics like this one:

“In the city (of Memphis), 56.6 percent of Wells Fargo’s foreclosures from 2005 to 2008 were in census tracts that are predominantly African-American, but only 11.5 percent were in tracts that are predominantly white,” the complaint reads. “In the county, 44.9 percent of Wells Fargo’s foreclosures from 2005 to 2008 were in predominantly African-American census tracts but only 22.2 percent were in tracts that are predominantly white.”

Beyond the numbers, there’s an even more basic idea the city and county likely will use to frame their argument. It’s the flash point for the litigation, and it’s only one word long: causality. What caused this loan to this borrower in this neighborhood to result in foreclosure? And, why did this lender make this loan to this borrower in the first place?

Attorney John Relman, who founded Relman & Dane, said he thinks the local foreclosure data will go a long way toward revealing the answers.

“Wells (Fargo) is getting it eight times more wrong in the black community than in the white community (in Memphis),” Relman said the day city and county leaders announced the suit at the end of December. “That just can’t happen in and of itself. What it means is they’re making loans they know at the time can’t succeed. Or they’re pricing people beyond their means or too high.”

Fair Housing Act

Title VIII of the Civil Rights Act of 1968, known as the Fair Housing Act, was signed into law by President Lyndon Johnson in 1968.
Johnson used the assassination of Dr. Martin Luther King Jr. that year as an opportunity to prod Congress to approve the legislation, something King had been associated with, according to historical data from the U.S. Department of Housing and Urban Development.
Among its provisions, the law makes it unlawful “to refuse to sell or rent after the making of a bona fide offer, or to refuse to negotiate for the sale or rental of, or otherwise make unavailable or deny, a dwelling to any person because of race, color, religion, sex, familial status or national origin.”
– Andy Meek

Defending Wells Fargo’s position in court, Sandler said companies need to recover as much of the processing costs of loans as they can. And he said that might mean the cost represents a larger percentage on smaller loans, like the kinds of loans often made in inner-city neighborhoods.

“To suggest that that is indicative of discrimination and that all you have to do is you say, ‘Aha, more minorities in Baltimore get smaller loans than non-minorities. Therefore, this is discrimination under the Fair Housing Act.’ Where do you stop?” Sandler asked. “What’s not discrimination? What business practice out there can a city that's thirsting for revenue by suing companies not go after?”

It’s clear Memphis has suffered in the wake of the housing bust and that a spike in foreclosures is one result of that. Niall Ferguson, a British historian who focuses on financial history, saw the problem firsthand when he came to Memphis a few years ago to research his book “The Ascent of Money.” PBS turned it into a documentary of the same name and broadcast it around this time last year.

At one point during the program, Ferguson is shown standing at the corner of Park Avenue and Getwell Road, studying the check-cashing and payday lending businesses around him.

“On a sultry Friday afternoon, shortly after arriving in Memphis from Detroit, I watched more than fifty homes being sold off on the steps of the Memphis courthouse,” Ferguson wrote. “In each case it was because mortgage lenders had foreclosed on the owners for failing to keep up with their interest payments. “Over the last five years, I was told, one in four households in the city had received a notice threatening foreclosure. … In 2006 alone subprime finance companies had lent $460 million to 14 Memphis ZIP codes. What I was witnessing was just the beginning of a flood of foreclosures.”

Race, creed, color

The city-county lawsuit was brought under terms of the Fair Housing Act of 1968. The act reads, in part: “It shall be unlawful to refuse to sell or rent after the making of a bona fide offer, or to refuse to negotiate for the sale or rental of, or otherwise make unavailable or deny, a dwelling to any person because of race, color, religion, sex, familial status or national origin.”

That idea applies in the reverse. Not only is it wrong for lenders to draw a ring on a map around poor or minority neighborhoods and refuse to write mortgages or make loans in those areas – they also can’t flood those same areas with only bad loans.

A Wells Fargo spokesman told The Memphis News the timing of a response to the city-county lawsuit was uncertain at press time. The fate of the Baltimore suit against Wells Fargo, though, is proving a test case that likely will play a part in shaping how both sides proceed here.

A federal judge has dismissed the existing complaint against Wells Fargo there but said the city has a little more time to come back with an amended complaint. The judge said he wanted to see a brighter line connecting Wells Fargo foreclosures in Baltimore with specific harm they caused.

Relman told The Memphis News they’d be filing an amended complaint in Baltimore soon.

One major plank of the case in Shelby County involves the foreclosure data, which supporters of the court action believe point overwhelmingly in one direction.

“I think we have reasonable grounds for our case,” said Shelby County Commissioner Steve Mulroy, a former attorney in the Clinton Justice Department. “The way one goes about proving this is it’s basically a statistical case. You compile statistics about the types of loans that they did, the ones with the really bad predatory lending terms, what neighborhoods they tended to do them in, and you can graph this.”

The city and county attorneys are still a long way from winning the day. At the moment, they are approaching the problem the same way someone would who’s trying to find out how people who’ve all gone to the same restaurant are coming down with food poisoning. They’re targeting the source. A judge will decide if their approach is valid.

The local suit will rely in part on testimony from two former Wells Fargo employees from Virginia and Maryland. They claim to have knowledge of Wells Fargo targeting minority neighborhoods in Shelby County for “abusive subprime practices.” One way “was to target the marketing of its subprime products to predominantly African-American ZIP codes in the city and county, while not targeting white ZIP codes,” the suit reads.

One of the two witnesses claims to have heard employees in Wells Fargo’s Mortgage Resources division “comment that white areas are not good for subprime loans.”

After Baltimore’s current complaint against Wells Fargo was dismissed earlier this month, Cara Heiden, co-president of Wells Fargo Home Mortgage, described it as a rejection of the claims against the lender. It’s a viewpoint they’ll likely bring to Memphis.

“From the beginning, we have consistently maintained that Baltimore’s economic problems could not be attributed to the small number of foreclosures Wells Fargo has done in Baltimore,” she said in a statement.

The suit against Wells Fargo in Memphis is still at an early stage, and so is the larger work of identifying and learning from the causes of the housing bust. 

Bank executives themselves are beginning to enter the fray, putting their own stamp on an explanation in books and public speeches. The remarks of former Wall Street titan Richard Kovacevich at a day-long program in March 2009 hosted by the Stanford Institute for Economic Policy Research offer one example.

“What is different (this time) is that all the previous banking crises generally started with the banks’ customers having problems due to macroeconomic issues and the economic cycle,” Kovacevich said. “This eventually led to credit problems and the write-downs of loans and assets.

“This time, financial institutions themselves caused the problem. … Let’s be honest. This problem was caused by a total disregard by financial institutions’ management of basic risk management fundamentals, even common sense, coupled with a serious lapse in ethical behavior. It was fueled by greed, unchecked by regulatory authorities, and reached an unprecedented scale due to the breakdown in previously reliable third-party safety valves. Namely, rating agencies.”

Kovacevich stepped down at the end of 2009 as chairman of Wells Fargo.

PROPERTY SALES 41 308 2,265
MORTGAGES 47 379 2,607
BUILDING PERMITS 128 1,018 6,068
BANKRUPTCIES 53 255 1,787