The New Redlining

It's different from the old, but minorities are still getting shortchanged

April 17, 1995

By Penny Loeb, Warren Cohen and Constance Johnson

Above the blighted neighborhood of North Philadelphia in Germantown, George and LaVerne Butts purchased an abandoned house seven years ago. It was something of a beachhead. Banks weren't making loans in the North Philadelphia area, but the Buttses persuaded them to try. They had the law on their side. The law was called the Community Reinvestment Act. Passed in 1977, the CRA requires banks to meet the credit needs of their entire communities -- rich or poor, white or black. The law permits citizens to protest a bank's community lending record and win agreements for more loans. That's what the Buttses did. And thanks to their efforts, some 200 abandoned houses nearby are home now to families. Children play in the yards. The mortgages get paid on time.

But the 18-year-old act has also generated plenty of controversy. Republicans have introduced bills in the House and Senate that would exempt nearly 88 percent of the nation's banks from the CRA. Supported by banking groups, GOP leaders say the private sector is doing everything it can to make mortgage money available to lower- income Americans. The Clinton administration says more needs to be done. It is pushing for stronger CRA regulations. In the meantime, the Justice Department is taking the lead on fair lending. Two weeks ago, Justice joined a discrimination case against American Family Mutual Insurance Co. in Milwaukee. The insurer quickly agreed to settle. It will invest $14.5 million in the inner city. Says Deval Patrick, assistant attorney general for civil rights: "Our cases illustrate that there is a far greater chance that minorities will face outright denial of financing -- or denial of financing at competitive rates -- than will white applicants with virtually identical qualifications."

Few people dispute that federal fair-lending laws have had a positive impact on bank lending to the poor. But critics contend the lenders could be doing a lot more. They concede that blatant discrimination -- in which financial institutions literally drew a red line around entire neighborhoods deemed off-limits for loans and homeowner's insurance -- is rare today. But formal redlining, they argue, has given way to other practices that effectively impede lending to poor neighborhoods. Compounding the problem, banks have been closing branch offices, pulling up a crucial financial anchor of many communities.

In a six-month investigation, U.S. News examined banking, lending and home-insurance coverage in poor and minority communities. The inquiry was based on an unprecedented study of nine sets of banking and insurance industry data, including more than 24 million mortgage records (methodology, Page 58). More than 200 interviews were conducted in 12 cities. These are the principal findings of the inquiry:

The number of poor and minority homeowners who cannot obtain full- coverage property insurance is nearly 50 percent greater than that for residents of mostly white, middle-class areas. Poor Americans also pay more than twice, on average, what residents of middle-class neighborhoods pay for property insurance. In high-minority, low- income areas, residents pay an average of $7.21 per $1,000 of homeowner's insurance. Residents of low-minority, middle-income neighborhoods, by contrast, pay an average of $3.53 per $1,000. Insurance carriers' loss costs are demonstrably higher for urban areas -- accounting for more stringent underwriting rules and higher premiums. Even so, a study done last year by the National Association of Insurance Commissioners reviewed three decades of insurance industry performance in urban areas and concluded: "Insurance redlining is widespread and has adversely affected residents of poor and minority neighborhoods." On current conditions, the study was less definitive. Higher prices and lack of insurance availability in poor, urban neighborhoods, it found, "may be driven, at least in part, by incorrect assumptions about the risk characteristics" of those neighborhoods.

Despite federal laws that encourage banks to lend to the communities they serve, banks are fleeing poor neighborhoods in ever greater numbers. An examination of Federal Deposit Insurance Corp. data for 12 major cities representing 31 percent of the nation's urban population found that in the past two decades, the number of bank branches in white neighborhoods had tripled compared with the number of bank branches in mostly minority areas. Nationally, according to the U.S. News study, there are an average of 38 bank branches per 100,000 residents in white areas but only 22 branches in minority neighborhoods. Two decades ago, the numbers were roughly equal. They have become unbalanced in recent years as banks have closed branches in poor areas.

Federal laws make it a crime to discriminate against mortgage applicants seeking to buy homes in mostly minority areas. But the U.S. News survey found that middle-income black applicants from mostly minority areas were more than twice as likely to be rejected for mortgage loans as middle-income whites living in mostly white areas. For blacks, the rejection rate was 37 percent; for whites, it was just 18 percent. Overall, residents of middle-income white neighborhoods received 61 percent more mortgage loans than residents of middle-income minority areas did.

The bottom line. Bankers and insurance executives say they work hard to do more business in poor and minority neighborhoods, and many do, particularly through community development banks. But higher crime rates and tumbling property values make lending in poor areas difficult. "Banks want to make loans," says the American Bankers Association's James McLaughlin. "It's how they make their money. ... The bottom line is that they're in the business of making loans." Leo Jordan, a vice president with State Farm Insurance Co., agrees. "There really isn't evidence of intentional discrimination by insurers against urban residents," he says. "What you have are neutral underwriting rules that have a disproportionate impact upon minority, urban residents."

Obtaining full-coverage insurance for a home is nearly as important as finding the financing to buy one. In Toledo, Ohio, Deborah Quinn- Lucy, a black high school teacher, owns a handsome frame house in a neighborhood of mostly well-maintained homes. The neighborhood is in central Toledo. Most of the residents are black. In the past four years, Quinn-Lucy has had her homeowner's insurance canceled twice. The reasons have differed each time. One insurer claimed that her house is located in front of an alley, creating a security problem. Another canceled over a broken window that actually was being replaced.

The crime rate in Quinn-Lucy's neighborhood is significantly higher than that in nearby Maumee. In 1993, the city of Toledo reported 64 property crimes for every 1,000 residents. In Maumee, the rate was 40.5 crimes per 1,000. The numbers mirror the national averages almost exactly: In central cities of 1 million people or more, the national average is 65 burglaries per 1,000 households, compared with 45 per 1,000 households in suburban areas.

Loss costs. The numbers are instructive on two levels. First, while the crime rate in inner cities is higher than in the suburbs, it is not twice as high, as is the average insurance premium paid by inner- city residents. Second, insurance carriers clearly have greater loss costs on policies sold in inner cities, but except for the most blighted inner cities, crime stats don't appear to justify decisions to exclude entire neighborhoods from insurance coverage. State Farm Insurance Co. is currently under investigation for its sales practices in Quinn-Lucy's neighborhood in Toledo and in several other Ohio cities. State Farm says it has broken no laws and is cooperating with the inquiry.

Insurers say they do not discriminate against residents of poor and minority neighborhoods. Rather, they say, their decisions on where and what kinds of insurance to sell are dictated by business reasons. One key factor is property values. In many inner-city neighborhoods, the value of housing stock of all kinds has fallen in recent years. That makes it difficult or impossible to offer "replacement value" coverage -- policies that pay to rebuild a structure and replace its furnishings at today's costs.

Still, a growing number of policy cancellations have attracted the attention of federal regulators. Although it has no statutory authority to police insurance carriers, the federal government can take action if there is the suspicion of civil rights violations. That is the authority the Department of Housing and Urban Development cited in opening its investigation of State Farm's sale practices in Ohio. HUD is also examining Allstate's sales of homeowner's policies in Illinois and those of Nationwide Insurance Enterprise in Louisville, Atlanta, Milwaukee and Chicago. A spokesperson for Allstate says the company is in compliance with the law and is cooperating with the government inquiries. Nationwide has informed HUD that it has no authority to investigate the company. A spokesperson says the company's sales policies comply with all applicable laws.

Wide gap. In its study of the insurance industry's performance in urban areas, the National Association of Insurance Commissioners collected data on the cost and type of policies sold in 33 metropolitan areas in 20 states. The study is considered the most comprehensive ever done on the subject. After statistically ruling out other factors, the NAIC study found that only 57.6 percent of the houses in high-minority, low-income areas were insured at all, compared with 81.5 percent in white, high-income areas.

In a controversial settlement with Maryland-based Chevy Chase Federal Savings Bank last year, the Justice Department cited evidence of discriminatory lending practices. Chevy Chase had a policy of opening branches only in mostly white neighborhoods, where it intended to sell mortgages, Justice said. In its settlement, Chevy Chase admitted no wrongdoing but agreed to open three new branches in mostly black neighborhoods and make $7 million available in nonconventional mortgage loans.

Chevy Chase was unusual. In other cities, despite fair-lending laws like the CRA, which is supposed to penalize banks for failing to serve people in all parts of their service areas, banks regularly ignore or underserve inner-city neighborhoods. The Dime Savings Bank of New York, for example, said it serves New York, except the Bronx, suburban Long Island, affluent Westchester County and areas upstate including Albany and Buffalo. "The Dime's communities consist of neighborhoods that are home to people of diverse ethnic and socioeconomic backgrounds," the bank's brochure stated. "We delineate our CRA communities by incorporating neighborhoods, including low- and moderate-income areas, located around our branch offices."

But the bank's map of its service area omitted the entire area of Harlem north of 117th Street -- despite the fact that the area is part of New York. Last year, Dime agreed to include the rest of Harlem in maps of its service area. After a challenge by a Bronx community group threatened to scuttle Dime's application to merge with the Anchor Savings Bank, it added the Bronx. A spokesperson says Dime made the decision earlier but hadn't published it.

The loss of bank branches creates a Catch-22 situation. Banks typically lend in their service areas, most often defined as areas around their branches. Fewer branches means fewer loans. In the 12 cities analyzed by U.S. News, the number of banks per 100,000 residents in minority and white areas was roughly equal in 1970. By 1993, the most recent year for which records are available, there were three times as many banks per 100,000 residents of white areas as there were for every 100,000 residents of minority areas.

Baltimore was one of the cities most affected by bank flight from poor areas. In 1970, the number of banks serving the city's white and minority neighborhoods was nearly even. By 1993, minority areas had just 1 bank branch for every 5 located in white neighborhoods. For Mary Harden, the nearest bank now is a 20-minute bus ride away. Like a lot of her neighbors, Harden goes to a commercial check casher now -- paying a fee of several dollars each time.

The stories differ, but not much. Not too long ago, Chandra Ward wanted to buy a house. At $15,000, the place was a steal, well within her budget. A single black woman with a steady job working for Federal Express, Ward saw her mortgage loan application rejected almost immediately -- the little bungalow was in a mostly black neighborhood in central Memphis. When Ward tried to buy a second house, her loan application for $71,500 sailed right through. The second house was in a racially mixed area.

The U.S. News analysis found that differences in mortgage-lending rates between whites and minorities could not be accounted for fully by income levels. In white areas where household incomes were at least as much as the area median, as determined by HUD, there were an average of 45 mortgage loans per 1,000 houses. In minority areas at the same income level, there were just 28 loans per 1,000 houses.

Assessing such disparities is tricky. Many residents of poor and minority neighborhoods don't believe they can qualify for mortgage loans and so don't apply. An inability to secure full-coverage homeowner's insurance further complicates the picture, as does the secondary market for conventional mortgages. Many big lenders sell the home loans they make to buyers like the Federal National Mortgage Association. Secondary-market buyers have strict criteria: Buyers must either have made a down payment on the home of at least 20 percent of the purchase price or they must buy private mortgage insurance, which guarantees repayment of the loan if the homeowner defaults. Many poor people cannot come up with a 20 percent down payment. Many cannot qualify for or afford private mortgage insurance.

The disparities in mortgage lending by neighborhood are important. The CRA was passed as a key element of the 1977 Housing and Urban Development Act, whose stated purpose was to outlaw "redlining" -- defined as a refusal by a financial institution to make mortgage loans to certain neighborhoods because of their racial composition, income level of the residents or age of the housing stock. The U.S. News findings for middle-income black and white mortgage applicants are best understood not by the race of the applicant but by the racial composition of the neighborhoods in which loan applicants sought to purchase homes. Jonathan Fiechter, acting director of the U.S. Office of Thrift Supervision, one of four federal agencies responsible for enforcing fair-lending laws, calls the trend dismaying. "I don't think we have the blatant discrimination we had in the 1950s and 1960s," Fiechter says. "I think it tends to be more unintentional, which may be just as egregious in some sense."

That's why the stakes in the current fight over the CRA are so high, its supporters say -- arguing that the act is a linchpin in the federal antidiscrimination enforcement machine, a "trigger" that can bring other antibias laws to bear.

Everyone seems to have a gripe about the law. Critics call CRA rules burdensome; others say the law has been ineffective in promoting far greater levels of lending to minorities.

Both, in a way, are right. The American Bankers Association's McLaughlin says banks spend $12 billion annually trying to comply with the CRA -- and most of that goes for paperwork -- an expensive and time-consuming burden. "There are some real small banks in this country that only have seven, eight employees that have to have 15 or 16 different written policies. ... It doesn't make a lot of sense."

Challenges generate loans. The law has done some good. Under the CRA, challenges to banks have resulted in pledges of more than $30 billion in loans to minority neighborhoods nationwide. In Illinois, Harris Bank, Northern Trust Bank and First National Bank of Chicago promised to lend $153 million over five years to poor neighborhoods. An evaluation found that the program had generated $117.5 million in new loans by the start of the fifth year -- and almost no direct loan losses.

But other evidence supports the argument that the CRA is a weak tool at best. Prior to 1992, the four bank regulatory agencies responsible for enforcement of fair-lending laws referred potential violators to the Department of Justice just one time; no enforcement action resulted. In the past two years, there have been 16 bank referrals to the Justice Department for racial and ethnic discrimination. Two lawsuits were filed as a result of those referrals. The Justice Department sent 11 of the complaints back to the agencies that originated them, citing insufficient evidence of violations or recommending administrative enforcement. Three referrals are under investigation. One big reason for the complaints about the CRA is the approach the law takes toward enforcement. Many who supported passage of the law initially said that banks ought to be made to serve all areas of the communities in which they did business. In exchange for government services like federal deposit insurance, the theory went, banks should have to meet certain minimal lending standards. Lawmakers wanted performance. What they didn't want was an overly rigid regulatory tool. What they got was a law that barely quantified lending activity at all.

Ratings. Federal bank regulators are supposed to evaluate lending records every other year. Banks are rated on 12 factors. Only three have anything to do with where loans are actually made and whether banks locate branches in poor neighborhoods. Three other rating factors relate only to paperwork. Banks are thus assessed, for example, on the quality of brochures they publish about their lending philosophy. Eugene Ludwig, comptroller of the currency, concedes the point: "What the law asks us to evaluate is, 'Are you meeting with the community? Are you advertising to the community?'"

Even defenders of the CRA call the rating system inadequate. Banks can be given one of four grades. In 1994, fewer than 1 percent of all banks -- the exact figure is 0.3 percent, just 17 banks out of 5,592 examined -- received the lowest CRA grade, a term regulators call substantial noncompliance. Of the 100 banks that ranked lowest in a separate U.S. News review of mortgage loans to minorities, not a single bank received the noncompliant grade.

Seeking favor. The U.S. News review also found extraordinary variation in the kind of information banks provide to regulators. One bank asked the FDIC for a favorable CRA rating because some of its employees participated in a community window-washing project; the FDIC approved the request. Another bank asked the Federal Reserve for a high CRA rating, in part because it established a $60,000 line of credit for local businesses to purchase Girl Scout cookies. The Fed commended the bank for the effort.

William Proxmire, the former chairman of the Senate Banking Committee who authored the CRA, envisioned regulators stepping in to block mergers and acquisitions because of poor CRA ratings. In fact, federal regulators have blocked almost no applications for mergers and acquisitions because of poor CRA grades. Since 1977, according to banking consultant Kenneth Thomas, regulators have denied just 20 of more than 77,000 applications for adding branches or merging with other banks.

Community groups say this is a critical time for the nation's inner cities. With interest rates higher than they were a year ago, borrowing is more expensive for most Americans. In the nation's poorest neighborhoods, the problems and difficulties are worse.

While the 104th Congress decides what to do now about the Community Reinvestment Act, banks and their Washington supporters are anxious to make their case. They are likely to get a sympathetic hearing. In the 1993-94 election cycle, banks and mortgage companies made nearly $12 million in campaign contributions. One of every five dollars went to key members of the banking committees.


This report is based on banking, insurance, demographic and campaign finance records from the Federal Deposit Insurance Corp., the Federal Financial Institutions Examination Council, the National Association of Insurance Commissioners, the U.S. Dept. of Housing and Urban Development, the Census Bureau, the Federal Election Commission, Inside Mortgage Finance and Sheshunoff Information Services. All conventional loans to purchase one-family to four-family houses in 1992 and 1993 were analyzed. Federally insured loans and refinancing loans were excluded. Loan data were combined with 1990 census data to determine loan locations. Median incomes for each metropolitan area were used to determine low- and moderate-income neighborhoods and applicants. Census data were added to data on location of bank branches to determine the racial composition of neighborhoods. Because of criticism of denial rates as an inaccurate measure, U.S. News also examined lending patterns by race and income of neighborhood and by income of applicant. Lenders were rated in cities with more than 10 percent minority populations where they made at least 25 loans. Banks with fewer than 50 total applications were excluded. Banks and mortgage companies were rated on loans in minority and low- and moderate-income areas, loans to African-Americans and Hispanics and denial rates for the two races. Banks were also rated on the number of branches in minority areas. With Joseph P. Shapiro; Kukula Glastris; Pamela Sherrid; Andrea Wright. Copyright 1995, U.S. News & World Report. All rights reserved.