On Monday, the American Civil Liberties Union filed a lawsuit against Morgan Stanley in what may become the most important civil rights case in a generation. If successful, the implications of this suit are profound and the impact could be staggering, both in addressing the damages suffered by devastated communities as a result of predatory lending triggering the foreclosure crisis and the symbolic importance of framing these damages as civil rights violations.
Too often, the story of the foreclosure crisis is told as a story of the failure of communities of color and individuals who signed loans they could not afford rather than the story of how sophisticated financial institutions and their investors preyed on these communities to earn billions by deliberately pushing bad loans. And, until now, there has been very little done to address the harms suffered by these communities. And where the government has acted, it has sued banks, not the secondary market, on grounds of fraud rather than civil rights violations.
This suit alleges that Morgan Stanley violated the Fair Housing Act by discriminating on the basis of race in the secondary mortgage market. Specifically, Morgan Stanley is liable under Title VIII of the Civil Rights Act by purchasing, pooling, and selling securitized mortgages in predominantly non-white neighborhoods. To be clear, this lawsuit is not alleging that Morgan Stanley or its employees held racial hostility to the black community, but that the policies and practices of the investment bank had a manifest racial impact in clear violation of the 1988 amendments to the Fair Housing Act.
Subprime loans were five times more likely in African American neighborhoods than in white neighborhoods. Subprime lenders targeted these communities — a process known as reverse-redlining — in order to satisfy the voracious investor demand for subprime securities. Because low-income, minority areas were historically excluded from the traditional lending markets through redlining, subprime lenders were able to saturate these communities with subprime loans, which were securitized and sold to investors. Morgan Stanley did not make these loans to homeowners themselves. Instead, they pushed the originating banks to make loans that were defective in violation of sound underwriting practices. They often knew, or should have known, that many these loans would fail.
Investment banks such as Morgan Stanley sought out high-risk loans disproportionately concentrated in non-white neighborhoods that were likely to default, bundled them and marketed them to investors, often, as the SEC complaint in the lawsuit settled with Goldman Sachs in 2010 illustrated, with the expectation that these loans would fail. In doing so, they created a market for subprime loans and other high risk loans, driving a subprime industry that targeted minority borrowers and borrowers in largely non-white neighborhoods. Goldman Sachs and Morgan Stanley are players in what is called the “secondary market” since they do not originate these loans, but they package them for investors through securitization. In many respects, it is the secondary market that set the terms for lending, not just to borrowers, but also for originating banks.
Minority borrowers were more willing to agree to the terms of such loans on account of the inadequate access to prime loans or traditional financing options. Consequently, lenders steered African American borrowers with prime credit to take out subprime loans through both intentional discrimination and discriminatory impact created by their policies. These borrowers paid more for loans that often featured balloon payments and adjustment rates. Consequently, they were more likely to default.
The damages for these practices, which are not limited to Morgan Stanley, may be in the billions. If successful, this suit will be the first of several. But it also might inspire the government to take meaningful action to protect homeowners and others from a financial system that is sometimes out of control. Part of the importance of this case lies in the fact that all of the government’s attempts to litigate the harms of the subprime crisis have typically been rooted in fraud, including the government’s recent lawsuit against Wells Fargo. This is the first major suit that alleges Civil Rights violations, which is, in some sense, a much clearer case. The regulations under the Amendments to Title VIII clearly specify that “pooling or packaging” loans on the basis of race is a violation of Title VIII (42 C.F.R. § 100.125). Since disparate impact claims are recognized under Title VIII, not just disparate treatment, a statistical showing of a racial impact provides the foundational proof of a Title VIII violation.
In my role as the Executive Director of the Kirwan Institute for the Study of Race and Ethnicity at the Ohio State University, and as a former national legal director of the ACLU, in 2007 I convened a team of researchers to investigate the emerging subprime lending and foreclosure crisis and its impact on communities of color across the nation. In October of 2008, a month after the failure of Lehman Brothers, we held a national convening supported by W.K Kellogg foundations that drew together academic researchers, community advocates, fair housing attorneys, and civil rights workers. In 2010, when the SEC filed suit against Goldman, I asked my team to examine grounds for a potential civil rights intervention on behalf of impacted communities. After all, if investors were defrauded, wouldn’t that suggest that the homeowners were also defrauded? Stephen Menendian, my senior legal researcher, identified clear grounds under Title VIII for suit, but the provision had apparently never been litigated. We brought this to the attention of Dennis Parker at the ACLU, who is lead counsel in the case against Morgan Stanley. With an initial grant from the Akonadi Foundation, we began the research of applying this Title VIII provision to subprime loans.
Too often today we conceptualize civil rights law narrowly. We tend to be backward looking, defensive and ambivalent about the role of courts. Some of us even believe that civil rights have become overly court-centric. This myopic view has diminished both the practice of civil rights and our training of the next generation of civil rights attorneys to think creatively and innovatively about the future of civil rights litigation. In the late 1980s and early 1990s, educational equity suits had run their course in federal courts, but along with few innovative lawyers, I helped develop the legal theory of educational adequacy that was used in cases like Leandro v. North Carolina. While legislative change is critical and the law may be too narrow, we must not forget the important role that courts can play in both protecting civil rights and generating meaningful societal change.
When the Brown litigation was first being developed by Charles Hamilton Houston and Thurgood Marshall, the courts were far from receptive to their cause. Yet, through painstaking advocacy, inside and outside the courtroom over several decades, they were able to change our nation. Cases like Adkins v. Morgan Stanley, the ACLU’s voter ID case in Pennsylvania, and the various stop and frisk suits are part of the future of civil rights advocacy, using clear, but rarely litigated provisions to address great harm, challenging discriminatory legislation, or creatively applying civil rights laws to new situations. Wherever there is a dual system, whether it is a dual school system or a dual credit system, it suggests we are treating some groups as though they are not full members of society, as truly belonging. Addressing this is what civil rights has always been about. We must not cede this vision to the courts, those opposed to civil rights, or the government, which has not brought these suits on our behalf. Rather, it is our responsibility as lawyers and citizens to advocate for change. Until this is fully addressed, there is not a post-civil rights movement, only a civil rights one.
The ideas expressed on the Haas Institute blog are not necessarily those of UC Berkeley or the Division of Equity & Inclusion, where the Haas Institute website is hosted. They are not official and not of one mind. Thoughts here are those of individual authors. We are committed to academic freedom, free speech and civil liberties.