Assault on the mortgage lenders: in the name of racial justice, the Clintonites want the power to decide who gets a home of his own.

QUIETLY, behind the scenes, the Clinton Administration is preparing for the biggest regulatory crackdown of recent years. Attorney General Janet Reno is linking up with banking regulators and with HUD Secretary Henry Cisneros to end the supposed epidemic of discrimination against minorities in making home loans. The implications for society at large are ominous.

Here, as in affirmative-action efforts in hiring, college admissions, and the drawing of voting districts, the Washington establishment is obsessed with "disparate impact," which it equates with racism. In the mortgage-lending area, there is ample evidence of disparate impact to feed this obsession. Data collected by the Federal Government reveal that in 1992, while 16 per cent of white applicants for mortgage loans were rejected, 36 per cent of black applicants were rejected.

But does disparate impact indicate racism? According to Lawrence Lindsey, the Federal Reserve governor who oversees the collection of mortgagelending data, even the celebrated Boston Fed study that inspired this crusade found that factors other than race--such as one's credit record and whether one has sufficient income to meet the payments--are enough to account for nearly all the difference in rejection rates. Furthermore, a different analysis of the data in the Boston Fed study by David Horne, an economist with the Federal Deposit Insurance Corporation, finds no evidence of a pattern of discrimination. In any case, Census data show whites and blacks, taken as groups, have similar default rates. If discrimination were in fact occurring--that is, if banks were applying a higher standard to blacks than to whites--you would expect blacks to have a lower default rate.

The essentially irrational assumption underlying the notion that there is widespread discrimination in mortgage lending seems to be that lenders are willing to give up good profits in order to feed their subtle but thorough-going racism. Says Senator Don Riegle (D., Mich.), "They talk about how the free-enterprise system is supposed to work, but it's sophistry, as we all know." Senator Riegle (one of the Keating Five who plans to retire rather than run for re-election next year) has made a holy crusade of mortgage-lending discrimination since he took over the Senate Banking Committee in 1989.

Senator Riegle has found enthusiastic allies in the Clinton Administration, particularly Attorney General Reno, Secretary Cisneros, and Comptroller of the Currency Eugene Ludwig. As Ludwig told the Senate Banking Committee, "We have to use every means at our disposal to end discrimination and to end it as quickly as possible."

One Size Fits All

MR. LUDWIG'S idea of ending discrimination is for blacks and whites to have the same rejection rates, regardless of the legitimate reasons for differences. The crackdown is already well under way, as the Administration turns many of its bank examiners into discrimination police by re-interpreting the Fair Lending Act of 1968 and the Equal Credit Opportunity Act of 1974.

The primary responsibility of banking regulators--the Office of the Comptroller of the Currency (OCC), the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision--has always been the safety and soundness of banks and thrift institutions. In the last few decades a separate cadre of bank examiners for fairness and consumer protection has been established. These so-called "compliance examiners" represent the shock troops of the Clinton assault. Ludwig is increasing the number of OCC compliance examiners from 330 to 530 by next year. Already they've been busy examining loan files; their work has resulted in four referrals to the Department of Justice for further investigation. Miss Reno, meanwhile, has chastised the other bank regulatory agencies, including the Federal Reserve, before the Senate Banking Committee for failing to get with the program.

While Justice has not yet identified any of the four referrals, two of them have publicly identified themselves: Shawmut National Bank of Hartford, Conn., the largest mortgage lender in New England, and Barnett Bank of Jacksonville, Fla. Only two weeks after Miss Reno's slap at the banking regulators in Senate testimony, the Federal Reserve Board, usually not prone to politicizing its bank examinations, prevented Shawmut from acquiring New Dartmouth Bank of Manchester, N.H., under a rarely used provision of the Community Reinvestment Act (CRA) of 1977, claiming Shawmut had discriminated against minorities. While it is impossible to judge the case against Shawmut without more information, the timing of the denial is suspicious. Henry Cisneros quoted Fed Chairman Alan Greenspan as saying in Senate testimony that an end to discrimination would boost economic activity. Mr. Greenspan has made no secret of his campaign to win over the President on the issue of the Fed's independence, endangered by battles with congressional leaders like House Banking Committee Chairman Henry Gonzalez. Thus, the Fed's Shawmut action might be seen as the regulatory equivalent of sitting next to Hillary Clinton at the President's inauguration.

Tightening the Screws

THE SHAPE of the future may be seen in a case that actually pre-dated the Clinton Administration-the case against the Decatur Federal Savings & Loan of Atlanta. That case was referred to Justice during the Bush Administration, and, under the threat of litigation, Decatur Federal agreed to a draconian settlement last year that permeates almost every activity the bank conducts. The settlement includes Maoist-sounding sensitivity training for Decatur's loan officers and recommends bonuses for those who bring in minority loans.

Justice's case against Decatur was not based on individual complaints and contained no proof that any single minority loan was rejected without just cause. It relied entirely on a computer model that attempts to duplicate the factors that banks consider when making loans--a process that is an art, not a science. As Congress's leading mortgage expert, Represehtative Bruce Vento (D., Minn.), explains: "We can't take away the judgment of individual financial institutions about what is a good credit risk. You can't put that into a computer because there are too many uncertainties. You have to have a market test at some point." Nevertheless, Justice's computer concluded that Decatur Federal had discriminated.

The Federal Reserve now has its own computer program too, according to Lawrence Lindsey, who revealed its existence in Senate testimony. The Fed apparently used it to make its case against Shawmut Bank and is using it to ferret out more cases to refer to the Justice Department. Furthermore, under the new examination process at both OCC and the Federal Reserve, compliance examiners can look through an entire mound of applications until they find a single case of an approved white loan applicant whose qualifications are close to those of any rejected minority applicant, which includes blacks, Hispanics, Asian-Americans, and Native Americans. This one close match would establish that the bank had discriminated. Stephen Cross, OCC's deputy comptroller for compliance management, says that perhaps as few as four examples a year would lead to a finding of a pattern of discrimination. Since no two applications are ever identical, this approach allows the discrimination police considerable latitude.

Mr. Ludwig is in the process of rewriting regulations for the Community Reinvestment Act so as to offer further inducements for banks to allocate credit by race. In the past, banks and thrifts were rated on the efforts they made to reach out to minorities. Under a directive from President Clinton, however, Ludwig plans to introduce new CRA regulations that will require lenders to meet certain numerical guidelines in total minority loans. Ludwig calls these "performance-based standards"--that is, they will judge institutions not on their efforts but on the results. Congressional supporters of the performance-based CRA standards, such as Senators Paul Sarbanes (D., Md.) and Carol Moseley Braun (D., Ill.), and Representatives Joseph Kennedy (D., Mass.) and Maxine Waters (D. Calif.), deny they are quotas--but some CRA consultants and Wall Street banking analysts say that banks having trouble finding qualified minority candidates will simply approve the minimum number of bad loans and consider them, as one put it, "blood money for the politicians."

The Clintonites go out of their way to gloss over the real agenda at work in the mortgage crackdown; they insist they would prefer the voluntary cooperation of mortgage lenders and that enforcement is only a last resort. Inside the velvet glove, however, is an iron fist. Miss Reno testified that many banks and thrifts have told her they want to lend more to minorities but have been unable to do so. These benighted institutions must be "educated," she says, in how to recognize discrimination in their own lending practices. It's so subtle and insidious, she explains, that the lenders do not see it themselves.

'Subtle Discrimination'

MISS RENO, like other mortgage militants, believes banks discriminate by such means as telling white applicants how to correct their applications so as to get loan approval, but not telling black applicants. The authors of the controversial Boston Fed study concur. The truth is, however, that most banks now routinely review all rejected minority applications, sometimes passing the loan file to the president's office. The Consumer Bankers Association has found that 88 per cent of banks responding to its annual "affordable housing" survey now automatically review all mortgage rejections.

HUD is also enrolled in the battle to ferret out "subtle discrimination." For now it is concentrating on a group of lenders known as "mortgage bankers," who are not covered by the Community Reinvestment Act. Mortgage bankers do not take deposits and do not hold mortgages in their own portfolios, as banks and thrifts sometimes do. Instead, they sell all their mortgages to investors in the secondary market. These firms are not closely regulated like banks and thrifts; they are therefore not hampered in reaching less profitable markets by the high cost of regulation, and so can be far more aggressive in filling in the gaps in the mortgage market. Ironically, therefore---in view of HUD's targeting them--mortgage bankers originate 80 per cent of government-guaranteed Federal Housing Authority (FHA) loans, which disproportionately benefit minorities.

The HUD crackdown on mortgage bankers is being administered by Assistant Housing Secretary Roberta Achtenberg, who before being tapped for the Clinton Administration gained fame in San Francisco for pressuring big corporations to stop funding the Boy Scouts. She has hired an independent testing firm that has been for several months sending out phony black, white, Hispanic, and AsianAmerican mortgage applicants to see if minorities are treated differently from whites. If a single loan officer or other employee in any way treats a single black applicant less favorably than a white applicant, then it can be considered a case of discrimination. Discrimination can be something as simple as not smiling at the black tester, having smiled at the white one.

Miss Achtenberg has considerable leverage against mortgage bankers, since HUD oversees the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Home Association (Fannie Mae), two government-sponsored private enterprises which buy mortgages from mortgage lenders and sell them to investors in the secondary market. If HUD denied a mortgage banker the right to sell its mortgages to Freddie Mac or Fannie Mae, that would force the banker out of business.

Pre-emptive Action

MEANWHILE, mortgage lenders are feverishly trying to improve their lending to minorities without sacrificing good underwriting principles. For several years now, mortgage lenders have been discovering that education and counseling can increase the pool of potentially credit-worthy minority homebuyers. Many minority applicants are rejected because they apply for a larger mortgage than they can afford or because they have failed to clear up past delinquent loans. Under "affordable housing" programs devised without Washington's help, lenders are finding that many rejected applicants can pass muster as early as a year after initial counseling and remedial action. The education reduces the credit risk of the borrower by making him or her a more responsible mortgage holder. The cost of the education is generally absorbed by non-profit organizations which provide it free to all would-be homeowners.

Mortgage lenders have been working vigorously on other fronts too. Increasingly, minorities can qualify for loans without conventional credit criteria, by counting regular rent and utility payments as proof of creditworthiness. Also, Fannie Mae, Freddie Mac, private mortgage insurers, and mortgage lenders have worked together to develop programs that combine counseling with lower down-payments (as low as 3 per cent of the applicant's own money), since the lack of a down-payment is the leading obstacle to greater minority home ownership. Happily, these affordablehousing loans have so far produced delinquency and default rates similar to those for loans with more conventional criteria.

To be sure, many potential applicants do not know of these affordablehousing programs, which have been around only since 1989. Mortgage lenders have found that advertising does not do the trick. It seems to require one-on-one contact to drive the message home, and so they have started trying to track down more of these potentially credit-worthy homebuyers by working with community housing groups, holding seminars, and sending out mailings.

Color-Blind Markets?

INDEED, some mortgage lenders now believe that low- and moderate-income borrowers are one of the growth markets of the 1990s. If left alone to devise methods of reaching this market, they will do so in a color-blind manner without sacrificing credit standards and without redistributing costs by charging other borrowers more for their mortgages. The alternative can already be seen at work at banks and thrifts struggling to improve their lending to minorities. The Consumer Bankers Association reports that 69 per cent of banks in its affordable-housing survey subsidize their minority-outreach programs, usually by offering lower interest rates, but also by incurring higher operating costs to administer the loans. Among banks that subsidize, 76 per cent of the subsidies come from bank profits, while the remaining subsidies come from government programs and non-profit organizations. The Clinton Administration's heavy-handed, raceconscious approach threatens to forcibly expand this small subsidy foothold.

The crackdown is, therefore, not a boon but a roadblock to racial progress. If it succeeds in driving banks to make bad loans in order to improve their minority-approval rates, this will eventually lead to more foreclosures in troubled inner-city communities. It will also reduce the available capital to credit-worthy borrowers, forcing more Americans to settle for a less attractive home than they had expected. Some whites who formerly would have qualified at the margins for a mortgage will be denied their chance at the American dream. And mortgage rates will rise for everyone to cover the losses from bad loans.

The Clinton method will achieve faster, but short-lived, results for minority rejection rates. And in the process it will heighten racial divisions in our society. As in every other field in which quotas have been tried, they will hurt the people they are trying to help--and everyone else, too.

Mr. Congdon is economic advisor to Gerard & National in London and managing director of the economic consulting firm Lombard Street Research.