In what is apparently the first legal action of its kind, an association of community-based organizations has filed a federal civil rights complaint against two of the three largest Wall Street rating firms, charging that their inflated ratings on subprime mortgage bonds disproportionately caused financial harm to African American and Latino home buyers across the country.
The complaint, filed by the National Community Reinvestment Coalition, alleges that Moody’s Investors Service and Fitch Ratings enriched themselves by assigning high ratings to bonds backed by mortgages “that were designed to fail” because of “unfair payment terms and insufficient borrower income levels.”
The firms “knew or should have known” that subprime loans disproportionately were marketed to minority consumers—a process known as “reverse redlining”—and that those borrowers would ultimately default and go into foreclosure at high rates, according to the coalition’s complaint.
Fitch Managing Director David Weinfurter said the NCRC’s filing “is fully without merit, and Fitch intends to defend itself vigorously.” Moody’s had no immediate comment.
The filing cites multiple studies that found that African Americans and Latinos received a disproportionate share of subprime loans during the housing boom years. A Federal Reserve study in 2006 estimated that 45% of mortgages extended to Latinos and 55% of loans to African Americans were subprime—a utilization rate “three to four times that of non-Hispanic whites.”
Because the loans themselves often came with terms that increased borrowers’ probability of default—upfront teaser rates followed by unaffordable reset payment adjustments, no required documentation of applicants’ incomes or assets, plus hefty prepayment penalties—African Americans with subprime mortgages are projected to lose $71 billion to $92 billion through foreclosures, while Latinos are projected to lose $75 billion to $98 billion, according to one study cited in the complaint.
“Had subprime loans been distributed equitably,” the complaint estimates, “losses for whites would be 44.5% higher and losses for people of color would be about 24% lower.”
The civil rights complaint is the latest in a series of lawsuits, regulatory investigations and congressional criticism of the rating firms’ roles and conduct during the mortgage bond heyday years of 2003-05. In dollar terms, subprime and so-called Alt-A no-documentation loans accounted for 32% of all mortgage originations in 2005. Their share had been 10% two years before. Virtually all of those high-risk loans were sold to Wall Street firms for inclusion in complex bond structures that were resold, often in bits and pieces, to pension funds and financial institutions.