The stock market crash of 1929 served a devastating blow to the national economy. Many people suddenly found themselves out of work as the nation spiraled into The Great Depression of the 1930s. Many Americans were forced to default on their mortgage loans. The Federal Housing Administration (FHA), a wholly-owned government corporation, was established under the National Housing Act of 1934. Its primary goals were to provide an adequate home financing system through insurance of mortgages and to stabilize the mortgage market. In 1938 Congress created Fannie Mae to refinance FHA insured mortgages. (http://www.fhatoday.com/fha.htm) Fannie Mae has developed into a dominating force in the home finance market since its introduction in 1938, undergoing some major transformations along the way. The organization was privatized in 1968, while at the same time retaining a number of connections to the government, converting it into somewhat of a governmental – private organization hybrid.
Examples of what makes Fannie Mae unique to most other “private” organizations include being exempt from state and local income taxes. Furthermore, the organization is not required to register its securities with the Securities and Exchange Commission. The secretary of the Treasury is also authorized to invest up to $2.25 billion in their securities and to approve their issuance of debt. (Wallison, Nationalizing Mortgage Risk, p.6) Since the company’s “privatization” in 1968, Fannie Mae has provided $4.0 trillion in financing to millions of American families. Homeownership is considered to be one of the major components of “The American Dream.” Not coincidentally, Fannie Mae’s slogan is “Our business is the American Dream.” The company claims responsibility for increasing the country’s homeowner rates by reducing the cost of buying a home. The company has generated a great deal of capital from investors as well as government subsidies to become America’s second-largest corporation asset-wise.
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“Keeping low-cost funds flowing to mortgage lenders to lend to homebuyers in all communities, at all times, under all economic conditions” (Fannie Mae, Annual Report) is what the company states are their primary objective. Whether or not this is Fannie Mae’s focus at all times is debatable. Aside from the stockholders, middle to low-income loan applicants is the primary stakeholders of the company. Making housing affordable for working families is what Fannie Mae prides itself on doing. Most of these stakeholders’ primary concern is the availability and affordability of mortgage loans. Fannie Mae claims to make home loans affordable by keeping interest rates low. Some economists contend that keeping interest rates low capitalizes into the cost of the home, making the real benefit go to the home sellers and not the home buyers. (Wallison, p.49) In 1995 the Congressional Budget Office conducted a study that showed approximately $6.5 billion of aggregate government subsidies went to Fannie Mae. The study learned that only a portion of that amount was passed through to the mortgage markets. The remainder was “retained for the benefit of the shareholders and management.” (Wallison, Serving Two Masters, p.7)
As stakeholders as well as taxpayers, mortgage loan applicants have a lot to question when it comes to Fannie Mae’s involvement with the mortgage loan market. The amount of subsidized money that the company has retained exposes them to a great deal of criticism. The possibility exists that the company values one group of stakeholders over another. Aside from the company’s criticisms, they have contributed a number of positive elements to the market. As stakeholders, it is the responsibility of all potential mortgage loan candidates to remain informed. Since the passing of the Civil Rights Act of the 1960s, there has existed a considerable amount of speculation in deciding whether or not discrimination exists in the loan application process. Various statistical studies have taken place over the years which have yielded conflicting results. Many of those who support the belief that discrimination exists in loan applications cite the higher percentage of minorities denied loan applications in comparison to non-minority applicants. Those who are doubtful of the existence of discrimination suggest other socioeconomic factors that could contribute to the difference.
If loan discrimination does exist, it does not exist in the absence of laws against it. The Equal Credit Opportunity Act (ECOA) prohibits lenders “from discriminating against credit applicants on the basis of race, color, religion, national origin, sex, marital status, age, the fact that all or part of the applicant’s income comes from any public assistance program, or the fact that the applicant has exercised any right under any federal consumer protection law.” (FDIC, pt. III H1) To help government agencies monitor ECOA compliance, mortgage brokers are required to request certain information at the time of taking a loan application. The Fair Housing Act was created to prohibit discrimination in residential real estate transactions on the same grounds as the ECOA. Sometimes settlement costs charged to the borrower vary. Most of the time, such differences are justified based on the applicant’s loan risk. If the differences in cost are not justifiable, they are unlawfully discriminatory.
Over the past decade, a number of studies have been conducted in search of evidence to either support or refute the claim that discrimination exists in the process of the loan application. One of the first studies that received a considerable amount of attention was conducted was in 1996 when researchers from the Federal Reserve Bank of Boston began a study and collected a high volume of information used to determine an applicant’s creditworthiness, with the goal of better isolating the effect of race on an applicant’s chance of being approved for a loan. Their analysis showed that much of the difference in denial rates across races is due to the fact that black and Hispanic loan applicants have, on average, less wealth, smaller down payments, and more credit blemishes than their white counterparts. Nonetheless, even after controlling for these factors, the Boston researchers concluded that minority applicants were more likely to be denied a loan than whites: “… minority applicants with the same economic and property characteristics as white applicants would experience a denial rate of 17 percent rather than the actual white denial rate of 11 percent.” (Munnell, p.2)
A study from 1998 by the University of California, Berkley focused on the Oakland area. The report stated that African Americans in Oakland are 54 percent less likely to be approved for a home loan than white applicants. Other minorities were also shown to be at a disadvantage. (Blout, p.71) Many studies that suggest the presence of discrimination on the loan approval process face the criticism that constraints exist in the researchers’ method of data collection. Last year, the Journal of Housing Research published a study in which the evaluation of loan discrimination was done with a new “informational-based approach.” With this new method called the generalized maximum entropy, the researchers hoped to avoid criticisms concerning the reliability of the data. The study looked at three different banks and concluded that there was potential discrimination at two of the three banks. More important than the finding the results of the study was the development of a more reliable way to measure the threat of discrimination. (Courchene, p.87-88)
One of the most prominent assertions that loan discrimination does not exist is the idea that the observed differences in approval rates between ethnic groups are a result of income as opposed to race. A study by the Federal Reserve in July of 2002 addressed the issue head-on. In this study, the impact of personal wealth on small business loan turndowns across demographic groups was studied. Through the study’s analysis, it was possible to control the wealth variable to increase the likelihood that the difference in loan acceptance rates was a result of the applicants’ ethnicity. The study found that “after controlling for personal wealth, large differences in denial rates across demographic groups remain.” This provides further support for the argument that bias does exist in the loan approval process. (Cavalluzzo, p.2) Not all studies have supported the argument that discrimination exists in the loan application process. A study was conducted by James Berkovec that sought to evaluate discrimination in home mortgage organizations by examining the performance of mortgage loan portfolios for different ethnic groups.
The empirical results suggested that all else being equal, blacks are the most likely to default on a loan. This finding accounts for an on average higher rejection rate for mortgage loan applications for that particular ethnic group. (Berkovec, p.24) A form of mortgage discrimination that has received a lot of attention is the practice of predatory lending. Predatory lending is the practice of approving loans to those who would be likely to default on the loan in order to exploit the overall financial benefit to the lender resulting from the defaulted transaction. In predatory lending, older adults are frequently targeted because of the equity they have in their homes. Unscrupulous lenders impose unfair terms on borrowers, taking advantage of a lack of understanding of complicated transactions. These deceptive lending practices have caused many consumers to lose their homes. Predatory lending is often prevalent in the loan market with borrowers who may have had past credit problems.
A number of states are currently proposing legislation to end predatory lending. Fannie Mae has sought exemptions from state laws curbing predatory lending. The company claims that it has been fighting predatory lending with its own rules, but “doesn’t want the mortgage market to get caught up in a confusing patchwork of state laws.” Furthermore, the organization holds that varying state laws would create different standards in different places. (Barta) It would be naïve to assume that it is impossible for discrimination and prejudice to exist in any form when making loan or mortgage decisions in any part of the country. When a case of discrimination develops, it is an illegal practice and should be dealt with accordingly. Although there are research studies that argue for both sides of the argument, there seems to be a general trend supporting the argument that discrimination exists. Nevertheless one would think that if there were an epidemic of discriminatory practices in the mortgage loan industry, there would be an overwhelming volume of disputes and lawsuits. This however is not the case.
The best weapon in combating this issue is an increased level of awareness and cultural sensitivity on the part of the loaners. With this increased awareness should come a higher level of accountability for the laws that already exist. Further governmental intervention would only complicate matters for everybody involved. Although there are several controversial issues surrounding the business practices of Fannie Mae, it has been ranked among the best corporate citizens and deservedly so. The company has led by example on matters of gender and race equality in the workplace. “At the end of 1999, women made up 54% of the total workforce at Fannie Mae, with 39% as officers, 45% as directors, and 44% within the management group. Minorities comprise 40% of Fannie Mae’s total workforce, with 22% as officers, 23% as directors, and 23% within the management group.” (Fannie Mae, annual report) The company has also done a lot to extend mortgage opportunities to minorities and women.
They have established business relationships with over 300 women and minority mortgage lenders. Fannie Mae also sponsors an elder care initiative that focuses on their employee’s needs to care for aging relatives. In 1995, the organization donated $350 million in Fannie Mae stock to the Fannie Mae Foundation to fund its activities, which serve the non-profit housing community and provide public service outreach supporting homeownership. (ibid.) Fannie Mae truly is an organization with a rich corporate culture and a sense of obligation to its community. The biggest flaw that we encountered in studying their operations is learning about the amount of federal money that went into the company’s shareholders and CEOs. True as it may be that the organization contributes a great deal to society, federal money could be better spent and the organization should be held accountable for the benefit of the loan applicants and not just the shareholders.