You might think that the last thing any business owner in America would be legally able to post outside their storefront or on their website would be a “Whites Only” sign, warning other races or ethnicities from seeking their goods and services. But an obscure ruling against the Consumer Financial Protection Bureau (CFPB) in federal court, if upheld, would effectively legalize this conduct for many lenders, including the majority of the entities that issue mortgages.
The ruling from U.S. District Court judge Franklin Valderrama goes against nearly 50 years of regulatory practice on the Equal Credit Opportunity Act of 1974 (ECOA). His decision states that ECOA regulates conduct only after a would-be borrower turns in an application, and does not cover conduct that discourages applicants before that stage. CFPB has appealed the ruling, which was issued in June, and a hearing at the Seventh Circuit Court of Appeals is expected this fall.
If the ruling is upheld, a host of practices would be out of reach of ECOA enforcement, including ones well below the radar of a Whites Only sign. In particular, lenders could exclude women, African American or Hispanic people, and other protected groups from targeted online marketing efforts, a sophisticated form of digital redlining that has recently come into fashion.
The case came not out of conservative and business interests’ favorite corners of the judiciary, though it did come from a federal district judge whom Donald Trump appointed and who was confirmed just six weeks before the 2020 presidential election. That fails to explain who Valderrama is, however. When four federal judge slots came up in Illinois in 2020, a package deal was announced where Republicans would select three judges and Democrats one. Valderrama, a Cook County judge for over a decade, was the Democratic choice, and at the time Sen. Dick Durbin (D-IL) praised him as “an outstanding addition to the federal bench.” Yet Valderrama may now be responsible for legalizing a pernicious form of discrimination in credit markets.
Durbin is now the chair of the Senate Judiciary Committee, where, through his deference to the “blue slip” process, he has allowed Republican senators to block Biden-nominated judges from those senators’ home states. Liberals have been lamenting the right-wing tilt of U.S. courts for decades. But the fact that the choice that Durbin (and his Illinois colleagues) made in 2020 is now leading this attack on consumer protection regulation suggests that the quality of some judges that Democrats select could be part of the problem.
THE CASE IS PRETTY STRAIGHTFORWARD. A Chicago-based non-bank mortgage lender named Townstone has for several years run a radio program/podcast called “The Townstone Financial Show,” which served as an infomercial for the business and which, according to the lawsuit, generated 90 percent of its applications. Going back to 2014, the show has included repeated comments by its hosts, who are senior loan officers with Townstone, that African American communities in the Chicago area are scary places to visit (“a real war zone”) and havens for “hoodlum[s].” Unsurprisingly, none of Townstone’s marketing was directed at African American communities, and almost none of Townstone’s mortgage applications were from Black borrowers, and almost none of its approvals went to Black borrowers or were in majority-Black areas.
CFPB filed suit against Townstone in July 2020, when the agency was still run by Trump’s handpicked director, Kathy Kraninger. The agency argued that the racist comments discouraged African American borrowers from using Townstone, and discouraged applicants from applying for loans in areas the hosts disparaged. This, CFPB said, violated ECOA.
But Judge Valderrama dismissed the case on the basis that ECOA cannot regulate pre-application conduct. He cited the language of the law, which states: “It shall be unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction, on the basis of race, color, religion, national origin, sex or marital status, or age.”
A more insidious form of discouragement has developed where credit offers are only made to specific populations, and protected classes are excluded.
The implementing regulation to ECOA, adopted in 1975 and known as Regulation B, explicitly states that “prospective applicants” cannot be discouraged from credit products on a discriminatory basis. But Valderrama said that Congress was unambiguous in saying that only applicants were covered under ECOA, noting that “applicant” was used 26 times in the statute. Therefore, because ECOA “says nothing about ‘prospective applicants,’” Valderrama writes, “the Court does not defer to Regulation B.” (As a minor textualist point, federal law states clearly that statutory language in the present tense includes the future tense, therefore making it reasonable that “applicants” could also include prospective applicants.)
The ruling essentially throws out the ’70s-era language of Regulation B, which was promulgated by the Federal Reserve, not exactly the most aggressive consumer protection entity. “There is a framing in the defendant’s brief as if this is some new, wild interpretation taken by the CFPB, which is not true,” said Stephen Hayes, a former CFPB lawyer who authored an amicus brief in the case. Hayes also notes that other anti-discrimination statutes are read in this exact same way, with pre-application discouragement seen as a violation of the law, even if the statute refers to applicants. “The idea that the text has to be read in an extremely cabined way is not consistent with the way courts have read it.”
In the ruling, Judge Valderrama failed to mention that Congress amended the ECOA statute in 1991, explicitly stating that agencies should refer to the attorney general any “pattern or practice of discouraging or denying applications for credit.” By definition, that would happen before the application stage. In addition, Congress gave regulators the express authority to make “adjustments and exceptions” to ECOA, to prevent “circumvention or evasion” from it. Discouraging women or Black people from applying for credit is certainly a way to evade the anti-discrimination law, if it were based on applicants alone.
IF THE RULING WERE TO STAND, lenders could blatantly announce that they will not serve Black, Hispanic, female, married, or LGBT borrowers, or borrowers on public assistance, and face no sanction from ECOA. They could usher anyone with these characteristics out of their storefronts the moment they walked in the door. They could give a two-page application to prospective borrowers without these characteristics, and a 200-page application to those with them.
In mortgage lending, where the homeownership gap by race is at its highest point since the 1890s, the Fair Housing Act (FHA) more explicitly bars pre-application discrimination. However, while prudential regulators supervise banks for FHA compliance, the CFPB is the only federal supervisor of non-bank mortgage lenders, and its examiners cannot use the FHA in looking at discrimination. As Hayes’s amicus brief, written on behalf of the National Fair Housing Alliance and several other organizations, states, this would give non-bank lenders, which account for over two-thirds of mortgage lending, a free pass on pre-application discouragement.
Even though the smallest community banks on up to the largest ones would be held to a higher standard than non-banks if this ruling were upheld, the Mortgage Bankers Association filed an amicus brief supporting Townstone in the case. The MBA did not return a request for comment.
Other consumer loans besides mortgages are governed by ECOA, including auto loans, small-business loans, and personal loans. Under Valderrama’s ruling, pre-application discouragement would be made effectively legal in many of those cases. This kind of conduct is already pervasive, as in the discouragement of women and minority-owned businesses from Paycheck Protection loans authorized under the CARES Act, in some cases through overt statements that those businesses not apply. But now, such practices won’t even be a violation of ECOA, if the ruling stands. The ruling gives would-be discriminators an effectively legal pathway to discriminate.
A more insidious form of discouragement has developed hand in hand with the rise of targeted advertising. This has created a new form of pre-screening, where credit offers are only made to specific populations, and protected classes are excluded. The most notorious instance of this occurred on Facebook, where lenders and other companies targeted offers to specific ages, genders, and race. Facebook, whose parent company is Meta, settled a lawsuit over this conduct in 2019, but media outlets have continued to find businesses discriminating in their marketing using Facebook tools.
Facebook is only one of the services used to target certain populations for marketing, which could create “digital redlining” for credit. “A lot of the targeting and applicant pool determinations happens before someone has applied,” Hayes told the Prospect. “It’s much easier to gather information about people who might be interested. Lenders can use some of this background information about people who have not applied to pre-screen applicants.”
TOWNSTONE FILED ITS RESPONSE TO THE CFPB APPEAL last week. The Federal Trade Commission issued a brief supporting the appeal, noting that it “receives thousands of complaints about credit discrimination each year,” even under the current standard where ECOA covers pre-application conduct. “The problem would worsen dramatically if the district court were right and naked discrimination were permitted before an application is formally filed,” the FTC wrote.
The case to reverse the Townstone decision may be further hampered by the Supreme Court’s imminent ruling in Loper Bright Enterprises v. Raimondo next term, which will challenge so-called Chevron deference, which gives regulatory agencies broad leeway to interpret federal statutes. If the Supreme Court rules against regulatory agencies in Loper, the Seventh Circuit would have fewer tools to overturn the district court in Townstone.
Judge Valderrama’s overly textualist reading in the case, however, walked past several off-ramps that would have been available even without Chevron deference. The judge could have recognized the 1991 amendment as showing Congress’s interest in stopping pre-application discouragement, or made the reasonable interpretation that a law about applicants also incorporates those steered away from applying. But instead, we have an overly literal reading that doesn’t even take reasonable textual interpretations, let alone the enormous implications for millions of borrowers, into account.
The ruling suggests that even some Democratic-approved judges don’t have an overriding judicial philosophy that is notably different from conservatives on many issues. That’s something to consider whether the CFPB prevails on appeal or not.