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IRS SUPPORT AND COMPLIANT REGULATORS

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Denver, 1961. When a few African Americans moved to a middle-class white neighborhood, speculators panicked white homeowners into selling at a deep discount.

AS PUBLIC HOUSING packed African Americans into urban projects, and federal loan insurance subsidized white families to disperse into single-family suburban homes, other racial policies of federal, state, and local governments contributed to, and reinforced, the segregation of metropolitan areas. One was the willingness of the Internal Revenue Service (IRS) to grant tax-exempt status to churches, hospitals, universities, neighborhood associations, and other groups that promoted residential segregation. Another was the complicity of regulatory agencies in the discriminatory actions of the insurance companies and banks they supervised.

The Color of Law does not argue that merely because government regulates a private business, the firm’s activities become state action and, if discriminatory, constitute de jure segregation. Such a claim would eliminate the distinction between the public and private spheres and be inimical to a free democratic society. But because of slavery’s legacy, the Constitution gives African Americans a special degree of protection. The three constitutional amendments—the Thirteenth, Fourteenth, and Fifteenth—adopted after the Civil War were specifically intended to ensure that African Americans had equal status. When government regulation is so intrusive that it blesses systematic racial exclusion, regulators violate their constitutional responsibilities and contribute to de jure segregation.

Real estate brokers don’t become government agents simply by dint of their state licensure. But when state real estate commissions licensed members of local and national real estate boards whose published codes of ethics mandated discrimination, acts to establish de jure segregation were committed. Similarly, universities, churches, and other nonprofit institutions cannot be considered state actors simply by dint of their tax exemptions. But we have a right to expect the IRS to have been especially vigilant and to have withheld tax-exempt status when the promotion of segregation by nonprofit institutions was blatant, explicit, and influential.

I

THE IRS has always had an obligation to withhold tax favoritism from discriminatory organizations, but it almost never acted to do so. Its regulations specifically authorize charitable deductions for organizations that “eliminate prejudice and discrimination” and “defend human and civil rights secured by law.” The IRS leadership recognized this in 1967 when the agency exercised its authority to withhold the tax exemption of a recreational facility that excluded African Americans. Yet until 1970, sixteen years after Brown v. Board of Education, the IRS granted tax exemptions to private whites-only academies that had been established throughout the South to evade the ruling. It rejected the exemptions only in response to a court injunction won by civil rights groups.

In 1976, the IRS denied the tax exemption of Bob Jones University because the school would not allow interracial dating by its students. The university mounted a court challenge to the IRS action, and when the case reached the Supreme Court the Reagan administration refused to defend the agency. So the Supreme Court appointed an outside lawyer, William T. Coleman, Jr., to make the argument that the government itself should have presented. Coleman’s brief asserted: “Indeed, if [the charitable organization provision of the IRS code] were construed to permit tax exemptions for racially discriminatory schools, the provision would be unconstitutional under the Fifth Amendment. The Government has an affirmative constitutional duty to steer clear of providing significant aid to such schools.”

In its widely noticed 1983 decision, the Court upheld the IRS decision and concluded that “an institution seeking tax-exempt status must serve a public purpose and not be contrary to established public policy.” It did not adopt Coleman’s constitutional argument to make its case, but neither did the Court reject it. In his opinion, Chief Justice Warren Burger wrote that many of those who submitted briefs in the case, including Coleman, “argue that denial of tax-exempt status to racially discriminatory schools is independently required by the equal protection component of the Fifth Amendment. In light of our resolution of this litigation, we do not reach that issue.” But Coleman’s argument was solid, and it implicitly condemned the decades-long passivity of the IRS by confronting how its tax-exemption policy strengthened residential segregation. Support for a ban on interracial dating certainly offended the Constitution, but its national policy significance was trivial in comparison to the IRS’s silence when nonprofit institutions promoted restrictive covenants or engaged in other activities to prevent African Americans from moving into white neighborhoods.

Churches, synagogues, and their clergy frequently led such efforts. Shelley v. Kraemer, the 1948 Supreme Court ruling that ended court enforcement of restrictive covenants, offers a conspicuous illustration. The case stemmed from objections of white St. Louis homeowners, Louis and Fern Kraemer, to the purchase of a house in their neighborhood by African Americans, J.D. and Ethel Shelley. The area had been covered by a restrictive covenant organized by a white owners’ group, the Marcus Avenue Improvement Association, which was sponsored by the Cote Brilliante Presbyterian Church. Trustees of the church provided funds from the church treasury to finance the Kraemers’ lawsuit to have the African American family evicted. Another nearby church, the Waggoner Place Methodist Episcopal Church South, was also a signatory to the restrictive covenant; its pastor had defended the clause in a 1942 legal case arising from the purchase of a nearby house by Scovel Richardson, a distinguished attorney who later became one of the first African Americans nationwide appointed to the federal judiciary.

Such church involvement and leadership were commonplace in property owners’ associations that were organized to maintain neighborhood segregation. In North Philadelphia in 1942, a priest spearheaded a campaign to prevent African Americans from living in the neighborhood. The same year a priest in a Polish American parish in Buffalo, New York, directed the campaign to deny public housing for African American war workers, stalling a proposed project for two years. Just south of the city, 600 units in the federally managed project for whites went vacant, while African American war workers could not find adequate housing.

In Los Angeles, the Reverend W. Clarence Wright, pastor of the fashionable Wilshire Presbyterian Church, led efforts to keep the Wilshire District all white. He personally sued to evict an African American war veteran who had moved into the restricted area in 1947. Wright lost the case, one of the few times before Shelley in which a state court held covenants to be unconstitutional. In a widely publicized ruling, the judge said that there was “no more reprehensible un-American activity than to attempt to deprive persons of their own homes on a ‘master race’ theory.” Yet the IRS took no notice; Reverend Wright’s activities didn’t threaten his church’s tax subsidy.

The violent resistance to the Sojourner Truth public housing project for African American families in Detroit was organized by a homeowners association headquartered in St. Louis the King Catholic Church whose pastor, the Reverend Constantine Dzink, represented the association in appeals to the United States Housing Authority to cancel the project. The “construction of a low-cost housing project in the vicinity . . . for the colored people . . . would mean utter ruin for many people who have mortgaged their homes to the FHA, and not only that, but it would jeopardize the safety of many of our white girls,” Reverend Dzink wrote, adding this warning: “It is the sentiment of all people residing within the vicinity to object against this project in order to stop race riots in the future.”

On Chicago’s South Side, signatures on a 1928 restrictive covenant were obtained in door-to-door solicitations by the priest of St. Anselm Catholic Church, the rabbi of Congregation Beth Jacob, and the executive director of the area’s property owners association. Trinity Congregational Church was also party to the agreement. In 1946, the Congregational Church of Park Manor sponsored a local improvement association’s efforts to cancel an African American physician’s home purchase in the previously all-white neighborhood.

On Chicago’s Near North Side, a restrictive covenant was executed in 1937 by tax-exempt religious institutions, including the Moody Bible Institute, the Louisville Presbyterian Theological Seminary, and the Board of Foreign Missions of the Methodist Episcopal Church. Other nonprofit organizations also participated, including the Newberry Library and the Academy of Fine Arts.

Tax-exempt colleges and universities, some religious-affiliated and some not, also were active in promoting segregation. In Whittier, a Los Angeles suburb, the Quaker-affiliated Whittier College participated in a restrictive covenant covering its neighborhood.

The University of Chicago organized and guided property owners’ associations that were devoted to preventing black families from moving nearby. The university not only subsidized the associations but from 1933 to 1947 spent $100,000 on legal services to defend covenants and evict African Americans who had arrived in its neighborhood. When criticized for these activities, University of Chicago president Robert Maynard Hutchins wrote in 1937 that the university “must endeavor to stabilize its neighborhood as an area in which its students and faculty will be content to live,” and that therefore the university had the “right to invoke and defend” restrictive covenants in its surrounding areas.

II

INSURANCE COMPANIES also participated in segregation. They have large reserve funds to invest, and because they are heavily regulated, state policy makers are frequently involved in plans for any housing projects that insurers propose.

In 1938, when Frederick Ecker, president of the Metropolitan Life Insurance Company, wanted to build the 12,000-unit Parkchester apartments in New York City, he could not proceed without an amendment to the state’s insurance code, permitting insurers to invest in low-rent housing. The state legislature adopted the amendment, fully aware that it was authorizing a project from which African Americans would be excluded.

After Parkchester was completed in 1942, Metropolitan Life embarked on a new project, the 9,000-unit Stuyvesant Town housing complex on the east side of Manhattan. For the development, New York City condemned and cleared eighteen square city blocks and transferred the property to the insurance company. The city also granted Metropolitan Life a twenty-five-year tax abatement, whose value meant that far more public than private money was invested in the project. The subsidies were granted despite Metropolitan Life’s announcement that, like Parkchester, the project would be for “white people only.” Ecker advised the New York City Board of Estimate that “Negroes and whites don’t mix. If we brought them into this development . . . it would depress all of the surrounding property.” Because of the project’s refusal to accept African Americans, the board was divided whether to allow it to proceed. It eventually paired its approval with an ordinance forbidding racial segregation in any subsequent developments for which the city had to engage in “slum clearance.” In response to public protests against its policy of excluding African Americans from Stuyvesant Town, Metropolitan Life built the Riverton Houses, a smaller development for African Americans in Harlem. Abiding by the new ordinance, the project was open to whites, but in practice it rented almost exclusively to African American families.

In 1947, a New York State court rejected a challenge to Stuyvesant Town’s racial exclusion policy. The decision was upheld on appeal in 1949; the U.S. Supreme Court declined review. The following year, the New York State legislature enacted a statute prohibiting racial discrimination in any housing that received state aid in the form of a tax exemption, sale of land below cost, or land obtained through condemnation. That same year, Metropolitan Life finally agreed to lease “some” apartments in Stuyvesant Town to “qualified Negro tenants.” But by then, the development was filled. New York City’s rent control laws, by which existing tenants pay significantly less than market-rate rents, helped to ensure that turnover would be slow. Rapidly rising rents in apartments that had been vacated made the development increasingly unaffordable to middle-income families. These conditions combined to make the initial segregation of Stuyvesant Town nearly permanent. By the 2010 census, only 4 percent of Stuyvesant Town residents were African American, in a New York metropolitan area that was 15 percent African American.

As in so many other instances, the low-income neighborhood that the city razed to make way for Stuyvesant Town had been integrated and stable. About 40 percent of those evicted were African American or Puerto Rican, and many of them had no alternative but to move to racially isolated communities elsewhere in the city and beyond. Although New York ceased to allow future discrimination in publicly subsidized projects, it made no effort to remediate the segregation it had created.

III

EVEN WHEN mortgage loans were not insured by the FHA or the VA, banks and savings (thrift) institutions pursued discriminatory policies. Banks and thrifts, however, are private institutions. Can it fairly be said that these discriminatory lending activities contributed to de jure segregation? I think so.

Government deposit insurance programs underwrite bank and thrift institution profits; in return, there is extensive oversight of lending practices. Examiners from the Federal Reserve, the Comptroller of the Currency, the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision all have regularly reviewed loan applications and other financial records of bank and savings and loan offices to ensure that lending practices were sound. Banks and thrifts were able to refuse service to African Americans only because, until recently, federal and state regulators chose to allow it.

The Federal Home Loan Bank Board, for example, chartered, insured, and regulated savings and loan associations from the early years of the New Deal but did not oppose the denial of mortgages to African Americans until 1961. It did not enforce the new race-blind policy, however—perhaps because it was in conflict with the board’s insistence that mortgage eligibility account for “economic” factors. Like the FHA, it claimed that judging African Americans to be poor credit risks because they were black was not a racial judgment but an economic one. As a result, its staff failed to remedy the industry’s consistent support for segregation.

In 1961 the U.S. Commission on Civil Rights challenged regulators about their complicity in banks’ redlining practices. Ray M. Gidney, then Comptroller of the Currency (responsible for chartering, supervising, regulating, and examining national banks), responded, “Our office does not maintain any policy regarding racial discrimination in the making of real estate loans by national banks.” FDIC chairman Erle Cocke asserted that it was appropriate for banks under his supervision to deny loans to African Americans because whites’ property values might fall if they had black neighbors. And Federal Reserve Board chairman William McChesney Martin stated, “[N]either the Federal Reserve nor any other bank supervisory agency has—or should have—authority to compel officers and directors of any bank to make any loan against their judgment.” Martin’s view was that federal regulators should only prohibit the approval of unsound loans, not require the nondiscriminatory approval of sound loans. If a black family was denied a loan because of race, Martin asserted, “the forces of competition” would ensure that another bank would come forward to make the loan. With his regulatory authority over all banks that were members of the Federal Reserve System, and with all such banks engaging in similar discriminatory practices, Martin surely knew (or should have known) that his claim was false.

When regulated businesses engage in systematic racial discrimination, when government regulation is intense, and when regulators openly endorse the racial discrimination carried out by the sector they are supervising, then in those cases the regulators ignore the civil rights they are sworn to uphold and contribute to de jure discrimination. As the Supreme Court once said, referring to banks chartered by the federal government: “National banks are instrumentalities of the federal government, created for a public purpose.”

IV

RACIALLY DISCRIMINATORY government activities did not end fifty years ago. On the contrary, some have continued into the twenty-first century. One of the more troubling has been the regulatory tolerance of banks’ “reverse redlining”—excessive marketing of exploitative loans in African American communities. This was an important cause of the 2008 financial collapse because these loans, called subprime mortgages, were bound to go into default. When they did, lower-middle-class African American neighborhoods were devastated, and their residents, with their homes foreclosed, were forced back into lower-income areas. In the early 2000s, reverse redlining was tolerated, sometimes winked at, by bank regulators.

Banks, thrift institutions, and mortgage companies designed subprime loans for borrowers who had a higher risk of default, and they charged higher interest payments to subprime borrowers to compensate for that risk. In itself, this was a legitimate practice. But federally regulated banks and other lenders created many subprime loans with onerous conditions that were designed to make repayment difficult. These mortgages had high closing costs and prepayment penalties and low initial “teaser” interest rates that skyrocketed after borrowers were locked in. Some subprime loans also had negative amortization—requirements for initial monthly payments that were lower than needed to cover interest costs, with the difference then added to the outstanding principal.

Borrowers should have been more careful before accepting loans they could not understand or reasonably repay, but they were victims of a market that was not transparent—in some cases deliberately not so. For example, mortgage broker compensation systems included incentives to pressure borrowers into accepting subprime mortgages, without the brokers disclosing the consequences. Brokers received bonuses, in effect kickbacks (called “yield spread premiums,” or YSPs), if they made loans with interest rates higher than those recommended by their banks on formal rate sheets for borrowers with similar characteristics. Regulators and banks that purchased these mortgages from marketers did not require brokers to disclose to borrowers what these rate sheets specified. The 2010 Dodd-Frank financial reform and consumer protection act banned YSPs. It took another year for the Federal Reserve to issue a rule implementing the ban, but borrowers who were deceived as a result of the kickback system are without recourse. Nothing, however, would have prevented the Federal Reserve from banning the practice years earlier.

Brokers and loan officers manipulated borrowers by convincing them they could take advantage of perpetually rising equity to refinance their loans before the teaser rates expired and take cash out of the increased equity (with a share left as profit for the lending institution). But frequently these mortgages were promoted and sold to African Americans who lived in distressed neighborhoods where little or no gain in equity could be expected—even before the housing bubble burst. In these areas where property values would be unlikely to appreciate, the scheme could not possibly work as promised, even if the nationwide housing boom continued.

These discriminatory practices were widespread throughout the industry at least since the late 1990s, with little state or federal regulatory response. Data on lending disparities suggest that the discrimination was based on race, not on economic status. Among homeowners who had refinanced in 2000 as the subprime bubble was expanding, lower-income African Americans were more than twice as likely as lower-income whites to have subprime loans, and higher-income African Americans were about three times as likely as higher-income whites to have subprime loans. The most extreme case occurred in Buffalo, New York, where three-quarters of all refinance loans to African Americans were subprime. In Chicago, borrowers in predominantly African American census tracts were four times as likely to have subprime loans as borrowers in predominantly white census tracts.

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Before the 2008 burst of a housing bubble, lenders targeted African American and Hispanic homeowners for the marketing of subprime refinance loans. When the economy collapsed, many homes went into foreclosure, devastating entire neighborhoods—like this block of boarded-up homes on Chicago’s Southwest Side.

In 2000, 41 percent of all borrowers with subprime loans would have qualified for conventional financing with lower rates, a figure that increased to 61 percent in 2006. By then, African American mortgage recipients had subprime loans at three times the rate of white borrowers. Higher-income African Americans had subprime mortgages at four times the rate of higher-income whites. Even though its own survey in 2005 revealed a similar racial discrepancy, the Federal Reserve did not take action. By failing to curb discrimination that its own data disclosed, the Federal Reserve violated African Americans’ legal and constitutional rights.

In 2010, the Justice Department agreed that “[t]he more segregated a community of color is, the more likely it is that homeowners will face foreclosure because the lenders who peddled the most toxic loans targeted those communities.” Settling a lawsuit against the Countrywide mortgage company (later a subsidiary of the Bank of America), Secretary of Housing and Urban Development Shaun Donovan remarked that because of Countrywide’s and other lenders’ practices, “[f]rom Jamaica, Queens, New York, to Oakland, California, strong, middle-class African American neighborhoods saw nearly two decades of gains reversed in a matter of not years—but months.” For those dispossessed after foreclosures, there has been greater homelessness, more doubling up with relatives, and more apartment rental in less stable neighborhoods where poor and minority families are more tightly concentrated.

In its legal action against Countrywide, the government alleged that the statistical relationship between race and mortgage terms was so extreme that top bank officials must have been aware of the racial motivation. And if top bank officials were aware, so too must have been the government regulators. Indeed, the Justice Department got involved only because Countrywide modified its government charter in 2007 so that the Office of Thrift Supervision assumed responsibility for its regulation from the Federal Reserve Board. The office noticed the racially tinged statistics and referred the lender to the Department of Justice for prosecution. The discriminatory practices had continued for years under the Federal Reserve’s supervision.

Several cities sued banks because of the enormous devastation that the foreclosure crisis imposed on African Americans. A case that the City of Memphis brought against Wells Fargo Bank was supported by affidavits of bank employees stating that they referred to subprime loans as “ghetto loans.” Bank supervisors instructed their marketing staffs to target solicitation to heavily African American zip codes, because residents there “weren’t savvy enough” to know they were being exploited. A sales group sought out elderly African Americans, believing they were particularly susceptible to pressure to take out high-cost loans.

A similar suit by the City of Baltimore presented evidence that Wells Fargo established a unit staffed exclusively by African Americans whom supervisors instructed to visit black churches to market subprime loans. The bank had no similar practice of marketing such loans through white institutions.

In 2008 the City of Cleveland sued a large group of subprime lenders, including Citicorp, the Bank of America, Wells Fargo, and others. The lawsuit alleged that the institutions should not have marketed any subprime loans in Cleveland’s depressed black neighborhoods because the lenders knew that high poverty and unemployment rates and flat property values in those communities would preclude borrowers from capturing sufficient appreciation to afford the higher adjustable rates they faced, once the initial low “teaser” rates expired.

Cleveland’s suit argued that the banks should be held liable for the harm they created, including loss of tax revenues and an increase in drug dealing and other crime in neighborhoods with many foreclosed and abandoned buildings. The city charged that the financial firms had created a public nuisance. A federal court dismissed the suit, concluding that because mortgage lending is so heavily regulated by the federal and state governments, “there is no question that the subprime lending that occurred in Cleveland was conduct which ‘the law sanctions.’”

The consequences of racially targeted subprime lending continue to accumulate. As the housing bubble collapsed, African American homeownership rates fell much more than white rates. Families no longer qualify for conventional mortgages if they previously defaulted when they were unable to make exorbitant loan payments; for these families, the contract buying system of the 1960s is now making its return. Some of the same firms that exploited African Americans in the subprime crisis are now reselling foreclosed properties to low- and moderate-income households at high interest rates, with high down payments, with no equity accumulated until the contract period has ended, and with eviction possible after a single missed payment.

By failing to ensure that banks fulfilled the public purposes for which they were chartered, regulators shared responsibility for reverse redlining of African American communities. When federal and state regulatory agencies chartered banks and thrift institutions whose unhidden policy was racial discrimination, the agencies themselves defaulted on their constitutional obligations.

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