The Use of Economic Analysis in Predatory Lending Cases: Application to Subprime Loans

20 November 2008
Dr. Denise Neumann Martin, Dr. Stephanie Plancich, and Dr. Faten Sabry

Lawsuits alleging predatory lending have been on the rise since the mid-1990s, with a sharp surge in filings in 2008. Such litigation is not new-indeed, the first cases date back several decades, having emerged after the passage of the Civil Rights Act and the Fair Housing Act in the 1960s, with additional cases arising after the passage of legislation targeted at predatory lending in the late 1980s. The earliest lending discrimination cases alleged a practice of "redlining," or denying mortgages to creditworthy individuals in minority or low-income neighborhoods. More recently, predatory lending cases have focused less on the denial of mortgages to specific groups and more on alleged targeting of exploitative or manipulative loan products to individuals or groups. Also in recent years, the composition of the mortgage market has been changing: the subprime market has grown significantly due to the continuous increase in housing prices and the availability of cheap credit. These two trends have now converged: the collapse of housing prices triggered a surge in defaults and delinquencies particularly in the subprime market, which led to a new wave of predatory lending lawsuits.

A range of lending behavior may be considered predatory, and recent cases have included an array of allegations. In some cases, plaintiffs allege that the loan-generating process itself was fraudulent. In others, certain types of loans or loan characteristics are alleged to have been unsuitable for the borrower. Other suits allege discriminatory practices, claiming disparate treatment of groups based on race or other demographic characteristics. Some plaintiffs seek injunctive relief, while others seek monetary damages.

In this paper, NERA Senior Vice Presidents Dr. Denise Martin and Dr. Faten Sabry and Vice President Dr. Stephanie Plancich review the definition of predatory lending and describe the recent litigation history. The authors then examine alleged discriminatory lending in detail, reviewing key economic theory and evidence, as well as relevant statistical techniques. Competing economic theories of discrimination are explored: one where differences in mortgage terms or rates are attributable to a preference for discrimination amongst lenders, and one where differences that appear correlated with race are instead caused by underlying measures of creditworthiness. The authors explain that rigorous investigations of alleged discriminatory practices require econometric analysis of the causes of differences in loan prices and terms, including the credit history, education, and income of the borrower, as well as the borrower's preference for risk (or discount rate). It may also be important to consider the competitiveness of the market in which the loan was arranged and other macroeconomic factors. Statistical analysis is essential to distinguish behavior that is predatory from that which is explainable by other factors and so does not provide evidence of discrimination.