View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

n Delivery
.D .T .)

Remarks of




to the

American Bar Association National Institute on "Consumer Credit"

New York, New York

June 16, 1977



Most of you who practice law probably share my interest in how
our language subtly but distinctly changes the meaning of words in common
usage. While I am not enough of an English scholar to know whether this
trend is accelerating in its velocity, it seems to me that words are changing
meaning faster.

I now hear words on television and in other public media

which recently were reserved for barracks room conversation.
There arc many examples of this change. The word "drugs” , for
instance. As you and I grew up, wo thought of "drugs" as having a life
giving connotation. The availability of life sustaining drugs produced a
very positive mental image when you used that word.

Unfortunately, today

it now has the opposite effect and usually denotes a very negalive mental
image of someone whose life is shortened by their use.
"Economy" is another example. In soapboxes it means large; in
automobiles it now means small.
But the word I want to talk about today is "discriminate.” My 197f>
edition of the Webster's New Collegiate Dictionary shows the evolution of
this word. Its derivation is clearly from the Latin diseriminatus which
means to distinguish between.

In its transitive sense the verb is defined


as "to distinguish or differentiate by discerning or exposing differences."
In its intransitive sense one meaning says "to make a distinction", another
says "to use good judgment." But the most modjrn definition is "to make
a difference in treatment or favor on a basis other than individual merit."
Most of you as members of the Bar are more familiar with this
latter definition. One of the subjects of this Conference is the Equal Credit
Opportunity Act which prohibits discrimination against any applicant on the
bases of sex, marital status, race, religion, age, national origin and so
forth. Now that this broadened Act has become effective, creditors are
turning to many of you for interpretation in order to assure that they are
complying with the true meaning of the statute. Many of you are reminding
your clients that the Act does not prohibit the showing of a difference, but
only the showing of a difference that is hostile or adverse to the applicant as a
result of considerations based on the prohibited bases.
The passage and implementation of this statute have brought into
sharper public focus the question of determining who is creditworthy and the
considerations used by creditors in making that determination. This public
interest by our consumer oriented society springs from our widespread
dependence upon consumer credit. The very efficient distribution system
which we enjoy does not allow a great deal of margin for errors in credit
judgment, since increased losses and collection costs would drive up the cost
of the distribution of goods and services throughout our land.


We sometimes get the mistaken idea that someone is either credit­
worthy or not. This is too often equated with some legal or social right. All
of us need to be reminded that creditworthiness is a concept which exists only
in the value system of a specific creditor for a specific transaction. It must
exist also in qualitative and quantitative terms. Even to an individual creditor
a conclusion of creditworthiness is only a present estimate of a future probability.
When determining that an applicant is creditworthy, a creditor decides that the
probabilities that the debt will be repaid are sufficiently high so that the creditor
is willing to assume that risk of nonpayment.
With these considerations in mind it is obvious that creditworthiness
must be a function of the creditor's risk premium charges as well as the
characteristics of the applicant. The determination is related also to the
period of time over which the risk is assumed as well as to the potential net
profit of the creditor.
When we limit by law a creditor’s legal capacity to judge credit­
worthiness we are tampering with a major component of our economic
system. I believe the Congress in framing the Equal Credit Opportunity
Act tried to walk the fine line between arbitrary, capricious and irrational
considerations of creditworthiness on one hand and a wide latitude for
creditors to make individual credit judgments on the other. The statute
is generally successful in making this fine distinction.



Unfortunately, however, the application of the so-called "effects test"
may confuse this fine distinction and throw the applicability of the statute
into doubt. A special study of credit scoring systems which are based on
mathematically predicted variables has been made by Professor Chandler at
Georgia State University. lie determined that of the 42 most commonly used
predictive variables there was not a single one that did not result in the showing
of a distinction related to one of the prohibited bases. Coupled with the know­
ledge that increasingly plaintiffs are using purely statistical devices as in­
direct proof of a discriminatory pattern or practice, this fact is causing many
of your creditor clients discomfort. The possible consequences of applying
the effects test in the area of credit discrimination led the Board of Governors
to treat the effects test so circumspectly in our regulations.
The Equal Credit Opportunity Act is not the only legislative area in
which our society has attempted to prohibit the showing of a distinction in
the extcntion of credit. The oldest of these is an area in which many of you
have had a considerable amount of experience, our state "usury” laws. I
have always rebelled at this terminology for these laws. Unfortunately, too
many people have read the Bible and noticed that usury has a religious as
well as a legal connotation. However, I don't think that most of the laws
labeled "usury" really pertain to the biblical subject. My own interpretation
of the biblical admonition was to prohibit the act of the unscrupulous against

the defenseless. Most of these laws are not designed for this purpose, but
are only price control legislation.
Like every other attempt to governmentally control prices, these laws
have seldom worked unless the ceiling is placed at a level high enough to
enable most transactions to take place. Those borrowers who would usually
pay higher interest rates due to greater risks or other costs are often those
discriminated against because the price coiling is below that necessary to
attract funds for their use.
Money is highly fungible and transportable. Yet its cost to the public
is politically sensitive. This situation has created a hodgepodge of pricing

Practices and developments such as discounts, add on interest,

extra fees, closing costs and similar deviccs arc largely the result of
political compromises to devise ways to get around an unrealistic price control
It might also be argued that many of these devices were invented by
lenders as a means to confuse or deceive the public from the true cost of
the use of credit. Fortunately, the Federal Truth in Lending statute now
makes such deceptions ineffective. No one would argue that the truth in
lending concept of measuring the cost of credit is an absolutely pure one.
Yet our national effort toward encouraging a better knowledge by the borrower
of the relative costs of credit is an improvement compared with the alternatives.


The truth in lending concept could be a basis for a fundamental change
in state ’’usury” attitudes and the laws which result therefrom. If creditors
are required to disclose the cost of credit on a reasonably comparable basis,
isn’t it time that the states stopped these artificial practices which encourage
deception? They would then focus on better ways for the defenseless to be
protected against the unscrupulous. A few states now restrict lenders' conduct
which has been decided to be unfair or deceptive for reasons not related to
the price of the credit.
A third type of credit distinction or discrimination is now receiving
a great deal of public attention. This is the concept of geographical dis­
crimination, commonly known as redlining. While many are speaking out
against it in various ways, there is not a commonly accepted definition as
yet. It is not clear whether the concept applies only to housing credit or
applies equally to all forms of credit. One early use of the term was in
the writing of auto insurance.
Some of redlining's strongest critics view the practice as being
fundamentally racially based. If this is true, there is no need for additional
legislation. As you and I already know, racial discrimination is clearly
covered under the present Equal Credit Opportunity Act. That Act very
explicitly prohibits any hostile differentiation based not only on the race of
a specific applicant but on considerations of race in general — whether they
are of the neighborhood or the other tenants in the property.


To many people redlining is the refusal of financial institutions
to consider real estate investments in a specific geographic area. This
practice is likely to be grounded in two past conditions. First, we have
gone through a long period of relative unattractiveness of housing credit
investments. We have had a mortgage money shortage. This shortage in
turn has its roots in our public policy to build a wall around housing credit —
not requiring that housing credit compete with other forms of investment.
This practice has produced short-term swings of feast and famine in housing
credit, thus discouraging many lenders from participating in housing credit
programs — even when these yields are attractive.
The other basis of geographical exclusion is the result of typical
herd instinct reaction to losses by some lenders.

We have to recognize that

there have been some losses in many urban areas, particularly in the blighted
central city neighborhoods. The results were that lenders began blindly to
run. They did not adjust their programs to meet the new risk and rewards

Furthermore, many Federal or local governmental subsidized

credit programs created new risks and supplanted the private market which
had existed in many of these neighborhoods.
As we work toward solutions to the problem of geographical differentiation,
we need to bear in mind several objectives.

We should stop our attempts to

substitute governmental procrustean formulae for the total result of many
individual risk and reward analyses. We must preserve the right to dis­
criminate - to show a difference.


At the same time, we can and should provide the information
necessary for objective, factual analysis. For example, local governments
could produce maps showing those older areas which have not suffered
abandonment or vandalism and in which the local government is pledged
to continue providing full municipal services. A charting of foreclosures by
location, amount and type of loan would help lenders estimate the probabilities
of future market price stability.
And we must develop ways to reduce or spread risk so that the rewards
look proportionately higher. Our best results of channeling resources through
the years have been based on providing incentives for private decisions to,
yes, discriminate in favor of the desired purpose. These incentives for
private action can be in the form of better information about the relative
rewards and risks or they may be in the form of direct subsidies to the users
of such credit which will thus enable them to offer higher rewards to creditors.
The best incentive for private action is probably the most difficult
to achieve. Private initiative often works hardest when government intervenes
least. Therefore, if we can resist the temptation to demand that government
"do everything," it is more likely that the private sector will become active.
The past record on this type of approach has been poor, for seldom have we
given it a real chance to woiic. Impatient to get quick results, mistakenly
thinking that government action only costs the other fellow, we continue to


demand more and more intervention. Yet it is a rare case when passing a
law and throwing money at it cures any problem.
Our economic system has been constructed on the concept of private
ownership of property and on economic freedom of choice in the use of that
property. The aggregate free choices, and differentiation of our people
have been the means by which our resources are allocated and our potential

Let us never lose sight that this capacity to discriminate — in

the nonsocial meaning of that word — has been one of the means by which
this country has become great.
True, there arc limes when any society must deny the freedom of
individual action in order to protect, preserve or benefit the group as a
whole. But we must be vigilant to assure that any abridgement of individual
choice, any denial of the right to discriminate, takes place only when the
total benefits to society derived therefrom clearly outweigh this loss of