The Hidden Clue

[First published in Forbes,
Jan 4, 1993]

Media hoopla to the contrary, the
evidence suggests that banks are color-blind when it
comes to mortgage lending.

"Definitive–changes the
landscape." -
-Office of the Comptroller of the
Currency.

"Comports with common sense, no
more studies needed."–
Richard F. Syron, president,
Federal Reserve Bank of Boston.

These ecstatic press notices
greeted the Boston Fed`s recent study claiming to prove
racial bias in mortgage lending–the social problem of
the season, with coverage in the Wall Street Journal
(five stories in eight weeks), regulatory rumbles from
the Federal Reserve, legislative leers from Congress.
The pressure is on mortgage lenders to change credit
standards for minorities.

But the study`s analysis makes an
elementary error about a crucial question: minority
default rates. Queried by Forbes,

Alicia H. Munnell
, Boston Fed senior vice president
and research director, conceded that the study`s
handling of default rates was "definitely not an
adequate look at all."

Minority mortgage applicants do
tend to be rejected more than whites. A Federal Reserve
Board survey of 6.6 million home mortgage applications
in 1991 showed that 37.6% of black applicants and 26.6%
of Hispanics were denied home loans, compared with only
17.3% of whites. This finding held across all income
levels. But was the difference the result of racism? Or
of an objective, color-blind application of sound credit
standards? The data on default suggest the latter is
true. Mortgage lenders consider a range of criteria
going far beyond income, such as net worth, age,
education, probability of unemployment and credit
history. Minorities frequently fare worse by such
measures. Perhaps that`s because society gives them
fewer opportunities. But mortgage lenders would still be
objective, not prejudiced, in rejecting them. The Boston
Fed study did correct for standard credit criteria,
based on a sample of Boston-area mortgage applications.
It found that these criteria did explain about
two-thirds of the difference between white and
black/Hispanic rejection rates. But even after this
correction, minorities seem to be rejected at a rate of
17%, as opposed to only 11% for whites. This difference,
the Boston Fed claimed, must be caused by racism. . [Mortgage
lending in Boston: Interpreting HMDA data
(Working
Paper 92-7
)]

Oh, yeah? But what about those
default rates?

"We were aware that people say,
`Oh, this may be

rational discrimination,
because minorities default
more,`"
the Boston Fed`s Munnell told Forbes.
But her study sample was too recent to check default
rates directly. Instead, the Boston Fed compared default
rates across census tracts. "And what we found was,
there was no relationship between the racial composition
of the tract and the default rate. So it wasn`t true
that tracts with large minority populations had higher
default rates."
Think about this carefully. The
Boston Fed authors apparently assumed that equal default
rates meant all minority applications are an equal
credit risk compared with whites. But they`re wrong.
These census tract mortgages had already passed through
the loan approval process-which had presumably rejected
a higher proportion of minority applicants on the way.
So the fact that white and minority default rates
finished up equal meant mortgage lenders knew what they
were doing.

The market, in short, worked. The
mortgage lenders somehow weeded out the extra credit
risks among minorities, down to the, point where white
and minority defaults were at an equal, apparently
acceptable, rate.

"[That] is a
sophisticated point,"
says Munnell, questioned by
Forbes
. She agrees that discrimination against
blacks should show up in lower, not equal, default
rates–discrimination would mean that good black
applicants are being unfairly rejected. "You need
that as a confirming piece of evidence. And we don`t
have it."


Forbes
: Did you ever ask the question that if
defaults appear to be more or less the same among blacks
and whites, that points to mortgage lenders making
rational decisions?

Munnell:
No.

Munnell does not want to repudiate
her study. She tells Forbes, on reflection, that
the census data are not good enough and could be
"massaged"
further: "I do believe that
discrimination occurs."

Forbes: You have no
evidence?

Munnell: I do not have
evidence…. No one has evidence.

But if there is racial
discrimination in lending, it means that mortgage
lenders forgo profitable business because they are
prejudiced. That`s unlikely on the face of it and
becomes more unlikely when one notices that
Asian-American applicants are actually turned down less
often (15% in the Fed survey) than whites. Moreover,
logically, it could be precisely those institutions
marketing most vigorously to minorities that generate
the most marginal applications–and therefore the
highest rejection rates.

The Boston Fed study itself noted
that denied minority applications on average had
"poorer objective qualifications,"
suggesting "a
systematic bias in mortgage lending is very difficult to
document. . . ."

But in today`s climate, any
statistical disparity is viewed as discrimination–and
an excuse for more social engineering.

[James
Fulford
writes:
After this was published, George
Galster of the Urban Institute wrote an attempt at
rebuttal:

The Facts of Lending Discrimination Cannot Be Argued
Away by Examining Default Rates
,
arguing that
because minorities as a class are poorer, and live in
worse neighborhoods, "In a world devoid of lending
discrimination, therefore, minority mortgage holders as
a group will tend to have higher default rates than the
pool of white mortgage holders."

[This
kind of thinking may be "good enough for government
work,"
college admissions, or civil service
promotions. But you can`t expect banks to act that way.
They`re using
their own money
, and must lend to people who can pay
it back.

[Raphael
Bostic
wrote

The Role of Race in Mortgage Lending: Revisiting the
Boston Fed Study
in 1997, which he said
"Thus, the claim that non-economic discrimination is a
general phenomenon is refuted. Further, I can say little
regarding the existence of discrimination among
`marginal` applicants. To conclude that such
discrimination exists, one must prove that the observed
differences are not due to economic factors."]