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Miron,TakingaHardLookatRacialBias,1992

Miron,TakingaHardLookatRacialBias,1992 - Economy Watch w...

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Unformatted text preview: Economy Watch w Taking a hard look at racial bias by J strut-iv A. MIRoN The possibility of racial bias in mortgage lending has received considerable attention recently. This atten- tion results in substantial part from the release of two new studies on the topic. According to most interpre- tations, the studies demonstrate definitively the exist~ once of racial piscrimination in mortgage lending. The evidence in these studies, however, does not by itself support a conclusion of discrimination, nor does. such a conclusion necessarily justify the policies advo- cated by some community activists and politicians. The first of the studies, conducted by the Federal Reserve Board, finds that blacks and Hispanics are substantiaily more likely than whites of similar income to be denied mortgage loans. As many bankers have argued. however, this fact does not prove discrimina- tion in bankers‘ lending practices. —— The evidence does not by itself support a conclusion of discrimination, nor does such a conclusion necessarilyjustiiy activist policies. To begin with, because the mean income of blacks is less than that of whites, a black with a given income likely has less total future income than a white with the same current income; the income of the black is probably temporarily high. Even more important, income is not the only finan- cial characteristic that. banks consider in their mort- gage lending decisions. Credit histories. employment history, loan—to-value ratios and many other factors are all potentially important determinants of an appli- cant's creditworthiness and therefore the likelihood of loan approval. ln response to these problems with the Fed study, a later study conducted by the Federal Reserve Bank of Boston, focusing on Boston area banks, examines whether racial differences in mortgage loan approval- rates persist if one controls for the characteristics of borrowersthat are recorded on standard mortgage loan applications. Two key results emerge from the Boston Fed study. First, differences in the financial characteristics of blacks and whites explain more than half the difference in the probability of loan approval. Second, these differences in financial characteristics fail to explain the entire difference in approval rates. The crucial question is what explains the remaining ' differences in approval rates for blacks vs. whites. One possibility is that the Boston Fed study does not completely control for all differences in the creditwor- thiness of blacks and whites. For example, many loan applications were omitted from the study because of missing data problems. If those applications are not a random sample of all the applications, results based on the remaining applications could provide biased esti- mates of the impact of race on lending decisions. Al- - ternatively, bankers may process the information in loan applications differently than the model assumed in’ the Fed study. A second possible explanation for the Boston Fed-'s results is that banks use race as a factor in making their decisions even though race plays no independent role in determining borrower creditworthiness. If so. one must wonder why banks are throwing away money by refusing to make profitable loans. As Gary Becker, the most recent Nobel prize winner in economics, has emphasiZed, discrimination is often costly not only for the person discriminated against but also for the person who discriminates. Even if many bankers discriminate, nondiscriminating banks could reap substantial profits by lending to customers unjustly denied loans by banks that discriminate. This reasoning does not mean discrimination is absent, but it suggests a third potential explanation for the Boston Fed‘s findings. , . , The third possibility is that blacks have higher de- fault or delinquency probabilities than whites, even controlling for observable aspects of creditworthiness. Banks may therefore use race as a determinant of loan approval because so doing increases profits. It is crucial to determine the correct explanation be- fore adopting specific policies aimed at remedying ra- cial disparities, since those policies may exacerbate rather than alleviate the problem. For example, if de‘ fault probabilities are higher for blacks than whites, holding observable characteristics of creditworthiness constant, a policy that forces, banks to make additional loans in neighborhoods where they accept deposits may encourage them to abandon those neighborhoods entirely, thereby harming precisely the people the pol- icy aims to help. Further research on the probabilities of default and delinquency by race is therefore re quired before adopting new policies aimed at reducing racial disparities in mortgage lending. Jeffrey A. Mir-on is chairman of the economics dc- pm'tment at Boston University: BoS-R—M thi‘he‘» Iwrnd‘ “/Ut/cll M, ..-/Ir lafi ...
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