The Fed's Flawed Mortgage Studies
WHEN the Federal Reserve announced its study showing that mortgage lenders reject the credit applications of blacks at twice the rate of whites, the reactions were predictable. Government officials said we need more rigorous enforcement of anti-discrimination laws in banking. "Fairness-in-lending" activists called for race-based lending quotas.
But before the banking and credit system is fundamentally altered to bring about a new distribution of loans, we need to take a closer look. The Fed study, like others before it, does not take into account enough real-world variables in the credit application process to justify the conclusion of institutional racism.
When a bank or other mortgage lending company considers making a loan, it looks at the applicant's income, assets and debt load, job history, job security, and credit history. All serve as proxies for the question that lenders are ultimately interested in: Will the borrower pay the money back?
There are many rational reasons for granting and rejecting loans. It harms the profits of the lender to make judgments based on isolated considerations of race and ethnicity. As Professor Jack Guttentag of the Wharton School of Business has argued: "Loan officers spend the major part of their time hustling for business. The thought that they would turn away a customer because they didn't like his skin color is ludicrous."
Why, then, do the numbers show racial discrepancy? The social and economic problems plaguing American blacks are unfortunately reflected in factors that determine credit worthiness. As even the Fed admits in its November 1992 Federal Reserve Bulletin, "minority applicants on average" have "weaker credit histories, fewer liquid assets, and lower net worths and incomes than white applicants."
Given these problems and others, the mortgage acceptance rate for minorities is actually high in absolute terms. The Fed study of 7.8 million mortgage applications showed that blacks are accepted for FHA and VHA loans more than 62 percent of the time, and Hispanics are accepted at a rate of 68 percent. This compares to a rate of 74.3 percent for whites.
For conventional loans, there is a 20-point racial discrepancy in the approval rate. But when this figure is adjusted for income, the gap narrows to as little as 7 points, with well-to-do blacks obtaining mortgage loans 74 percent of the time, compared with 81 percent of the time for whites.
Similarly, a study of comparably limited data by the Federal Reserve Bank of Boston reduced the racial gap to only 6 points by adjusting for both assets and employment.
Unfortunately, the Fed's studies have not further adjusted data for considerations of debt load, credit rating, job security, or job history. Banks are not even required to provide this information to the Fed. Though the Fed has touted these studies as proving institutional racism in lending, they prove nothing of the kind.
In another case, a Wall Street Journal study did not consider credit history, income, or anything else relevant to the loan market. Nonetheless, the paper's story was strewn with misleading rhetoric, and even included a United States map highlighting the banks it accused of racial discrimination.
Moreover, the numbers can be interpreted to show that banks are racist against whites and in favor of Asians, because banks more often reject conventional mortgage applications from whites.
An activist group called ACORN (Association of Community Organizations for Reform Now) sees any discrepancy as anti-black racism and even calls for discarding traditional standards of credit worthiness. ACORN has threatened to wage public campaigns against banks and says it has 30 written agreements with major banks to give special privileges in lending to racial minorities (Asians excepted). It has effectively created a "private" race-based quota program in credit markets.
IN the midst of mergers battles, ACORN "persuaded" NCNB and Sovran banks to set aside $10 billion for minority loans when they merged to become Nationsbank earlier this year. Chemical bank agreed to set aside more than $750 million, and the Bank of Boston agreed to increase "community development activities" by $600 million. Mellon Bank gave 212 special-consideration mortgages last year, for a total of $5.7 million, and has pledged another $230 million. In short order, these special-consideration loans c ould reach the $20 billion mark.
All this finagling is bad for business. Since the Community Reinvestment Act of 1977, banks have been doing more complying than banking. The extensive paperwork required has been especially harmful on smaller banks. Housing and Urban Development Secretary Jack Kemp, a convert to the cause of arbitrary state power, has taken the extreme step of conducting government sting operations against mortgage companies designed to check for discrimination.
Yet the standards that banks and mortgage companies use to evaluate loans are not arbitrary. They were developed for the purpose of promoting efficiency, fairness, and sound banking principles. In this way, the credit market has its own built-in rationality. If deserving people are overlooked, competitors are driven by the profit motive to correct the error. Constant market pressures make credit allocation fair for all.
We saw what happened to the S&L industry when it became reckless with its loans. Banks should not be forced to give up traditional standards of credit worthiness for the sake of special-interest politics.