Are mortgage lenders discriminating against minority borrowers?

By Dr. Harold A. Black

CNN ran a story that harkened back to the good old days. It was about Navy Federal Credit Union’s rejecting over half of its mortgage applications from blacks while accepting more than 75% of applications for the same type of mortgage from whites. It was the type of story that was published in big city newspapers during the 1970s and was similar to the ones in Nashville newspapers in the 1990s. These stories looked at the differential between black and white acceptance rates. The earlier studies charged that the differentials were proof that blacks were being discriminated against in the mortgage lending decision. The CNN article states explicitly that Navy Federal may not be discriminating against blacks but the disparity raises that possibility. The earlier studies simply looked at the final accept/reject disparities. The CNN study uses the data mandated by the Home Mortgage Disclosure Act. These data are publicly available and include the applicant’s race, gender, income and debt-to-income ratio, the loan amount, the property value and the neighborhood’s socioeconomic makeup. However, the data do not include credit worthiness which is proprietary and why CNN cannot positively assert discrimination although they strongly imply it. CNN states that black applicants were more than twice as likely to be denied as white applicants and “Latino applicants were roughly 85% more likely to be denied than White applicants.”

I must admit some personal responsibility in the analysis of lending discrimination. My study of discrimination in mortgage lending while at the Comptroller of the Currency in the early 1970s was the first econometric study that modeled the lending decision and used a unique statistical procedure to test for discrimination. That study led in part to the Home Mortgage Disclosure Act and the Community Reinvest Act (CRA). The early newspaper articles alleging lending discrimination prompted the Comptroller of the Currency to ask me to determine if the allegations were true for national banks that were regulated by the agency. The problem was that in those days there were no data. Therefore, we went to interview major bank lenders. We asked what were the important variables in the lending decision and constructed a mortgage lending application form that contained those variables. We did not put race on the application because we felt that a minority borrower would be reluctant to indicate race if it were felt that the lender might discriminate. So we put the demographic variables on a separate tear-off form with a number linking it to the application. The borrower was to fill out the information and put it in an envelope addressed to the FDIC which did the data compilation. The FDIC forwarded the data to me at the comptroller’s office. We then analyzed the data and later published the results in the American Economic Review (May 1978). The results showed weak statistical evidence of discrimination by race but stronger evidence of redlining which is discrimination against the property. That is, if a white applicant applied for a mortgage in a certain geographic area, it had a higher likelihood of being rejected.

Motivated in part by our results, Congress passed HMDA so that the regulators would have relevant data and passed the Community Reinvestment Act which was targeted at redlining requiring lenders to make loans in underserved neighborhoods. The regulators would be privy to the creditworthiness data and could use it to make a determination as to whether the lending practices were in fact discriminatory.

When we first started the analysis, our priors were that discrimination was possible in markets characterized by little competition among lenders. In those days most of the mortgage loans were made by savings and loans and not by banks. Credit unions could not make mortgages. In fact, this was the case and several lenders were punished by the regulators for discriminatory practices. Economics tells us that if there is excess demand for mortgages and few lenders, then the lenders can reject loans that would be profitable because of the limited supply of funds available. However, this is not the case today. Now banks, savings and loans, credit unions and online lenders can originate mortgages. Thus, rejection of profitable loans would be irrational on the part of the lenders. In many institutions, the mortgage loan officer is compensated by the mortgages underwritten. It would then be irrational for a loan officer to reject a qualified applicant if it lowered the officer’s compensation. Also, the regulators who examine the lender’s decisions are junkyard dogs looking for discrimination. As a consequence, a lender who discriminates in today’s environment is not only irrational but is also foolish. It would be akin to speeding at 100 MPH with a state trooper at every mile marker. Lastly, Navy Federal should know that its lending disparity is out of line and would warrant more detailed examination from the Federal authorities. Other institutions have gamed the system by increasing the acceptances of marginal minority applicants to lessen the disparity. One wonders why Navy Federal did not do the same.