Consumer Law

Does the Subprime Crisis Rebut Claims of Lending Discrimination?

By Jeff Sovern

by Jeff Sovern

The extent of discrimination in lending has long been a hotly-debated subject.  The famous Boston Fed Study, publicized in 1992 and later published as Alica H. Munnell, Geoffrey M.B. Tootell, Lynn E. Browne & James McEneaney, Mortgage Lending in Boston: Interpreting HMDA Data, 86 American Econ. Rev. 25, 26 (1996), reported that "white applicants with the same property and personal characteristics as minorities would have experienced a rejection rate of 20 percent rather than the minority rate of 28 percent."  That study led to considerable discussion: some argued that the study was flawed and that in fact discrimination does not occur, while others claimed that discrimination occurred.  A book-length study of the issue and points raised by many of the commentators is Stephen Ross & Ross Yinger, The Color of Credit (2002). 

That brings us to subprime lending.  Studies have found that subprime borrowers are more likely to be people of color, female, elderly, low-income, or some combination of the foregoing.  So if lending discrimination was occuring, we might expect to see less subprime lending.  For many years, of course, subprime borrowers did find it more difficult to obtain loans, but starting in the nineties, subprime lending took off, with the results that we all know about.

In his book Economic Facts and Fallacies, Thomas Sowell suggests that the enormous amount of money lost on subprime loans implies that people of color were not in fact discriminated against by lenders.  The argument (I'm putting it in my own words here and updating it a bit because the book was published in December 2007, before the subprime criss fully unfolded) goes like this: if lenders had discriminated against borrowers of color, they would have charged higher rates than the risk of lending justified.  But because they charged rates that were lower than the risks justified, they lost money on those loans, and in fact many subprime lenders went out of business.  Accordingly, they could not have been discriminating against minority borrowers.

This is an interesting argument, and it may prove to be borne out by the facts.  But I think we need to know more to know whether it is correct.  Obviously lenders underestimated the risks of lending, but a big risk that lenders underestimated was the risk that housing prices would fall, thereby preventing borrowers from refinancing, That has nothing to do with race.  Indeed, it may turn out that some subprime borrowers defaulted because of high interest rates and unaffordable monthly payments, which could be the product of charging higher rates to people of color, say, than the borrowers might have qualified for.  Or borrowers could have defaulted because of their inability to refinance, even though lenders would have charged them lower rates all along had they been white.   I'm not saying that happened; all I'm saying is that lenders could have underestimated the risks of lending while still engaging in discrimination.  I'm afraid that the foreclosure fiasco has not put an end to arguments about whether lending discrimination occurs but rather only added more to argue about

Full post as published by CL&P Blog on March 25, 2009 (boomark / email).