Abstract
This article addresses a gap in the economic literature on race and credit markets: the theoretical basis of lending discrimination and redlining. It provides a unified model for exploring why discrimination and redlining exist in credit markets. This model is first used to examine three explanations offered by other authors—bigotry, differential risk, and market segmentation. The article then suggests several new explanations of race effects. These emphasize the interlinkage between labor and credit markets; market spillovers due to housing liquidity, refurbishment, and branch location effects; and strategic interaction among lenders.
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
Notes
Section 2 defines these terms more precisely. Studies using Home Mortgage Disclosure Act data have consistently found lower credit flows in minority than in nonminority neighborhoods. For example, Alicia Munnell, Lynn Browne, James McEneaney, and Geoffrey Tootell found, inMortgage Lending in Boston: Interpreting HMDA Data (Working Paper No. 92-7. Boston: Federal Reserve Bank of Boston, 1992), that African American applicants in Boston had a 60 percent greater chance of loan denial than equally creditworthy whites. And many audit studies have demonstrated racial bias by bankers, brokers, and auditors; see Cathy Cloud and George Galster, “What Do We Know About Racial Discrimination in Mortgage Markets?”Review of Black Political Economy 22 (1993): 101–120, and George Galster, “Racial Discrimination in Housing Markets during the 1980s: A Review of Audit Evidence.”Journal of Planning and Educational Research 9 (1990): 183–202.
A skeptical review of redlining studies is Richard Hula, “Neighborhood Development and Local Credit Markets.”Urban Affairs Quarterly 27 (1991): 249–267. Galster himself has pointed out the limits of empirical studies of bank lending; see “Housing Discrimination and Urban Poverty of African-Americans.”Journal of Housing Research 2 (1991): 87–124. A recent article skeptical of empirical findings of race effects is Charles Calomiris, Charles Kahn, and Stanley Longhofer, “Housing-Finance Intervention and Private Incentives: Helping Minorities and the Poor,”Journal of Money, Credit and Banking 26 (1994): 634–674.
George Galster, “Research on Discrimination in Housing and Mortgage Markets: Assessment and Future Directions,”Housing Policy Debate 3 (1992): 639–683. The phrase quoted in the text appears on page 673.
While this paper is entirely theoretical, my own research with Veitch has emphasized the empirical, historical, and institutional aspects of race effects in credit markets in Los Angeles. See Gary Dymski and John Veitch, “Taking it to the Bank: Race, Credit, and Income in Los Angeles,” inResidential Apartheid: The American Legacy. Edited by Robert Bullard, J. Eugene Grigsby III and Charles Lee (Los Angeles: Center for Afro-American Studies, UCLA, 1994): 150–179; and Dymski and Veitch, “Financial Transformation and the Metropolis: Booms, Busts, and Banking in Los Angeles,”Environment and Planning A, forthcoming.
For example, the Fair Housing Act of 1968 provides, in section 3605(a): “It shall be unlawful for any person or other entity whose business includes engaging in residential real estate-related transactions to discriminate against any person in making available such a transaction, or in the terms or conditions of such a transaction, because of race” (42 U.S.C., sec. 3601-3631 (1968)).
This argument is made by Michael Dowdle, “The Descent of Antidiscrimination: On the Intellectual Origins of the Current Equal Protection Jurisprudence,”New York University Law Review 66 (1991): 1165–1232.
This argument is made by Sondra Hemeryck, Cassandra Butts, Laura Jehl, Adrienne Koch, and Matthew Sloan, “Comment: Reconstruction, Deconstruction and Legislative Response: The 1988 Supreme Court Term and the Civil Rights Act of 1990,”Harvard Civil Rights-Civil Liberties Law Review 25 (1990): 475–590.
See Madeline Marsden, “Board Issues Fair Lending Policy Statement,”Financial Update, Federal Reserve Bank of Atlanta, 7, 1-2 (January–June 1994): 1–3.
Gary Becker,The Economics of Discrimination, 2d ed. (Chicago: University of Chicago Press, 1971).
A distinct race effect arises if minorities can only purchase or rent in restricted areas such asX due to “jim crow” laws or practices. Under jim crow, minorities may pay higher home prices inX because they are prohibited from competing for housing supply inY. See Becker,ibid., Ch. 5; and Yoshitsugu Kanemoto,Theories of Urban Externalities (Amsterdam: North-Holland, 1980), Ch. 6.
The general arguments for shriveling race effects are discussed critically by Kenneth J. Arrow, “Models of Job Discrimination,” inRacial Discrimination in Economic Life. Edited by Anthony Pascal (Lexington: Heath, 1972), 83–102. Guttentag and Wachter, discussed in the next section, apply the argument that discrimination based on psychological disutility will not persist in the mortgage market. They argue that discrimination has a material cost; and over time the inducements of lower mortgage rates and housing prices inX should leadw agents and banks to change their preferences and practices, respectively.
Joseph Stiglitz and Andrew Weiss, “Credit Rationing in Markets with Imperfect Information.”American Economic Review 73 (1981): 393–410. Also see Stiglitz,op cit.
Calomiris et al.,op cit.,“ criticize adverse selection-models of race effects on the grounds that it is unrealistic to assume that borrowers have informational advantages over lenders in urban credit markets. They posit instead that race effects exist in urban credit markets because of moral hazard. In terms of our model, they argue thatb agents have less wealth thanw agents, pledge lower amounts of collateral, and are more likely to default. This approach, however, does not so much prove that moral hazard is the key problem as illustrate the problems of differential racial wealth analyzed in section 7.
Jack Guttentag and Susan Wachter, “Redlining and Public Policy,”Monograph Series on Finance and Economics. No. 1 (New York: Salomon Brothers Center for the Study of Financial Institutions, 1981).
Another costly information model is developed by William Gruben, Jonathan Neuberger, and Ronald Schmidt, “Imperfect Information and the Community Reinvestment Act.” Federal Reserve Bank of San FranciscoEconomic Review (Summer 1990): 27–46. In their model, a bank allocates its loan portfolio between a rich neighborhood and a poor one in which loan returns are lower and the (parametric) variance of returns is larger. Banks initially lack information about risk and return parameters in both neighborhoods. They can invest in costly information-gathering in these neighborhoods to overcome this problem. Initially, the bank overestimates risk more in the poor than in the rich neighborhood; so it views information-gathering there as yielding a lower return in the poor neighborhood, and both invests and lends less there.
William Lang and Leonard Nakamura, “Housing Appraisals and Redlining.”Working Paper 91-3, Economic Research Department, Federal Reserve Bank of Philadelphia (January 1991). Also see Lang and Nakamura, “A Model of Redlining,”Journal of Urban Economics 33 (1993): 223–234.
Our model assumes the credit market is imperfectly competitive because loanmaking is costly and because asymmetric information exists between borrowers and lenders. The notion of racial discrimination rooted in imperfect competition is investigated by David Swinton, “A Labor Force Competition Model of Racial Discrimination in the Labor Markets.”Review of Black Political Economy 9 (Fall 1978): 5–42.
William Darity Jr., “What’s Left of the Economic Theory of Discrimination?” inThe Question of Discrimination: Racial Inequality in the U.S. Labor Market. Edited by Steven Shulman and William Darity Jr. (Middletown, CT: Wesleyan University Press, 1989), 335–374.
George Galster and Mark Keeney, in “Race, Residence, Discrimination, and Economic Opportunity: Modeling the Nexus of Urban Racial Phenomena,”Urban Affairs Quarterly 24 (1988): 87–117. These authors attempt to model the “nexus of urban racial phenomena” as a set of interlocking social relations. Galster (op cit., 1991) also takes this approach. Galster’s stimulating work in this area has largely centered on empirical estimation and reduced-form demand and supply equations, not the behavioral roots of race effects which are emphasized here.
Douglas Massey and Nancy Denton,American Apartheid (Cambridge: Harvard University Press, 1993).
Much of the voluminous empirical and institutional literature on labor-market discrimination and on the impediments to minority entrepreneurs is reviewed, respectively, in Jeremiah Cotton, “A Regional Analysis of Black Male-White Male Wage Differences,”Review of Black Political Economy 22(1) (1993): 55–72; and in the Special Issue on Minority Business,Review of Black Political Economy 22(2) (1993). The list presented in the text does not include a higher unemployment rate forb than forw agents. Our model excludes unemployment as such; its first period can be thought of as encompassing a young agent’s entire working life, so life-long unemployment is unlikely. But prolonged life-long effects from discriminatory wage scales, slower promotions, lesser training opportunities, and so on, are captured in this list.
See Cloud and Galster,op cit.,“ esp. pp. 109–113.
As one alternative to this approach, the bank could treat all borrowers as if they had the earned-income prospects ofw borrowers. In figure 3a, this yields aw- borrower equilibrium at pointM, as before, but a b-borrower equilibrium at pointP. This equilibrium is suboptimal for the lender, who must absorb a loss from lending tob borrowers (at a rate that is “too low”) coextensive with the triangleMOP. Another lender strategy is to treat all borrowers as if they had the earned-income prospects ofb agents; but this would invite entry, since other lenders could offer better terms tow borrowers.
Lang and Nakamura,op cit.,“ suggest lending volume may have a spillover effect because market thickness may affect the accuracy of price signals. This idea is complementary to the arguments developed here, but different.
See, for example, the papers inHousing Policy Debate 3(2) (1992); and Cloud and Galster,op cit. Numerous agents involved in the mortgage and real-estate markets are suspected of personal discrimination: in addition to bank loan officers, the list of suspects includes real-estate agents, assessors, insurance companies, and mortgage underwriters.
This solution technique for a lender faced with adverse selection in its borrower pool is suggested in Joseph Stiglitz, “The Causes and Consequences of the Dependence of Quality upon Price.”Journal of Economic Literature 25 (1987): 1–48.
About this article
Cite this article
Dymski, G.A. The theory of bank redlining and discrimination: An exploration. The Review of Black Political Economy 23, 37–74 (1995). https://doi.org/10.1007/BF02689991
Issue Date:
DOI: https://doi.org/10.1007/BF02689991