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Abstract
Unsustainable high-cost lending was a major contributor to one of the worst financial crises in U.S. history. While several studies examine individual- and community-level predictors of high-cost lending, little research has tested for the possible causal effect of racial segregation. Using two-stage least squares statistical models, we find evidence that even after controlling for percentage minority, poverty, unemployment, low credit scores, home value escalation, and bank branch accessibility, black/white segregation is a significant predictor of the proportion of subprime loans originated in the largest 200 U.S. metropolitan areas. We also find that increased black education levels are important protective factors, while greater shares of mortgages originated by independent mortgage companies increase the risk for subprime lending. We find no evidence for an effect of Hispanic/white segregation on subprime lending. This research suggests that policy initiatives aimed at limiting high-cost lending should address the context of black/white segregation, education, and financial reform.
Acknowledgments
An earlier version of this paper was presented at the 2009 Federal Reserve System Community Affairs Research Conference. Views expressed in this paper are those of the authors and do not represent the views of the U.S. Department of Housing and Urban Development. We thank the Ford Foundation and the National Fair Housing Alliance for supporting this research. We also thank Casey Dawkins, Jason Dietrich, Constance Dunham, Darryl Getter, Allison Hyra, Nandinee Kutty, Sherrie Rhine, Jeffrey Timberlake, and Alan White, as well as the anonymous reviewers, for their helpful suggestions on drafts of this paper.
Notes
1. There is an important difference between legitimate subprime lending and predatory lending, but the line between them is not always clear. Most predatory lending occurs in the subprime market. Fannie Mae and Freddie Mac have estimated that between one-third and one-half of those receiving subprime loans would qualify for prime loans (Engel & McCoy, Citation2002). Subsequent analyses show that 55% in 2005 and 61% in 2006 of subprime borrowers would have likely qualified for prime loans (Brooks & Simon, Citation2007). Despite the distinction between subprime and predatory lending, it is likely the case that initiatives to reduce one will reduce the other.
2. While segregation has decreased since the 1960s, it still persists in most cities, and at hypersegregated levels in many (Fischer, Stockmayer, Stiles, & Hout, Citation2004; Logan, Stults, & Farley, Citation2004; Timberlake & Iceland, Citation2007; Wilkes & Iceland, Citation2004).
3. In this article, the terms high-cost, subprime, and high-priced loans are used interchangeably.
4. It is important to note that controlling for individual, loan, and community characteristics reduces the subprime lending gap between people of color and whites but does not explain it away (see Avery et al., Citation2007; Bocian, Ernst, & Li, Citation2008; Courchane, Citation2007; Reid & Laderman, Citation2009).
5. A recent study by Rugh and Massey (2010) uses 2SLS models to investigate the causal effect of segregation on foreclosures. While understanding the connection between segregation and foreclosures is important, it is also vital to investigate the relationship between segregation and subprime loans because high-cost loans are important precursors to foreclosures (Coulton, Chan, Schramm, & Mikelbank, Citation2008; Immergluck & Smith, Citation2005).
6. Following the Depository Institutions Deregulation and Monetary Control Act of 1980, the passage of the Alternative Mortgage Transaction Parity Act in 1982, which allowed lenders to use variable interest rates and balloon payments, and the Tax Reform Act of 1986, which allowed interest rate mortgage deductions, facilitated, to some extent, the emergence of the subprime market. Some also argue that the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 contributed to the evolution of the subprime market (Aalbers, Citation2009; Weicher, Citation2007).
7. In the subprime literature, there is a debate as to what is a subprime loan, but most studies after 2005 use the high-cost loans flagged in HMDA as a proxy for subprime loans.
8. In addition to these studies, others attempted to investigate whether mortgage-pricing differentials between whites and minorities are justified relative to standard risk-based pricing and underwriting factors. A study by Courchane (2007) demonstrates that up to 90% of the APR gap for African Americans and 85% of the gap for Hispanics is explained by observable differences in underwriting, costs, and related market factors. Edelberg (2009) discovered that after controlling for the financial cost of issuing debt, the likelihood of price differential between whites and minorities decreased after 1995, when risk-based pricing became more prevalent. These studies suggest that lending institutions might not be allocating higher debt prices in a discriminatory way. However, it is important to note that in these studies, racial price disparities are not fully eliminated.
9. Metropolitan and micropolitan statistical areas are geographic entities defined by the U.S. Office of Management and Budget for use by federal statistical agencies in collecting, tabulating, and publishing federal statistics (see http://www.census.gov/population/www/estimates/metroarea.html, accessed July 24, 2010).
10. Rugh and Massey's (2010) analysis of the effect of segregation on foreclosures also assumes the spillover logic for they assess the influence of metropolitan segregation on metropolitan foreclosure levels.
11. Loans are defined as high-cost when the APR is 300 basis points above a comparable Treasury note.
12. The dissimilarity and isolation indices each range from 0 to 100 when reported as a percentage. The closer each index is to 1, the higher the level of segregation.
13. The 2000 Census is the most recent available dataset that can be used to accurately construct these indices.
14. These indices are standard segregation measures (Massey & Denton, Citation1988) and have been used in recent studies exploring the effect of segregation on subprime lending (Been et al., Citation2009) and foreclosures (Rugh & Massey, Citation2010).
15. Following Rugh and Massey (2010), we compute a measure of the housing price increase in each CBSA by dividing the ratio of the average annual increase in the FHFA's HPI from 2000 to 2006 by the average annual increase from 1995 to 1999. The HPI is a weighted, repeat-sales index that measures price changes in repeat sales or refinances on the same properties. By using the 1995–1999 HPI increases in the denominator, we construct a variable that measures the change in prices during the housing boom of the 2000s relative to a previous time period.
16. Some of the CBSAs were in two geographic regions, and CBSAs were labeled for the region in which the majority of their census tracts were located.
17. We utilize four different measures of segregation in our analyses—black dissimilarity, Hispanic dissimilarity, black isolation, and Hispanic isolation—and estimate separate 2SLS models for each respective segregation index.
18. Been et al.'s (2009) study did not assume a positive linearity relationship between segregation and high-cost lending. They assessed the effect of segregation on high-cost lending by dividing metropolitan areas into low, medium, and highly segregated areas. In their models, assessing high-cost home purchase loans, they found an effect for black/white segregation in all three levels of metropolitan segregation, while the effect for Hispanic/white segregation was only significant in highly segregated areas. In this study, and in other studies (NCRC, 2005; Rugh & Massey, Citation2010), the effect of black/white segregation on subprime lending is more robust, while the effect of Hispanic/white segregation is inconclusive.
19. We do not present direct evidence that minorities in more segregated metropolitan areas are disproportionately receiving subprime loans, but based on prior research, such as the studies referenced in the literature review section, this is likely the case.
