Ebook Segregation and the Subprime Lending Crisis
The growth in subprime lending, coupled with rising defaults and record-level foreclosure rates, has gripped the nation since 2008. Blame is being directed at ill-informed consumers, lax underwriting by loan originators, failure of regulatory agencies, predatory lending practices, greedy investors, misguided appraisers and credit rating agencies, job loss in economically distressed regions, and a range of other institutional and individual factors (Baily, Elmendorf, and Litan 2008; Gramlich 2007). Virtually ignored in this debate is the role of structural and contextual forces, most notably various trajectories of inequality, uneven metropolitan development, and racial segregation. While there is widespread recognition that lower income households and communities, racial minorities, women and other vulnerable populations are hardest hit, the context of racial segregation as a driver of subprime lending, and as an explanation for the variance in such lending across cities and communities, has not received serious consideration. Yet there are theoretically plausible reasons why the segregation of minorities may establish a context in which these lending practices would flourish (Squires 2008a).
It is plausible that in highly segregated cities, minority populations are more susceptible, for at least three reasons, to high-cost financial products. One explanation is that in segregated cities, minority communities are more isolated, and may be less experienced with purchasing financial products. Consequently, subprime lenders might more effectively target those areas in their marketing strategy and exploit differences in financial education. There is some evidence that some financial institutions have targeted low-income and minority neighborhoods for subprime products (Avery, Brevoort, and Canner 2006; Bocian, Ernst, and Li 2008; Squires 2008a). Second, mainstream, prime lenders might avoid segregated, low-income areas and there may be less competition among lenders, leaving borrowers, regardless of their financial education level, little choice other than high-cost products. Finally, lenders may place a higher risk-based premium for those living in low-income, segregated areas. In more segregated cities, there may be more at-risk areas (or at least the perception of greater risk) and people in these communities, and this might affect the city’s overall proportion of high-cost loans. These mechanisms may explain why segregation might contribute to variation in subprime lending across cities.
Understanding the predictors of subprime loans is important because these types of loans are more likely to foreclose (Avery, Brevoort, and Canner 2007; Coulton, Chan, Schramm, and Mikelbank 2008; Immergluck and Smith 2004), and cause financial harm to multiple parties including homeowners, lenders, investment banks, insurance companies, cities, and states (Immergluck and Smith 2005; Joint Economic Committee 2007; Pennington-Cross 2004; U.S. Conference of Mayors 2007). Additionally, there is some evidence that these loans are being originated in ways that disproportionately affect minority homeowners and neighborhoods. In 2006, 53.7 percent of African American, 46.6 percent of Hispanic, and 17.7 percent of white mortgage recipients received a high-priced loan. In census tracts where the population was at least 80 percent minority, 46.6 percent obtained high-priced loans, compared to 21.7 percent in communities where racial and ethnic minorities accounted for less than 10 percent of the population (Avery, Brevoort, and Canner 2007). The intent of this research is to uncover whether racial segregation is an underlying dynamic associated with the allocation of subprime loans.
The primary question we explore is whether metropolitan regions that exhibit greater segregation have proportionately more subprime loans, controlling for a range of socio-economic factors traditionally understood to account for the prevalence of high-cost loans. The dependent variable, drawn from the 2006 Home Mortgage Disclosure Act (HMDA) data, is the share of high-cost home purchase and refinance loans for each metropolitan area. The measure of residential segregation is the black and Hispanic dissimilarity indices. Control variables include percent with low credit scores, percent minority, poverty and unemployment rates, median home value, and education level.
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