Discrimination and Credit

SOM’s Fiona Scott Morton and Yale Law School’s Rick Brooks on barriers facing minorities in the credit and real estate markets.

For much of American history, Yale Law School professor Rick Brooks told a room full of SOM students, African-Americans and other minorities were systematically prevented from becoming homeowners — by racial zoning statues and private covenants, for example. And when they did finally get access to real estate and credit markets in recent years, he said, it was not on the same terms as other groups — and the results were far less positive.

Brooks and Yale SOM professor Fiona Scott Morton gave an informal talk on discrimination in credit markets on March 5, as part of Yale SOM’s observation of Black History Month. The event was co-sponsored by the SOM Finance Club. (Brooks and Scott Morton examined related issues in a discussion for Qn, the Yale School of Management magazine.)

"Most people think of homeownership as a stabilizing force," Brooks said. But according to data collected by Harvard professor Elizabeth Warren, African-Americans who declare bankruptcy are more likely to be homeowners than renters — the opposite of the pattern for whites.

"There is something about the housing market itself, about loan practices," Brooks said, "that means that minorities are given loans at rates that make repayment less likely" — such as the subprime loans that helped spark the current financial crisis.

In 2002, he pointed out, Citigroup’s subprime lending subsidiary was prosecuted for deceptive lending practices. He read from the testimony of a loan officer: "If someone appeared uneducated, inarticulate, or was a minority, or was particularly old or young, I would try to include all the additional costs Citi Financial offered."

Scott Morton, who has done research on car sales, said that she had found that car dealers similarly looked for shoppers who appeared to be vulnerable. "The car dealer is explicitly looking for the uninformed buyer, and he’s trying to charge the uninformed as much as he can extract," she said, "The uninformed buyer is going to be disproportionately low-income and lower education, and you see a disproportionate share of minorities in those categories."

In a complicated transaction like a purchase of a house or a car, she added, "the payoffs for education and financial sophistication go way up."

After introductory remarks from Brooks and Scott Morton, students in the audience jumped in, asking why competition doesn’t eliminate predatory sales and loan practices (the difficulty in comparing offers when they vary across multiple dimensions, like interest rate and length of term, Scott Morton said) and about the roots of the subprime crisis, the Obama administration’s proposed housing bill, and more.

During the explosion of subprime lending, the two professors agreed, many homebuyers could have qualified for less onerous terms than they received. But because lenders were securitizing their loans — slicing them up and selling them to investors — they had no incentive to make loans that were likely to be repaid. Brooks added that one reason that minority borrowers were more likely to get subprime loans, even if they were good credit risks, is that in some cases their previous credit transactions were made with check-cashing, rent-to-own, and payday loan establishments, which don’t report to credit-rating agencies.

Scott Morton expressed skepticism that Obama’s plan — which cuts interest rates for mortgage-holders — would be successful in preventing foreclosures, and pointed instead to a plan proposed by Yale economics professor John D. Geanakoplos in a March 5 op-ed piece he co-authored for the New York Times. Geanakoplos’s plan would force lenders, in some cases, to write down the principal of an "underwater" loan, in order to get it below the worth of a house.

Scott Morton and Brooks agreed that the economic prospects for many minorities had been damaged by their experience with homeownership.

"There were stable families that are now unstable," Brooks said. "The structure of the loans destabilized them."

"I’m concerned about the social effects," he added. "Minorities may pull away from the idea that homeownership is a good thing. Owning a home and having a credit record are just valuable assets, and there are large portions of our population that have been excluded from that and now might be further excluded and might not even want to participate."