Mortgage Lending Discrimination - Urban Institute

[Pages:176]Mortgage Lending Discrimination: A Review of Existing Evidence

Margery Austin Turner and Felicity Skidmore, Editors

Mortgage Lending Discrimination: A Review of Existing Evidence

Margery Austin Turner and Felicity Skidmore, Editors

The Urban Institute

2100 M Street, N.W. Washington, D.C. 20037 Phone: 202.833-7200 Fax: 202.429-0687 E-Mail: paffairs@ui.

Copyright June 1999. The Urban Institute. All rights reserved. Except for short quotes, no part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by information storage or retrieval system, without written permission from the Urban Institute.

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders; they do not necessarily reflect the official policies or positions of the U.S. Department of Housing and Urban Development or organizations with whom the authors collaborated on this project.

Contents

1. Introduction, Summary, and Recommendations 1 Margery Austin Turner and Felicity Skidmore Why It Is Difficult to Measure Lending Discrimination 3 Different Forms of Discrimination 3 Possible Reasons for Discrimination 4 Potential for Discrimination throughout the Mortgage Lending Process 5 Summary of the Evidence 5 Advertising and Outreach 7 Pre-Application Inquiries 8 The Loan Approval or Denial Decision 9 Loan Administration 13 Recommendations for Expanding the Knowledge Base 16 Launch Systematic Research on Office Locations, Outreach, and Referrals 16 Expand and Refine Paired Testing of Lenders 16 Conduct a Rigorous Statistical Analysis of Mortgage Approvals Nationwide 19 Design and Conduct Research on Loan Terms and Conditions 20 Further Evaluate "Best Practices" for Remedying Discrimination 21

2. New Evidence from Lender Testing: Discrimination at the Pre-Application Stage 23 Robin Smith and Michelle DeLair The NFHA Tests 24 The Urban Institute Reanalysis Data Set 25 Results 26 Regional Differences 31 Lessons for Future Testing 31 Annex A: Mean Differences between White and Black Testers in Contact Length 34 Annex B: Information on Requested Loan Amounts by City 35 Annex C: Reanalysis Data Collection Form 36

3. Does Discrimination in Mortgage Lending Exist? The Boston Fed Study and Its Critics 43 Stephen L. Ross and John Yinger Background 43 Omitted Variables 44 Evaluation 47 Reanalysis 47 Interpreting the "Meets Guidelines" Results 50 Data Errors in the Explanatory Variables 54 Evaluation 55 Reanalysis 56 Conclusions 57 Misclassification in the Dependent Variable 57 Evaluation 59 Reanalysis 61 Conclusions 61 Incorrect Specification 61 Evaluation: Reverse Regression 64 Reanalysis: Reverse Regression 64 Evaluation: Lender-Specific Underwriting Guidelines 65 Conclusions 68 Endogenous Explanatory Variables 68 Evaluation 70 Reanalysis 72 Conclusions 75 Conclusions Concerning the Boston Fed Study 75

4. Other Evidence of Discrimination: Recent Studies of Redlining and of Discrimination in Loan Approval and Loan Terms 85 Stephen L. Ross and John Yinger Loan Denial Studies Based on HMDA Data 86 Loan Denial Studies Based on Applications to Individual Lenders 88 Studies of Discrimination in Loan Terms 93 Recent Studies of Redlining 95 Recent Studies of Process-Based Redlining 96 Recent Studies of Outcome-Based Redlining 98 Conclusions 99 Studies of the Causes of Discrimination 99 Conclusions 104

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5. The Default Approach to Studying Mortgage Discrimination: A Rebuttal 107 Stephen L. Ross and John Yinger Methodological Issues in the Default Approach to Studying Discrimination 108 Unobserved Underwriting Variables 108 Unobserved Borrower Characteristics 110 Sample-Selection Bias and the Power of the Default Approach to Detect Discrimination 111 Conventional versus Government-Insured Loans 113

MORTGAGE LENDING DISCRIMINATION: A REVIEW OF EXISTING EVIDENCE

New Twists on the Default Approach 114 Simulations 114 A Default Test Based on Market Concentration 117

Conclusions 120

Technical Appendix to Chapters 3 through 5 129 Stephen L. Ross and John Yinger Econometric Concepts 129 Chapter 3: Omitted Variables, Reanalysis 131 A Simple Model of Endogeneity in the Loan Denial Equation 131 A Complex Model of Endogeneity in "Meets Guidelines" 132 Chapter 3: Data Errors in the Explanatory Variables, Reanalysis 133 Chapter 3: Endogenous Explanatory Variables, Reanalysis 133 Chapter 5: New Twists, a Default Test Based on Market Concentration 134

6. Inside a Lender: A Case Study of the Mortgage Application Process 137 Kenneth Temkin, Diane K. Levy, and David Levine Description of Case Study Lender 138 Lender's Origination Process 139 Overview 140 Referral 141 Initial Application Interview 142 Underwriting 144 Post-Underwriting 144 Conclusions 145 The Lender's HMDA Performance 145 Overall HMDA Performance 146 HMDA Performance Controlling for Applicant Income 146 HMDA Analysis for Government Loans 148 Conclusions 149 What the Lender Isn't Doing and Should Do 149 Develop a Formal Mission Statement 150 Monitor Fair Lending Performance 150 Compensate Staff in a Manner Consistent with Fair Lending Objectives 150 Develop a Diverse Workforce 151 Provide Training in Fair Lending 151 Conduct Outreach to Minorities 151 Self-Monitor Fair Lending Performance 152 Designate an Employee to Receive Fair Lending Complaints 152 Implementation Strategies 153 Implementation Steps 154 Policy and Research Conclusions 158

References 161

About the Editors 169

About the Contributors 171

CONTENTS

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Chapter 1

Introduction, Summary, and Recommendations

MARGERY AUSTIN TURNER FELICITY SKIDMORE

Amajor element of the American dream is a home of one's own in the neighborhood of one's choice. Owning a home is one of the primary ways of accumulating wealth in our society, a form of wealth acquisition that is especially protected in the U.S. tax code. Being a homeowner increases people's feelings of control over their lives and their sense of overall well-being. High rates of homeownership are believed to strengthen neighborhoods as well, by increasing residents' stake in the future of their communities.

Not all Americans, however, enjoy equal access to the benefits of homeownership. Federal law prohibits discrimination in the homebuying process, mandating that all would-be homebuyers must be treated equally by real estate agents, lenders, appraisers, and insurance brokers.1 However, existing enforcement mechanisms may not be effective enough to guarantee equal treatment or equitable results. Indeed, research clearly shows that minorities still face substantial discrimination in the process of looking for a home to buy (or rent).2

Many people believe that minorities also face discrimination when they try to obtain a mortgage--a necessity for most Americans wanting to buy a home. There is no question that minorities are less likely than whites to obtain mortgage financing and that, if successful, they receive less generous loan amounts and terms. But whether these differences are the result of discrimination--rather than the inevitable result of objectively lower creditworthiness--is the subject of a raging debate. The problem is not that analysts or practitioners have ignored the question of discrimination in mortgage lending. Many research and investiga-

tive studies have addressed certain facets of it, using different data sets and analytic techniques to study various outcomes. The problem is that these studies have not produced a clear consensus on a set of conclusions.3

The purpose of this volume is to sort through the research evidence on mortgage lending discrimination, in order to provide policymakers with a comprehensive and comprehensible review of the current state of knowledge on lending discrimination and identify important questions that still need to be answered in order to recommend how best to further the goal of fair housing for all.4 Our review of the existing research evidence concludes that minority homebuyers in the United States do face discrimination from mortgage lending institutions. Although significant gaps remain in what we know, a substantial body of objective and credible statistical evidence strongly indicates that discrimination persists. Specifically, we find that:

Discrimination in home mortgage lending takes two forms--differential treatment and disparate impact--and in many instances it is difficult, if not impossible, to disentangle the two.

Despite individual instances of discrimination uncovered at every major stage in the mortgage lending process, almost no research has focused on the advertising, outreach, and referral stage or on the loan administration stage.

Paired testing at the mortgage pre-application stage (conducted by the National Fair Housing Alliance) indicates that differential treatment discrimination occurs at significant levels in at least some cities. Minorities were less likely to receive information about loan products, they received less time and information from loan officers, and they were quoted higher interest rates in most of the cities where tests were conducted.

Statistical analysis of data assembled by the Federal Reserve Bank of Boston finds large differences in loan denial rates between minority and white applicants, other things being equal. These differences have not been explained away by data errors, omitted variables, or other technical shortcomings. Although it is conceivable that these disparities are attributable to legitimate underwriting standards, the Boston Fed analysis establishes a strong presumption that discrimination exists, shifting the "burden of proof" to those who would argue that these differences are entirely due to legitimate underwriting criteria that reflect an applicant's creditworthiness and therefore serve a business necessity.

In-depth examination of the mortgage loan origination process from an individual lender's perspective suggests that even among institutions with good intentions, minority customers may not be receiving equal treatment. Moreover, achieving significant reductions in lending discrimination may require systemic institutional reforms. If employees do not perceive the importance of change, and if reforms are not effectively integrated into the day-to-day operations of a business, they are unlikely to take root.

This introductory chapter begins with a brief review of the issues involved in measuring the incidence and severity of lending discrimination, including different ways in which discrimination can be defined and measured and the reasons why lenders might discriminate. This is followed by a brief summary of the evidence that highlights the new contributions of this volume. The chapter ends with

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MORTGAGE LENDING DISCRIMINATION: A REVIEW OF EXISTING EVIDENCE

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