Michael J. Rosenfeld, 2001

 

Notes on Segregation, free markets, and the Mortgage and Real Estate industries:

 

1) Blacks pay more for housing that it would otherwise be worth, because they face a housing shortage

 

2) Whites pay a premium for living in 'Nicer' neighborhoods, that is neighborhoods to which Blacks have no access.

 

3) Boundary neighborhoods are subject to 'blockbusting', that is prices are driven down as Whites flee, and then prices are driven back up as the properties become available to Blacks with the means to buy.

 

4) Key Point: Segregation may drive up housing prices in all 3 kinds of neighborhoods. Realtors and Mortgage lenders stand to profit from this segmentation of the market.

 

 

But Why Can't the Free Market Solve this Problem?

 

1) According to Economists like Gary Becker (see The Economics of Discrimination, 1971), discrimination is inefficient, and like all inefficiencies will eventually be driven away from the market. If one believes this theory, discrimination should hardly exist at all. For example, take mortgage lending:

 

 

Black Family

White Family

Family Income

$60,000

$60,000

Kids

2

2

Parents' Education

College degrees

College degrees

Proposed Home value

$150,000

$150,000

Credit History

Always pay bills on time

Always pay bills on time

Looking for loan of

$135,000

$120,000

 

 

 

 

 

 

 

 

 

 

 

 

 

2) According to the free market, banks are profit motivated and don't care about the applicant's race. As a profit oriented institution, banks should be equally likely to lend to Whites and Blacks. If the White family and the Black family both have good credit histories, the bank should lend them both money. According to Becker's theory, non-discriminatory banks which lend to all credit worthy customers will make more profit than discriminatory banks, and so the discriminatory banks will quickly go out of business.

 

3) Key Fact: The White family is much more likely than the black family to get the loan.


If it's in the bank's economic interest to lend to all credit worthy people, why doesn't the Black family get the loan?

 

 

Black Family

White Family

Family Income

$60,000

$60,000

Kids

2

2

Proposed Home value

$150,000

$150,000

Credit History

Always pay bills on time

Always pay bills on time

Looking for loan of

$135,000

$120,000

 

 

 

Proposed Neighborhood

Racially Mixed, unstable prices

All White; Stable prices

Family Net Financial Worth

(See Oliver and Shapiro Table 5.7)

$12,303

$66,800

Main family earner, potential for future promotion and raises

uncertain

excellent

 

1) The home loan industry is not a 'free market'. Most home loans are subsidized or guaranteed, in one way or another, by the Federal Government. So if the Federal government 'redlines' an inner city neighborhood, the bank would not be able to make an attractive loan to the residents of that neighborhood, even if they wanted to.

 

2) The history of discrimination in the U.S., and the inability of previous generations of Blacks to own homes or businesses means that today's educated upper middle class Blacks have much lower net worth than their White peers (see Oliver and Shapiro).

 

3) Even if the Black family had the same net worth as the White family, they are hurt by neighborhood effects (See Massey and Denton, and my notes on Neighborhood effects). Blacks are frequently forced to buy homes in less desirable areas, where home prices are less stable, and which the bank (in its purely profit oriented motives) is less willing to invest in.

 

4) Even if the Black family found a potential home in the most exclusive, most desirable, lily White part of town, and even if the Black family has more than enough financial means to afford the house, the bank may still be unwilling to make the loan. Because Blacks face discrimination at work, in the legal system, and elsewhere, the potential future earnings of the Black family are perhaps lower than that of a White family with the same profile. Discrimination exists in all areas of American life, and it wouldn't be prudent, or profit- oriented, for the bank to bet against that discrimination.


 

5) An answer to Becker: If the bank were the only racially discriminatory institution in the country, it would go out of business. But if racial discrimination is pervasive in other areas of American life, the bank can only stay in business by discriminating as well. If the system works to make Blacks less 'credit worthy', then, in the narrow economic sense, the bank is simply making a rational judgment about the inability of potential Black borrowers to pay back the loan. In the bank's view, they may reject all Black loan applicants for purely rational or economic reasons.