Sunday, October 10, 2010

Some Demographic Groups Have Higher or Lower Loan Delinquency Rates Than Credit Scores Predict

I am posting for the first time an old comment that I posted on EconLog on June 19, 2010. The reprinted comment below was in response to a blog post "Mortgage Lending and Discrimination" by Arnold Kling on June 18, 2010:
In 2007, the Fed issued a study of credit scores, "Report to the Congress on Credit Scoring and Its Effects on the Availability and Affordability of Credit" using a national statistical sample of 301,536 individuals.

From the executive summary of the report:
The analysis also finds that some groups perform worse (experience higher rates of serious delinquency) on their credit accounts, on average, than would be predicted by the performance of individuals in the broader population with similar credit scores. For example, on average, blacks perform worse than other racial and ethnic groups with similar credit scores. Similarly, single individuals and those residing in predominantly black or low-income census tracts perform worse on their loans than do their complementary demographic groups with similar credit scores. In contrast, the loan performance of Asians, married individuals, foreign-born individuals (particularly, recent immigrants), and those residing in higher-income census tracts was better than the performance predicted by their credit scores. The results hold after controlling for the other personal demographics of these individuals and for an estimate of the individuals incomes and locations; other factors that could be important, such as differences in employment experience, were not available.
Also see this fair newspaper summary of the report:

The study was done before the housing crisis and looked at all types of credit.

Lenders by law must lend equally to all borrowers with similar incomes and credit scores. If lenders include demographics, such as race or ethnicity, in their credit decisions, or adjust credit scores by race, etc., they would be found to have unlawfully discriminated.

The Fed study shows that while credit scores work well within ethnic and racial groups to predict default, different ethnic and racial groups with similar credit scores have different default rates.

Both the Fed and banks know that some groups with similar credit scores have higher default rates than other groups with the same credit scores. The banks however cannot impose more stringent credit terms on those with the higher default rate because it would be illegal discrimination.

Prior to all the anti-discriminatory lending laws, bank lending practices were based more on actual default rates than credit scores, which is why the Boston Fed study of 20 years ago did not find higher default rates among whites due to lax lending standards. After the passage of all the anti-discriminatory lending laws, banks were forced to treat all borrowers with identical credit scores equally, even if their expected default rates were different, which is why we now see higher default rates among some minority groups.

Despite protests by the the media, politicians and and back of the envelope calculations to the contrary by several liberal economists, much of the blame for the severity of the current foreclosures and housing mess can be traced back to well-intentioned laws that interfered with mortgage lending and housing decisions.

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