Housing-Finance Intervention and Private Incentives: Helping Minorities and the Poor
Calomiris, Charles W., Kahn, Charles M., Longhofer, Stanley D., Journal of Money, Credit & Banking
Despite the plethora of government programs and heated policy debates over the last several decades, little has been settled about the proper role for government in housing markets in general, and the mortgage market in particular. Government, it is argued, can play an important role in encouraging homeownership and eliminating discrimination in credit markets. Yet, hard evidence on the existence of discrimination is weak, as is the existing theoretical literature explaining discrimination in the credit market. Without an understanding of the magnitude and origin of discriminatory behavior in the marketplace, any policy response is merely a shot in the dark. Moreover, while being a minority is not synonymous with being poor, many programs designed to deal explicitly with poverty and its effect on housing market access are often shrouded with racial overtones in policy debates, further complicating discussion of their relative merits.
This paper provides a survey and analysis of government interventions in the housing credit market.(1) We propose several possible goals behind government intervention in housing finance, outline market imperfections and other behavior that motivate intervention into housing finance, examine the details of the specific programs that exist in response to these goals, and investigate their relative costs and benefits by focusing on their impact on the incentives of the participants in the market. Despite the complexity of government programs, we are able to come to some strikingly simple conclusions regarding the relative effectiveness and desirability of various interventions.
On the theoretical front, this paper argues that the existing informational models used to examine government intervention in lending markets are inappropriate for analyzing the market for individual mortgages. To remedy this deficiency, we develop two further explanations of discrimination in the credit market. The first is based on the idea that it is less profitable for bankers to evaluate minority loan applications, either because of a lack of "cultural affinity" between bankers and applicants, or because minorities are on average poorer than whites and hence less creditworthy as a group. As a result, minorities are denied loans more frequently than are whites. In this model discrimination can result in the sense that some individuals suffer negative externalities as a result of their race. The second model focuses on moral hazard, as opposed to the adverse selection models typically used in credit rationing studies. We argue that this moral hazard story is more natural in the housing credit market, given the informational asymmetries necessary for adverse selection models to work, and show that the policy implications of this moral hazard model are quite different from the more common adverse selection case.
An additional contribution of this paper is to shed some light on the so-called "Becker Paradox" in determining the presence of racial discrimination in the home mortgage market. Most studies of mortgage market discrimination [most notably Munnell et al. (1992)] focus on loan denial rates and typically conclude that not all of the disparity in these rates can be explained by "economic factors," suggesting that discrimination exists. Default rate studies (Berkovec et al. 1994; Evans, Maris, and Weinstein 1985; Green and von Furstenberg 1975), however, suggest that minorities default more often than do whites, even after controlling for relevant economic characteristics, a finding which many economists regard as inconsistent with a conclusion of discrimination.(2) We show, however, that the added screening costs brought about by "cultural affinities" or differences in average wealth across races can lead to minorities endogenously exhibiting higher default rates than do whites, thereby providing a theory of discrimination that is consistent with both of the above observations.
The structure of the paper is as follows: Section 1 enumerates and distinguishes a variety of possible goals for housing credit policy. …