Lending Discrimination; R. Batemarco

LENDING DISCRIMINATION: THE UNENDING SEARCH 259 Conclusion Another worthwhile exercise for the reader would involve the identification of other self-destructive economic policies that fail to consider long-range conse quences. Even as I write, there is proposed legislation that would produce automatic increases in the minimum wage in response to inflation. Minimumwage laws are justifledas acts that willhelp low-skilled workers earn a living wage. But it is clear that such laws only force employers to layoff more unskilled workers. And so, the very law that was supposed to help unskilled workers earn more money has the long-range effect of costing many of them their jobs. Such is the nature of liberal "compassion" that ignores the economic way of thinking. D LENDING DISCRIMINATION: THE UNENDING SEARCH by Robert Batemarco H L. Mencken once called politics • "the art of looking for trouble, find ing it everywhere, diagnosing it incorrectly, and applying the wrong remedies." You don't have to spend much time looking around to seejust how right he was. Menck en's characterization fits some recent regu latory follies to a tee.

One problem the politicians and bureau crats set out to find was discrimination in lending. They found it in just about every rundown neighborhood in which mortgage lenders failed to extend credit because there wasn't a sufficient probability of recovering money lent. This avoidance by lenders of certain areas, known as red-lining (so-called because red lines were supposedly drawn Dr. Batemarco, The Freeman's book review editor, teaches economics at Marymount Col lege, Tarrytown, New York. This paper was delivered at the December 1993 Round Table at FEE. around areas where banks would not make loans) was outlawed by the Community Reinvestment Act of 1977. Other types of lending discrimination were forbidden un der the Equal Credit Opportunity Act of 1974.1 Interestingly enough, despite the cur rent political climate, which encourages members of officially designated victim groups to make any of life's little disappoint ments into a federal case, the Federal Re serve System's office that deals with credit discrimination has received but a trickle of complaints, not one of which was found to entail illegality. The Fed's response to this dearthof activitywas to seekoutcomplaints from civil rights activists. Even this had no discernible effect.2 The misdiagnosis was the idea that these areas were rundown because they couldn't get loans. Dysfunctional families, public schools incapable of imparting the skills to prepare children for a productive adulthood, 260 THE FREEMAN • MAY 1994 pervasive dependency on government lar gesse, high unemployment, and rampant crime which prevents those who are pro ductive from enjoying the fruits of their labor get nary a mention as contributing factors. Certainly, the notion that these factors, which cannot help rendering a neighborhood rundown, might also make loans there a losing business proposition seems not to have occurred to those who are so quick to cry "discrimination."

Indeed, the very existence of racial dis crimination in lending is only plausible be cause of the misinterpretation of the avail able data. The finding by the Federal Reserve Bank of Boston that, in 1991, 15.0 percent of Asian, 17.3percent of white, 26.6 percent of Hispanic, and 37.6 percent of black applicants for mortgage loans were denied credit is taken by regulators as proof of such discrimination. 3 Whether it is or not, however, depends on a number of factors which such summary statistics are incapable of revealing. Unless the members of each, of these groups possessed identical levels of such characteristics relevant to credit worthiness as income, net worth, employ ment stability, and quality of the collateral they can post as security for the loan, to name a few, the numeric discrepancies men tioned above provide but the flimsiest of circumstantial evidence regarding the exis tence of discrimination.

Those studies which have taken such factors into account have discovered that Asians, whites, Hispanics, and blacks with similar levels of credit-worthiness do indeed have similar rejection rates. A study of lending behavior at a Detroit-area bank which controlled for factors related to cred it-worthiness found no correlation between one's likelihood of having his mortgage application approved and one's race. 4 Even the study conducted by the Federal Reserve Bank of Boston, which has been held by many as evidence of widespread discrimi nation, shows that taking credit-worthiness into account reduces the differences in re jection rates among racial groups. Its au thor, Alicia Munnell, has conceded that her study does not prove discrimination. 5 DefaultRates If any statistic could shed some light on the presence or absence of discrimination among various ethnic groups, it would be the relative default rates among those groups. If lenders both made loans only on nondiscriminatory profitability criteria and were able to avoid systematic errors, default rates would be identical for all groups. As a matter of fact, data cited by Ms. Munnell establishes the absence of any statistical relationship between race and default rates. 6 Any fair-minded observer would have to conclude from this evidence that lending discrimination, if it exists at all, is a nonproblem. Indeed, the very regulators charged with enforcing Community Rein vestment Act guidelines have rated nearly 90 percent of commercial banks as "satis factory" or "outstanding" regarding their fair lending records. 7 Not only are the numbers incapable of supporting the charge of lending discrimi nation, but so are theoretical consider ations. To the extent that loan officers' incomes are based on the number and the value of the loans they generate, indulging whatever prejudices they may have against members of other races who in point of fact are fully qualifiedfor loans would be a pricey indulgence indeed.8 Furthermore, as long as such prejudices were not acted upon by all lenders, any qualifiedapplicant turned down by one lender because of his race would represent a profit opportunity for those lenders not blinded by prejudice.

It should be noted that those who single mindedly seek to find discrimination are not deterred by anything as pedestrian as the absence of evidence or logic on their side. Thus, Richard F. Syron, President of the Federal Reserve Bank of Boston, while realizing that loan rejection rates have more to do with weak credit histories than with race, nevertheless exhorts lenders and reg ulators to stop asking if there is a problem and begin to workto solve it.9 Alicia Mun nell continues to insist that lending discrim ination occurs even though she had admitted that neither she nor anyone else has any LENDING DISCRIMINATION: THE UNENDING SEARCH 261 evidence of it. tO Indeed, some regulators, when they can't find discrimination, are still not satisfied. Federal Reserve Board Governor Lawrence Lindsey, for instance, sought to prevent First Interstate Bancorp from acquiring another bank, not because there was any evidence that it discrimi nated, but because he did not think that it worked aggressively enough to make mortgage loans in particular low-income and minority areas. ll Atlanta's Decatur Federal Savings & Loan was put through the wringer for not advertising in black media and not giving special treatment to black borrowers, specifically not making loans at below-market rates to black borrowers who did not qualify by· traditional banking criteria. 12 Mencken Was Right As Mencken realized, regulators would not be so hell-bent on finding problems unless they were itching to tryout their (invariably counterproductive) pet solutions on them. One preferred solution is to foist on lenders the same types of affirmative action requirements which become so much a part of the business landscape. Regulators' abil ity to withhold approval of new branches or acquisitions until their mandates are com plied with in full is a potent threat indeed.

Shawmut Bank, New England's third largest banking company, knows by painful experiencejust how effective it is. The bank has seen its efforts to expand through ac quisition of other banks, a virtual necessity in today's fiercely competitive environ ment, halted abruptly not because it has been convicted of, or even indicted for any violation of any law, but merely because of suspicion that Shawmut may be guilty of lending bias, which is being investigated by the Justice Department. 13 Until the banks' officials comply with the commands of reg ulators, they will remain at a competitive disadvantage. Some of the actions which they have taken in an effort to placate the powers-that-be include requiring lower down payments of certain low-income ap plicants, earmarking $25 million for applicants whose unstable employment histories would not qualify for loans under traditional standards, and paying $100,000 to a left wing community activist group which one would expect to otherwise make further accusations of discrimination. 14 Similar pressures forced Decatur Federal to "pay heavy fines, institute lending quotas, pay bonuses to people who didn't qualify for mortgages, hold racial brainwashing ses sions for employees, and pay a hefty ransom to liberal community groups." 15 Another proposed "solution," while less punitive, may set an even worse precedent.

This is the Community Development Bank, (CDB) whose mission is to "stimulate the economy in areas where other bankers are loath to lend. ,,16 The CDB is modeled on some private institutions which already ex ist-although these generally enjoy some subsidy either from the government or pri vate foundations. (In any case, they have sufficient private capital invested that must seek out only the credit-worthy.) Govern ment CDBs, on the other hand, are likely simply to depend far more on political cri teria and to end up making mostly uneco nomic loans. Critics hold up the federal Farm Credit System, which required $4 billion of government funds to cover the losses it incurred on agricultural loans in the early 1980s,as an example of the likely fate of these CDBs. 17 Of course, given that credit, as are all economic goods, is scarce, if the government makes loans to those who fail to meet traditional qualification criteria, it must be taking credit away from those who do meet them. Thus, it diverts credit from those more able to repay it to those less able to do so.

Ultimately, all of these proposed solu tions constitute an attack on the rational economic calculation which Ludwig von Mises identified as the sine qua non of the market economy. Each of these measures replaces calculations based on expected profits and losses with those based on po litical criteria. Furthermore, such actions also erode the rights of property owners, specifically the right to use their property where it offers the greatest potential for gain.

262 THE FREEMAN • MAY 1994 What the government has been doing to lenders is not an isolated case. Government attempts to suppress decisions based on the profit motive in the name of some unattain able notion of fairness or equality are quite widespread in the United States today. The insurance industry has also come under attack for alleged red-lining. Community ratings statutes in a number of states have prevented health insurers from "discrimi nating" between good and bad risks. The Clinton Administration and several key Congressmen are now considering extend ing the Community Reinvestment Act to cover mutual funds and other financial in stitutions. 18 Even the use of information regarding prospective employees has come under attack by our courts, with the bizarre legal principle of "compelled self-publica tion," under which your telling a prospec tive employer the official reason why you were fired by a previous employer, gives you standing to sue that previous employer for slander. 19 These examples are but the tip of the iceberg. And if our country does not shift course soon, that iceberg is likely to sink the Good Ship Capitalism. D 1. This act includes among its prohibitions a bank's refusal to lend money to welfare recipients.

2. Statement by John P. LaWare, Chairman, Federal Financial Institutions Examination Council and Member, board of Governors of the Federal Reserve System, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, February 24, 1993, Federal Reserve Bulletin, April 1993, p. 194. 3. Peter Brimelow and Leslie Spencer, "The Hidden Clue," Forbes, January 4, 1993, p. 48. 4. Jonathan Chait, "Bad Examples," Reason, December 1993, p. 58. 5. Brimelow and Spencer. 6. Ibid. 7. Dean Foust with Kelley Holland, "Taking A Sharper Look at Bank Examiners," Business Week, April 19, 1993, p.99. 8. Jack M. Guttentag, "Most Lenders Would Rather Profit Than Discriminate," American Banker 158, January 6, 1992, p.4. 9. "Statement of Richard F. Syron, President, Federal Reserve Bank of Boston, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, February 24, 1993," Federal Reserve Bulletin, April 1993, p. 314.

10. Brimelow and Spencer. 11. Kenneth H. Bacon and Suzanne Alexander Ryan, "Shawmut Decision Shows Fed's Division over Adequacy of Fair-Lending Records," Wall Street Journal, November 22, 1993, p. A4. 12. Llewellyn Rockwell, Jr., "Fact," Forbes, Septem ber 27, 1993, p. 86. 13. Kenneth H. Bacon and Gary Putka, "Shawmut's Plan for Acquisition Rejected by Fed," Wall Street Journal, No vember 16, 1993, p. A2. 14. Kenneth H. Bacon and John R. Wilke, "Fed Gives Bias Law New Clout As It Blocks a Bank Acquisition," Wall Street Journal, November 17, 1993, pp. Al and A9. 15. Llewellyn Rockwell, Jr., "Nader Aim at Banks Unsafe at Any Rate?" The Washington Times, August 24, 1993,p. F2. The fines in question amount to $1 million, paid to 48 black applicants who were denied loans. 16. Dean Foust with David Greising, "Banks That Believe in Many Towns Called Hope," Business Week, November 30, 1992, p. 89.

17. Foust and Greising, p. 90. 18. Janet Novack, "What's Ahead for Business," Forbes, October 25, 1993, p. 39. 19. Junda Woo, "Quirky Slander Actions Threaten Em ployers," The Wall Street Journal, November 26, 1993, p. 81. Bankers and Regulators T he current u.s. financial structure, in despair and disrepute, is the logical outcome of financial thought that places legislators and reg ulators in the center of things. It is a precarious system that builds -on government insurance and government guarantees and, in final analysis, depends on monopoly money and legal tender force. It is a dis credited system that is inflicting immeasurable harm on many people. The seventeen essays in this volume, all selected from earlier issues of The Freeman,examine in detail the failure of regulation and offer hope for a return to sound banking. The collection includes, among ot~ers, articles by Hans F. Sennholz, Ken S. Ewert, E.C. Pasour, Jr., Christopher Culp, Richard M. Salsman, and Lawrence H. White.

176 pages, indexed, $14.95 paperback Correction, Please! The Mother of All Myths "Analysts watch consumer spending closely because it represents roughly two-thirds of all economic activity." -Associated Press (October 30, 1993) I n the early 1990s, in the depths of the recession, Range Rover, a British maker of sports-utility vehicles, ran an unusual ad in USA Today. It announced its formula for ending the downturn: "Buy Something." Of course, Range Rover wanted you to buy their car, but in any case, purchase some thing. "Buy a microwave, a basset hound, theater tickets, a Tootsie Roll, something." Anything to get the economy moving again. In late 1991, Federal Reserve chairman Alan Greenspan suggested that the eco nomic contraction was caused in part by retrenchment in consumer and business debt during the early 1990s.The implication is that the economy could be on its way to recovery if only consumers and business would start spending again, even if it meant spending beyond their means.