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Credit Card Redlining

posted by Adam Levitin

Several months ago, when I was a scarcely tolerated guest blogger, I wrote a post that asked (What Determines) What's In Your Wallet? The point was to highlight how little we know about what determines what credit card offers a particular individual receives. I suggested that there was a danger of red-lining in the credit card industry based at least on what solicitations one received. (I got a bunch of indignant e-mails about this emphasizing that federal law prohibits discriminatory lending...as if no one ever violated the law. Ah, Camelot.)

Well, now comes an empirical study from Ethan Cohen-Cole, an economist at the Boston Federal Reserve that indicates that there is redlining in the credit card industry. Residents of black neighborhoods are less likely to receive less consumer credit than residents of white neighborhoods, all things being equal:

This paper’s principal observation is that remarkably, in spite of identical scores and identical community characteristics, our individual in the Black neighborhood receives less consumer credit (e.g. fewer credit cards) than the individual in the White area. That is, in spite of the fact that both have been assessed to have similar risks of nonpayment, as determined by the credit score, the person living in the Black area has less ability to access credit.

And if there is less available credit card credit, where do people in black neighborhoods turn for credit?

To be sure, a single empirical study is just that and one can quibble about methodology, but wow! Talk about opening up a new front in credit card regulation. I've got to think that if this study gets some attention it is going to cause Congress to ask some questions. Of course, the study says nothing about the terms of the credit, but if I had to take a guess...well, what would you think?

The study includes a number of appropriate caveats about its findings. It also notes that

given the degree of regulatory scrutiny over the credit decision itself, one suspects that if any disparity exists in the provision of credit, it likely originates in the pre-screening (marketing) efforts.

I'm less sure of this. Certainly the marketing is a big factor; there are certain cards that are specifically marketed at particular minority communities, e.g., the Freedom Card (not to be confused with the Chase Freedom Card), which is marketed to poor blacks in Philadelphia. Moreover, the study can only speak to aggregate levels of credit, not to individual issuers' lending solicitation and lending decisions.

But the regulatory scrutiny of the credit issuance decision--what exactly is that? Who (if anyone) is actively screening for Equal Credit Opportunity Act (ECOA) violations and how are they doing it? We don't have anything like HMDA data for credit card lending. If the issuer never records the race of the borrower, but only uses a proxy variable, it would be pretty hard for an examiner to pick up systematic ECOA violations. And is it a ECOA violation is the discrimination is not on race per se, but on a proxy variable?

The card industry has carefully homed in on all sorts of variations in consumer behavior to fine-tune its profit model. In a competitive industry that does such careful data mining, do we really think that every issuer would shy away from discriminatory lending if it were (a) profitable and (b) not explicitly discriminatory because of use of a proxy variable? Or is racial discrimination different and just out of bounds? I'm not sanguine.

What this all speaks to is the need for greater transparency in the credit card industry, including the collection of more publicly available data. Government agencies are charged with enforcing the ECOA, but they have limited resources. Making collecting data and making it publicly available allows the academic community to contribute to ECOA monitoring, a win-win for the public and data hungry academics.

Comments

I thought receiving too many credit card solicitations is usually identified as a problem (Elizabeth Warren, movie Maxed Out). That's why we have opt-outs. So the minority communities being less targeted by the solicitations isn't necessarily bad, right?

Perhaps not, but I'll bet the credit they're being offered is on worse terms than that of comparable white consumers. We've seen that with subprime lending.

All things being equal, less credit will lead to lower credit scores, will lead to higher costs of credit down the road.

We may have a situation in which some people are plagued with too many credit offers (or to be precise, it is not that there are too many offers, but too many offers of a problematic product) and others may not have enough opportunities to get cards, which might be turning to less salubrious sources of credit.

I had a salubrious girlfriend once.

The FDIC's 1994 statement on ECOA compliance addressed this, stating that: "Disparate impact--use of a policy or practice that is neutral on its face but has a disproportionate adverse effect on a protected group, and that cannot be justified by business necessity" is, in fact, illegal discrimination.

Mike -- Nice use of quotation marks -- but that's not what the FDIC policy statement says. Would you care to make clear what source you are quoting from?

My guess is that you are just cribbing from the ABA Banking Journal's summary, as found here, for example:

http://www.allbusiness.com/government/advocacy-consumer-protection/615428-1.html

But if that's the case, it would be better to say so.

Vaguely remembering the differential equations of demand and consumption I computed in Samuelson's course decades and decades ago, I am curious to understand how an 'intuitive predictive credit score' - the VantageScore's patented model - and the participating parties (credit agencies, banks, insurance companies, real estate companies, etc) survives a conspiracy to diminish competition, attempt to monopolize, invasion of privacy, price fixing and fraud challenge.

Any accurate 'intuitive predictive model' would red-line on zip codes.

Any model based on 'percentage of credit used' implies an internally-initiated conspiracy - one conspirator reduces the credit line, lowering the score and all conspirators follow in suit based on the score.

Nowhere in the model is there any knowledge of pensions, 401Ks, trusts, gold, diamonds, alien artifacts from Zircon - the latter may be attachable in bankruptcy.

Oh Alice, How can this be?

It's not racism, since issuers want to lend money they think they'll get back, but rather, it's reality. Blacks, in general, are bad credit risks, due to their own behavior and dysfunctional culture.

Mark--I strongly reject your assertion about blacks being bad credit risks and think it reflects a sad denial of the realities of structural and personal racism. I think the problems with your position are so self-evident that it isn't worthwhile arguing about them.

I also think you didn't follow the Cohen-Cole study. The point is that if you have two neighborhoods with identical characteristics other than racial composition--that is same credit score, etc.--the white neighborhood will have more credit per capita than the black neighborhood. In other words, white neighborhoods that present the same credit risk as black neighborhoods are treated better. That sure sounds like racial discrimination to me, and can't be explained away except by racist arguments that blacks are inherently worse credit risks because they are black.

No one said blacks are bad credit risks because they are black, but because of their behavior and dysfunctional culture. It is anti-white racism for you to say that black behavior and culture are equal other ethnicities when that is obviously not true.
Political correctness also is to blame for the sub-prime housing mess, because of blacks complaining of so-called red-lining in the early '90's, led to government-backed loans, which led to a housing bubble with all that easy money to people who shouldn't have had loans in the first place.

To blame racism when none exists is racist in itself.

I'll let readers judge Mark by his own words. You know what I think.

Andrew-

Thanks for the correction. I was under the impression that the ABA's journal was quoting from the FDIC's statement. My apologies.

So here's the FDIC policy statement, from http://www.fdic.gov/regulations/laws/rules/5000-3860.html accessed at 5:20pm ADT on 4/12/2008:

"This policy statement applies to all lenders, including mortgage brokers, issuers of credit cards, and any other person who extends credit of any type."

"When a lender applies a policy or practice equally to credit applicants, but the policy or practice has a disproportionate adverse impact on applicants from a group protected against discrimination, the policy or practice is described as having a "disparate impact." Policies and practices that are neutral on their face and that are applied equally may still, on a prohibited basis, disproportionately and adversely affect a person's access to credit."

(Sorry, don't know how to format for block quotes)

This being the case, it would seem that usage of a proxy variable would be an ECOA violation according to the FDIC. I cannot definitively state that all credit-card issuers are subject to FDIC/NCUA scrutiny-however, I would hazard a guess that the majority of credit cards issued are from FDIC-regulated sources.

As for the statements about "dysfunctional culture" etc above, I would be interested to see a study normed for income that shows what (if any) difference there is in default rates between African-American borrowers and white borrowers.

Again, my apologies for not properly attributing my prior quote. Shoddy research on my part.

I have a Spanish surname and often receive credit card solicitations from the same bank in both English and Spanish. I don't actually read Spanish, but it's easy to see that the teaser and regular APRs are both higher in the Spanish offers.

Don’t count on Congress to bail the credit card holders out. One political journalist on CNN put it very well when he said on last years bill introduced to make bankruptcies harder to obtain, quote 'Government will hold you down while the credit card company pummels you'.

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