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Modern Redlining in Historical Context

posted by Ethan Cohen-Cole

A paper that I wrote while an employee of the Federal Reserve System a couple years back documents the presence of ‘redlining’ in the issue of credit cards. Credit Slips picked it up here (link).

(To ensure there are no misunderstandings, this paper did not and does not represent the views of the Federal Reserve Bank of Boston or the Federal Reserve System; in fact, both entities did their utmost to prevent its release) ... continue…

To be more specific: I find that credit issuers use the racial composition of a neighborhood in determining how much credit to give to individuals that live in it. I use the term ‘redlining’ with historical reference: this idea is that particular areas have been identified as high risk. What I find is that the ‘high risk’ areas are highly correlated with the presence of minorities.

I’ll be clear, I cannot definitely prove that lenders use race—I’m an economist, not a lawyer! Regardless, I’ll present the point that the practice is still redlining even if lenders never use race, but use location-based information that is correlated with race.

To explain why, I’ll go back a few years.

A nice abbreviated history of the home owners loan corporation (HOLC) is here. This depression-era program was set up to help refinance underwater homeowners. Part of the program was to ensure home values in locations where loans were given. Neighborhoods were assigned risk ratings, and loan approvals were based on the location. This program supported the long run use of the risk ratings. Lenders didn't have to worry about legal or social challenges and so instead of using location-based default probabilities (which were hard to get), they could just use race. Draw a red line around the neighborhood and stop lending.

Fast forward 80 years. Data on defaults are easier to get and the use of race is a bit harder, politically and legally. Using the race of a borrower would be a huge publicity problem, not to mention a practical one (many credit card applications are taken online or by phone).

So issuers have an alternate method. Location of residence, shopping location, etc.

But wait, wasn’t this what got us here in the first place? 80 years ago, lenders figured out that some locations were riskier. These happened to be the ones with minorities in them. Today, we’re doing the same thing, we’re just being a bit more coy about it. Instead of using the racial composition directly, let’s just use a flag for the location. By coincidence or design, if it happens to accomplish the same thing as using race to define location, I hold it in similar view.

That is, this has the same pernicious impact as redlining on economic growth, segregation, etc. Whether there is legal culpability is somewhat beside the point.

*One final nuanced point. I want to make clear that the point here is not the same as claiming that disparate impact is the same as disparate treatment. A disparate treatment argument could very well include by definition and historical precedent the use of location-based information that correlates with race even if issuers don't use a race variable itself.


And limiting credit card debt is bad because...???

I'd call your article an example of racism against non-minorities. We all know that the purpose of credit card debt is primarily to indenture people for their entire lifetime.

To somehow imply that those who get more credit are more blessed is a point that I would have to respectfully disagree with.

Ethan, your methodology suggests disparate impact analysis to me. That's a perfectly legitimate independent basis for allegations of redlining. Disparate treatment isn't necessary.

By contrast, auto insurers are permitted to evaluate risk by geographic location.

And of course, increasing subprime lending in a given area (because in a time of loose lending standards, interest rate and crappy terms are a proxy for risk level, not refusal to lend) increases likelihood of default, making the geographical assocation a self-fulfilling prophecy.

I spent over 15 years in the credit card industry and saw no evidence of your so called "redlining". I would agree with the comments already provided and add that maybe you should contact Representative Barney Frank for his input.

Thanks for your comments - this is a topic that always generates strong opinions.

* limiting credit card debt is bad? Well, only if it is differentially limited. One could make a similar argument about access to mortgages, insurance, etc.

* My comment on disparate treatment is based on the notion that the original underwriting differed based on location, not the ex-post amount of credit available.

* 15 years and no evidence: I'm curious, did you not observe the use of a race variable or didn't observe the use of location-based measures at all?

If minority based areas were given more credit than others, one could cry racism based on predatory lending of credit cards.

If minority based areas were given less credit than others, once could cry racism based on credit deprivation.

Just sayin.


Ultimately, disparate impact is not about areas but the impact of policies on residents of those areas vis a vis persons in non-disadvantaged areas. This must be established by expert statistical analysis.

Is there a statistically significant greater likelihood that African American Person A in Neighborhood 1 received a subprime loan for the same purchase than Person B in Neighborhood 2, even though the credit scores, employment, income are comparable? IOW, if we isolate for geography, is that what is creating the disparity in access to credit on the same terms?

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