Discriminating risk: the U.S. mortgage lending industry in the twentieth century

Abstract

Discriminating Risk: The U.S. Mortgage Lending Industry in the Twentieth Century. Guy Stuart. 248 pages. Cornell University Press, Ithaca, New York, 2003. The title of Guy Stuart's book suggests that it would provide an objective summary of the evolution of the lending decisions of the American mortgage lending industry in the twentieth century. Instead, the primary focus of the book is on the way lenders ''construct risk'' in ways that discriminate against racial and ethnic minorities- namely, blacks and Hispanics. Stuart's book begins with an explanation of his concept of risk construction in which cultural, institutional, and spatial issues affect the lending decision in a manner that discriminates against certain minority groups. He distinguishes [following Keynes (1921) and Knight (1921)] between the concepts of uncertainty and risk by explaining that uncertain decisions are those in which the decision maker is not aware of the probability distribution of future events, whereas risk decisions are made when decision makers attempt to translate uncertainty into risk by evaluating the probability distribution of future events. Cultural, institutional, and spatial issues affect the way lenders construct risk in the face of uncertainty. Without delving into the quagmire of whether lenders engage in blatant discrimination, as implied by the Federal Reserve Bank of Boston study (Munnell, Browne, McEneaney, and Tootell, 1992), Stuart argues that the ways lenders construct risk result in unfair treatment of minority loan applicants. In particular, he suggests that lenders construct risk in an implicit social context that affects the way they receive and process information and thereby develop lending rules. Furthermore, he suggests that the lending guidelines promulgated by the dominant institutions in the mortgage industry [the Federal Housing Administration (FHA), the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac)] continue to put minority borrowers at a disadvantage in mortgage lending decisions. Lastly, he argues that the manner in which appraisers and lenders identify and delineate neighborhoods makes the conclusions lenders reach regarding changes in property value a self-fulfilling prophecy. Chapter 1 of the book considers the ''meaning of value'' and the role that appraisers play in the mortgage lending decision. Stuart provides an interesting discussion of the progress made by the appraisal profession (largely at the urging of the Department of Justice) toward reducing explicit racial and ethnic discrimination. He comments on Frederick Babcock's writings in the Federal Housing Administration's Underwriting Manual (1936), used for many years after the FHA's inception under the Roosevelt administration, and concludes (p. 58) that the ''. . . (misguided) genius of Babcock's solution'' that calls for the careful delineation of ''neighborhoods'' from which comparables should be chosen in the sales comparison process created a class and race sensitive appraisal process. Eventually in 1976 the Department of Justice and the American Institute of Real Estate Appraisers and the Society of Real Estate Appraisers agreed to strike all racist-like language from their training materials. The passage of the Home Mortgage Disclosure Act of 1975 and the Community Reinvestment Act of 1977 brought transparency to the lending industry, which helped expose explicit racial discrimination in the lending decision process. Today, the dominant players in the mortgage lending industry explicitly prohibit discrimination against neighborhoods based on the race of the inhabitants. But, Stuart (p. 187) argues, ''. . . the logic of the appraisal process dictates that segregation [continues to] be tacitly acknowledged in the selection of comparable properties.'' Chapter 2, ''Rules for Assessing the Borrower and Managing Behavioral Risk'' considers how loan-to-value (LTV) ratios, debt-to-income ratios, and credit records help lenders construct risk. …