Progressives’ Financial Inclusion Agenda Is Likely to Backfire

banking regulation, financial regulation, financial innovation, community reinvestment act, financial inclusion

banking regulation, financial regulation, financial innovation, community reinvestment act, financial inclusionIn a recent op-ed for CNN, Rep. Rashida Tlaib (D-MI) suggests a plan for improving the financial inclusion of minority households. She believes that reversing the Trump administration’s recent regulatory initiatives on credit discrimination and mortgage reporting legislation would improve matters.

While Rep. Tlaib is right to point out the disproportionate numbers of blacks among those lacking access to financial services, their financial exclusion goes back, not years or months, but decades. Moreover, her recommendations would mainly double down on existing regulations that seem to perpetuate rather than mitigate financial exclusion.

Rep. Tlaib begins with the striking finding that, ostensibly, the black homeownership rate in the second quarter of 2019 was lower than at any time since 1970. At 40.6 percent, it came in six percentage points below the Hispanic homeownership rate and almost a third below that of whites. Tlaib worries that, because black Americans are so much less likely than other racial groups to own their home, they will have a harder time achieving economic stability.

While homeownership is indeed a popular form of wealth accumulation, the share of Americans who own their homes is hardly a straightforward measure of financial security. For example, the homeownership rate among all households hit an all-time high of 69.1 percent at the start of 2005, a time of exceptionally high home prices and extremely loose credit standards. The financial crisis that followed, with foreclosures hitting up to 10 million families, belied the assumption that the new homeowners had achieved financial security.

Black Americans’ low homeownership rate is the product of many causes, notably decades of institutional discrimination that made it difficult or impossible for blacks to gain access to the same job opportunities and schooling as whites. Discrimination caused black households to have persistently lower incomes and greater professional and personal instability, frustrating their attempts to earn and save. Explicit government policies also limited black Americans’ access to credit by designating predominantly black neighborhoods as “hazardous” to prospective lenders. Because banks since the 1930s have sold most of their mortgages to government and government-sponsored entities, an official recommendation against lending in certain areas had the power of a veto.

Rep. Tlaib is right to focus attention on the troubling legacy of redlining, but blaming a recent and marginal reduction in regulation for blacks’ low homeownership rate is highly suspect. For one thing, the most recent quarterly rate of 40.6 percent is only slightly below the 41 to 43 percent range recorded for most quarters since the beginning of 2012. The estimate’s margin of error, at 0.9 percent, is also high. Thus, the record low reported for the last quarter could be a statistical fluke or a short-lived dip. Giving one quarterly result great significance is probably unwise at this stage.

Tlaib’s op-ed also makes an important category mistake. As evidence of redlining, it refers to a piece of investigative journalism that claimed to find discrimination against minorities in mortgage lending. But, while they may affect similar communities, credit discrimination and redlining are quite different practices. Redlining involves the systematic avoidance by lenders of certain neighborhoods. Discrimination, on the other hand, is the denial of credit to people because of their gender, race, age, disability status, or other personal traits. Redlining is geographical, whereas discrimination focuses on individual characteristics. Each calls for a different policy fix.

Moreover, the study in question was controversial at its publication because, in analyzing lending data for different racial groups, it did not consider borrowers’ credit scores. These scores seek to summarize the risk of lending to individuals and predict their likelihood of default. They are probably the most important factor in a lender’s decision to approve a loan and on the terms of the loan. Excluding credit scores from a study of discrimination will almost surely yield spurious findings, because credit scores correlate with both borrower income and race.

Rep. Tlaib believes the Trump administration’s housing policies, such as a rumored tightening of the evidentiary standard required to make a discrimination claim and a reduction of mortgage reporting requirements for small lenders, attack “the last line of defense against the declining rate of minority homeownership.”

But there is no clear positive correlation between these regulations and the black homeownership rate. On the contrary, the fear of a disparate-impact claim under the current standard may chill lending activity and innovation. Furthermore, tighter mortgage underwriting rules – whether beneficial or harmful on net – did lead banks small and large to reduce their footprint in this area, a retreat that nonbank fintech lenders have only partially offset. The CFPB’s recent request for comments on how its qualified mortgage (QM) regulations should change ostensibly seeks to make compliance less burdensome, without promoting loans that will likely fail.

Rep. Tlaib rightly points out the unintended phenomenon whereby regulations under the Community Reinvestment Act (CRA) cause most of the lending for which regulators grade banks to flow to higher-income borrowers in low-income areas. My own research using District of Columbia data shows that two-thirds of mortgages eligible for CRA points in 2017 went to this group. Further statistical analysis undertaken with my colleague Andrew Forrester suggests that CRA lending may in fact accelerate the displacement of low-income residents in gentrifying neighborhoods. In DC’s census tracts, each additional percentage-point increase in CRA lending between 2012 and 2017 correlated with a three-percentage-point decline in the minority share of that tract’s population.

Tlaib wants CRA points to be “based more heavily on a person’s income, rather than location.” But such a shift would violate the statutory language of the CRA, which requires that lending be “consistent with the safe and sound operation” of banks. Because lower-income borrowers tend to be riskier, mandating that banks lend to them could harm financial stability. Recent experience of how the executive and legislative branches carelessly expanded the affordable housing goals of Fannie Mae and Freddie Mac, the dominant purchasers of mortgages originated by U.S. banks, suggests that the risk low-income lending would backfire is not merely hypothetical.

The high rate of unbanked and underbanked households among minority Americans is a serious concern, as limited access to banking impairs one’s ability to borrow, save, and invest for the future. But the statutes Rep. Tlaib cites in her op-ed, such as the Fair Housing Act, the Home Mortgage Disclosure Act, and the CRA cannot help to increase the share of Americans with bank accounts, because their goal is to combat credit discrimination (for the FHA and the HMDA) and redlining (in the case of the CRA). Instead, public policy should seek to reduce the cost of holding a bank account for people who maintain low balances and to enable firms that the unbanked trust to provide basic banking services. According to government surveys, cost and trust are the two main factors causing the unbanked not to hold bank accounts. As I explained in Sunday’s Washington Post, cutting the regulatory cost of bank accounts and allowing nonbanks such as retailers and tech firms to offer mobile accounts would help to reduce the number of unbanked.

I applaud Rep. Tlaib for bringing the financial exclusion of lower-income and minority Americans into the spotlight. Unfortunately, her recipe to address exclusion relies almost exclusively on the regulatory status quo. One hopes that, as a prominent progressive, Tlaib will come to recognize that the policies of the 1970s cannot solve the policy concerns of 2019.