The Vulnerability of Minority Homeowners in the Housing Boom and Bust
Patrick Bayer, Duke University and NBER
Fernando Ferreira, The Wharton School, University of Pennsylvania, and NBER
Stephen L Ross, University of Connecticut
This paper examines mortgage outcomes for a large, representative sample of individual home purchases and refinances linked to credit scores in seven major US markets in the recent housing boom and bust. Among those with similar credit scores, black and Hispanic homeowners had much higher rates of delinquency and default in the downturn. These differences are not readily explained by the likelihood of receiving a subprime loan or by differential exposure to local shocks in the housing and labor market and are especially pronounced for loans originated near the peak of the boom. Our findings suggest that those black and Hispanic homeowners drawn into the market near the peak were especially vulnerable to adverse economic shocks and raise serious concerns about homeownership as a mechanism for reducing racial disparities in wealth.
Homeownership has long been viewed as an important mechanism for building wealth and, hence, the substantially lower ownership rates of minority households may be a serious impediment to reducing racial wealth disparities.
Motivated by this perspective, a number of public policy programs have an explicit goal of encouraging homeownership and many politicians have embraced it as a means of upwards mobility. President George W. Bush famously said in a 2004 speech that “We're creating... an ownership society in this country, where more Americans than ever will be able to open up their door where they live and say, welcome to my house, welcome to my piece of property”. With this view in mind, the expansion of housing credit in the United States from late 1990s to mid-2000s was largely cheered and homeownership by households of all races and ethnicities reached record high rates in the mid- 2000s.
As the subsequent housing and economic crises developed, however, the risks of homeownership became increasingly obvious. Delinquency and foreclosure rates rose sharply, especially in minority and low-income neighborhoods, and many households not only lost substantial housing wealth but also faced the prospect of lower credit scores (higher borrowing costs) for years to come. A comparison of mortgage delinquencies and foreclosures between 2005 and 2009 provides a particularly stark picture of the differential impact of the downturn by race.
Figures 1 and 2 shows that while all homeowners had negligible 90-day delinquency and default rates in 2005 for our sample of seven major markets,
A rising tide lifts all boats
large racial differences had emerged by 2009. More than 1 in 10 black and Hispanic homeowners in our sample had a delinquent mortgage by 2009, compared to 1 in 25 for white households, and a similar pattern held for foreclosure rates. The differential impact of the downturn highlights a key concern with homeownership as a means for reducing racial wealth disparities. Namely, if the downside risks associated with owning a home are distributed unequally by race, increased rates of delinquency and default may ultimately exacerbate rather than diminish the racial wealth gap.
There are huge differences in median or even 75th percentile wealth between whites versus blacks or Hispanics. Whites have been making more money for more generations, and they tend to spend proportionately less of their incomes on cars and fiestas. Since they tend to be related to other white people, they also are more likely to have a private safety net of family members who can help them out in a financial crisis so that they don't default.
But, lenders are not supposed to notice this. Fortunately, down payment requirements provided a race-neutral way to put your money where your mouth is. However, George W. Bush's war on down payment requirements in 2002-2004 as racist barriers to his Ownership Society neutered this.
In this paper, we examine mortgage outcomes by race during the last housing cycle in a diverse set of U.S. housing markets. The main goal of our analysis is to distinguish among a number of potential explanations for the higher rates of delinquency and default by minority homeowners in the housing market bust, with the ultimate aim of providing a better understanding of the benefits and risks associated with homeownership as a vehicle for building wealth.
While researchers have documented the greater exposure of minority households to income and health shocks, much less is known about the differential impact of credit and financial shocks, especially in housing markets. The literature suggests that subprime lending has been an important factor in explaining rising foreclosure rates in low income and minority neighborhoods. Here we take a different approach by proposing an important explanation for high rates of negative credit market outcomes for minority homeowners during the crisis, i.e., the selection of high-risk households into the housing market close to the peak of the housing cycle.
We explain this mechanism in the context of a simple model of credit markets in which borrowers are heterogeneous in both their risk of having adverse economic events and in their ability to manage adverse events should they occur. We show that an expansion in credit availability selects borrowers into the market that face a higher risk of adverse events, leading to an increase in default rates among borrowers unable to manage adverse events in any subsequent market downturn. To the extent that wealth and liquidity gaps leave minority households especially vulnerable to negative economic shocks, our model implies that those minority households drawn into homeownership following a major expansion of credit are especially likely to default in a subsequent downturn.
Our empirical results show that black and Hispanic households are more likely to become delinquent and default on their mortgages than white households with similar credit scores, house type, neighborhood, and loan characteristics, especially for mortgages originated for new home purchases in 2005-06.
One prominent, potential explanation for higher delinquency and foreclosure rates is that minority borrowers were concentrated in the subprime sector of the market, where they faced higher interest rates and more onerous loan terms than white borrowers with equivalent credit history and circumstances. Since 2004, the Home Mortgage Disclosure Act data has contained an indicator for high cost (or rate-spread) loans that is often considered a proxy for subprime loans. Yet, while having a high-cost loan is a strong predictor of subsequent delinquency and default, controlling for this variable has only a minor impact on the estimated racial and ethnic differences in future credit market outcomes. These differences in delinquency and default are also relatively unaffected by the inclusion of lender and neighborhood fixed effects, and additional controls for the influence of subprime lending. Thus, strikingly, most of the observed differences in credit market outcomes for minority homeowners are not related to differential access to lenders, types of loans, or any observable factor that might have been used to price the mortgages in the first place.
In other words, stereotypical racial/ethnic prejudices turned out to offer incremental insight, especially in the 2005-2006 environment of very, very low down payments.
We next consider whether racial and ethnic differences in loan performance might be attributable to differential exposure to the housing market collapse and associated recession. To capture shocks associated with both the labor and housing market, we include a series of controls that measure variation in the severity of the crisis: (i) tract and county by year fixed effects, (ii) individual indicators of a household’s equity position in each year, (iii) the interaction of equity position and county by year unemployment rates, and (iv) race-specific measures of unemployment rates by county and year. The addition of these controls has little impact on estimated differences between Hispanic and white homeowners in either the new purchase or refinance sample. And, while the inclusion of these controls does reduce the estimated differences in delinquencies and foreclosures between black and white homeowners to some extent, substantial differences remain, especially in the home purchase sample. Thus, while increased exposure to labor and housing market shocks explains some of the increased delinquency and default rate for minority homeowners, a substantial unexplained gap remains.
A big question is how much did the recession cause mortgage troubles versus how much did mortgage troubles cause the recession. More specifically, mortgage troubles in 2007-2008 in Sand States like California, Arizona, Nevada, and Florida did more to cause the national recession of 2008-2009 than vice-versa, according to the laws of time and space.
As a final test of the predictions of our mortgage market model following a major expansion of credit, we examine whether the timing of the selection into the housing market has an effect over and above the other mechanisms proposed in the literature. We find that racial and ethnic differences are largest for home purchase originations in 2006, the peak of the housing boom according to the Case-Shiller price index.
Peak = scraping bottom of the barrel.
Importantly, the larger differences in 2006 remain even after controlling for the subsequent higher rates of negative equity for borrowers who purchased near the peak of the housing market. Along similar lines, we also examine racial and ethnic differences for a subsample of refinance mortgages that were originally purchased between 1998 and 2008 and subsequently refinanced in our sample period. For this subsample, racial and ethnic differences in foreclosure are tiny for homes that were originally purchased from 1998 to 2003, but substantial for homeowners who originally purchased their homes between 2004 and 2007 – i.e., those drawn into the market at the peak of the credit expansion.
Taken together, our results provide strong evidence that minority households drawn into homeownership late in the recent housing market boom were especially vulnerable in the subsequent downturn in ways that are not explained by (i) exposure to different lenders or loans, (ii) the performance of local labor and housing markets, and (iii) the differences in equity position. These results call into question the idea of encouraging homeownership as a general mechanism for reducing racial disparities in wealth. To the extent that increases in homeownership are driven by the entry of especially vulnerable households into the owner- occupied market, such a push may backfire, leaving vulnerable households in a difficult financial situation and adversely affecting their wealth and credit-worthiness for years.
This is enough of a direct shot across the bow of the entire race-mortgage sub-industry of activists and wheeler-dealer lenders and developers that Mr. and Mrs. Sandler's Center for Responsible Lending issued a denunciatory response here. Up until 2007, a lot of rich people and powerful politicians earned a lot of money and/or votes by fighting racism by inducing blacks and, increasingly, Hispanics into debt peonage.
Not surprisingly, despite the mounting number of academic studies demonstrating this, it hasn't been a popular topic in the media.