Discriminating Risk: The U.S. Mortgage Lending Industry in the Twentieth Century

Published by EH.NET (June 2004)

Guy Stuart, Discriminating Risk: The U.S. Mortgage Lending Industry in the Twentieth Century. Ithaca: Cornell University Press, 2003. xi + 248 pp. $39.95 (hardcover), ISBN: 0-8014-4066-1.

Reviewed for EH.NET by William J. Collins, Department of Economics, Vanderbilt University.

Readers who are interested in the historical interaction of American cities, race, and mortgage finance will find many aspects of Guy Stuart’s Discriminating Risk informative and insightful. The book sheds light on the grass-roots operation of the lending process, on the influence of conceptual debates on industry practices, and on the unusual interaction of public policy and private property that characterizes the mortgage industry. Stuart’s close reading of real estate journals, manuals, and guidelines, and his collection of field interviews, provide an inside view of how information has been collected, processed, and acted upon in the mortgage industry. He often clarifies the implications of this process for long-run racial disparities in housing market outcomes. Stuart accomplishes this in a framework that emphasizes “rules, networks, and the production of space.” Economic and financial historians, urban economists, and policy makers will find some aspects of the book frustrating, as discussed below, but the book is certainly a useful contribution to the literature on the history of American housing markets. Stuart is an Associate Professor of Public Policy at Harvard’s Kennedy School of Government.

The book is organized into seven main chapters, plus a substantial and informative introductory chapter. Chapters 1 and 2 are the most interesting chapters from an historical perspective. Chapter 1 is essentially a history of how real estate professionals have defined, appraised, and anticipated changes in property values. Stuart effectively combines this conceptual history with a recounting of the institutional changes that profoundly reshaped the American mortgage industry. Throughout, Stuart highlights the primacy that real estate professionals attached to neighborhood stability and homogeneity. Not surprisingly, the promotion of such high levels of neighborhood homogeneity has tended to reinforce residential segregation by income and race, and dismantling this segregation becomes the main target for Stuart’s policy recommendations. Chapter 2 documents the industry’s standard practices for evaluating the riskiness of loans and loan applicants, and it includes a fascinating discussion of the emergence of a network of credit bureaus in the early twentieth century. By itself, the disclosure of the FHA’s first “Standardized Factual Data Report” form (circa 1935) makes the chapter worth reading. In addition to the information one would expect (e.g., income and employment), the form included queries about the applicant’s “racial descent” (“answer whether Anglo-Saxon, Greek, Hebrew, Italian, Negro etc.”), about the applicant’s wife (“Does his wife lend encouragement to him?”), and about the applicant’s personality and family reputation (“Is he self-satisfied or ambitious?” “Does his family have the reputation of living extravagantly?”). Thus, perceived “character” and “willingness to pay” were explicit considerations in lending decisions. By the century’s end, automatic underwriting software and heavy reliance on simple credit scores had greatly altered the loan-screening process.

In Chapter 3, the book moves away from an historical orientation, and it focuses on the loan application process in recent decades. Here, interviews with real estate and mortgage professionals illustrate the strength of personal networks in the industry (e.g., between real estate agents and mortgage brokers, and between real estate agents and particular neighborhoods). The interviews also demonstrate how those evaluating loan applications exercise a certain amount of “common sense” discretion within a fairly well-understood set of rules for evaluating loan applications.

Chapters 4 and 5 both draw extensively on Stuart’s detailed knowledge of Chicago’s neighborhoods and real estate markets. The chapters are fairly ahistorical, in that readers will not learn much about Chicago’s housing history by reading them. Rather, the chapters’ goals are to provide case-study level illustrations of the author’s broader points about the shaping and packaging of homogeneous neighborhoods in the context of ever-shifting patterns of demand and supply. These are the only chapters that report and discuss housing market data, and they do so only for the 1990s. I had high expectations for chapter 5’s discussion of lending discrimination, but I was disappointed. The review of the existing literature is thin, and while the discussion of lending patterns in Chicago in the mid-1990s is insightful, there is not much compelling new evidence on the nature, extent, or ultimate impact of lending discrimination. Stuart’s point that concentrating people with poor credit in particular neighborhoods makes their property illiquid and thereby reinforces high likelihoods of default is interesting and plausible, but it would certainly benefit from a more thorough empirical exploration. More generally, plausibly important assertions about discrimination, housing segregation, and access to credit are found throughout the book, but readers are usually left without convincing econometric identification of cause-and-effect relationships and without an empirical sense of just how large such effects might be.

Chapter 6 revisits and reiterates arguments from the previous chapters. Chapter 7 concludes the volume with several policy recommendations. I have reservations about this chapter. Readers are told in the introduction that the book will attempt to initiate “a practical debate about how to embed social justice in the process of delivering financial capital to all people and neighborhoods that need it” (p. 2). It becomes clear that Stuart has a particular version of “social justice” in mind, a particular sense of who “needs” financial capital, and a particular set of policy ideas for getting capital markets to conform to his idea of justice. The book’s concluding sentence notes that “the value I most cherish in the context of this discussion is the ability of people of all races, ethnicities, and incomes to live in any neighborhood, subdivision, or suburb they choose” (p. 206). This vision is difficult to square with the central reality of urban economics: land is a scarce resource that is priced accordingly. The vision is also difficult to square with the population’s tendency to sort itself by income, independent of race, ethnicity, and real estate agents. Some of the policy recommendations of Chapter 7 are intriguing, for example the suggestion that government agencies should support the development of a risk-based pricing system for home loans that includes a mutual insurance provision. But it is impossible to gauge the potential benefits or costs of such reforms on the basis of the book’s discussion.

All books must draw boundaries and that means leaving out some potentially interesting issues. In this case, topics left out include: description of the origins of American mortgage markets, the connection between mortgage finance and the development of the American banking system, and the history of inter-regional financial market integration (Kenneth Snowden’s work would have been helpful here). Also missing are any empirical characterizations of home-ownership rates and of the influence of mortgage market innovations on the costs of home ownership.

While the book frequently cites racial disparities in loan rejection rates, readers get no sense of the extent to which the higher rate of rejection passes through to African-Americans’ home ownership status (i.e., once rejected, is ownership delayed, or is it never achieved, or is it achieved readily but only for less valuable housing?). Racial disparities in assets, which are much larger than racial disparities in income, are left in the background (Edward Wolff’s work would help in this regard). The 1968 Fair Housing Act is only lightly touched upon, though more recent legislation receives more thorough discussion.

In sum, Discriminating Risk is full of useful historical and contemporary information on the lending process, insightful interviews, and a valuable close-reading of the real estate industry’s standard operating procedures. I learned a great deal by reading the book, and I recommend it to other scholars with an interest in the history of American housing markets.

William J. Collins is an Associate Professor of Economics at Vanderbilt University and the Model-Okun Fellow at the Brookings Institution (2003-2004). He is the author of “The Economic Aftermath of the 1960s Riots in American Cities: Evidence from Property Values” (with Robert Margo), NBER Working Paper 10493; “The Housing Market Impact of State-Level Anti-Discrimination Laws, 1960-1970,” Journal of Urban Economics (May 2004); “Race and the Value of Owner-Occupied Housing, 1940-1990” (with Robert Margo), Regional Science and Urban Economics (May 2003); and “Race and Home Ownership: A Century-Long View” (with Robert Margo), Explorations in Economic History (January 2001).