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For release on delivery
1:15 pm PDT (4:15 pm EDT)
September 21, 1992

Breaking Free From Some Outdated Myths

Address by
Lawrence B. Lindsey
to
A Community Reinvestment Conference

Sponsored by
The Federal Reserve Bank of San Francisco
and
The Federal Home Loan Bank of San Francisco
Santa Monica, California
September 21, 1992

Breaking Free From Some Outdated Myths

Thank you.
setting.

It's a pleasure to be here in this beautiful

We all know from recent events and from our discussions

here today that life is not necessarily as beautiful as our
current surroundings.
Shortly after joining the Board last November, Chairman
Greenspan asked me to chair the Fed's Committee on Consumer and
Community Affairs.

I must admit that I had no particular

knowledge or expertise in that area when he appointed me.

But,

as someone who has spent many years in education, I thought that
this was an opportunity to learn something new.

At the very

least, my lack of prior experience permitted me to go into this
area with an open mind.

Over the intervening months I've

travelled throughout this country, seen first hand what's working
in our cities and what isn't, and met extensively with both
community groups and bankers.

As an experience in what's really

happening, I must admit that these last 10 months have easily
beaten the years I spent in graduate school.
It was during this same period that a great deal of
attention was focussed on discrimination in mortgage lending.
Late last year, the nation's bank regulatory agencies released
the first detailed information on the relationship between race,
income, and mortgage lending, known as HMDA data.

The volume of

information processed was staggering, even to an old micro-data
empiricist like myself.

Stacked in computer printout, the data

2
on the HMDA disclosures would nearly reach to the top of the
Washington Monument.
Later this fall we will be releasing the HMDA data for 1991.
We will also be releasing, through the Federal Reserve Bank of
Boston, an extensive study of mortgage lending in that city that
was conducted by examining 4100 actual loan files from 131 banks,
savings institutions, and mortgage companies.

Other regulators,

notably the New York State Commissioner of Banking and the U.S.
Department of Justice have been involved in similar reviews.
My comments today reflect both what I have learned from my
travels, and what can be gleaned from some of these other
efforts.

By no means do I claim to have a monopoly on the truth.

The subject we are dealing with is enormously complicated as well
as being extremely sensitive, and others may draw different
conclusions.

But I am not going to let either complexity or

sensitivity stand in the way of candor.

Finding solutions to our

problems is far more important.
Recently, when testifying before the U.S. Commission on
Civil Rights, I heard an outstanding summary of this view by its
Chairman, Arthur A. Fletcher. He said that it may be too much to
ask us to change our deeply held, and often unconscious,
prejudices, but it is not too much to ask to have them stop
controlling our behavior.

To that end, I believe that our

current beliefs and behavior are tied to a series of outdated
myths that hold us back from making progress in providing
economic opportunity for all Americans.

Unfortunately, our

3
nation's media and opinion leaders are doing little to dispel
these myths, and may actually be reinforcing them.

When these

myths are exposed for what they are, we will all find it in our
interest to stop letting them control our behavior.
The first myth that I would like to dispel is the view held
by some that there is no racially based problem in the area of
mortgage lending.

There is a problem and it is one which we

absolutely must address.
Having said that, two important qualifications are in order.
First, it does appear that the HMDA data exaggerate the extent to
which approval rates differ for racial reasons.

When economic

factors other than income are incorporated into the analysis of
HMDA data, the disparity between black and white approval rates
is reduced.

However, that does not in any way diminish the

qualitative conclusion that race based differences exist and that
they must be eliminated.
Second, the evidence of race-based differences in loan
approvals is overwhelmingly of a statistical nature, based on
racial averages, and is very hard to document by examining
specific loan applications, such as during the bank examination
process.

Accepting this fact is difficult for those who seek

simple, straight-forward explanations for the racial disparities.
It's always easier when there's a smoking gun and an identifiable
culprit.
However, the reality in this case is not so simple.
Understanding the limitations of statistical analysis may be key

4
to solving the underlying problem and establishing truly equal
credit opportunities for all Americans.

While statistical

analysis can highlight inequity, it cannot eliminate it.

That

must be done on an individual basis, on the front lines, between
the applicant and the loan officer.
Let me clarify what appears to be going on.

It appears

from the available evidence that both blacks and whites who meet
all of the criteria which banks have laid down for loan approvals
are approved and those who clearly do not meet the criteria and
are obviously bad credit risks are rejected.

What is left is a

sizable middle group, which comprises a majority of mortgage
applicants of both races.

All of these applicants could be

rejected for a valid reason: level of income, job tenure, debt to
income ratios, or a variety of other factors.

However, with some

level of effort and explanation, many of these applicants can,
and often are, approved.
This makes identification of race-based decision making
quite difficult during the examination process.

In the case of

rejected applicants, both black or white, there is almost always
a non-racial explanation for the rejection.

This finding was

best highlighted in a recent report by the New York State Banking
Commission, entitled "Are Mortgage Lending Policies
Discriminatory - - A Study of 10 Savings Banks".
From this middle group some individuals of both races are
accepted, but on average whites in this middle group are more
likely to be accepted than blacks.

Acceptance of marginal

5

applicants generally requires a detailed explanation of any
mitigating circumstances for why the applicant should be
accepted.

This seems to have led to what I will refer to as the

"thicker file" phenomenon.

There is fairly solid, albeit

anecdotal, evidence that many marginal white applicants have
physically thicker loan application files than marginal black
applicants.

This extra paper may very well represent the

documentation of mitigating circumstances or evidence countering
the putative reason to reject the applicant.
There have been a number of theories advanced for this
"thicker file" phenomenon.

It might be that white applicants

have had, on average, more prior exposure to the credit process
and therefore come better prepared.

It might also be that loan

officers spend greater time, on average, with white applicants,
probing more deeply into whether they might have evidence to
offset the reason that might otherwise lead to rejection.

I

would term this "coaching".
If "coaching" or the "thicker file" phenomenon represents
part of the problem, then one solution to racial based
disparities may well be found in improving the information flow
that takes place in the credit underwriting process.

In other

words, give each and every applicant the opportunity for a
"thicker file".

This can be done by providing more information

to applicants so that they are better prepared in advance of the
application procedure to answer any questions about their
qualifications.

If loan officers are going to be coaches, then

6
they should be careful to coach everyone, and not a few favored
applicants.

It certainly involves sensitizing all of those in

the loan application process to the problems which exist. But let
us make no mistake: race-based disparities in mortgage lending do
exist and they are totally unacceptable.
The second myth I would like to address involves the
economic status of blacks, and particularly the change in that
status in the past decade.

This is a very important subject to

address because both banking in general, and mortgage lending in
particular, are profit driven businesses.

Lending will take

place where there is money to be made, or more precisely, where
it is perceived that there is money to be made.

Unfortunately,

there is a widespread myth, reinforced by the media, that the
great majority of blacks live in poverty, and that little
progress has been made recently in ending that situation.
The facts could not be more different.

During the 1980s

tremendous gains were made by the great majority of black
families.

Between 1981 and 1990, median black family income rose

12.3 percent after controlling for inflation.

By contrast, the

income for the median white family rose only 9.2 percent. Black
income growth particularly outpaced white income growth among
those families most likely to be first time homebuyers.

After

controlling for family size, the top quintile of black families
saw their real income rise 28 percent during the 1980s.

The

second quintile of black families enjoyed a 19 percent gain.

The

proportion of black families living in suburban counties rose by

7
a third and the proportion of black families earning real incomes
over $50,000 rose by 42 percent.

Such individuals are the

natural applicants for mortgage loans.
Not only that, but the situation is likely to get better in
the next generation due to significant gains in black educational
achievement.

During the 1980s, the SAT scores of black

children rose 23 points in math and 20 points on the verbal test,
compared with essentially stagnant scores for white students.
The black dropout rate from high school fell from 18 percent to
13 percent over the same period.

These facts augur well for

future black income gains.
It is not just in the area of mortgage lending that
minorities represent an underserved market.

The Wall Street

Journal called the 1980s the decade of minority capitalism.
Between 1983 and 1987 there was a 50 percent increase in the
number of businesses owned by African Americans and 81 percent
increase in the number of Hispanic owned businesses.

More black

owned businesses were created from 1982 to 1987 than in any other
comparable five year period in our history.

I might also add

that more Asian Americans and women went into business during
this period than at any other time.

These businesses not only

need banks for capital, they also need them for financial
expertise.
Increased awareness of the opportunities for minority
lending means dispelling the myths about the lack of economic
importance of minority communities.

One of the places that I

8
have seen where this myth was most successfully destroyed was in
Dallas.

The South Dallas - Fair Park area of that city is

overwhelmingly black and generally low income, comprising roughly
80,000 residents.

Prior to last year, no bank branch had

operated in the area for at least two decades.

Last month,

NationsBank celebrated the first anniversary of its Fair Park
branch.

The branch had exceeded its first year target for

consumer loans by 40 percent, and was one of the top 3 performing
branches in the entire state of Texas.

I might add that Bank One

has also opened a branch four blocks away and NationsBank is
planning to duplicate this success by opening similar branches in
other low income neighborhoods in Texas.

Where myths are

destroyed, markets will work.
The third myth I would like to consider is that sweeping
national solutions will solve the problems we face.

Congress has

recently been quite disposed to a highly prescriptive approach to
regulating the banking industry.

In the case of racial

disparities, such an approach may seem attractive.

Racial

discrimination tears at the very fabric of our national ideal.
While further legislation would certainly be well intentioned, I
am not at all convinced that one-size-fits-all national rules
represent the best approach to increased minority lending, or to
improved credit availability of any sort.

I am repeatedly struck

as I travel around the country about that old saw - - the Law of
Unintended Consequences.

In too many instances it is well

intentioned government policies that are exacerbating the

9
problems we face.
Consider for example, the legislation and organization which
created the secondary mortgage market in this country.

Fannie

Mae has, by most accounts, been quite successful at its main
mission: to provide liquidity to the mortgage market by creating
easily traded mortgage backed financial instruments.
has been paid for such liquidity.

But a price

Increasingly, banks have moved

to standardized lending practices as they have seen their
mortgage business evolve into that of a broker, rather than a
lender.

It is no longer crucial that banks know their customer,

but rather that their customers fit a predetermined profile.
Credit evaluation is based increasingly on quantitative criteria,
rather than qualitative judgments.
If you're a one-size-fits-all customer, you have probably
benefitted greatly from this approach.

If you are one of those

people who is different from the norm, your need for that
coaching I discussed earlier, rises dramatically.

Let me say

that Fannie Mae recognizes this problem and is striving to make
sure its guidelines take a broader array of applicants into
account.

For example, seasonal part-time income is now

considered regular income if the person has earned that money at
least two seasons in a row, child support payments are now
counted, maintenance and zoning standards for property have been
liberalized, and credit history standards have been modified in a
number of ways.

A recent Congressional testimony by Jim Johnson,

Fannie Mae's Chairman, lists 20 such changes in the last 5 years.

10
Indeed, the very quantity and detailed nature of these changes is
proof of how complex the lending decision has become.
Recently, the Federal regulatory agencies, prompted by
Congressional action in last year's banking bill, considered
establishing maximum loan-to-value ratios for single family
housing lending.

I strongly opposed such a move because it would

further exacerbate the difficulty of obtaining a loan for
individuals who do not meet the normal criteria.

I was

particularly concerned about the impact of this on mortgage
lending to low and moderate income families who have limited
funds to cover closing costs, let alone provide a major
downpayment.

In fact, the fewer such rules we have, the easier

it will be for non-traditional borrowers, who are often members
of minority groups, to obtain credit.
As I've travelled around the country I've seen numerous
other examples of well intentioned government policies that are
making access to housing more difficult, particularly for
minority groups.

For example, consider the cap on the size of

loans eligible for FHA insurance.

As a result of these limits,

FHA loans are virtually unavailable in New York City, where the
overwhelming majority of housing costs more than the limits
allow.

Nearly every Neighborhood Housing Services coordinator I

spoke with felt limited by the Davis-Bacon legislation which
drives up the cost of housing construction and limits job
opportunities for inner city residents.

In city after city,

rules regarding the taxes owed on vacant land or on abandoned

11.

buildings are inhibiting the development of low and moderate
income housing and the development of communities.
it is human nature to place the blame for problems on
others.

Some might say that for elected politicians and other

decision makers it is a requirement for the job.

Today we are,

here primarily to consider what financial institutions might do
to improve minority home ownership.

But those of us who are here

from government must go back and consider our own policies.
Government, like the medical profession, should follow the first
principle of the Hippocratic Oath: above all do no harm.
The final area of mythology and. ignorance which I would, like
to address M s

to do with credit itself.

The level of ignorance

which exists about credit is truly remarkable, given the
widespread nature of its use.

Nor is it an easy area to master..

Highly educated people often know little or nothing about the
factors used to make credit decisions.
Consider for example, the case of Jacqueline Mixon of South
Dallas, who received a home improvement loan after numerous
rejections.
people.

Mrs. Mixon is a college graduate and supervises 200

Yet she admitted that shie and her husband were

unfamiliar with the loan process and tha,t this might have been a
factor in their previous rejections.
The great myth that may exist among bankers is that their
customers have some way of knowing their bank's credit standards
and other credit decision criteria.

Frankly, I consider myself

to be above average when it comes to knowledge about the credit

12
decision.

Eight years ago, I was a new member of the Harvard

economics faculty and my wife and I were first time homebuyers.
Even with helpful suggestions from colleagues who had recently
gone through the same experience, finding a home mortgage was a
daunting and difficult experience.
Thus, a good part of the problem that we face in reducing
disparities has to do with myth and ignorance.

There is a

widespread lack of recognition of the size and potential value of
minority lending.

This may adversely affect both strategic

planning by institutions and the judgment of individuals making
loan decisions.

We have created a needlessly complex conundrum

of regulations which attempt to substitute rules for reason.
Standardization, while well-intentioned, limits the ability of
individuals within the system to meet the needs of individuals
who are different from the standard.

Finally, the widespread

ignorance of credit rules in the population may not be met by
sufficient willingness of lending institutions to provide
information to their customers.
I think that these problems are all personified in the case
of Willard Brown of St. Louis.

Mr. Brown, who is an African

American, was rejected four times before finally getting a
mortgage loan.

He had steady employment -- over 20 years at the

same job, a salary in excess of $30,000, and an outstanding
credit report.

The reason for his rejection was high credit card

debt, which put his ratios in excess of Fannie Mae guidelines.
But, Mr. Brown had cash in the bank, in fact more than enough to

13
bring his ratios into line.

None of the first four loan officers

suggested that he do so, although it would have meant a good loan
to a qualified customer.
Mr. Brown's case is one in which the lending institutions
obviously ignored the potential of the black community, were
hamstrung by needlessly complicated guidelines, and failed to
make their process clear to their customers.

In practice, this

case reflects both the "thicker file" and the coaching phenomenon
I spoke of at the beginning of this talk.

This case is not only

exemplary of the ignorance I spoke of, it indicates a strong
predilection on the part of the lender to resist any effort to
disclose the facts.

Such behavior reflects not only a potential

problem in racial attitude, it reflects a fundamental problem of
business attitude.

The key to solving our lending problems, I

believe, lies in good old fashioned business sense about how to
run a service business: how you treat the customer is key.
Back in May, here in Los Angeles, I recommended to the
members of the California Bankers Association that they
experiment with using shoppers at their institutions to test the
fairness of their lending practices.

Such shoppers should

explicitly work for the bank as what they are gathering is
proprietary information regarding customer service.

In

combatting discrimination, it is important to make sure that loan
officers are extending the same courtesy and even the same level
of coaching to all customers of all races.

But, an equally low

level of assistance to both black and white customers is not the

14
answer.

We need more customer education for everyone.

Banks

must make clear what is expected of the customer, or the customer
is bound to end up with a bad feeling.

In fact, heightened

sensitivity to the opportunities offered by minority lending are
appropriate all the way up the decision hierarchy.
Community outreach is also an important way of providing
quality service while finding new customers.

Huntington National

Bank in Columbus, Ohio, has begun a lending program which works
through churches in black neighborhoods.

The program includes

classes on how to apply for loans along with basic credit
information.

Let me note that the program could prove a good way

for Huntington to evaluate credit risk by providing a potentially
valuable credit reference.

Here is a way of gathering more

information in making an informed loan judgment, the exact
reverse of the simple statistical approach, which actually
requires discarding valuable information.
Another outreach technique used by some lending institutions
is simply providing a second, internal review of mortgage
applications that are turned down.

Usually this is done by

separate officers or committees that can take a fresh look at
each application and ensure that policies are applied in the same
manner for all applicants.
A multi-bank approach which has proven successful in
expanding minority lending is the use of mortgage review boards.
In Boston and Detroit, rejected mortgage applicants may forward
their applications to the board to appeal the outcome of a

15
lending decision.

Members of the review board are banking and

thrift institutions which are active in local "mortgage lendingi
Rejected applicants who meet the Board's criteria are provided':*-•
loans by Board members on a rotating basis.

Philadelphia has a

similar, but more aggressive, program-targeted at -specific

~

neighborhoods which involves automatic referral of applications
that, based on. a preliminary review, suggest rejection*;* ••It also:?
entails a community outreach component, use of'flexible
underwriting standards, and credit counseling..

. r

:.> •*

.Because itradds a

second judgment, this program helps-ensurerthe fairness•of•the
loan process.

It also promotes consumer education and ../•.>

understanding of the mortgage market.

;v ;

-st

> r:,r

A final hurdle to success is the need to seek greater
flexibility in lending criteria and to reinsert judgment into the
loan process.

In spite of the advantages of the secondary market

in the form of liquidity, there are costs in terms of the variety
of people served.

Ultimately, the solution is for banks to take

on more of their mortgage loans for their own portfolios, and not
sell them in the secondary market.

Of course, this means that

the bank, not the market, must absorb any credit risk from such
loans.
this.

But ultimately, our capital markets will catch on to
Banks which keep mortgages for their own portfolios have

an incentive to know something more about their customers than
banks which resell packaged portfolios of mortgages in the
secondary market.

Once that information gets out, it should be

clear which is the smarter bank in which to invest.

I might add

16
that one large national bank has already decided to keep a larger
share of its minority mortgage and small business loans in its
own portfolio.
I would like to close with one final observation.

By

any

standard, America is the most successful multi-racial society
that history has ever known.
fine -- they're not.

That doesn't mean that things are

But we've got everyone else who has ever

tried beat by a long shot.

I think the reason for this is our

willingness and constant efforts to try to make things better.
am very happy to be part of this meeting today, which I believe
is yet another example of Americans, coming together, in just
such an effort.

I