Predatory lending and the stripping of African American wealth - PowerPoint Presentation

Slide1

Predatory lending and the stripping of African American wealth

Douglas

Orr, Ph.D.,

Economics

City College of San

Francisco

dorr@ccsf.eduSlide2

The primary goal of any capitalist is the accumulation of capital (wealth).

This can be done through the exploitation of labor in the process of production.

It can be done through the direct expropriation of resources through colonialism or neocolonialism.Or, in the case the advanced capitalist systems, using financial mechanisms to strip wealth from vulnerable communities.In the U.S., one of the communities most vulnerable to this type of attack is the African American community.

Slide3

In the United States, because the social safety net is so limited, wealth is also important for non-capitalist individuals.

The Social Security system was designed to provide only a minimal floor of retirement income. It was expected that employers would supplement retirement income through pensions.

Up until the 1970s, it appeared that this would be the case. But today, the majority of workers do not have pensions and must rely on their individual wealth to provide for their retirement income. Slide4

At the end of the Civil War, slavery was made illegal and African Americans were given the right to own property.

However, the federal courts determined that the discrimination in private property contracts was legal.

This led to most rural black becoming tenant farmers and blacks in urban areas being segregated into a limited number of neighborhoods.This segregation was supported by several government policies and was enforced through the use of white terrorism inflicted on the black community. This terrorism came to be known as Jim Crow. Slide5

The Civil Rights Act of 1968 made outright discrimination in property contracts illegal. As a result the degree of racial segregation has been reduced.

One measure of segregation is the Index of Dissimilarity, which measures the fraction of the black population that would have to move to another census tract in order for each tract to have a share of the black population in the tract match that of the share of blacks in the population as a whole.

Of large metropolitan areas, those with populations greater than 500,000, the most segregated city in 2010 was Milwaukee Wisconsin, where 81.5% of the black population would need to move to achieve integration. Of large metro areas with a significant black population, Las Vegas, Nevada is the least segregated, where only (!) 38% of the black population would need to move. Slide6

For comparison of some of the cities of the participants on this trip, these are their indices:

New York 78.0%

Chicago 76.5% Detroit 75.3% Cleveland 74.5% Baltimore 65.0% Boston 64.0% Denver 62.6%

Washington DC 62.3%

San Francisco 62.0%

Albuquerque 30.9%

In Albuquerque, only 2.2% of the population is black. In labor economics, this is referred to as “the importance of being important.”

Slide7

In any economic system there must be a mechanism for transferring resources from those who do not need to use them immediately to those who need the resources.

This has been done through mechanisms as varied as communal decision making or dictatorships.

In modern capitalist economies this is done by moving savings into productive investments in the real economy by using financial mechanisms.Historically, the financial sector has created significant instability and has been subject to government regulation. Slide8

As a result of the banking crisis of the 1930s, commercial banks were limited to taking in the deposits of savers, and making loans for the operation of firms and the creation of real economic assets.

The title to these assets was held by the bank as collateral to cover the loan, and the loan amount was required to be less than the value of the asset.

Banks were reluctant to make amortizing loans for the purchase of houses because deposits could be removed at any time, but the loans could not be called before the maturity date of the loan, which was usually 30 years.In order to encourage banks to make these loans, the government created two new institutions.

Slide9

The first was the Federal Housing Administration, FHA, which would guarantee that the bank would repaid in case of default, as long as the loan “conformed” to certain conditions:

the borrower must pay a down-payment of at least 20%

the mortgage payment must not exceed 30% of monthly income.Typically the bank would hold the loan to maturity and the income to the bank came from the interest paid on the loan.Despite this guarantee, banks were still not willing to make home loans because they wanted to have more “liquidity,” or the ability to convert assets back into money.

Slide10

This required the government to create a second institution, the Federal National Mortgage Association (Fannie Mae).

If a bank needed liquidity, it could sell some mortgage contracts to Fannie Mae.

Fannie Mae would then bundle many of these mortgages together and sell them to some financial-investor.These bundled mortgages are called “derivatives” because they derive their value from another financial asset. They are also called Mortgage Backed Securities (MBS).This new system expanded the resources available in the mortgage market, and home ownership rose from less than 30% in 1930, to 66.8% by 1970.

Slide11

However, participation of African Americans in this new market was limited by discriminatory practices of banks and by government regulations.

From 1938 to 1970, the ‘secondary market”, in which derivatives are bought and sold, became well established.

In the early 1970s, “entrepreneurs” saw a profitable new opportunity.They created what are now called “shadow banks”.These are companies that do not take deposits, but do make mortgage loans. They derived their income only from the fees they charged to create the loan. They then bundled the loans into derivatives and sold them in the secondary market.

Because they were not a “real bank,” they were not subject to any government regulation.

Slide12

One of the first shadow banks was

CountryWide

Financial. Initially, their loans were “conforming,” with a required 20% down-payment. This firm started making loans in the black community, at interest rates only slightly higher than those of regular banks.Early on, CountryWide was seen as a savior in the black community, because it allowed them to bypass the discriminatory practices of regular banks, and allowed them access to the housing market.African American homeownership rates rose from 34.5% in 1950 to49.4% in 2004.

Slide13

Because most non-wealthy families hold their wealth in the value of their home, this allowed black families to finally start accumulating wealth.

Median black wealth more than doubled from $6,700 in 1983, to $16,100 in 1992. It was negatively affected by the 2001 recession, but was still $13,700 in 2004.

For comparison, median white wealth in these years was $96,000 in 1983, $95,700 in 1992, and $137,000 in 2004. Slide14

CountryWide

was enormously profitable, so other entrepreneurs started to imitate them.

However, at some point, the market of families that could afford conforming loans was exhausted. So firms started reducing the requirements necessary to qualify of a loan.The down-payments were reduced from 20% to 10%, then to 5%, then to zero. New types of loans with adjustable interest rates made the payments for the first few years affordable.These came to be called “sub-prime” loans.This flood of money into the mortgage market vastly expanded the demand for houses, driving up prices, which ultimately created the housing bubble.

Slide15

Sub-prime and predatory lending

There is no precise definition of predatory lending, but four aspects are generally accepted:

the interest rate does not reflect actual risk, the conditions of the loan make it difficult to repay, the borrower is targeted because some characteristic makes them vulnerable, the lender is exploiting the lack of knowledge of the borrower.

Because the shadow banks immediately sold the loans as derivatives, they did not care about the risk of borrowers not being able to repay the loans.

They aggressively marketed to the black community, sometimes sending representatives door to door encouraging families to take out loans that the salesmen knew the families could not repay.

Slide16

One study in Detroit showed that in a white community, with a median family income of $51,000, only 17% of loans were predatory.

In a black community with a median family income of $49,000, fully 70% of the loans were predatory.

By 2006, white families, which made up 66.4% of the population, held just 17.2% of high-cost loans. Black families, which made up 13.4% of the population, held 54.7% of high-cost loans.As a result of the collapse of the housing bubble, in 2010 more than 240,000 families had been displaced from their homes. By 2014, the number had risen to more than one million.

More than 20% of black families than owned a home in 2007 had lost that home by 2014.

Slide17

The following table shows the overall impact on black wealth has been extreme. In this table, spillover effects are the decline in surrounding home values when a house that has been foreclosed is left empty.

From 1999 to 2007, the only increase in the wealth of black families came in the form of home equity, which was $655 billion, or 37.6% of total black wealth. Because housing prices have now returned to their 1999 levels in most metropolitan levels, this wealth has been wiped out.

As a result, between 2007 and 2014, 47.6% of all wealth held by the black community has been destroyed. Put another way, about half of all wealth acquired by the black community from the end of the Civil War until 2014 is now gone.

Slide18

This wealth did not just disappear. It was systematically transferred to capitalists in the financial sector

. Today, the median wealth in the African American community is less than it was in 1983.

This

is a clear example of the predatory nature of the financial sector in advanced capitalist countries.

This predatory nature is even more extreme in the less developed world, but that is a topic for another time.

Slide19

Lessons for the Cuban people:

There have many scholars, including Smith, Marx, Veblen and Galbraith who have argued that the allocation of society’s resources based on the profit motive is destructive.

It has led to the exploitation of labor and the destruction of the environment. It has pit groups of individuals against other groups of individuals, both at the domestic and international level. The more free reign given to the profit motive in the real economy, the higher the levels of unemployment and poverty.

Slide20

Allowing the profit motive to control the financial markets is equally destructive.

In any society, there must be a mechanism for transferring resources from those how do not need to use them immediately to those who currently need resources. In economic terms, there must be a mechanism to transfer saving into productive uses.

The financial crisis in the global capitalist system is just the most recent example of why this mechanism should not and cannot be based on the profit motive. As Cuba moves into a new period of economic development, it is essential that the most basic mechanism for allocating saving to productive use not be allowed to fall into the hands of those driven by the profit motive, either at the State or local levels. To do so would be to doom the Cuban revolution and lead the country down the path to capitalism.