Thursday, July 12, 2012

Credit Standards and Segregation
INSEAD Working Paper 2012/68/EPS revised version of 2011/87/EPS

How do credit standards on the mortgage market affect neighborhood choice and the resulting level of urban segregation? To answer this question, we first develop a model of neighbourhood choice with credit constraints. The model shows that a relaxation of credit standards can either increase or decrease segregation, depending on racial income gaps and on races' preferences for neighborhoods. We then estimate the effect of the relaxation of credit standards that accompanied the 1995_2006 mortgage credit boom on the level of school segregation. Census tract racial composition is strongly correlated with the racial composition of the 10 closest schools in the cross section. Matching a national data set of mortgage originations with annual racial demographics of each of the public schools in the United States from 1995 to 2006, we find that the relaxation of credit standards has caused an increase in the segregation of blacks through a lower exposure of blacks to hispanics and whites.