From: dlv@bwalk.dm.com (Dr.Dimitri Vulis KOTM)
Date: Wed, 11 Dec 1996 19:44:50 -0800 (PST)
To: cypherpunks@toad.com
Subject: Re: Redlining
In-Reply-To: <v03007802aed4c09f8265@[207.167.93.63]>
Message-ID: <y7ysyD141w165w@bwalk.dm.com>
MIME-Version: 1.0
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"Timothy C. May" <tcmay@got.net> writes:
> Whether to offer credit to some entity is, like many other such
> transactions, an economic transaction which involves a number of factors:
> interest rates charged, other uses for the money, expectation of payback,
> government interference (distortions of markets), etc.
>
> As with insurance in all its various forms, the decision process involves
> _probabalistic assessments_ based on avialable information, such as from
> past payback data, actuarial tables, the legal system, etc. By the nature
> of such probabalistic assesments, certain "lumped" categories will have to
> be used: age groups, sex, For example, here are just some obvious areas to
> consider:
>
> - age -- if under-25 persons have a 20% higher default rate on loans, "for
> whatever reason," this will be a factor in setting rates or even in
> granting a loan
>
> - sex -- if women are generally twice as likely to repay a loan, this will
> be a factor
>
> - ethnicity -- if persons of Norwegian heritage are 4 times less likely to
> default on a loan than persons of Blatislavan heritage are, a loan officer
> would factor this in (absent government market distortions)
>
> - education -- if college-educated persons are less likely to default than
> high school dropout, etc.
>
> ...and so on...one could make a list of several dozen categories, then run
> correlation tests of various sorts. This is clearly what banks and other
> lenders do in establishing loan criteria.

As usual, Timmy May spouts racist, anti-Semitic shit. As usual, he has
no idea what he's talking about. So what else is new...

The interest that a bank charges on a commercial loan can be thought of as
three components: a chunk to offset the anticipated effects of inflation;
a chunk that goes into a "bad debt" reserve; and a chunk that's the economic
revenue of the bank.

Imagine that a bank could set its loan rates freely, without the government
distorting the market. Two Brooklyn Jews (the kind of people Timmy May hates
with a vengeance and wants dead :-) apply for $50K loans to open little grocery
stores. The only difference is that Jew 1 (let's call him Abram) wants to open
his store in Park Slope (inhabited by Jewish Lesbians) and Jew 2 (Baruch) wants
to open his store in Morningside Heights (Blacks, Hispanics, a few Columbia
University students). The loan officer would consider the fact that Baruch's
business venture is much riskier that Abram's and charge Baruch a higher
interest rate to offset the higher risk of the default. If the banks writes a
lot of such loans, then on the average they'll have the same profit from all of
them. Think of this as the higher life insurance premiums smokers pay - they
don't add anything to the insurance company's profits. If Baruch thinks the
bank charges him too much for the added risk, he can go to another bank - there
are plenty of them.

Now consider the distorted market where a bank can't charge Abram and Baruch
different rates as determined by the free market. The bank knows precisely how
risky each loan is, but is not allowed to use this knowledge. Instead the bank
tries its best to avoid giving the loan to Baruch, because this loan would be
riskier than the equalized interest rate makes it worth. Baruch can't open a
store.* Baruch and his potential customers suffer. The bank is forced to write
some Baruch loans (fewer than it would in the previous paragraph), so it tries
to charge Abram higher rates that in the previous paragraph to offset the
losses on Baruch loans. Abram passes on some of this higher interest to his
customers. Abram and his customers suffer. Another bank might be more
successful in fending off Baruch's loan application, so it'll offer Abram a
lower interest rate, and he'll patronize that bank. Thus "socially undesirable"
behavior is rewarded. Finally, banks that don't give loans to Baruch do less
business overall, earn less profit, and their owners (shareholders) suffer.
(But they'd suffer even more of their banks loaned money to Baruch at the
same rate as to Abram, of course.)

--
* What happens in real life is - Baruch goes to another institution that issues
loans at much higher interest rates than a regular bank (often just below the
usury cap, or above if it's an unregular loan shark). Abram is welcome to
borrow there too, but he doesn't have to. The institution effectively
specializes in loans to businesses that can't obtain loans at regular lending
institutions through setting a high interest rate.

---

Dr.Dimitri Vulis KOTM
Brighton Beach Boardwalk BBS, Forest Hills, N.Y.: +1-718-261-2013, 14.4Kbps