With the point from Robin Green’s guest post “Don’t Recognize Racist Externalities with a Pigou Tax” in my mind, I was fascinated by the possibility that Veda Boykin raises in the guest post below that some of the disparity in wealth between African Americans and whites might be do to prejudice in where people want to live. As I discussed in “The Wrong Side of Cobb-Douglas: Matt Rognlie’s Smackdown of Thomas Piketty Gains Traction,” a big part of household wealth is housing wealth. And a big part of the value of a house comes from people’s desire to live in a particular neighborhood. If many people don’t want to live in predominantly African American neighborhoods, that will reduce the value of their houses and so their wealth. (Even if they were also able to buy there houses more cheaply, this would still put a damper on their wealth because capital gains on houses are skewed upward.) 

Veda is a student in my “Monetary and Financial Theory” class. This is the 16th student guest post this semester. You can see the rest here.

The economic inequality between racial and ethnic groups has risen markedly over the past half century. The graph belowillustrates a sharp divergence in average family wealth by race/ethnicity over the period from 1963- 2013. How can such a large difference be accounted for? Disparity in income and education readily spring to mind as explanations. While these variables certainly account for some of the difference, wealth disparity is three times greater than income disparity by some measures, and the wealth of college-educated minority groups still lags behind that of the majority counterpart. There is an additional explanation.  In this post I attempt to argue that current racial wealth disparity is partially explained by one of the largest components of wealth: housing. To be sure, early FHA policies set in motion a housing valuation scheme based on neighborhood demographics, and the legacy of these policies are seen in the current wealth disparity.

Why housing is worth considering:

The most valuable item on many household balance sheets and a significant component of net worth is home value. According to the Federal Reserve Board, primary residences account for 30% of household balance sheets. (See the the pie chart below.) Home equity is used by many families to finance education and save for retirement. As one of the most valuable privately-owned assets, it is a nontrivial factor in calculations of household net worth. Given the positive effect of net worth on consumption and output trends, a substantial amount of attention is owed to the political and social forces that made and continue to make wealth accumulation difficult for some.

A history of federal housing policy sheds light:

As part of the New Deal Housing program The Federal Housing Administration instituted racial assessment in rating property values. In doing so, the FHA redlined integrated and minority neighborhoods giving them lower (red) ratings than exclusively white neighborhoods. The government cited financial risk as the rationale behind their ratings system. This lead to the governments underwriting of over $100 billion in new housing loans from 1934-1962 (where graph above begins) almost exclusively to white home buyers. Alternatively, federal housing projects were built in central cities which housed high concentrations of non-white minorities. The result of such actions was to suburbanize America racially.

When the FHA ended its policy of racial risk assessment and non-white families were able to move into suburban neighborhoods, their neighborhood property values declined. Original residents of these subdivisions faced incentives to sell off their properties in anticipation of lowering house values. This reinforced the FHA’s initial policy, creating a dual housing market: one which subsidized home ownership for families of the racial majority and one that divested minority families of the same opportunities for wealth accumulation. Although the government eventually turned to more progressive policies, it had already laid the groundwork for economic disparity into the future.

A 2010 report from John R. Logan and Brian J. Stults on “The Persistence of Segregation in the Metropolis” illustrates the current legacy of such policies:

“In 367 metropolitan areas across the U.S., the typical white lives in a neighborhood that is 75% white, 8% black, 11% Hispanic, and 5% Asian.”

“The basic message here is that whites live in neighborhoods with low minority representation. Blacks and Hispanics live in neighborhoods with high minority representation, and relatively fewwhite neighbors. ”

Clearly, the effects of government redlining did not reverse course when public policy changed.

Much of wealth is inherited. The role of inheritance in passing on wealth suggests that the structure of residential segregation established in the mid-1900s in part contributes to present position of net wealth. I.e., if transfers of wealth are generally familial, then the effects of discriminatory housing in the fifties, for instance, are likely show up in the current racial wealth gap. This is further compounded by current residential preferences and incentives (to protect property value by living away from minority groups) reminiscent of those in existence when neighborhoods first opened to integration, a claim supported by the neighborhood statistics cited above.

Remedial policies must address the effect of housing discrimination on wealth if they are to unlock a more robust consumer base and consequently drive up the growth rate of output. This post takes a further look at one of the root causes of racial economic disparity in the U.S., the effects of which still linger. This is a first step in the process of ensuring full participation of all U.S. citizens in the American economy and its recovery.