Fair Lending and Cities’ Fiscal Health: How Direct Are the Connections?

by Aaron Shroyer, Solomon Greene, Maya Brennan, and Tracy Gordon

In a landmark decision, the US Supreme Court held that cities can sue lenders for discriminatory lending practices under the Fair Housing Act when cities allege that those practices cause financial harm, such as lost property taxes or increased demand on services. In its decision, the court recognized that the “housing market is interconnected with economic and social life” and that discriminatory lending can “cause ripples of harm to flow” beyond borrowers to broader communities, cities, and regions.

But the court warned that the law may not extend to “wherever those ripples travel.” Rather, cities would have to show some “direct relation” between discriminatory practices and financial harm to cities.

Although the court declined to define what this might look like, research can help lenders, city leaders, and lower courts make such determinations.

Measuring the housing market’s impact on local government revenue

At a recent conference cohosted by the Urban Institute and the Lincoln Institute of Land Policy, researchers pointed to several signs that the Great Recession and housing crisis continue to affect cities’ fiscal health. Municipal revenue and local government employment remain below prerecession levels. Housing stress from depressed home prices, delinquent mortgages, and foreclosures continues in many places. According to a recent study published by the Lincoln Institute of Land Policy, a 26 percent decline in home prices during the crisis was associated with a 4 percent decline in property tax revenue across a sample of the nation’s largest cities. The study, conducted by Howard Chernick, Andrew Reschovsky, and Sandra Newman, concluded that approximately one-third of the post-2009 decline in these cities’ per capita revenue was attributable to housing market stress.

“Ripples” from discriminatory or predatory lending practices may take time to reach municipal coffers because property taxes are tied to assessed values and not market values, and reassessment cycles are usually longer than one year. Most jurisdictions also have caps and limitations built into the taxation process that can further delay catching up to market values. A typical lag between a change in housing prices and property tax revenue is three years.

Property taxes are important to local government finances, accounting for nearly a quarter of local general revenue. But the Great Recession produced a double whammy of the second-greatest decline on record for own-source revenue (including taxes and fees) and the greatest decline on record for state aid.

In cities with balanced budget requirements, a drop in revenue has implications for local government spending, which can lead to budget cuts and lapses in service delivery. The Lincoln Institute study found that education and capital outlays bore the brunt of spending cuts, falling 6 and 18 percent, respectively, from 2007 to 2014.

What cities were most affected?

Chernick and his coauthors found that the fall in house prices and the rise in foreclosures were severe in Miami, the plaintiff in the Supreme Court case. Miami was, like a plurality of the 91 large cities studied, a “boom-and-bust” city. These cities experienced sharp home sale price increases associated with the housing bubble, followed by precipitous price declines and other indicators of housing market stress in the years following the recession. This category includes 10 cities in California; 7 in Florida; other notable foreclosure hot spots like Las Vegas, Nevada, and Tucson, Arizona; and cities whose boom and bust drew less national attention, such as Baltimore, Chicago, Minneapolis, and Philadelphia.

Because the effects of housing market conditions on city finances can be obscured by differences in operating structures, researchers from the Lincoln Institute have constructed a Fiscally Standardized Cities (FiSC) database. It combines cities’ revenue or expenditures with other governmental entities—counties, school districts, or other special districts—that serve their residents or businesses. The FiSC database shows that rates of property tax revenue decline in these cities were not as straightforward as their boom-and-bust similarities might suggest. In the FiSC database, the greatest percentage decreases in property tax revenue often occurred in cities in the South and West, with Florida’s boom-and-bust cities losing between 18 and 33 percent of property tax revenue between 2007 and 2014. But not all boom-and-bust cities experienced such great losses. In many of California’s boom-and-bust cities, the rate of reduction in property tax revenue post-bust was between 5 and 15 percent. Some cities, including Baltimore, Maryland; Los Angeles, California; and Worcester, Massachusetts, actually increased their property tax revenue over this period.

Why was there so much variation? An analysis of the experiences in Florida and California highlights the complex path between a housing market bust, foreclosures, and property tax revenue. Despite similar housing price patterns, the foreclosure rate and the decline in property tax revenue were greater in Florida than in California. The Lincoln Institute study explains the states had different foreclosure processes, which made Florida foreclosures take longer to resolve. Property tax fluctuations in California were also reduced by the presence of caps in Proposition 13, which limit revenue-generating potential as home values increase, but minimize volatility when home values decline.

How did race play into the housing crisis for cities?

Because the Supreme Court case focused on allegations of Fair Housing Act violations, cities would need evidence linking the housing bust to discrimination based on race or other protected class. Racial disparities in mortgage lending are well documented. Debt, credit history, assets, and other borrower characteristics do not fully account for these disparities. Perhaps reflecting racial disparities in mortgage access, enormous increases in black and Hispanic homeownership rates came during the loose lending environment leading up to the housing crisis, with borrowing peaking concurrently with home prices in 2005.

But these home purchases were often on unequal terms. Alex Schwartz found that more than half of black homebuyers and nearly half of Hispanic homebuyers received subprime loans in 2006, compared with less than a quarter of whites. In majority-minority census tracts, residents were almost three times more likely to have a subprime home-purchase loan than residents of very low–minority tracts.

This disparity is not just about creditworthiness. Although estimates vary, many of the people who received subprime loans qualified for less-costly prime mortgages or subprime loans with lower interest rates than what they were charged. Among buyers with high credit scores, blacks and Hispanics were more likely than whites to receive loans with high interest rates, prepayment penalties, and other factors that increase default risk. Differences by race in loan terms were so stark that white families earning less than $30,000 a year were less likely to be given a subprime loan than black and Hispanic families making more than $200,000 a year. The evidence suggests that minorities were often offered different lending products that carried higher costs and higher risks.

The consumers who were given subprime loans, including racial and ethnic minorities who qualified for better loan terms, suffered the consequences of a system that encouraged unsuspecting borrowers to take on mortgage debt they could not afford under unsustainable conditions. The connection between racial disparities in mortgage terms, housing market busts, and property tax revenue losses is grounded in evidence, yet still unclear is whether a court would find it sufficiently direct.

Protecting cities from revenue shortfalls

Beyond tracing how discriminatory lending and housing market stress can hurt municipal fiscal health, research can help us develop, understand, and share solutions. The experiences of the boom-and-bust cities should be further explored.

During and following the recession, cities took steps to protect themselves against revenue shortfalls, built up reserve (or “rainy day”) funds, and clarified policies on how and when to use those funds.

Cities also tried to stay below their property tax levy caps to give themselves more room to adjust rates during economic downturns. Other cities have turned to multiyear budget plans or other types of fiscal planning to better prepare for various outcomes.

Research suggests discriminatory lending can harm municipal fiscal health. But more work needs to be done to help cities, courts, and lenders navigate not just the complicated relationship between residential lending and city government finances, but also how to support more financially healthy cities and more responsible lending practices.

An earlier version of this post was published on Urban Wire, the blog for the Urban Institute.