DP8300 Credit Standards and Segregation
How do credit standards on the mortgage market affect neighbourhood 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 neighbourhoods. 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.