Available online at www.sciencedirect.com ScienceDirect Journal of Economic Theory 157 (2015) 811–841 www.elsevier.com/locate/jet Blockbusting: Brokers and the dynamics of segregation ✩ Amine Ouazad 1 Received 5 July 2013; final version received 7 February 2015; accepted 13 February 2015 Available online 23 February 2015 Abstract The paper presents a dynamic model of neighborhood segregation where fee motivated real estate bro- kers match sellers optimally either to minority or to white buyers. In an initially all-white neighborhood, real estate brokers thus either keep the neighborhood in a steady-state white equilibrium or trigger racial transition by matching sellers to minority buyers, a process called blockbusting. Racial transition leads to a higher rate of property turnover in the neighborhood once the fraction of minorities has reached a tipping point—but racial transition also leads to lower prices, and this is the trade-off faced by a broker. The model shows that with multiple brokers, blockbusting profit per broker is lower as brokers free ride on each other’s groundbreaking efforts. The model predicts that racial transition will happen in the neighborhood when (i) the number of brokers is limited, (ii) racial preferences lie in an intermediate range, (iii) the arrival rate of offers is intermediate. Otherwise, real estate brokers steer white households toward white buyers. © 2015 Elsevier Inc. All rights reserved. JEL classification: C72; C73; D62; R00 Keywords: Dynamic games; Segregation; Multiple equilibria ✩ I would like to thank two anonymous referees as well as Roland Bénabou, Leah Platt Boustan, Ambika Gandhi, Denis Gromb, Maria Guadalupe, David Hemous, Francis Kramarz, Guy Laroque, François Maniquet, Vladimir Mares, Eric Maurin, Scott Page, Thomas Piketty, Romain Rancière, Albert Saiz, Xavier Vives, Tim Van Zandt, and Yves Zénou for suggestions and comments on preliminary versions of the paper. I would also like to thank the audiences of the Urban Economics Conference, CREST, the London School of Economics, INSEAD, and CORE at the Université Catholique de Louvain. The usual disclaimers apply. E-mail address: [email protected]. 1 Assistant Professor of Economics, INSEAD. http://dx.doi.org/10.1016/j.jet.2015.02.006 0022-0531/© 2015 Elsevier Inc. All rights reserved. 812 A. Ouazad / Journal of Economic Theory 157 (2015) 811–841 Typically the practice, known as blockbusting, involves an agent claiming that property values will drop because members of minority groups are moving into the neighborhood. The agent tries to persuade the homeowner to let him sell the house before the values drop, and the agent then gains a commission. [U.S. is Investigating Charges of Blockbusting, New York Times, October 1995.] 1. Introduction Despite increasing levels of ethnic and racial diversity, racial segregation is a defining feature of American cities. According to the 2010 Census, the average urban,2 African American house- hold lives in a neighborhood that is only 35% white (Logan and Stults [27]).3 Empirical evidence suggests that racial segregation has adverse welfare consequences (Cutler and Glaeser [16], Alesina and Ferrara [3], Card and Rothstein [15], Boustan and Margo [13]). It is interesting that, while overall racial segregation across neighborhoods remains high, the racial composition of some neighborhoods changes dramatically over short periods of time. Social interaction models explain the mechanisms of neighborhood tipping (Schelling [33]), whereby the entry of a small number of minority residents in a neighborhood is followed by large outflows of white households, departures that are often referred to as white flight (Grubb [22], Boustan [11,12]). Card, Mas and Rothstein [14] present U.S. evidence of neighborhood tipping in recent decades, where the fraction of minority residents that triggers large departures of white households ranges from 5% to 20%.4 Historical evidence (Helper [23], Orser [31], Gotham [21]) as well as law articles (Glass- berg [20], Mehlhorn [29]) suggests that brokers play a decisive role in neighborhood tipping. The U.S.-based National Association of Real Estate Boards found the issue sufficiently concerning that, until 1956, Article 34 of Part III of its Code of Ethics specified that “a realtor should never be instrumental in introducing into a neighborhood a character of property or occupancy, mem- bers of any race or nationality, or any individuals whose presence would clearly be detrimental to property values in that neighborhood.”5 A series of congressional hearings during develop- ment of the 1968 Civil Rights Act considered the role of real estate brokers in neighborhood change. These hearings led to section 804[e] of Title VIII of that legislation,6 which prohibits blockbusting7: r[e] Fo profit, to induce or attempt to induce any person to sell or rent any dwelling by rep- resentations regarding the entry or prospective entry into the neighborhood of a person or persons of a particular race, color .... 2 We consider a household to be urban when it resides in a metropolitan statistical area (MSA). 3 Bayer, McMillan and Rueben [4] suggest that segregation by socioeconomic characteristics does not fully explain racial segregation. 4 Swedish evidence of neighborhood tipping in response to immigrant inflows is described by Aldén, Hammarstedt and Neuman [1]. The U.S. evidence on tipping is disputed by Easterly [18]. 5 “Race or nationality” was removed in 1956, but the rest of the article remains in the Code of Ethics. 6 Title VIII of the 1968 Civil Rights Act is also called the 1968 Fair Housing Act. 7 Newspapers also reported a large number of alleged cases of blockbusting. At the time this article was written, the New York Times had published 844 real estate articles on blockbusting, e.g. “New Neighbors Pushing at the Edge; Brooklyn Hasidim Seek to Expand Into a Black and Hispanic Area,” New York Times, July 19, 1999; “Town Tries to Keep Its Balance in Wake of White Flight,” March 11, 1996. A. Ouazad / Journal of Economic Theory 157 (2015) 811–841 813 And although the word blockbusting was arguably coined in U.S. literature, there is evidence in other countries including Canada (Teixeira and Murdie [35]), France (Bonnet, Safi and Lalé [10]), and Greece (Drydakis [17]) that real estate brokers’ steering behavior may be able to shape urban racial segregation. However, to our knowledge, no theoretical framework describes real estate brokers’ incen- tives and optimal strategies in the process of neighborhood segregation, and in particular in the process of neighborhood tipping. There is substantial evidence that brokers steer—i.e., match— minority and white buyers and sellers to particular houses, particular households, and/or partic- ular neighborhoods (Turner and Mikelsons [36], Ondrich, Ross and Yinger [30]). Yet dynamic models of urban segregation (Schelling [33], Benabou [6,7], Becker and Murphy [5], Frankel and Pauzner [19]) do not explain whether brokers have an incentive to match sellers to same-race buyers or to buyers of another race; and when brokers have incentives and are able to substan- tially change a neighborhood’s racial composition. This paper focuses on the ability and the incentives of a real estate broker to engage in block- busting. It presents a dynamic model of a neighborhood where, in each period, a fee-motivated real estate broker matches sellers to either white buyers, or to black buyers, i.e. blockbusts.8 Starting with an initially all-white neighborhood,9 the broker chooses to steer sellers to black or white buyers based on comparing the present discounted value of his brokerage fee revenue in an all-white neighborhood with that results if the same neighborhood experiences racial transition.10 We assume that white households prefer living with white neighbors to live with minority neighbors. Households have forward-looking expectations of the neighborhood’s racial compo- sition,11 and may experience negative shocks, e.g. a job loss on the base utility they derive from the neighborhood. With such shocks the neighborhood has a natural turnover rate that gener- ates brokerage fees even when its racial composition does not change. When the broker matches white sellers to minority buyers, there is an increase in the fraction of minority households in the neighborhood. At first, only Whites experiencing a negative shock sell to minority buyers, turnover is low. We show that there is a unique tipping point: a fraction of minorities in the neighborhood beyond which all white households—regardless of whether they are experiencing the shock or not—are ready to sell. Then turnover is high, although prices (and thus brokerage fees per transaction) are lower than in the all-white neighborhood. The broker thus faces a trade-off. On the one hand, maintaining an all-white neighborhood ensures high prices and high brokerage fees but results in low turnover. On the other hand, triggering a racial transition generates sequential patterns of transactions and fees. Prices and turnover are initially low: high-valuation white households do wnot sell (lo turnover) and white households expect a neighborhood change (low prices). But when the neighborhood reaches its tipping point, turnover increases and the broker realizes higher revenues. After the transition, however, turnover and prices decline to level below those for an all-white neighborhood. Given 8 The model’s mechanisms do not rely on the particular labeling “black” and “white” of these specific groups. Evidence suggests that immigrant inflows may also cause neighborhood tipping (Saiz and Wachter [32]). Section 804 of the 1968 Civil Rights Act mentions “race, color, religion, sex, familial status, or national origin.” 9 In law, Bisceglia [8] defines blockbusting as “the first sale in a previously all white area to a black—so that the racial homogeneity of the block is ‘busted’.” 10 Thus the model endogenizes the steering behavior of real estate brokers. Aleinikoff [2] states: “The quickest and surest sales can be made by satisfying buyer preferences [...] members of the buyer’s own race.” 11 In contrast, Becker and Murphy [5] assume myopic expectations.