Living in Americaâ€™s Fringe Economy
Ron Cook is a department manager at a Wal-Mart store in Atlanta. Maria Guzman is an undocumented worker from Mexico; she lives in Houston with her three children and cleans office buildings at night. Marty Lawson works for a large Minneapolis corporation. (The names have been changed to protect the privacy of the individuals.) What do these three people have in common? They are all regular fringe economy customers.
The term "fringe economy" refers to a range of businesses that engage in financially predatory relationships with low-income or heavily indebted consumers by charging excessive interest rates, superhigh fees, or exorbitant prices for goods or services. Some examples of fringe economy businesses include payday lenders, pawnshops, check-cashers, tax refund lenders, rent-to-own stores, and "buy-here/pay-here" used car lots. The fringe economy also includes credit card companies that charge excessive late payment or over-the-creditlimit penalties; cell phone providers that force less creditworthy customers into expensive prepaid plans; and subprime mortgage lenders that gouge prospective homeowners.
The fringe economy is hardly new. Pawnshops and informal high-interest lenders have been around forever. What we see today, however, is a fringe-economy sector that is growing fast, taking advantage of the ever-larger part of the U.S. population whose economic lives are becoming less secure. Moreover, in an important sense the sector is no longer "fringe" at all: more and more, large mainstream financial corporations are behind the high-rate loans that anxious customers in run-down storefronts sign for on the dotted line.
The Payday Lending Trap
Ron and Deanna Cook have two children and a combined family income of $48,000 -- more than twice the federal poverty line but still $10,000 below Georgia's median income. They are the working poor.
To make ends meet, the Cooks borrow from payday lenders. When Ron and Deanna borrow $300 for 14 days they pay $60 in interest -- an annual interest rate of 520%! If they can't pay the full $360, they pay just the $60 interest fee and roll over the loan for another two weeks. The original $300 loan now costs $120 in interest for 30 days. If they roll over the loan for another two-week cycle, they pay $180 in interest on a $300 loan for 45 days. If the payday lender permits only four rollovers, the Cooks sometimes take out a payday loan from another lender to repay the original loan. This costly cycle can be devastating. The Center for Responsible Lending tells the tale of one borrower who entered into 35 back-to-back payday loans over 17 months, paying $1,254 in fees on a $300 loan.
The Cooks take out about ten payday loans a year, which is close to the national average for payday loan customers. Although the industry claims payday loans are intended only for emergencies, a 2003 study of Pima County, Ariz., by the Financial services for the poor and credit-challenged are big business.
Southwest Center for Economic Integrity found that 67% of borrowers used their loans for general non-emergency bills. The Center for Responsible Lending found that 66% of borrowers initiate five or more loans a year, and 31% take out twelve or more loans yearly. Over 90% of payday loans go to borrowers with five or more loans a year. Customers who take out 13 or more loans a year account for over half of payday lenders' total revenues.
Maria Guzman and her family are part of the 10% of U.S. households -- more than 12 million -- that have no relationship with a bank, savings institution, credit union, or other mainstream financial service provider. Being "unbanked," the Guzmans turn to the fringe economy for check cashing, bill payment, short-term pawn or payday loans, furniture and appliance rentals, and a host of other financial services. In each case, they face high user fees and exorbitant interest rates.
Without credit, the Guzmans must buy a car either for cash or through a "buy-here/pay-here" (BHPH) used car lot. At a BHPH lot they are saddled with a 28% annual percentage rate (APR) on a high-mileage and grossly overpriced vehicle. They also pay weekly, and one missed payment means a repossession. Since the Guzmans have no checking account, they use a check-casher who charges 2.7% for cashing their monthly $1,500 in payroll checks, which costs them $40.50 a month or $486 a year.
Like many immigrants, the Guzmans send money to relatives in their home country. (Money transfers from the United States to Latin America are expected to reach $25 billion by 2010.) If they sent $500 to Mexico on June 26, 2006, using Western Union's "Money in Minutes," they would have paid a $32 transfer fee. Moreover, Western Union's exchange rate for the transaction was 11.12 pesos for the U.S. dollar, while the official exchange rate that day was 11.44. The difference on $500 was almost $14, which raised the real costs of the transaction to $46, or almost 10% of the transfer amount. Without a checking account, the Guzmans turn to money orders or direct bill pay, both of which add to their financial expenses. For example, ACE Cash Express charges 79 cents per money order and $1 or more for each direct bill payment. If the Guzmans use money orders to pay six bills a month, the fees total nearly $57 a year; using direct bill pay, they would pay a minimum of $72 in fees per year.
All told, the Guzmans spend more than 10% of their income on alternative financial services, which is average for unbanked households. To paraphrase James Baldwin, it is expensive to be poor and unbanked in America.
The Cooks and the Guzmans, along with people like Marty Lawson caught in a cycle of credit card debt (see sidebar), may not fully appreciate the economic entity they are dealing with. Far from a mom-and-pop industry, America's fringe economy is largely dominated by a handful of large, well-financed multinational corporations with strong ties to mainstream financial institutions. It is a comprehensive and fully formed parallel economy that addresses the financial needs of the poor and credit-challenged in the same way as the mainstream economy meets the needs of the middle class. The main difference is the exorbitant interest rates, high fees, and onerous loan terms that mark fringe economy transactions.
The Scope of the Fringe Economy
The unassuming and often shoddy storefronts of the fringe economy mask the true scope of this economic sector. Checkcashers, payday lenders, pawnshops, and rent-to-own stores alone engaged in at least 280 million transactions in 2001, according to Fannie Mae Foundation estimates, generating about $78 billion in gross revenues. By comparison, in 2003 combined state and federal spending on the core U.S. social welfare programs -- Temporary Aid to Needy Families (AFDC's replacement), Supplemental Security Income, Food Stamps, the Women, Infants and Children (WIC) food program, school lunch programs, and the U.S. Department of Housing and Urban Development's (HUD) low-income housing programs -- totaled less than $125 billion. Revenues in the combined sectors of the fringe economy -- including subprime home mortgages and refinancing, and used car sales -- would inflate the $78 billion several times over and eclipse federal and state spending on the poor.
There can be no doubt that the scope of the fringe economy is enormous. The Community Financial Services Association of America claims that 15,000 payday lenders extend more than $25 billion in short-term loans to millions of households each year. According to Financial Service Centers of America, 10,000 check-cashing stores process 180 million checks with a face value of $55 billion.
The sheer number of fringe economy storefronts is mindboggling. For example, ACE Cash Express -- only one of many such corporations -- has 68 locations within 10 miles of my Houston zip code. Nationwide there are more than 33,000 check-cashing and payday loan stores, just two parts of the fringe economy. That's more than the all the McDonald's and Burger King restaurants and all the Target, J.C. Penney, and Wal-Mart retail stores in the United States combined. ACE Cash Express is the nation's largest check-casher and exemplifies the growth and profitability of the fringe economy. In 1991 ACE had 181 stores; by 2005 it had 1,371 stores with 2,700 employees in 37 states and the District of Columbia. ACE's revenues totaled $141 million in 2000 and by 2005 rose to $268.6 million. In 2005 ACE:
- cashed 13.3 million checks worth approximately $5.3 billion (check cashing fees totaled $131.6 million);
- served more than 40 million customers (3.4 million a month or 11,000 an hour) and processed $10.3 billion in transactions;
- processed over 2 million loan transactions (worth $640 million) and generated interest income and fees of $91.8 million;
- added a total of 142 new locations (in 2006 the company anticipates adding 150 more);
- processed over $410 million in money transfers and 7.6 million money orders with a face value of $1.3 billion;
- processed over 7.8 million bill payment and debit card transactions, and sold approximately 172,000 prepaid debit cards.
Advance America is the nation's leading payday lender, with 2,640 stores in 36 states, more than 5,500 employees, and $630 million this year in revenues. Dollar Financial Corporation operates 1,106 stores in 17 states, Canada, and the United Kingdom. Their 2005 revenues were $321 million. Check-into-Cash has more than 700 stores; Check N' Go has 900 locations in 29 states. Almost all of these are publicly traded NASDAQ corporations.
There were 4,500 pawnshops in the United States in 1985; now there are almost 12,000, including outlets owned by five publicly traded chains. In 2005 the three big chains -- Cash America International (a.k.a Cash America Pawn and Super- Pawn), EZ Pawn, and First Cash -- had combined annual revenues of nearly $1 billion. Cash America is the largest pawnshop chain, with 750 locations; the company also makes payday loans through its Cash America Payday Advance, Cashland, and Mr. Payroll stores. In 2005, Cash America's revenues totaled $594.3 million.
The Association of Progressive Rental Organizations claims that the $6.6 billion a year rent-to-own (RTO) industry serves 2.7 million households through 8,300 stores in 50 states. Many RTOs rent everything from furniture, elec tronics, major appliances, and computers to jewelry. Rent- A-Center is the largest RTO corporation in the world. In 2005 it employed 15,000 people; owned or operated 3,052 stores in the United States and Canada; and had revenues of $2.4 billion. Other leading RTO chains include Aaron Rents (with 1,255 stores across the United States and Canada and gross revenues of $1.1 billion in 2005) and RentWay (with 788 stores in 34 states and revenues of almost $516 million in 2005).
These corporations represent the tip of the iceberg. Low-income consumers spent $1.75 billion for tax refund loans in 2002. Many lost as much as 16% of their tax refunds because of expensive tax preparation fees and/or interest incurred in tax refund anticipation loans. The interest and fees on such loans can translate into triple-digit annualized interest rates, according to the Consumer Federation of America, which has also reported that 11 million tax filers received refund anticipation loans in 2000, almost half through H&R Block. According to a Brookings Institution report, the nation's largest tax preparers earned about $357 million from fringe economy "fast cash" products in 2001, more than double their earnings in 1998. All for essentially lending people their own money!
The fringe economy plays a big role in the housing market, where subprime home mortgages rose from 35,000 in 1994 to 332,000 in 2003, a 25% a year growth rate and a tenfold increase in just nine years. (A subprime loan is a loan extended to less creditworthy customers at a rate that is higher than the prime rate.) According to Edward Gramlich, former member of the Board of Governors of the Federal Reserve System, subprime mortgages accounted for almost $300 billion or 9% of all mortgages in 2003.
While the fringe economy squeezes its customers, it is generous to its CEOs. According to Forbes, salaries in many fringe economy corporations rival those in much larger companies. In 2004 Sterling Brinkley, chairman of EZ Corp, earned $1.26 million; ACE's CEO Jay Shipowitz received $2.1 million on top of $2.38 million in stocks; Jeffrey Weiss, Dollar Financial Group's CEO, earned $1.83 million; Mark Speese, Rent-A-Center's CEO, made $820,000 with total stock options of $10 million; and Cash America's CEO Daniel Feehan was paid almost $2.2 million in 2003 plus the $9 million he had in stock options.
Fringe-economy corporations argue that the high interest rates and fees they charge reflect the heightened risks of doing business with an economically unstable population. While fringe businesses have never made their pricing criteria public, some risks are clearly overstated. For example, ACE assesses the risk of each check-cashing transaction and reports losses of less than 1%. Since tax preparers file a borrower's taxes, they are reasonably assured that refund anticipation loans will not exceed refunds. To further guarantee repayment, they often establish an escrow account into which the IRS directly deposits the tax refund check. Pawnshops lend only about 50% of a pawned item's value, which leaves them a large buffer if the pawn goes unclaimed (industry trade groups claim that 70% of customers do redeem their goods). The rent-to-own furniture and appliance industry charges well above the "street price" for furniture and appliances, which is more than enough to offset any losses. Payday lenders require a post-dated check or electronic debit to assure repayment. Payday loan losses are about 6% or less, according to the Center for Responsible Lending.
Much of the profit in the fringe economy comes from financing rather than the sale of a product. For example, if a used car lot buys a vehicle for $3,000 and sells it for $5,000 cash, their profit is $2,000. But if they finance that vehicle for two years at a 25% APR, the profit jumps to $3,242. This dynamic is true for virtually every sector of the fringe economy. A customer who pays off a loan or purchases a good or service outright is much less profitable for fringe economy businesses than customers who maintain an ongoing financial relationship with the business. In that sense, profit in the fringe economy lies with keeping customers continually enmeshed in an expensive web of debt.
Funding and Exporting America's Fringe Economy
Fringe economy corporations require large amounts of capital to fund their phenomenal growth, and mainstream financial institutions have stepped up to the plate. ACE Cash Express has a relationship with a group of banks including Wells Fargo, JP Morgan Chase Bank, and JP Morgan Securities to provide capital for acquisitions and other activities.
Advance America has relationships with Morgan Stanley, Banc of America Securities LLC, Wachovia Capital Markets, and Wells Fargo Securities, to name a few. Similar banking relationships exist throughout the fringe economy.
The fringe economy is no longer solely a U.S. phenomenon. In 2003 the HSBC Group purchased Household International (and its subsidiary Beneficial Finance) for $13 billion. Headquartered in London, HSBC is the world's second largest bank and serves more than 90 million customers in 80 countries. Household International is a U.S.-based consumer finance company with 53 million customers and more than 1,300 branches in 45 states. It is also a predatory lender. In 2002, a $484 million settlement was reached between Household and all 50 states and the District of Columbia. In effect, Household acknowledged it had duped tens of thousands of low-income home buyers into loans with unnecessary hidden costs. In 2003, another $100 million settlement was reached based on Household's abusive mortgage lending practices.
HSBC plans to export Household's operations to Poland, China, Mexico, Britain, France, India, and Brazil, for starters. One shudders to think how the fringe economy will develop in nations with even fewer regulatory safeguards than the United States. Presumably, HSBC also believes that predatory lending will not tarnish the reputation of the seven British lords and one baroness who sit on its 20-member board of directors.
What Can be Done?
The fringe economy is one of the few venues that creditchallenged or low-income families can turn to for financial help. This is especially true for those facing a penurious welfare system with a lifetime benefit cap and few mechanisms for emergency assistance. In that sense, enforcing strident usury and banking laws to curb the fringe economy while providing no legal and accessible alternatives would hurt the very people such laws are intended to help by driving these transactions into a criminal underground. Instead of ending up in court, non-paying debtors would wind up in the hospital. Simply outlawing a demand-driven industry is rarely successful.
One strategy to limit the growth of the fringe economy is to develop more community-based lending institutions modeled on the Grameen Bank or on local cooperatives. Although community banks might charge a higher interest rate than commercial banks charge prime rate customers, the rates would still be significantly lower than in the existing fringe sector.
Another policy option is to make work pay, or at least make it pay better. In other words, we need to increase the minimum wage and the salaries of the lower middle class and working poor. One reason for the rapid growth of the fringe economy is the growing gap between low and stagnant wages and higher prices, especially for necessities like housing, health care, pharmaceuticals, and energy.
Stricter usury laws, better enforcement of existing banking regulations, and a more active federal regulatory system to protect low-income consumers can all play a role in taming the fringe economy. Concurrently, federal and state governments can promote the growth of non-predatory community banking institutions. In addition, commercial banks can provide low-income communities with accessible and inexpensive banking services. As the "DrillDown" studies conducted in recent years by the Washington, D.C., nonprofit Social Compact suggest, low-income communities contain more income and resources than one might think. If fringe businesses can make billions in low-income neighborhoods, less predatory economic institutions should be able to profit there too. Lastly, low and stagnant wages make it difficult, if not impossible, for the working poor to make ends meet without resorting to debt. A significant increase in wages would likely result in a significant decline in the fringe economy. In the end, several concerted strategies will be required to restrain this growing and out-of-control economic beast.