Explosion of "Fringe Financial Services" Underscores Need for Strong Consumer Protection Agency

With the nation slowly recovering from the worst economic sucker punch in more than 50 years, consumers are finding they need to be ever more vigilant in protecting themselves from businesses that may not have their best interest at heart.

Be it in banking, credit services, utilities, insurance, or any number of other industries, ethically questionable practices -- and the legal loopholes that make them possible -- continue to anger and frustrate Americans on both sides of the political divide.

As the Obama administration works with Congress to enact sweeping financial regulatory reform, consumer advocates say now is the time to put in place essential protections to keep the most vulnerable populations from being further victimized by unscrupulous lenders.

Yet pro-business legislators seem intent on ensuring that regulatory reform goes the way of healthcare reform, becoming gradually watered down until it no longer resembles reform at all. At the moment their efforts are being directed largely at trimming the claws of a proposed Consumer Financial Protection Agency (CFPA). The fate of the agency remains in limbo as a standoff over its creation among top lawmakers in the Senate Banking Committee intensifies.

The financial reform bill that passed the House in December included a CFPA with the power to monitor the regulatory compliance of banks, credit unions, mortgage brokers and other lenders; but Republicans, with the backing of the U.S. Chamber of Commerce and the financial services industry, are intent on keeping the agency out of the Senate version.

Elizabeth Warren, the chairwoman in charge of overseeing federal bailout funds, says a strong consumer protection agency is a vital weapon in what she calls a "David vs. Goliath fight" between consumers and Big Finance.

"The fate of the Consumer Financial Protection Agency will be the best way to follow the [reform] story moving forward because consumer products were the most abusive and because the CFPA has real muscle to stop those abuses," Warren said, in a January 19 open letter.

Consumer advocates agree, saying that such an agency is an essential first step in protecting the city's poor from predatory financial services.

"I'm hopeful that it's going to happen but I'm discouraged it's taken as long as it has," said Cathy Carr, executive director of Consumer Legal Services of Philadelphia, which offers civil legal services for free to Philadelphia's low-income communities. "I think it's kind of surprising that we're this far into an admittedly devastating mortgage crisis and there still has yet to be legislation to prevent this kind of fraud from happening again."

Carr says that while the methods and tactics may change, poor and minority communities are disproportionately at risk of falling prey to predatory financial service schemes that almost always do more harm than good.

"We've done a lot of work over the years and really tried to get regulators to take an aggressive position to protect people [but] the one thing about American capitalism is there always seems to be someone out there trying to scam another buck out of somebody," Carr said.

Among the pitfalls that low-income consumers fall into, Carr says some of the more common today include education services that offer high-interest loans to people hoping to learn computer, driving, beauty, or other skills.

"People take out loans, often federal loans, and really get nothing for the money and end up with no real advantage for the courses," she said.

The group has also aggressively taken on the payday loan industry. Payday loans are very short-term loans, typically ranging from $100 to $1,000, with extremely high annual percentage rates. During 2008, Payday lenders in the U.S. extended 120 million loans with a total value of $42.1 billion. The fees associated with these advances amounted to $7.3 billion according to Financial Service Centers of America, the trade association representing the payday lending industry.

In 2005 CLS filed a lawsuit against Cash Today, one of Philadelphia's largest check-cashers, for breaking Pennsylvania's usury laws (which cap interest rates on consumer loans at 6 percent) by charging annual interest in excess of 400 percent on payday loans. The company declared bankruptcy shortly after the suit was filed. CLS continues to pursue restitution in bankruptcy court.

Beyond payday loans, consumer advocates point to a host of other "fringe financial services" that market to low-income consumers, almost all of which charge higher than average fees and/or interest: services like rent-to-own, auto-title loans and tax-refund loans.

With tax season upon us, organizations across the country are educating consumers about the pitfalls of so-called Refund Anticipation Loans (RALs); these are essentially very short-term, high-interest loans on tax refunds that are offered by commercial tax services such as H&R Block and Jackson Hewitt.

According to the most recent data, 8.7 million RALs are issued each year, representing one-in-17 tax returns, and costing taxpayers $900 million dollars annually in lost refund money. According to the Consumer Federation of American, RAL fees can range from 50 percent to as high as 500 percent. Like most high-interest/high-fee financial services, RALs disproportionately target low-income consumers, particularly those eligible for the Earned Income Tax Credit (EITC).

Kerry Smith, a staff attorney with Community Legal Services of Philadelphia (CLS) who specializes in predatory lending and RALs, cites research showing that neighborhoods with the highest number of commercial tax preparation stores also tend to be communities where a high percentage of residents get the EITC.

"The Earned Income Tax Credit is probably one of the country's most successful antipoverty tools, but it's distributed as a tax refund," she said. "The problem is that when you're talking about lots of cash coming in at one particular time it creates all kinds of opportunities for commercial folks to try and get their hands on that and that's exactly what's happened."

For people who are often living check-to-check, the promise of immediate cash offered by RALs is often an enticing prospect (the average wait time for a refund for those who choose direct deposit is eight to 15 days). The problem, says Smith, is that in many cases consumers are given inadequate information, or none at all, about the nature and cost of RALs, and alternative options.

What all fringe financial services have in common is that they disproportionately target low-income consumers who lack access to more traditional financial services.

"When you don't have banks going into poor communities, you're going to wind up with places where there are a lot of predatory products," said Kathleen Day, a spokeswoman for the Center for Responsible Lending, a Washington-based advocacy group.

In 2009, the Federal Deposit Insurance Corporation (FDIC) found that nearly 20% of lower-income households ? almost 7 million households earning below $30,000 per year ? do not have a bank account. A whopping 54 percent of black households are either "unbanked" or "underbanked" -- which the FDIC defines as a household that has a checking account or a savings account but relies on alternative financial services. The results are telling: studies show that African Americans are more than three times as likely as whites to be steered into high-interest subprime loans, even when they qualify for a prime loan.

Meanwhile, new bank branches continue to pop up like mushrooms, just not where they are needed most. According to a recent FDIC study, of the 10,000 new bank branches added over the past five years, just one-in-ten made it into low-income and minority neighborhoods; two-thirds of all new bank branches are in neighborhoods with income higher than the national average.

"It's like the proverbial ambulance chasers," Charles O'Neal, a vice president at the Dallas Black Chamber of Commerce, told the Associated Press last August, when the study was released. "They're all chasing the same dollar and they get little return. Meanwhile, on this side of town, folks are literally spending sleepless nights trying to figure out where do we go to find a financial institution that will be responsive to their needs."

For the past three decades providers of fringe financial services have been eager to capitalize on this void. Following the deregulation of the financial industry in the 1980s, the number of check-cashing businesses - which charge fees between 1.5 and 3.5 percent the face value of the check - have surged, reaching 13,000 by 2005. Likewise, from its emergence in the early 1990s through about 2006, the payday lending industry enjoyed explosive growth. According to a recent report from the Federal Reserve, in 1996, there were an estimated 2,000 payday lending stores operating in the U.S. By 2007, that number had grown to approximately 24,000.

In the long term, experts say, these trends have created a significant "racial wealth gap" that is only getting worse. According to the Fed, in 2004 the average black family had 12 cents for every dollar of wealth held by the typical white family; today it has just a dime.

On January 19, the Insight Center for Community Economic Development, a coalition of experts working to promote economic security at the community level, launched a nationwide campaign -- the Closing the Racial Wealth Gap Initiative -- aimed at drawing attention to the disproportionate impact of the financial crisis on communities of color.

Among other things the group is advocating for a "strong and independent" CFPA and an expansion of the Community Reinvestment Act (CRA) -- which prohibits mortgage lenders from excluding low-income neighborhoods - to include other forms of financial services.

Meizhu Lui, the director of the initiative, says all the income building initiatives in the world will have limited effect if these systemic issues are not addressed.

"In some ways our project says we have two issues in the country; we have to address poverty in general and figure out ways to use asset building to help people out of poverty, but we also have to explicitly name the racial gap and have policies targeted toward people of color in order to close that gap," she said.

Protecting low-income consumers from predatory financial services is the first step in this process. Lui backs companion proposals in the House and Senate that would create a Financial Product Safety Commission -- modeled after the Consumer Product Safety Commission -- to monitor industry best practices and provide consumers with stronger protections and better information in connection with consumer financial products.

"People of color were especially hurt by the financial chicanery that was going on and so one of the things that's important is to have really safe, sound trustworthy products, so-called plain vanilla, and unfortunately they are not requiring the use of such products and we think they are very important, especially in communities that have really been taken for a ride and don't know who to trust," She said.

Lui says beyond the obvious things, like the disproportionate number of mortgage foreclosures in low-income neighborhoods, there are less visible symptoms of the expanding racial wealth gap.

"Take the college dropout rate. In the early 1970s you had this huge increase in the number of minorities - particularly African Americans -- who were able to go to college and graduate, so that gap has really been reduced, but now we're starting to see an increase in the dropout rate again because of the financial crisis," said Lui. "So if we see this education gap developing, that's going to affect employment and income and then wealth again."

Carr says until better protections are put into place, it's important for consumers to educate themselves. Her group and others like it offer a number of free services.

"Getting good advice when you're taking out a loan is essential, and there are places you can go for help," said Carr, adding, "but it's equally important to face your trouble as early as you can and take action and get good legal advice rather than sticking your head in the sand."

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