Preface

Shortly after starting to work on Shortchanged, I visited a “buy here, pay here” used-car lot in Houston, Texas. Dressed in blue jeans, a T-shirt, and a baseball cap, I went to the lot to get a feel for how the system worked. The salesman showed me the typical overpriced $3,000$–5,000 used cars that were slightly sporty, with high mileage and interiors that had obviously hosted a few parties. Even the cleaner cars had hardened cola spills, cigarette holes in the seats, and a musty smell reminiscent of smoke and fast-food burgers. I popped hoods, kicked tires, and tried to be enthusiastic about my dire need for a vehicle.

The salesman was affable until I asked about financing. “It’s only $60 a week,” he said, “pretty good for a car like this.”

I nodded and then mistakenly asked, “What’s the interest rate?” The negotiations chilled as the salesman turned his back and walked away. I followed him, asking why I was suddenly getting the cold shoulder.

“I don’t know who you are, but I know you’re bullshitting me.”

Sheepishly I asked, “How do you know?”

“None of my customers ever ask about interest rates. All they care about is how much they gotta pay each week.” In a nutshell, that’s how the fringe economy works.

For many years, I included a small amount of material on the fringe economy as part of my graduate course in social policy. Although I understood the general concept of the fringe economy, I wasn’t fully aware of the details.

About five years ago, I arrived early for a dinner at a restaurant in a small, run-down Houston strip mall. With almost an hour to kill, I stopped in at a check-cashing outlet and browsed through the leaflets. Since it was tax season, many brochures advertised “instant tax refunds.” Being the only customer, I asked the clerk how these refunds worked. Through a small hole in the bulletproof glass we chatted about tax refunds, check cashing, and payday loans. After hearing the details I was taken aback. While I understood the economics of higher risk and higher cost, the abuse of unregulated market power in regard to the economically fragile angered and dismayed me. I had always known that the poor got a raw deal in the fringe economy; I just hadn’t realized how bad it really was.

Throughout the dinner my feelings alternated between outrage and relief. As a tenured college professor, I felt relieved that I’d never descend into that economic abyss. But, like much of the middle class, I had in the back of my mind that nagging “what if?” I knew that only a few shaky rungs separated me from the bottom of the economic ladder. Perhaps I’d knock the rungs out myself, or maybe they’d break because of events I couldn’t control. This brief encounter led to my journey into the dark underbelly of America’s fringe economy.

The first question I’m often asked is, “What’s the fringe economy?” In the context of Shortchanged, I use “fringe economy” to refer to corporations and business practices that have a predatory relationship with the poor by charging excessive interest rates or fees, or exorbitant prices for goods or services. While some consumer groups use the term “alternative financial services sector,” I prefer “fringe economy,” because it better addresses the marginality of this economy and many of its customers.

After I list the visible parts of this economy—payday lenders, check cashers, rent-to-own stores, buy here, pay here used-car lots, tax refund lenders, and so forth—most people know what I’m talking about. But, as the book illustrates, these businesses are only the tip of a complex financial structure that engulfs virtually every area where people borrow, spend money, or purchase goods and services. At this point, a caveat is necessary. Some financial institutions that serve the poor—especially those in the nonprofit sector—are nonpredatory and are doing a remarkable job. Most for-profit businesses are not.

Despite its bland storefronts, the fringe economy is not composed primarily of family-run pawnshops, payday lenders, and check cashers. On the contrary, it’s an industry increasingly dominated by a handful of large, well-financed national and multinational corporations with strong ties to mainstream financial institutions. It’s also a comprehensive, mature, and fully formed parallel economy that addresses the financial needs of the poor and credit-challenged in much the same way as the mainstream economy meets the needs of the middle class. The main difference is the exorbitant interest rates and fees and the onerous loan terms that mark fringe economy transactions.

I had several goals in writing this book. My first was to shed light into this dark and shadowy sector of the American economy. Paradoxically, while the fringe economy is everywhere, it is hidden from public view. For instance, we’ve all passed the throngs of pawnshops, check cashers, payday lenders, rent-to-own stores, tax refund lenders, and buy here, pay here car lots that are increasingly populating America’s cities and towns. While some of us have used these services, most of us don’t really know what happens there. For others, fringe economy storefronts are like porn shops. We don’t exactly know what goes on inside, but we’re pretty sure it’s unwholesome. As Shortchanged illustrates, this intuition is correct—there’s indeed something seedy going on in most parts of the fringe economy. Behind this seediness are economic transactions marked by desperation and exploitation. It’s a hidden world where a customer’s economic fate is sealed with a handshake, a smile, and fine-print documents that would befuddle many attorneys.

My second goal was to show how poor and credit-impaired consumers are systematically exploited by a subeconomy with few restraints. Lawmakers and government officials have largely ignored much of the untoward activities of the fringe sector, instead focusing on protecting the financial interests of the rich. This has resulted in an economy with one set of rules for the rich and a different set of nonrules for the poor. For example, Wall Street brokers are prosecuted for complex financial crimes that most people can’t grasp. At the same time, tax preparers and refund lenders are permitted to skim off $1.3 billion from the Earned Income Tax Credit, a program designed to help the nation’s poorest families. These nonrules have allowed a Wild West economy—one with an open season on the poor—to flourish.

My hope is that concerned citizens, advocates, and state and federal officials and lawmakers will be sufficiently alarmed by these activities to bring some measure of justice—or simple economic decency—into this sector. I am also hopeful that this book will further the ongoing dialogue about the need for alternative forms of credit and financial assistance, such as community banks, credit unions, and community development corporations. To further this goal, I’ve included suggestions for reform in most of the chapters.

My third goal was to make consumers aware of the inherent dangers of the fringe economy. Despite ads that promise to help people in need, fringe economy transactions are one-sided, and rarely do customers walk away better off financially. In most cases, the financial problems that drew people to the fringe economy are only exacerbated by overpriced goods and services, high interest rates and fees, impossible-to-meet loan terms, and short repayment schedules. This book may help friends, family members, and human-service professionals to steer financially troubled people away from the fringe economy. Some of this assistance might involve helping them find alternative and less predatory forms of financing.

In the avaricious world of the fringe economy, crafty merchants and economic institutions pander to the belief that everyone can have the American dream—only the poor have to pay more for it. In fact, the fringe economy leaves virtually no one without credit as long as they’re willing to pay the price. Besides, if a transaction seems unaffordable, the down payment, interest rate, or terms can be adjusted to make it seem manageable, at least in the short run. While the fringe economy makes goods and services available to consumers who can’t otherwise afford them, it also traps them in a cycle of debt.

The fringe economy is an unforgiving system that claims to give the poor and credit-challenged relief and a second chance. On the contrary, vulnerable customers are dragged deeper into a quagmire of debt. For most people, the greatest danger of the fringe economy doesn’t lie in a single exploitive transaction, although it sometimes can. The real danger is becoming enmeshed in a subeconomy from which escape is difficult. For some at-risk consumers, fringe financial services are like an addiction—there’s always money there when they need it. But, like most addictions, it comes at a high price.

A final goal was to show how the modern fringe economy reflects a break from the past. The availability of high-cost predatory credit is hardly a new phenomenon in the United States. On the contrary, the nation has a long history of indentured servants, debt servitude, company stores, loan sharks, pawnshops, and predatory finance companies. For example, company stores in mill towns, coalfields, and migrant camps have traditionally kept poor workers in a cycle of perpetual debt. Black sharecroppers were held in debt servitude to landowners by land and crop mortgages carrying exorbitant interest rates.

What makes the modern fringe economy different is the level of organization, the corporate control, the presumed legitimacy of these enterprises, the growing appeal to large sectors of middle-income households, and the geographic reach of these companies. While older fringe businesses were local, the new fringe economy is national and even global in scope. And the fringe economy is not just an urban phenomenon. Many small towns and cities across the United States have multiple pawnshops, check cashers, payday lenders, and rent-to-own stores. Even a small town like Bay City, Texas (population 21,000), boasts two pawnshops, two check cashers, and four rent-to-own stores, including three of the biggest—Aaron’s, ColorTyme, and RentWay.

Lending money has historically been profitable, and this didn’t escape the notice of the underworld. For example, in 2003, six associates of the Colombo crime family were charged with illegal loan-sharking, among other crimes. According to the Justice Department, one underworld crew operated a large-scale loan-sharking and bookmaking operation that preyed upon young employees of stock-brokerage firms. Usurious loans were made at interest rates of 1%–5% a week, or the equivalent of a 52%–250% APR (annual percentage rate). Ironically, a 52% APR loan would be a bargain for many fringe economy customers. Even the 250% APR charged by the Colombo loan sharks is less than the 470% APR charged by many legal payday lenders.

Entrepreneurs soon realized that they could make vast sums of money by providing “legal” financial services to desperate borrowers. In turn, mainstream banks lent entrepreneurs the money to set up check-cashing outlets, rent-to-own stores, and payday lending operations. Illegal loan-sharking became redundant in many low-income communities as payday lenders took over. Consequently, some poor and middle-class consumers have simply shifted their borrowing habits from illegal to legal loan sharks. A few notes on the book may be helpful. To begin with, I underestimated the difficulties I would encounter in the research. For example, when I started the book, I phoned an old friend whose daughter worked for a large payday lender in Arizona. Having known the family for 20 years, I was certain that Marcy would return my phone call. She never did. I phoned several more times, and still no return call. Finally, the family admitted that their daughter couldn’t talk to me because she had signed an employee loyalty oath promising that she wouldn’t discuss the business with anyone. Breaching that oath would result in dismissal, and she needed the income. I encountered the same refusal to discuss “the business” with employees in check-cashing outlets and pawnshops. In another instance, my wife, Anna, talked to a client whose daughter managed a pawnshop. The mother enthusiastically volunteered her daughter for an interview. When Anna followed up, she was told that her client’s daughter couldn’t discuss the pawnshop, and if I wanted more information, I’d have to contact the owner directly. The lack of transparency was striking, and I couldn’t help but suspect that something was being hidden.

Some readers may be put off by the book’s focus on the economic straits of the poor and the middle class, thinking that it minimizes the true impact on the poor. I had originally titled the book Scamming the Poor, but as I dug deeper, I soon realized that the fringe economy is also affecting a growing number of functionally poor households—those with above-average incomes but with little or no assets and high debt. Indeed, many financial transactions have become so tricky that the middle class, especially the functionally poor middle class, is also vulnerable to the predations of the fringe economy. As Shortchanged illustrates, the lines between the fringe and mainstream economies are blurred, and the interests of the poor and the functionally poor middle class are growing closer.

Several readers may find details about the fringe economy tedious. In the fringe economy, as in many things, the devil is in the details. Understanding the fringe economy requires a grasp of how financial schemes circumvent state and federal laws, and how consumers are becoming trapped in a cycle of indebtedness through loan rates and terms that are almost impossible to satisfy. In large measure, the fringe economy exerts its control by carefully manipulating the details of the financial transaction.

Some case examples are taken directly from interviews, while others are composites. Surrogate names are used throughout the book to protect the privacy of the interviewees. A few readers will notice variations in statistical data used in various parts of the book. These are due to the differences in data-gathering techniques used by different non- and for-profit organizations and federal agencies. Data discrepancies are often the most evident between fringe industry trade groups and consumer organizations. In those cases, I chose what I surmised to be the most reliable data.

Finally, the critical reader will certainly ask the challenging question, don’t the credit problems of some fringe economy customers justify the high interest rates? The obvious answer is yes. Most of us wouldn’t lend money to some fringe economy customers because it would be financially imprudent. But at what point does the profit so overshadow the risks that the transaction becomes predatory?

The answer is obvious in some cases. For instance, consumers who pawn their vehicle for one-third of its value, then pay 300% or more a year in interest to get it back, are exploited. Some consumers are forced to deposit hundreds or thousands of dollars into a low-interest-bearing savings account—which they aren’t permitted to use to pay off their balances—to get a secured credit card. These cardholders then pay 30% or more in interest, plus monthly and sundry fees, for the “privilege” of using the card. They are exploited. Customers who take out a $200 payday loan costing almost $40 for 14 days at a 417% APR are exploited. Check-cashing customers who pay 3%—$30 on a $1,000 check—to cash a secure government check are exploited. Homeowners enticed into high-interest refinancing loans that systematically strip equity from their property are exploited. Still others who pay 28% in interest on a 10-year-old overpriced car are exploited.

The list goes on and on. Interest rates in the fringe economy are often in triple digits, and the grossly inflated prices of goods and services have no relationship to their real market value. The poor and credit-poor live in a world where borrowing means temporarily or permanently losing a valued possession or paying an exorbitant fee for a small cash advance.

The following is a brief roadmap to Shortchanged.

Chapter 1 looks at the scope and size of the fringe economy and the characteristics of its customers. It then examines the major players in the fringe economy, including mainstream financial institutions. Chapter 2 explores key factors that explain the phenomenal growth of the fringe sector, including stagnant wages, the rising numbers of working poor, the impact of welfare reform, immigration, and the rise of the Internet. Chapter 3 looks at the functionally poor middle class, an economic group increasingly targeted by the fringe sector. It also investigates the role of household debt in the growth of the fringe economy.

Having a credit card is almost a necessity in America’s plastic-driven society. Without one you can’t rent a car, book a room or flight, or order goods online. Chapter 4 examines credit and the credit card industry. Specifically, it explores how the credit industry makes the unaffordable seem affordable by artificially manipulating interest rates and terms, how creditworthiness is determined, and how the credit card industry works. It also investigates how aggressive marketing lures young adults into a credit card trap. Finally, the chapter examines the high costs of alternative credit and debit cards.

Rows of payday lenders, pawnshops, and tax refund lenders are increasingly lining the streets of American communities. Chapter 5 explores cash loans. One of the fastest-growing segments of the fringe economy is the payday loan industry. Despite the keen competition among payday lending corporations, the spectacular rise in consumer debt—around $9 trillion in 2004—portends a rosy future for this multibillion-dollar loan industry.

Pawnshops have historically assumed the role of the neighborhood banker, lending money to those frozen out of the economic mainstream. This chapter examines the high cost of pawn transactions and its economic effects on borrowers. In addition, it looks at the important role that mainstream and federally insured banks are playing in the fringe economy.

Tax time is feeding time for the fringe economy. From January to April, newspapers, television, and radio are buzzing with ads about “instant tax refunds.” Brochures are placed in thousands of convenience stores and supermarkets. Abandoned stores are suddenly occupied, at least for a few months. Appliance stores, car dealers, and other merchants advertise “instant money” if you promise to buy their wares. Chapter 5 explores the real costs of this instant money.

Chapter 6 investigates check cashing and auxiliary financial services (money orders, electronic bill paying, and so forth) that are lucrative parts of the fringe economy. The chapter also looks at how the fringe economy provides consumers with necessities such as appliances and furniture by way of the rent-to-own industry. Like furniture and appliances, telephone service is a necessity for many people. Without phone service it is difficult to secure employment interviews, contact relatives, or be available for family emergencies. The chapter examines the alternative telecommunications sector, including prepaid home and cell phone service.

While payday lenders, pawnshops, and check cashers can boast high earnings, the biggest revenues come from housing. Simply put, it would take 500 payday loans of $200 each to equal one $100,000 home mortgage. Not surprisingly, the rapaciousness of the fringe economy is clearly evident in the housing area. Chapter 7 investigates the fringe housing sector, the difference between subprime and predatory mortgage lending, various kinds of risky home mortgages, and home equity and refinancing loans. Chapter 8 looks at housing speculation and foreclosures.

Those who live in urban or rural areas without adequate public transportation need a reliable vehicle for arriving at work on time, for picking up children from school or day care, for exercising family responsibilities, and for shopping in low-cost stores. Vehicle ownership is also an area where fringe economy abuses are evident in everything from car purchases to insurance. Chapter 9 investigates the fringe auto economy and explores the obstacles faced by the poor in finding and keeping basic transportation.

Americans are besieged by two contradictory messages: get more and cheaper credit, and get out of debt. Unfortunately, the first message appears to be the most compelling. If the getting-into-debt industry is growing, the getting-out-of-debt industry is following closely on its heels.

Chapter 10 examines the latter, including collection agencies, the organization and evolution of consumer credit counseling agencies, the structure and limitations of debt-management plans, the corruption of “nonprofit”-agency status, debt settlement, and debt dispute and file segregation.

Chapter 11 looks at what can be done to control the fringe economy. It examines various strategies for reforming the fringe economy, including government regulations, consumer education, the need for mainstream banks to better serve the poor, and the creation of alternative lending institutions. Finally, the chapter looks at the future of the fringe economy.