April 27th, 2006

Brad @ Burning Man

Shortchanged

There are definitely times when I miss the days of mafia rule in America. From when the mobs took over most state and big-city governments around 1929 until a new, greedier breed of dons broke the ancient rule against dealing in opiates in the late 1950s, those were dangerous times to be an honest reporter, or an honest cop. And if you made a mistake in who you dealt with or how, and made the wrong people angry, you could be murdered with impunity. So I don't romanticize that time period. But there were things that the mafia understood, that even now in these debased times that they still understand ... better than the Republicans, the right wing Democrats, and nearly all of the corporate executives who keep paying for their campaigns, and the short-sighted Libertarians who provide them with their intellectual ammunition, understand them. I'm hard pressed to come up with a better example of what I mean than this paragraph from the preface to Howard Karger's Shortchanged: Life and Debt in the Fringe Economy, which I finished only about a week ago:
... 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 [gambling] 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. Even the 250% APR charged by the Colombo loan sharks is less than the 470% APR charged by many legal payday lenders.
How can that be legal? That's a question you'll ask over and over again if you read the book. After a solid preface then a couple of somewhat weak introductory chapters, the real meat of the book, the part both most important and most readable, is the series of chapters that make up part II of the book, which examines each of the following financial services industries that are aimed at the poor and the working (or lower-middle) class, and who are eagerly trying to position themselves to take advantage of the economic distress of the middle and professional (or upper-middle) class during the next economic downturn: the sub-prime and secured credit card industry, pawnshops, payday lenders, tax refund anticipation lenders, check-cashing stores, rent-to-own furniture stores, pre-paid cellphone companies, the sub-prime mortgage lenders, buy-here-pay-here used car lots, and "debt counseling" scams. And after spending years using every technique of undercover and investigative journalism against the increasingly large, increasingly powerful, and insanely profitable companies behind all of these scams, he found that nearly all of them have several traits in common.

The first thing they all have in common is that they have all lobbied state governments and the federal government hard for every exemption they could find to state usury laws, truth in lending laws, consumer protection laws, or fair business practices laws. When these businesses each discovered that even with interest rates capped at the highest rates that even the least-protective state in the union would allow, there was still money to be suctioned out of people who were powerless to shop elsewhere, they lobbied legislatures and courts to define dozens of exemptions to the word "interest" that should never have passed the "laugh test," the one that says that no matter how good your theory is if you put it in front of a jury and they laugh at you, you're wrong. The net effect has been to raise the interest rates that are charged to pretty much the entire poor and working class, no matter what kind of financial transaction they're involved in, to rates that would make the most heartless of mafia dons blanch.

The second thing they all have in common is that, truth be told, they don't actually want you to pay them on time, let alone pay them back, and would go bankrupt if everybody did. Most of them make their money off of getting your initial deposit and application fee and transaction fee, then repossessing the car or furniture or house or whatever they sold you or you used for collateral for free and selling it. The rest are counting on the the threat of their ability to do so to make sure that you don't complain, to them or to any attorney general, about any legal or illegal fees they choose to charge you for the privilege of staving off the destruction of your life. The actual interest payments, let alone the principle, aren't designed to be paid off. On the contrary, they're designed to be impossible to pay off; the threat to actually try to collect those loans is used for leverage to steal everything you have.

The third thing they all have in common is that unlike every other sector of the financial services industry, in the fringe economy the rates and fees charged bear not even the slightest resemblance to the costs of doing business or the risk of default. None whatsoever. Their lobbyists say otherwise, but that leaves them with no explanation for why the fringe economy parts of previously legitimate companies are the only parts making big percentage returns. I can think of no more vivid, or personally distasteful, example than in the section on stored-value credit cards. This one personally offends me, because I was working at Mastercard International when its then-CEO Pete Hart all but invented the product. Pete Hart's vision was that by building on very trivial add-ons to our existing debit-card infrastructure, we could make it possible for any issuer to offer cards to even the poorest, least reliable, most risky customer. A stored value card was meant to be thought of as being like an old S&L passbook savings account: you put your own money in, the money sits there earning little no interest (as befits its low balances and high volatility of balance), you get it back out for free at any MasterCard (or, assuming our competitors would catch up with us, Visa or Discover) credit card terminal. The issuers would have basically no costs thanks to our turn-key and highly optimized solution, would incur no risks since no money was ever lent, and would earn an automatic transaction fee (as all credit card and debit card purchases do) at the point of the transaction. This would make it possible for them to offer accounts that could be used to pay bills by phone, to make purchases in places that only take plastic, and to save money, at virtually no cost to either the issuing bank or to the customer. We thought we were being great humanitarians. How has the product been used? Consider the fees charged by the example issuer on page 61 of the book, Four Oakes Bank and Trust. $149 (plus $10 minimum balance) in application and processing fees just to set up the account, even though our software makes this an operation that could be completed by one clerk on one computer screen in under 5 minutes with no manual back-end processing to charge for. Then $3.95 per month account fee, plus 50¢ to $1.00 fee for every deposit, plus $5.00 per month extra fee if you want paper statements issued, plus another $5.00 per month if your transactions don't total enough to meet their minimum, if they don't get enough per-transaction fees out of you to pay their (supposed, but actually almost non-existent) costs over and above the $149 one-time and $8 or so per month in fixed fees, for a type of account that gives them free float plus pays transaction fees out of the merchant fee and which costs them next to nothing to operate. It's beyond unjustifiable, it's criminal; it's got no business being legal.

The fourth thing they all have in common is that they have no fear of destroying their customers, none whatsoever. This is not explained in the book, but reading between the lines of what the few people at the lower management levels of these companies said in unguarded moments, I think it's clear why not. They have no fear of destroying their customers because they're counting on the American economy to deliver an ever-increasing number of new customers for them to suction dry. They practice honest-to-god slash and burn economics. In the unlikely even that they were to run out of current poor people, if they drove them all to suicide or homelessness, they feel that they can count on the current US economy to sufficiently bankrupt the working poor as to bring them into the fringe economy's clutches, and examination of the financials of those of these companies that are publicly traded bears this out so far. And in their internal memos and company plans and financial statements, you can smell the excitement as they plan for the day that the middle class, having lost everything that they could use to stave off disaster, falls into their clutches and loses everything to these same closely-held multinational corporations that are mostly owned by a tiny number of people even relative to the usual concentrations of wealth in America. Either they know something we don't know about the impending burst of the real-estate speculators' bubble, or they have strong suspicions.

But why hasn't the much-worshiped Invisible Hand of the Markets stepped in and remedied this? According to Libertarians, Republicans, and the Democratic Leadership Council, these wildly profitable business sectors should have attracted much new competition. And, as anybody who's driven through a poor or working class neighborhood in the last several years can tell, you has happened. According to their theory, this should have led to them being forced to compete with each other on price until the cost of their services dropped to the level where it was only barely profitable. Instead, the interest rates and "fees" charged in the fringe economy have doubled or more as the competition increased. How can this happen? Has the law of economic gravity been repealed? It can happen because almost everybody that enters the market understands that there is enough poverty to go around that there's no need to compete on price. Small numbers of honest businesses and many non-profits have attempted to enter the fringe economy with more affordably priced alternatives to the fringe economy offers, yes, and I celebrate them. In particular, I found out through this book about the National Community Investment Fund
s 3-year (2002-2005), $750k Retail Financial Services Initiative, an attempt to provide seed capital and technical assistance to non-profits like credit unions that seek to enter the same markets as the predatory lenders and under-cut them. They sound wonderful. But the net effect is negligible, because that 3/4 of a megabuck over 3 years is dwarfed by the billions of dollars that the predatory fringe economy companies had available to spend to make their products more ubiquitous and promote them so heavily (and dishonestly) that the customers can't tell the difference between them and the honest small businesses and non-profits. Once anyone, or any collection of people with a common interest, acquire sufficient power it is trivially easy for them to club to death any competitor that doesn't play by their rules.

The net effect of this is that more and more neighborhoods every year are infiltrated by these invidious vermin, and every year tens of millions of more people fall into their clutches. Some of these are people who made a mistake, but for the most part these are working people whose "mistake" was having an employer cut their health insurance, or being out-lawyered in a child-support case, or being injured on the job by an employer that out-lawyers them on damages. These are people who did everything they were told. They stayed in school, they stayed out of trouble, they go to church, they work hard at their jobs, the cut every corner on costs, they try to invest in their neighborhoods and try to save for their children's education. But instead of getting what every almost every American of the last 400 years was promised if they did that, instead of being able to rely on getting by and being able to have reasonable faith that their children will live a better life than them, they're finding that everything about the modern economy is designed so that normal, foreseeable, daily and monthly expenses eat every penny of their livelihood with nothing left to save. They find that even they do save anything up by working extra hard and being extra-frugal that the current US economy finds excuses to suction their bank accounts dry even if they do nothing wrong. And worst of all, once that happens they are dumped onto the tender mercies of people whose business plan is to make sure that not only do these people never get ahead; their perfectly (lobbied for) legal business plans is to steal from these people everything they own and then effectively kill them. That's so disgusting that a mafia leg-breaker would have an attack of conscience instead, it's so immoral that it's condemned by every religion in history (including Christianity, if you actually read the what their Bible has to say about those who place heavy burdens on the poor), and until fairly recently it used to be illegal -- and still should be.

If there is anything, politically and economically, that I stand for, it is this: we must stop them. We must revoke the loopholes and exemptions they have used to evade usury laws, eviscerate bankruptcy protection, and rob customers of their livelihood. We must do everything in our power to use the existing tools that we already have to replace our long-wrecked Savings and Loan system with something aimed at the same goals, at enabling even the poorest worker who is also the worst abuser of credit to save money, to not be robbed in transaction fees, to fully participate in the modern economy for free or at affordable or even subsidized rates, to find some kind of political and technological solution to provide the unbanked with affordable, honest, non-profit banking services however limited. That's right, hit them from both sides: regulate their sleaziest, greediest, most destructive and dishonest (and therefore most profitable) business practices out of existence, and if need be subsidize competition for them. Because somebody, the gods help us, has got to stand up for the American Dream while there's still at least one generation alive who remembers the promise.