All the major banking institutions say the right things about race and equality. They all have diversity programs. A few financial industry leaders, like Robert Rubin and Jamie Dimon, even support socially liberal causes. Yet the banking industry covertly uses payday lenders as a "front," a way to prey on minority neighborhoods without getting their hands dirty.
It's a classic Rigged Game: The banks deny normal credit to lower-income people, then profit from usurious forms of alternative credit (or as it's known in economic circles, "fringe banking"). Fortunately, efforts to draw attention to these practices are beginning to have having some effect.
Race and lending
Payday loans hurt all their customers, of course, not just minorities. But studies have shown that payday lenders disproportionately exploit minority neighborhoods with loans that are issued at an average annual interest rate of 455%. The average number of loan each borrower takes out is nine pre year, according to one study, as these high rates lead to a cycle of indebtedness. The loans are secured with the borrower's next paycheck, so only people with jobs qualify. It's a vicious circle, designed by the banking industry to maximize profits at the expense of the economically vulnerable.
This pillaging is taking place against the backdrop of an ever-increasing racial/economic divide. A Brandeis University/Center for Responsible Lending study showed dramatic increases in the economic gap between white and African-American households, as the difference in their financial assets quadrupled between 1984 and 2007.
And that was before the economic crash of 2007. The meltdown drove many low-income wage earners even deeper into debt, and the unavailability of loan modification programs traps them there. The banks also caused the crash and are ensuring that loans can't be modified, which takes the Rigged Game to an even higher macroeconomic level.
Payday lenders: Big banks' predator drones
Payday lenders were originally storefront operations, but more and more belong to highly-profitable chain operations. The payday industry has grown exponentially, thanks to Wall Street funding. As a report from National People's Action and the Public Accountability Initiative demonstrates, big banks - many of them TARP recipients - are fueling their growth with "financing arrangements, leadership ties, investments, and shared practices." One lender, Advance America, was given $40-50 million in credit to build their business before they had even opened a single location.
By acting as silent partners to the payday lenders, the big banks can exploit lower-income people group with a very unpopular form of lending without tarnishing their own brands. Payday lenders are Wall Street's predator drones, a tool they're able to deploy without putting themselves in danger. That has to change - and it is changing.
Advance America: Caught in the act
What did Advance America do with that money? We know they used some of it to open stores in North Carolina that violated state law, by charging 450% interest at a time when 36% was the legal maximum. (They never admitted wrongdoing, but agreed to pay $18.5 million to settle a class action suit against them.)
Advance America's actions were "your tax dollars at work": It received large chunks of its startup capital from Bank of America, which received $45 billion in TARP funds. Its other major investors were Wachovia and Wells Fargo. Wells Fargo received enormous tax breaks for its acquisition of Wachovia, as the result of a special IRS ruling during the banking crisis. Wachovia and Wells Fargo have also been deeply involved in the laundering of drug cartel money, which means they've profited by promoting yet another social plague.
All in all, big banks provided \more than $1.5 billion in capital to publicly traded payday loan companies, and an estimated $2.5 to $3 billion in total.
American banks have a long and checkered racial history. Government intervention was required to stop "redlining," the practice of denying financial services (or charging more for them) to minority neighborhoods. The biggest banks play a major role in backing auto loans, which studies have also shown to charge higher interest rates to African Americans than Caucasians. HSBC settled a lawsuit accusing it of charging minority borrowers more. Do payday lenders really target minorities? As this study shows, these fringe bankers have disproportionately set up shop in minority neighborhoods. The study, "Race Matters," was conducted in North Carolina, where African-American communities had three times as many payday lenders per capita as white communities, even when adjusted for other factors.
Remember, this is in the same state where taxpayer-assisted banks helped bankroll Advance America. These banks are profiting handsomely from the exploitation of minority communities, behavior they disguise by using payday lenders as their "undercover brothers."
Won't it hurt minorities if payday lenders are shut down?
In a word: No. While this has been a common argument, we now have experience and data on the subject. North Carolina's anti-usury law (the one Advance America violated) has been in place since the law effectively ended payday lending in 2006. A survey was conducted to determine the impact of the law. One key finding: More than twice as many former payday borrowers reported that the absence of these lenders has had a positive effect on their households, rather than a negative one.
No credible defense
There have been attempts to defend these institutions on the grounds that they provide a service to lower-income communities, but these arguments don't hold water. Jim Hawkins at the University of Houston Law Center made a thought-provoking and intellectually honest attempt, but Nathalie Martin's critique of Hawkins is right on target: In the real world, that's not how these loans play out. Economist Gregory Elliehausen mounted another defense, but it seems clear to me that the three studies I cited here undermine his argument and render his assumptions invalid. (I'd be happy to have more eyes looking at these studies and critiquing both sides of the debate.)
Defenders who suggest that payday loans are designed to help people with one-time cash flow problems should read a study from the University of North Carolina entitled "Payday Lending: A Business Model That Encourages Chronic Borrowing." These lenders know exactly what they're doing when they trap people into a long-term debt cycle at 450% interest. It's a common practice to offer cheap loans to first-time borrowers, for example, to begin the entrapment process. ("50% Off For New Customers! Only $9.31 per $100! ")
The "No, you're the racist!" argument
Oh, some defenders will say, so you would leave these poor and minority people without any access to short-term loans? You bleeding hearts don't really care about them! And you call us racist! (For the record, I don't think these lenders or their big bank funders are racist - they're just profiting from a racially inequitable system.) These payday defenders sometimes even argue that those who would reform the system are the "real racists," because they're implying minorities can't make informed financial decisions for themselves.
First, the North Carolina survey indicates that low-income communities (and even payday loan customers themselves) feel their lives are improved when payday lenders are shut down. That doesn't suggest that a ban on usurious lending would harm them. And the absence of a fair lending system is no defense for an unfair and exploitative one.
Nor is it a matter of second-guessing the borrowers' choices. The key words are are "rigged game," "asymmetrical," and "entrapment." First the banking industry forecloses borrowers' other options (the rigged game). They have no alternatives left once they contact a payday lender. What comes next is a classic example of what economists call an "asymmetrical transaction," where one party has more information than the other. The payday lenders and their big-back financiers understand how the cycle of entrapment works. Most borrowers don't (it's not well-known by the general public), and quickly fall into a spiral of repeated cash flow problems caused by the cost of borrowing - which in turn leads to greater debt. They're trapped into a downward spiral of indebtedness that their exploiters have not only studied, but rely on in their business models.
It's not just borrowers who lose out in the payday system. The money they give to these institutions in interest payments is taken out of the general economy. Every dollar of interest paid to a payday lender (and its big bank backers) is a dollar that's not spent for food, or clothing, or other goods that stimulate the economy and provide jobs.
Fixing a rigged system
There's a solution for low-income people who have short-term borrowing needs: Provide them with access to credit on reasonable terms. That will either require the big banks to step up - which is reasonable to ask of institutions that benefit from low-cost Federal Reserve money and implicit future government help - or a government program to support credit unions and other low-cost and trustworthy alternatives.
Payday lenders need to be cut off from the lifeline of Wall Street money that's fueling their growth. Fortunately, the big financial institutions are beginning to feel the heat. A report in the Los Angeles Times suggests that big banks are showing a certain cooling of passion toward their payday lender partners. But the pressure on them must be unrelenting. Citizen action will help (here's a good place to start).
A coordinated program should end the payday lenders' lifeline to easy credit - a lifeline that stretches all the way from the Federal reserve to the "loan store" on a poor neighborhood streetcorner. Other forms of lending should be promoted, along with with effective financial education and advisor programs.
It's time to stop letting the big banks use this rigged game to take advantage of minority Americans and everybody else who walks through their doors, while hurting the economy for everyone else.
This post was produced as part of the Curbing Wall Street project.