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Broke, USA: From Pawnshops To Poverty, Inc.—How The Working Poor Became Big Business
By Gary Rivlin
Broke, USA: From Pawnshops To Poverty, Inc.—How The Working Poor Became Big Business by Gary Rivlin introduces us to the world of predatory mortgage lenders and payday lenders. Rivlin interviewed several entrepreneurs who started payday lending firms. He interviewed the founders of quickie tax companies, which focus upon offering people loans in anticipation of tax refunds (so-called instant tax refunds). Rivlin interviewed community activists and others who have worked to regulate or shut down payday lenders and predatory mortgage lenders. He spoke with lobbyists representing these firms. He talked with attorneys who sue these firms. He interviewed employees of these companies. And, he interviewed the people who've used the services of these companies (or have been exploited by them, depending upon your view and the specific situation). What results is a detailed picture of a world unknown to many Americans. We see how greed and deregulation created the subprime mortgage crisis that devastated the American economy in 2008.
"There are 40 million or so people in the United States living on $30,000 or less a year, according to the Federal Reserve. There are no doubt some people making more than $30,000 a year borrowing against their next paycheck with a payday lender (just as there are people getting by on $20,000 who would never use a check casher or a subprime credit card), but $30,000 seems a useful cutoff if trying to describe the working poor: those who earn too much to qualify for government entitlements but who earn so little there's no hope they'll ever save money given the rising cost of housing, health care, transportation, and everything else one needs to live life in twenty-first-century America. If each person living on under $30,000 per year donated equally to the poverty industry, that would mean their annual share of that $150 billion is $3,800. For the warehouse worker supporting a family on $25,000 per year, that works out to a 15 percent annual poverty tax."
This $3,800 largely goes to pay fees and ultra-high interest rates that ultimately don't benefit the borrower. Many times, the poor are duped into paying exorbitant amounts. Rivlin tells us the story of eighty-year-old Annie Lou Collier who owned her own home for about 40 years in Atlanta, Georgia. One day a fly-by-night salesman knocked on her door offering to sell her a new roof. She said she couldn't afford the $6,900. He offered to drive her to a lender where she could borrow the money. One year later in 1991, she couldn't make the loan payments and was on the verge of losing her home. The home improvement loan "included 22 percent in points and fees and carried an annual 25.3 percent interest rate." The loan was made regardless of Collier's ability to pay the loan and despite her second grade education. The so-called contractor never finished the roof.
It turns out this door-to-door home repair financing scam was pushed by a company called Fleet Finance (Fleece Finance?). Collier was by no means alone. Another elderly lady borrowed $5,000 to fix her windows. After refinancing twice, she owed Fleet $63,000. And, she had already paid $19,000 in fees and interest over nine years for that $5,000 loan.
By 2002, Georgia's governor, Roy Barnes, and others worked to pass a predatory lending bill. Realizing one of the major problems of subprime predatory loans was the ability to securitize the loan or sell it to investors, the legislators declared any entity that held a mortgage loan for resale would become legally liable for the integrity of the loan. Rivlin's chapter covering this is titled "The Great What-If." Would America have faced financial collapse in 2008 if such a law had passed and become the standard throughout the country?
In Columbus, Ohio, other slime balls were up to similar predatory loan shenanigans. The predatory lending poster couple were the elderly Clays, Larry and Martha. Both were blind and, after 39 years of work, they lived on $1,700 in monthly disability. Convinced to refinance their home loan six times, the couple owed $80,000 on a home valued at $37,000.
"As Martha Clay described it, they had been paying 7 percent interest on a $72,000 home loan but then the same mortgage broker who had put them in that loan only eight months earlier told them he could get them a better rate. But then the Clays ended up signing papers on an $80,000 loan carrying a 10 percent interest rate. So whereas the couple had been paying $480 a month on their home prior to that final refinancing, their new monthly bill was $702. For his troubles, the mortgage broker paid himself a $3,200 fee."
Churning people through multiple loan refinancings generated more fees. The profits were so huge that many established companies ventured into predatory lending. Wells Fargo, Citibank, Bank of America all became subprime predatory lenders. Greed ultimately drove mortgage brokers to sell people subprime loans, even if the people qualified for traditional mortgages at a lower interest rate. Brokers were paid a commission based upon the "yield spread premium," which meant gouging the person for a higher interest rate then they objectively should have paid. Rivlin quotes a Wall Street Journal study that said more than half the people who were sold subprime loans actually qualified for conventional mortgage rates.
Rivlin tells us how Citigroup CEO Sandy Weill destroyed Citibank with subprime loans. Citigroup's stock would plummet by 98% from over $50 a share to about $1 thanks largely to Weill. Weill would get rich by growing a subprime lender called "Commerical Credit." That allowed him to purchase a substantial share of Traveler's Insurance. Travelers Group then merged with Citigroup. Citigroup became involved with subprime lending in a big way under Weill. Investors who took a clubbing in Citigroup stock will learn the truth about what destroyed the company by reading Broke, USA.
In my 2001 book, Becoming An Investor, I wrote why banks and insurance companies are somewhat dangerous investments for individual retail investors:
This is one reason banks and insurance companies are somewhat dangerous investments. Both businesses if properly managed represent wonderful opportunities. Banks sell money. As long as the borrower can repay the loan and intends to repay the loan, all is well. Similarly, insurance companies can price policies according to sound actuarial principles. …
The problem with investing in such businesses is that an outsider has no real way of knowing what kind of loans or insurance policies are being made. If loans are being made to customers who lack the ability or desire to repay them, banking can quickly turn into a horrible business. …
You might wonder, "Why would a bank make a bad loan or an insurance firm underwrite an unfavorable policy?" One of the more common reasons is management's desire to report more earnings. CEO's and sales staff are often compensated based upon growth in sales. This can be OK, but, sometimes, there is a self-serving pressure to begin underwriting less than desirable policies. …which will lead to large write-offs down the road. … eventually, it catches up to the company and unfortunately shareholders."
This self-serving behavior is exactly what hurt Citibank investors. Rivlin explains Weill was "…anxious to demonstrate for the Street that his company, despite its size, was still a top-pick growth stock—a company, in other words, always on the lookout to jack revenues." Citigroup purchased a company called Associates, which some considered one of the worst predatory lenders. (Rivlin tells us about one borrower who wound up paying $19,000 in fees for a $1,250 home equity loan from Associates. Citibank, for its part, briefly said it thought, through superior Citibank management, Citibank could extract more per customer than Associates had in the past!)
Consumer advocate Martin Eakes spoke at a shareholder's meeting and gave Citibank investors this bit of advice, "Any CEO who will cheat his customers will eventually cheat and lie to his shareholders."
Rivlin explains why Citibank did so poorly in the mortgage mess: "Citigroup's primary problem was that it had full exposure on both sides of the subprime debacle: Through CitiFinancial, it was one of the country's leading subprime mortgage originators and on the investment banking side its people had aggressively pursued a derivative product called a collateralized debt obligation that was based on underlying portfolios of mortgages."
Rivlin points out the merger between Travelers and Citigroup would not have been permitted if it hadn't been for the Gramm-Leach-Bliley Act pushed by Texas Senator Phil Gramm. That act "…undid the post 1929 crash reform mandating that banking, brokerage, and insurance businesses remain separate." The Fed under Alan Greenspan also didn't believe in "interfering" with the mortgage markets. Greenspan believed in the Ayn Rand ideology that markets would regulate themselves and that there was little need or good in regulating capitalism. Non-Ayn-Randers believed that if behavior was left totally unchecked then greed, fraud, and corruption would run amuck. Ideology met reality, and Greenspan admitted he had found a flaw in his thinking. He was "shocked" the markets didn't self correct.
After laying waste to the morally bankrupt subprime mortgage lenders, Broke, USA turns its attention to payday lenders, which by comparison don't seem nearly as horrific. Payday lenders make short-term loans to be repaid by a person's next paycheck. Critics argue that the fees charged for these cash advances are usury and that this loan product is inherently defective because it seeks to trap people in a perpetual series of expensive loans.
The rates charged for these payday loans make loan sharks blush. For a two-week loan of $100, we learn one company charged $33. This works out to an interest rate of 858%. (I'd argue that this rate isn't fully correct. In particular, it neglects the time value of money. If we consider borrowing $100 for one year, every two weeks we'd pay $33 in interest. The total interest paid by rolling over these loans is 26 times $33 or $858. This would be a simple calculation of the actual interest paid. However, when we consider APR, we really should look at the rate we effectively pay when we borrow money at the start of the year and repay the loan in full with interest at the end of the year. This calculation would consider 26 compounding periods at 33%. Raising 1.33 to the 26th power, we'd get 1,660%. The first calculation ignores that the person borrowing the money doesn't have full use of all of the money for the full year. In fact, after 3 two-week periods, the person has already fully repaid the loan amount.)
The payday lenders argue it's expensive to make these small denomination loans, and they need to pay rent for storefronts and hire employees. They also argue people needing these loans sometimes face larger costs. For example, they need money to prevent their electrical power from being turned off, which might cost many times the loan fee to turn back on. One notorious payday lender, Allan Jones, claimed his stores barely earn minimum wage when figured on an hourly basis. During Jones' woe-is-me number, Rivlin quickly calculated Jones earned over $20 million per year from his operations. (It's kind of hard to feel sorry for a guy who has a full-size football field, fully equipped with bleachers and lights, in his back yard.)
Broke, USA does an excellent job chronicling Ohio's fight to rein in payday lending and the industry's response of launching a ballot initiative (Proposition 5) to defeat this regulatory legislation.
In the end, Rivlin concludes payday lending does more harm than good, comparing it to strip mining the poor. Rather than just meeting the occasional financial over extension, Rivlin shows us the payday loan business is crucially dependent upon repeat customer business. People earning $25,000 per year can't spend thousands a year in fees to pay off short-term loans.