Wall Street Mega-Banks Employ 'Undercover Brothers'
to Rip Off Minorities with Payday Loan Scams
The big banks are using middlemen to exploit 
lower-income people without tarnishing their own brands.
By RJ Eskow
Blog for Our Future / Alternet
October 4, 2010  |  
http://www.alternet.org/story/148398/wall_street_mega-banks_employ_%27undercover_brothers%27_to_rip_off_minorities_with_payday_loan_scams
 

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.

Ghetto blasters

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.

Everybody loses

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.

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