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America's unbanked.

Shortchanged: Life and Debt in the Fringe Economy

BY HOWARD KARGER

Berrett-Koehler Publishers Inc.

San Francisco

2005, 200 pages, $24.95, hardcover

SHORTCHANGED EXPLAINS WELL WHY banks and other legitimate lenders are greeted with skepticism and suspicion when they try to penetrate lower-income, inner-city markets. The financially uneducated and credit-impaired consumers in America's poorest neighborhoods have not been well-served by the slew of fringe players--payday lenders, pawn brokers, check-cashers, used-auto dealers, predatory lenders, tax preparers, refund lenders and some for-profit credit counselors--who have offered them "financial services" at a very high price.

Contrary to common conjecture, fringe businesses have also infiltrated the pockets of the functionally poor middle class, or in author Howard Karger's terms, those who "have moderate incomes but are asset-poor and debt-rich."

According to a 1999 joint report by the Federal Reserve, Federal Deposit Insurance Corporation (FDIC), Office of the Comptroller of the Currency (OCC) and Office of Thrift Supervision (OTS), Interagency Guidance on Subprime Lending, the objective of subprime lending is to "extend credit to borrowers who exhibit characteristics indicating a significantly higher risk of default than traditional bank lending customers." Legitimate subprime lenders appropriately take pride in the fact that they serve a massive market of disadvantaged consumers who, in previous decades, were denied financial services. And these legitimate lenders are providing a much-needed service. It is the fringe businesses with their questionable brand of financial services that are giving legitimate subprime lenders undeserved infamy.

In his book, Karger tells the tale of the immigrant, unbanked, poor and lower-middle-class population sectors--those living from paycheck to paycheck--and how they have been continuously taken in by the false promises of illegitimate fringe companies. These companies may be operating within the law but clearly without the public good in mind. After reading Karger's book, it becomes obvious why these victimized populations continue to be suspicious of companies having anything to do with financial services.

Shortchanged richly documents the highly questionable business practices of the worst of these players that operate in the shadows of the fringe economy.

Part of the problem is there is no simple, objective, reliable and easily accessible way for financially unsophisticated consumers to distinguish between legitimate and predatory financial-service companies. Because there is no standardized, simple way to tell these players apart, fringe businesses find loopholes that allow them to conduct transactions that appear favorable to customers because of misleading advertising offering quick-fix solutions, but end up doing great damage to these consumers' financial situations.

Fringe businesses have become so successful partly because they have mastered the mentality of their market. They understand that these consumers typically are concerned solely with how much they have to pay each week, not the interest accumulating or the fees and rules governing their long-term purchases.

Karger's anecdote of Johnny Walker explains it perfectly: "I needed a couch really bad," said Walker. "The only way for somebody in my income bracket to buy things is to make payments. I went in and they had this nice, big sectional [couch] with a couple of recliners. They wanted $600 if you paid right then. I had the $66 every two weeks. By the time I finished paying it off in a year and a half, I had forked over $1,200 for that couch. I ended up throwing it away, since it was a piece of [garbage], anyway."

Through a series of examples like Walker's, Karger explains why many lower-income consumers feel helpless when it comes to making smart decisions about debt and financing terms. The background information Karger provides in his book includes facts and statistics on many of the most marginal business sectors, which, sadly, have proven to be not so marginal after all.

According to John Caskey, professor of economics at Swarthmore College, Swarthmore, Pennsylvania, in his book Fringe Banking, the 4,500 mom-and-pop pawnshops in the United States in 1985 multiplied into 14,000 by 2000, five of these being publicly traded chains. The Fannie Mae Foundation stated in its 2001 report, Low-Income and Minority Families Rely Increasingly on High-Cost Financial Services, that there are now more pawnshops in the United States than both credit unions and banks combined.

The growth of payday-loan shops and check-cashing outlets in the past decade has matched that of pawnshops. As Karger writes, "McDonald's has 13,500 U.S. restaurants, Burger King has 7,624, Target has 1,250 stores, Sears has 1,970, J.C. Penney has about 1,000 locations and the entire Wal-Mart retail chain includes about 3,600 U.S. outlets. The combined 29,000 locations are fewer than the nation's 33,000 check-cashing and payday lenders--just two sectors of the fringe economy."

Although Karger's objective is to spread awareness to consumers by dismantling each fringe sector's puzzling methods of exploitation, he admits that the fringe economy serves an important purpose: Fringe businesses address the financial needs of the credit-impaired, poor-consumer based of America that would otherwise be unable to afford, a safe ride or a secured credit card. Karger puts it best in his book: "[T]he fringe economy can't be simply outlawed without harming the very people who need it the most."

So if abolishing the fringe economy would cause more hurt than it would help, a better answer appears to be imposing tighter regulatory reforms on the most offensive segments of these industries. And to reform the fringe economy, Karger believes we must institute "more-robust federal and state regulation" over the fringe economy; advocate consumer empowerment through financial literacy services; push for the continuing development of traditional banks and mainstream financial institutions serving lower-income populations; and create more well-funded, community-based financial institutions.

Indeed, Karger's plea for reforms echoes an initiative being pursued by the Mortgage Bankers Association (MBA), as articulated by Chairman-Elect Regina Lowrie, CMB, in her May 2005 testimony before the House Financial Services Committee. From a mortgage lending standpoint, Lowrie and MBA believe there needs to be a uniform federal standard in order to better address predatory and abusive lending practices rather than the piecemeal and conflicting state and local laws that don't provide uniform protections in all markets.

As Karger and MBA both understand, knowledge can truly be power when it comes to conducting safe and consumer-friendly business dealings in the nonprime lending industry. As Lowrie testified: "MBA is strongly committed to borrower education to help consumers understand the mortgage process and shop for the best mortgage that meets their needs. MBA also believes that education protects borrowers against lending abuses. Accordingly, MBA would support further government activity to facilitate borrower education as part of a national law to combat abusive lending."

Shortchanged is filled with realistic human anecdotes that bring the book's economic and financial data to life. These anecdotes provide readers with an insider's guide into the judgment process of a typical fringe-economy customer. For example, Nancy Morrow turned to pawnshops when she had nowhere else to go. When she had reached an all-time financial low--no bank account, credit card or sources for borrowing money--she got "sucked into a pawnshop," she said. Her addiction to pawning persisted until she was thousands of dollars in debt to one pawn shop.

Listen to Morrow's story: "I have until January 28 to come up with $80. Here's the thing ... $80 to get [the pawned item] out, or I could just pay the $29 in interest to keep them from selling it. I always push it to the last possible day--'OK, well, tomorrow the computer is spitting it out. It's going to be on the floor. It's 10 days past the last grace day.' Most pawnshops are the same. I've got 10 days past this date. They don't say it, but they won't put my stuff out. As long as I come in--it's worse than a drug habit," she said.

Some players in the rent-to-own industry can drive people into similar downward financial spirals. Listen to Jim Marolian, former manager of a rent-to-own store and reformed salesman, tell it like it is: "When you go into homes that you're delivering furniture or merchandise to, you have to step over something, like a hole in the floor. Those old wood houses they live in, definitely living week-to-week, pay-check-to-paycheck. But they were sure to have their $10 rental payment to the store for that 19-inch TV that was [financed] for 78 or 91 weeks and cost them $900 instead of $200--which in itself is criminal. But it's the way it was and still is.... Could these customers do it any other way? Could they save money up? Yes. Probably with some help, someone could help them with their finances," he said.

This brings up another problem. According to the book, there are some players in the getting-out-of-debt industry that pose under the heading of "nonprofit" companies even though they conduct for-profit businesses. As a result of the seemingly inadequate regulation governing these businesses, the total complaints registered with the Better Business Bureau in 2002 against debt-management and credit-counseling agencies rose to 1,480 in 2002, up from 261 in 1998, according to the Better Business Bureau's 2002 study.

The National Consumer Law Center (NCLC), Boston, states: "The credit-counseling industry has undergone an alarming transformation in the last decade.... Aggressive firms masquerading as nonprofit organizations are gouging consumers. Deceptive practices and outright scams are on the rise. More consumers are getting bad advice and access to fewer counseling options."

Finally, what attracts many susceptible consumers to fringe-economy businesses is the way in which they market themselves. Fringe businesses under-stand their lower-income customers want a sugarcoated salesperson to sympathize with their situation, speak their language and work in a neighborhood that is convenient for them to walk to. Although many are attracted by advertisements many more are lured in by the initial patience, kindness and familial air of sales staff.

However, Kyle and Marti Johnson, two college students from the University of Oklahoma, said the service-with-a-smile doesn't always last: The experience "was horrible, absolutely horrible," they said. "They [rent-to-own collectors] are ridiculous. And they harass you. They come to your door. We are two or three days behind. Phone calls every five minutes. Once they start coming to your door, they leave nasty notes on it, like, 'We're going to come pick up your stuff if you're late again.' We were definitely treated with disrespect."

To promote more widespread financial literacy so consumers aren't as likely to fall prey to abusive financial services schemes, MBA launched its consumer education Web site for prospective homebuyers, Home Loan Learning Center (www.homeloanlearningcenter.com) in May 2005. A Spanish version of the site (www.centrohipotecas.com) was launched in July 2005. Both Web sites provide consumer-friendly, jargon-devoid advice along with numerous tips stressing the importance of seeing a lender first when home-shopping.

According to Charles Gerena, a business writer for Region Focus, the Federal Reserve Bank of Richmond's quarterly business magazine, in his 2002 article "Need Quick Cash?," the few hundred payday-loan shops in the United States in 1990 grew exponentially to about 10,000 in 2001. Gerena predicted that number would more than double in just one year, to 25,000--a fact Karger confirms in his book, stating that there were more than 25,000 payday-loan shops in the country by the end of 2002.

From a mortgage banking standpoint, the main challenge for the industry in the years ahead will be to find a way to help these people become successful homeowners and financially savvy borrowers and to put their days of being at the mercy of fraudulent players behind them. Shortchanged gives the reader some insight into the scope of this challenge.

Reviewed by Molly Shaw, an editorial contributor to Mortgage Banking and a member of the Communications and Marketing Department at the Mortgage Bankers Association (MBA).
COPYRIGHT 2005 Mortgage Bankers Association of America
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Title Annotation:Shortchanged: Life and Debt in the Fringe Economy
Author:Shaw, Molly
Publication:Mortgage Banking
Article Type:Book Review
Date:Oct 1, 2005
Words:1961
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