Making Nice With the Loan Sharks

On November 8, South Dakota approved a ballot measure that prohibits payday lenders and other small-dollar loan makers from charging an annual interest rate of more than 36 percent. It was a rare moment of bipartisanship in an otherwise ugly election season. Democrats, Republicans, and faith leaders from across the state came together to support the regulation, which passed with about 75 percent of the vote. The result marked the fourth time in eight years that a state chose to rein in usurious lending practices through the ballot box.

For some time now, public sentiment toward these high-interest, short-term loans has been souring. In March 2015, President Obama called for cracking down on payday lenders because they trap “hardworking Americans into a vicious cycle of debt.” Four months later, the Pentagon imposed a rate cap of 36 percent on firms that lend money to service members. The Consumer Financial Protection Bureau (CFPB), the agency created as part of the Dodd-Frank reform act and tasked with protecting against deceptive business practices, has also proposed rules to ensure that creditors are vetting whether their customers have the ability to settle their balances. But in her new book, The Unbanking of America: How the New Middle Class Survives, Lisa Servon asks that we consider a different perspective. She argues that payday lenders and other alternative financial institutions like check-cashing companies serve a “logical, albeit expensive” purpose for those that don’t trust or even have access to banks. And the people who opt for the former over the latter are often making a rational choice, no matter how predatory the terms of use.

Servon, a professor of city and regional planning at the University of Pennsylvania, contends that decades of consolidation within the banking industry have led to a system that is sclerotic and unresponsive to the needs of millions of Americans. Gone are the days when parents would take their children to the local community savings and loan to start putting their allowance away for a rainy day. Four commercial banks—Chase, Wells Fargo, Bank of America, and Citi—together hold about $7 trillion in assets, or 44 percent of the industry’s total. Despite the efforts of the CFPB, these organizations have faced no real consequences for their worst abuses, according to Servon. “It’s become easier for the big banks to make demands on government instead of the other way around,” she writes. “They’ve focused so single-mindedly on profit that they’ve sacrificed the well-being of their customer.”

If you’ve ever had a run-in with a bank over a bogus charge, this book will feel like a proper comeuppance for an industry that in 2015 made $164 billion in net income. The author rails against the underhanded tactics—like reordering transactions to trigger overdraft fees—that allow banks to run up the score (though the CFPB has made some progress here). Servon’s narrative largely pits the banks, which in her estimation care only about enriching their executives and stockholders, against alternative financial services that may be expensive but at least have straightforward terms of use and will take a chance on the low-income family that can’t afford a sudden medical expense. In this context, payday lenders and check cashers don’t seem so bad.

But this is a false choice. While it’s true that many of the most economically vulnerable Americans don’t have checking accounts because of their credit history, that doesn’t mean they should be left to pay exorbitant fees to cash a check. Or that those who need a quick infusion of cash because of an emergency should be forced to accept a 400 percent interest rate. This debate shouldn’t be about who offers the marginally better deal, but, rather, about why the choices are all so unsatisfactory.

To her credit, Servon acknowledges that payday lenders and check cashers have their share of problems and discusses the broader economic forces—including rising income inequality and stagnating wages—that are pushing more people to the financial brink. However, The Unbanking of America is set up to give a bigger voice to industry insiders like Joe Coleman, the president of a New York City–based check-cashing firm called RiteCheck, and John Weinstein, the president of Check Center, a payday lender in California. Both let Servon work at their companies so she could learn more about what drives consumers to them even with their unsavory reputations. From her perch as a clerk at both businesses, the author introduces us to actual customers forced to choose between bad and worse options. There’s Michelle in the South Bronx, who pays $2 to access $10 on her Electronic Benefits Transfer card because she needs the money immediately. There’s Ariane, a single mother, who takes out five payday loans to fix her busted car despite being employed at Check Center alongside Servon. In both instances, it’s an alternative financial institution that steps in to provide a lifeline.

These personal stories are compelling and, on one level, serve to soften the image of organizations that are often referred to as “sleazy” and “exploitative.” While it can be helpful to humanize the statistics behind a policy debate, there is a downside—one that Servon readily concedes. The businesses that allowed her to work for them are self-selecting. If they were skirting the law or openly bullying their customers, they wouldn’t have given her unfettered access to their stores and employees. Though she tries to balance this with a stint at a helpline for those mired in payday lending debt, the crux of the book is based on experiences with companies that are most likely outliers.

This isn’t the only problem with Servon’s thesis, which is based on the idea that large numbers of consumers are leaving the banks. While there may be undercurrents pulling people away, more and more Americans are doing business with mainstream financial institutions. In October, the Federal Deposit Insurance Corporation released a report showing that the number of households that have at least one checking or savings account rose to 93 percent in 2015. That’s up from 92.3 percent in 2013 and the highest rate the FDIC has recorded since it started keeping track in 2009.

The Unbanking of America, which was written before Donald Trump’s stunning electoral upset, strikes a decidedly populist tone, urging us to reject the weakening of the social safety net as “the new normal.” Putting payday lenders and check cashers out of business is a strategy that treats the symptoms, not the underlying disease. Predatory firms exist because millions of Americans—even those considered “middle class”—are living paycheck to paycheck. (More than half of respondents in a 2015 survey by Pew Charitable Trusts, a nonpartisan research group, said they spend the same as or more than they make in a typical month.) What’s really required, Servon maintains, is a fundamental redesign of the U.S. economy so that anyone working full-time can make enough money to support a family. “The only way to guarantee that all of us will have the ability to achieve financial health is for the government to intervene and play a much larger role,” she says. “In order to repair the system, we need a shared understanding that access to good financial services is a right, not a privilege of the fortunate few.”

How Servon would get there is not clear. Some of the solutions she advocates for, like creating a universal basic income and providing more childcare or housing subsidies for working families, are not politically realistic in the near term. She also suggests that the government could subsidize banks as an incentive to take on less profitable customers, put more federal dollars toward expanding community banks, or provide banking services at post offices, but the details are scant.

For the time being, we may be stuck with just treating the symptoms. The easiest path forward is probably to back businesses that are transforming the way we calculate a person’s credit score or are offering lower-cost loans to cut into the payday market. Servon writes about Oportun, a company in Redwood City, California, that lends money at an average interest rate of about 33 percent, but there are many more examples. Towns like Cuyahoga Falls, Ohio, have enabled their employees to borrow against future paychecks at a minimal cost. Here, too, the government can play a supporting role by cutting down on regulations while businesses test new financial products.

In the end, it will be up to our elected officials. But with the White House and both houses of Congress under Republican control for at least the next two years, things will most likely get worse before they get better. Repealing Obamacare and weakening Medicare are two of the Republican leadership’s top priorities. Trump, who campaigned on a platform of alleviating the economic pain felt by low-income and middle-class Americans, not only appointed a slew of billionaires to fill his cabinet, but chose a Treasury secretary whose former company foreclosed on the mortgages of thousands of homeowners.

Less regulation, not more, can be expected in the foreseeable future. “We have the resources and the ideas,” writes Servon. “What we need now is the political will.”