ShortchangedLife and Debt in the Fringe Economy
Berrett-Koehler PublishersCopyright © 2005 Howard Karger
All right reserved.ISBN: 978-1-57675-336-1
Chapter One America's Changing Fringe Economy
Driving through low-income neighborhoods, you can't help but notice the large number of pawnshops, check cashers, rent-to-own stores, payday and tax refund lenders, auto title pawns and buy-here, pay-here used-car lots. We are awash in "alternative financial services" directed at the poor and those with credit problems. These fringe economy services are equivalent to an economic Wild West where just about any financial scheme that's not patently illegal is tolerated.
Elise and Bernardo Rodriguez are typical fringe economy customers. The Rodriguezes emigrated from Honduras to San Antonio, Texas, in the middle 1990s. Elise works for a company that cleans office buildings, and Bernardo owns a small landscaping company. They have two school-age children. Although the Rodriguezes are paid by check, they don't have a checking or savings account. Instead, they use ACE Cash Express to cash their checks and to electronically pay bills. When electronic bill paying is not available, the Rodriguezes use money orders. They also wire money back to their family in Honduras through ACE. In fact, ACE is an important part of the Rodriguezes' banking system. Occasional trips to pawnshops and check cashers round out their informal banking system.
There are several reasons why the Rodriguezes use check cashers. For one, they can't wait for checks to clear. Because they make so little money, they live hand-to-mouth, and waiting a week or more for a check to clear the banking system means not having food on the table. Second, their account balances are so small after the rent and car payments that there's almost nothing left after the second week of the month. Third, the Rodriguezes live in a cash economy, and many of the small shops where they buy food, clothing, and other necessities accept only cash. Checks are viewed skeptically and generally not accepted. The Rodriguezes don't trust banks, and they don't feel welcome there. They are also reluctant to write checks for fear of bounced-check fees from banks and merchants. All told, the Rodriguezes spend almost 10% of their net income on alternative financial services, which is average for unbanked households that rely on the fringe economy for their financial needs.
Defining the Fringe Economy
There is no generally agreed-upon definition of the fringe economy or of predatory lending. In fact, if a broad definition is applied that includes high-interest home refinancing and credit cards, then the fringe economy is used as frequently by the financially troubled middle class as by the poor. Nevertheless, in a public relations spin, the industry uses "subprime lending" to refer to "loans made to borrowers with credit problems by charging higher, but still fair, fees." The Federal Reserve Board defines subprime lending as "extending credit to borrowers who exhibit characteristics indicating a significantly higher risk of default than traditional bank lending customers."
Although a continuum supposedly exists between subprime and predatory lending, the delineation between the two is unclear. For example, what differentiates "expensive" or "very expensive" from "predatory" lending? When does an interest rate go from subprime to predatory? While not all subprime loans are predatory, all predatory loans are subprime. As Citigroup concedes, "There is no standard industry-wide approach to the definitions of either subprime loans or subprime lending programs, indicating that the meanings of these terms are institution specific."
Under the Home Ownership and Equity Protection Act (HOEPA), a mortgage is considered high interest if the annual percentage rate (APR) is 8 points (8%) for first mortgages and 10 points for subsequent loans above the rate of return on Treasury securities for the same period, or if the fees and points at closing are 8% or more of the loan amount. This definition of a high-cost loan would be a bargain for the many fringe economy customers whose interest rates are measured in the hundreds of percent. A clear definition of predatory lending is important, since without it all manner of abuses can be overlooked.
The Scope and Profitability of the Fringe Economy
The spartan and often shoddy storefronts of the fringe economy mask the true scope of this economic sector. In 2003 government spending on social welfare programs included the following:
$29 billion for Temporary Aid to Needy Families (TANF), the replacement for Aid to Families with Dependent Children (AFDC)
$35 billion for Supplemental Security Income (SSI)
$33 billion for food stamps, the Special Supplemental Food Program for Women, Infants, and Children (WIC), and school lunch programs
$25 billion for the U.S. Department of Housing and Urban Development's (HUD) low-income housing programs
Altogether, the bulwark of America's public-assistance programs cost less than $125 billion. By comparison, check cashers, payday lenders, pawnshops, and rent-to-own stores engaged in at least 280 million transactions in 2001, generating about $78 billion in gross revenues. If we add subprime home mortgages and refinancing, as well as used-car sales, revenues in the combined sectors of the fringe economy are several times higher than federal and state spending on the poor.
About 22,000 payday lenders extended more than $25 billion in short-term loans to millions of households in 2004. The 11,000 check-cashing stores alone processed 180 million checks in 2002, with a face value of $55 billion. The sheer number of fringe economy storefronts illustrates the scope of this sector. For example, 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. These combined 29,000 locations are fewer than the nation's 33,000 check-cashing and payday lenders, just two sectors of the fringe economy.
ACE Cash Express, the nation's largest check casher, is an example of the scope, growth, and profitability of the fringe economy. In 1991 ACE had 181 company-owned stores; by 2003 that number had risen to 1,230 company-owned and franchised stores in 37 states and the District of Columbia. (ACE plans to add another 500 stores by 2008.) In 2000 ACE's net income was $8.3 million; by 2004 that had risen to $17.1 million. ACE claims about 1.2 million new customers a year, and in 2004 it served 38.2 million customers, or about 11,000 an hour. The company's revenue corresponded to its growth. In 2000 ACE's revenues were $141 million; by 2004 they had jumped to $247 million. In 2004, ACE
engaged in 41 million total transactions worth over $8 billion,
cashed approximately 13.2 million checks with a face value of $5.1 billion,
made 1.9 million payday loans and earned $77 million in fees,
completed 9.7 million bill-payment transactions,
made 2 million wire transfers (worth $581 million) and sold 8.8 million money orders with a face value of $1.2 billion,
added 53 new stores, compared with 14 in 2003.
ACE expects its total revenue for fiscal 2005 to range between $265 million and $270 million.
Advance America, Cash Advance Centers, Inc., is the nation's leading payday lender, at least as measured by the number of its stores. By 2004 Advance America had 2,290 stores in 34 states. In 2003 it employed 5,300 people and had $489.5 million in sales with a net income of $96 million. Advance America allied with out-of-state banks in 2002 to evade limits that some states imposed on the industry's excesses. After the federal Comptroller of the Currency cracked down on a bank that helped Advance America evade state regulation, the company affiliated with Federal Deposit Insurance Corporation (FDIC)-regulated state-chartered banks to further dodge regulation.
The company is a strange bird in the world of payday lending. William "Billy" Webster IV, Advance America's CEO and cofounder, was former president Clinton's director of scheduling and advance. Despite lending money to working people at exorbitant interest rates, Advance America partnered with seven nonprofit organizations in 2004 to "get out the vote." These nonprofits included the League of Women Voters, the National Urban League, the National Association of Latino Elected and Appointed Officials Educational Fund, People for the American Way Foundation, the League of United Latin American Citizens, the Southwest Voter Registration Education Project, and the Georgia Coalition for the People's Agenda. The drive signed on 110,000 new voters-double its original goal of 50,000-partly because of the availability of voter-registration forms in more than 2,000 Advance America locations in 29 states.
Dollar Financial Corporation operates 1,106 stores-including 630 company stores-in 17 states, the District of Columbia, Canada, and the United Kingdom. Company stores operate under names like Money Mart, Loan Mart, and Money Shop. Dollar's 2004 revenues from its U.S. and international operations were $246.5 million. Unlike most fringe economy sectors, Dollar lost $28 million in 2004. Check into Cash has more than 700 stores, and CIC, its financial subsidiary, makes personal loans up to $1,000 in select markets.
In 1985 there were 4,500 pawnshops in the United States; by 2000 that number had risen to 14,000, including five publicly traded chains. The three big chains-Cash America International, EZ Pawn, and First Cash-had combined annual revenues of nearly $1 billion in 2003. Cash America is the largest pawnshop chain, with 750 total locations in 17 states. It also offers payday loans through Cash America Payday Advance stores. In addition, Cash America provides payday loans and check cashing through Cashland and Mr. Payroll stores. In 2003 Cash America had revenues of almost $438 million, with a net income of $30 million. From 2001 to 2003 its revenues rose 23%, and net income was 60% higher from 2002 to 2003.
EZ Pawn owns 275 pawnshops in 11 states. Its 2003 revenues were $206 million, with a net income of almost $8.9 million. First Cash Financial Services, the nation's third-largest publicly traded pawnshop chain, has 280 pawnshops and check-cashing outlets in 11 states and Mexico. Its revenues totaled about $164 million in 2004.
The $6 billion-a-year furniture and appliance rent-to-own industry serves 3 million customers annually. Rent-A-Center is the largest rent-to-own corporation in the world, employing 15,000 people. The company owns or operates more than 2,800 stores in the United States and Puerto Rico under the names of Rent-A-Center, Rent Rite, Rainbow Rentals, and Get It Now. It also controls 320 franchises through its subsidiary Color-Tyme. n 2003 Rent-A-Center's sales were about $2.3 billion, with $181.5 million in net income. Aaron Rents has almost 900 stores across the United States and Canada. In 2003 its gross revenues were $767 million, reflecting a net income of $36.4 million. In 2004 RentWay operated 753 stores in 33 states and had revenues of almost $504 million.
Low-income consumers paid almost $1.75 billion in fees for tax refund loans in 2002, and the nation's largest tax preparers earned about $357 million from fringe economy "fast-cash" products in 2001, more than double their earnings in 1998. All told, about 12 million consumers received tax refund anticipation loans in 2002, almost half through H&R Block, whose revenues jumped from $2.4 billion in 2000 to $3.8 billion in 2003.
The fringe economy is also buoyant in the housing market, where subprime home mortgages rose from 35,000 in 1994 to 332,000 in 2003, a growth rate of 25% a year and an almost tenfold increase in just nine years. In 2003 these mortgages accounted for almost $300 billion18; by that year, almost 9% of all mortgages were subprime.
One reason for the profitability of the fringe economy is the relatively low cost of starting and running these businesses. For example, few of the check-cashing and payday stores I visited had more than one employee working at a time. Usually I was the only customer, and I was hard-pressed to imagine a restaurant or retail operation surviving with so little traffic. I suspected that the profit margin was so high that it compensated for the slow traffic.
Unlike typical retail businesses that require a substantial inventory and a large number of employees, a new payday or check-cashing store can open with a relatively modest investment, although that varies based upon the size and type of store. For instance, starting a new check-cashing store requires about $65,000-$75,000, which is counterbalanced by incentives from corporations like MoneyGram. The basic startup costs include property improvements, computer equipment, and a security system. In addition, the typical check-cashing and payday storefront requires working capital of $80,000-$100,000 for operating expenses and to fund the store's loan portfolio. According to ACE, it takes about one year for a store to break even.
There's considerable money to be made from the financial misery of the poor and credit-challenged. And if the fringe economy squeezes its customers, it's certainly generous to many of its CEOs. According to Forbes, salaries in many fringe economy corporations rival those at much larger companies. Sterling Brinkley, chairman of EZ Pawn's board of directors, earned $1.26 million in 2004. Cash America's CEO, Daniel Feehan, was paid almost $2.2 million in 2003 plus the $9 million he had in stock options. Feehan is also on the board of Radio Shack. James Kauffman, executive vice president of Cash America's international operations, received a paltry $932,000 but had $2 million in stock options. In 2003 First Cash Financial Services' board chairman, Phillip Powell, made $1.4 million along with the $19 million he had in stock options. Rick Wessel, vice chairman of First Cash's board, received $1 million in salary and owned $3.9 million in stock options.
According to ACE, "We also take great pride in being an active and empowering force in the communities in which we operate. That is why we give 1% of net income annually to support children's causes, education and financial literacy. We call it: Giving Back-The ACE Community Fund.... During fiscal 2004, ACE donated over $200,000 to various charities across the U.S." In contrast to ACE's "generosity," its CEO, Jay Shipowitz, received $2.1 million in total cash compensation in 2004 on top of his $2.38 million in stocks.
Dollar's losses in 2004 didn't stop CEO Jeffrey Weiss from earning $1.83 million, of which $1 million was a bonus. Rent-A-Center's CEO, Mark Speese, made $820,000, with total stock options of $10 million. R. Charles Loudermilk, Aaron Rents' CEO, received a total cash compensation of $1.17 million in 2003 and had stock options of $5.8 million. He also controls 60% of the company's voting power.
Billy Webster, Advance America's CEO, earned only $650,000 in 2003. However, the 4.6 million shares he owns in the company were worth almost $101 million in early 2005. (Webster's wife also owns considerable stock in Advance America.) Not to be outdone, George Johnson Jr., chairman of Advance's board and its other cofounder, indirectly owns about 10 million shares in the company worth $218 million in early 2005. Inducted into the South Carolina Business Hall of Fame, Johnson served three terms in the South Carolina House of Representatives, having been elected as an independent, a Democrat, and a Republican. From 1984 to 1985 he was also a director of the Federal Reserve Bank of Richmond.
America's fringe economy is clearly not a mom-and-pop industry composed of small storefronts that generate moderate family incomes. Instead, it is a fast-growing and highly developed parallel economy that provides low-income and credit-impaired consumers with a full spectrum of cash, commodities, and credit lines.