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Taming the Sharks: Towards a Cure for the High-Cost Credit Market

Taming the Sharks: Towards a Cure for the High-Cost Credit Market

by Christopher Peterson

Taming the Sharks: Towards a Cure for the High Cost Credit Market chronicles the historic, economic. legal, and political factors breeding America's feverish high cost debt industry. The ideas presented are novel, progressive, and controversial. Historians have long argued that interest rates provide a sort of economic and political health of nations. If true,


Taming the Sharks: Towards a Cure for the High Cost Credit Market chronicles the historic, economic. legal, and political factors breeding America's feverish high cost debt industry. The ideas presented are novel, progressive, and controversial. Historians have long argued that interest rates provide a sort of economic and political health of nations. If true, the contemporary American market for credit shows troubling signs of distress. While Federal Reserve Board monetary policy has kept commercial and prime consumer interest rates low, the past two decades have seen explosive growth in an industry specializing in high-cost consumer debt. Payday loan outlet chains, automobile title loan companies, rent-to-own furniture stores, pawnshops, and sub-prime and manufactured home mortgage lenders are transforming the personal finance patterns of millions of Americans. Many observers have complained this industry charges excessive prices, uses unfair business practices, and is generally causing more harm for its borrowers than good. Industry insiders retort they are merely responding to a legitimate demand for financial services that, in effect, consumers vote with their feet. Echoing problems of past centuries, today's consumers face difficulty comparing credit prices, patterns of reckless lending and borrowing, as well as distressing economic externalities. With an idea on the future, Peterson's book hopes to find ingredients of a compromise to protect working-poor borrowers while simultaneously preserving economic competition.

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University of Akron Press, The
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Series on Law, Politics, and Society
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5.75(w) x 8.75(h) x 1.38(d)

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Taming the Sharks

Towards a Cure for the High-Cost Credit Market
By Christopher L. Peterson

The University of Akron Press

Copyright © 2004 Christopher L. Peterson
All right reserved.

ISBN: 1-931968-09-8

Chapter One

Debt Fever: An Introduction to High-Cost Consumer Credit

If you advance money to any poor man amongst my people, you shall not act like a money lender: you must not exact interest from him. If you take your neighbor's cloak in pawn, you shall return it to him by sunset, because it is his only covering. It is the cloak in which he wraps his body; in what else can he sleep? If he appeals to me, I will listen, for I am full of compassion. -Exodus 22:25-7

A leading and acclaimed business historian said of credit that, "free market long-term rates of interest for any industrial nation, properly charted, provide a sort of fever chart of the economic and political health of that nation." In general, mainstream America has enjoyed historically low interest rates for over a decade, suggesting a robust economy and a responsive democracy. Our consumer credit system facilitates access to shelter, transportation, education, and many other goods and services both necessary and desirable in modern life. A family home bought over time with an inexpensive fixed-rate mortgage is a mainstay of the American dream, creating stability in extended families, neighborhoods, and entire communities. In financing a car, a worker can exchange a financial obligation for the priceless freedom to travel where and when she chooses. Borrowing in order to finance an education is an irreproachable investment in one's future. For these reasons and others we should all be proud that affordable credit is available to so many Americans.

Nevertheless, we must also remember that nations are made of groups within groups and ultimately of individuals. To say a nation has an interest rate fever is only to make a generalized claim about particular people, each with names and stories, and each of whom more or less contributes to the truth of the statement. A nation infected with a fever is so called because many people pay high prices for the use of money, people like Leticia Ortega, a computer store cashier in San Antonio, Texas. Short on cash, Ortega was facing termination of her past due telephone and electrical utilities. With her next paycheck still two weeks away, she saw an advertisement for a short-term loan in the Thrifty Nickel, a weekly local classified listing newsletter. The advertiser, National Money Service, Inc., offered a two-week $300 loan for a charge of $90. Despairing for some other solution to her shortfall, Ortega borrowed the money. But after two weeks had passed she was no closer to financial solvency than before. Unable to pay the entire $390 due, National Money Service "rolled over" the loan by withdrawing $90 directly from Ortega's checking account. Because Ortega was living paycheck to paycheck, with no surplus income available to retire the $300 debt, she continued to pay the $90 every two weeks for nearly a year. Eventually she paid $1,800-a substantial portion of her yearly income-but still owed all of the original debt. The annual interest rate of Ortega's loan was just under a feverish 800 percent.

Even "healthy" nations have always had individuals who pay feverish prices for the use of money. The governments, corporations, banks, and wealthy individuals of our society have in general successfully immunized themselves from high interest rates through sound monetary policy, well-considered government regulation, and, most importantly, by harnessing competitive market forces. But for America's working class, and for America's increasingly vulnerable lower-middle-class, the analogy between health and credit prices begins to suggest a different medical chart. This book argues the high-cost consumer credit often extended to this group is best seen as a persistent low grade infection, sometimes more and sometimes less noticed by elites, but always burning the vulnerable.

Americans in all demographic categories are borrowing more relative to their disposable income than ever before. In fact, for the first time in American history, our collective debts have exceeded our collective disposable income. As Table 1.1 shows, debt burden as a percentage of disposable income has grown steadily throughout the latter twentieth century. From a modest 31.9 percent of disposable personal income in 1949, outstanding debt grew to 71.9 percent by 1979. By the mid-1990s debt represented 91.9 percent of personal disposable income. And, despite rapid growth in stocks and productivity in the latter 1990s, by the turn of the century Americans had more debt than disposable income. Thus, as the Economic Policy Institute explained, "[a]t the aggregate level, debt is a more important feature of the household economy than at any time in modern history."

For most Americans this increasing debt has been benign. The purchased use of money-credit-is a valuable commodity for nations, corporations, and households alike. As one scholar has explained, "consumer credit is about much more than instant gratification. It is also about discipline, hard work, and the channeling of one's productivity toward durable consumer goods." For affluent Americans it is safe to say the increasing debt load of the past two decades may be ascribed to comparatively well-considered obligations purchased at tolerably low interest rates for mostly good reasons. Moreover, the stock market boom and dramatically rising productivity of American workers in the 1990s was kind to America's more affluent citizens, offsetting the impact of rising debts. Despite the burst technology bubble and currently slower growth, for the relatively affluent middle class on up, America has a strong economy and bright prospects.

But for less well-off Americans, the ever-rising proportion of disposable income dedicated to outstanding debt hints at a darker future. At the end of the twentieth century a new and distressing trend of spreading financial infection has emerged-an interest rate fever for which a growing number of working-class and lower-middle-class Americans have scant resistance. With approximately 90 percent of all stocks and bonds owned by the wealthiest 10 percent of American society, the stock market boom of the 1990s scarcely benefitted our most vulnerable groups. According to the most recently published federal survey of consumer finances, approximately 12.6 percent of all American families have annual incomes of $10,000 or less. Of these families-including families with household heads at ages close to or in retirement-less than two percent have invested in mutual funds, less than four percent own any stocks at all, and no statistically significant number own bonds. Table 1.2 explains that while vulnerable families' assets grew, their debts grew faster. The result was that the least wealthy 40 percent of American households saw a dramatic decline in their net worth despite the growing economy. Thus, as one scholarly work puts it, "the real story of the 1990s was not the stock market boom, but the debt explosion." Or, in the more restrained -and portentous-words of Federal Reserve Board Chairman Alan Greenspan, "families with low-to-moderate incomes and minorities did not appear to fully benefit from the highly favorable economic developments of the mid-1990s."

At the same time net worth has declined, low to moderate income Americans have also experienced stagnation or a decline in the real value of their wages. Between 1973 and 1999, the median weekly wage in the United States fell 12 percent from $502 to $442. Although the real value of median weekly wages recovered slightly in the mid- to late 1990s, it still has not recovered to its 1988 level. In the words of Federal Reserve Board researchers, "mean incomes for all education groups in 1998 were lower than they had been in 1989." For families headed by a worker with no high school degree, real income declined even in the rapid growth years between 1995 and 1998.

Unsurprisingly, key indicators of financial instability have increased in proportion to declining real wages and net worth. For instance, the 1990s saw significant increases in the number of households with debt service payments equal to more than 40 percent of household income-an important indicator of financial hardship caused by over-indebtedness. Perhaps more ominous is a startling increase in the number of lower-middle-income families who were late in paying bills over the past decade. Of families with annual incomes between $25,000 and $49,999, in 1989 only 4.8 percent were late sixty days or more in paying at least one bill. By 1998 this figure nearly doubled to close to one family in ten.

While working poor families saw increased debt load and decreased earning power, their access to traditional banking services has also decreased. Prefacing a major market shift in the financial servicing of America's working poor, the number of families without a bank account increased by 77 percent between 1977 and 1989. Many of the key pressures keeping working poor families out of banks and savings associations remained, and perhaps increased, in the 1990s growth economy. A Federal Reserve Board report shows that while most banking fees paid by solvent customers remained static, those fees commonly charged to consumers in financial trouble grew dramatically in the late 1990s. Stop payment orders, overdraft charges, not sufficient funds fees, and below minimum balance fees-all acutely felt by families experiencing income shocks-grew much faster than inflation in the last decade. For instance, bank and savings association overdraft charges grew 17 and 23 percent respectively between 1994 and 1999 alone. Not sufficient funds check fees and stop payment order prices both rose about 15 percent in this five year period. And bank fees charged to customers whose savings account balances dipped below minimum requirements grew by a surprising 31.3 percent. At the turn of the century, the best estimates suggest 13 to 15 percent of all American families are "unbanked"-"nearly double the proportion in England." Of families without checking accounts, 86.2 percent had annual incomes less than $25,000 and 44.7 percent had annual incomes less than $10,000. About 57 percent of these families were non-white or Hispanic. Currently, over 20 million Americans have no access to mainstream banking services.

Observing these trends, many have begun to ask this question: If working poor and lower-middle-class families have, over the past two decades, borrowed more, but banked with traditional first-tier lenders less, with whom are they doing business? A short survey of recent headlines begins to answer this question:

"Short-term Loan Firms Prospering: Critics Say High Interest Rates, Easy Terms Have Led to Exploitation of Working Poor"

"Easy Money: Subprime Lenders Make a Killing Catering to Poorer Americans. Now Wall Street Is Getting in on the Act"

"Payday Lenders Face Fiery Criticism: Consumer Advocates Say Federal Law Allows Institutions to Operate Like Loan Sharks"

"Time to Restore Loansharking Laws"

"Borrowing Trouble: How Can Legislators Not Be Offended By Payday-Advance Business that Charge Outrageous Fees to Cash Strapped Consumers?"

"How High Can the Finance Companies Go? With Interest Rates, the Sky Is the Limit"

"Banking on a Costly Alternative: Low Earners Turn to Check Cashing Stores"

"Wolf At the Door: Vulnerable Need Protection Against Predatory Lenders"

"Shark Attacks: An Encounter with Predatory Lenders Can Leave You Without Your Money-Or Your Home"

"Feeding Off the Bottom"

"Little Loans Come at Staggering Cost"

"New Lenders with Huge Fees Thrive on Workers With Debts"

"It Was Illegal When It Was Loansharking"

Unfortunately, hard data on financial service providers that cater to the working poor is notoriously sparse. Nevertheless, upon examining the growth and business practices, as well as the stories associated with many second-tier lenders, the answer becomes clear. Working poor families have turned to a looseknit patchwork of businesses, including small moneylending firms, multinational consumer credit corporations, high-rate credit card issuers, mortgage loan companies, payday loan/check-cashing outlets, automobile title loan companies, rent-to-own furnishing stores, and pawnshops, to serve their financial needs. Although this industry has a wide variety of practices, norms, and agendas, the one unifying characteristic possessed by all is that they sell credit at relatively high cost.


The personal finance industry catering to high-risk, low-income borrowers defies easy description. A variety of names are associated with this industry including alternative finance lenders, sub-prime lenders, specialty lenders, small loan lenders, fringe bankers, predatory lenders, and sometimes loansharks. In the eighteenth and nineteenth centuries the word "usury" contextually linked the group together-given widespread interest-rate caps which drew a rough line between socially acceptable and unacceptable credit. Originally the word "usury" came from the Latin noun usura which referred to the "use" of anything; "hence, usury was the price paid for the use of money." But as moderately priced consumer credit sold to the middle class became entrenched in the twentieth century, the legal as well as cultural lines distinguishing usurious credit eroded. For some "usury" refers to an unfair loan. Others use the word to describe an illegal loan without hinting at any concurrent moral condemnation. The word can also refer to the body of law regulating the amount of interest charged. It may also refer to a particular statutory limitation in a particular jurisdiction. Sometimes usury refers not to an entire loan, but only to the amount of interest that exceeds the legal rate. Courts have disagreed whether non-interest charges are included for purposes of calculating usury law violations. Often it is not clear from the context which meaning the authors intend. At the beginning of the twenty-first century the word "usury" has become something of an inconveniently ambiguous anachronism.

A more useful reference increasingly used in both federal and state law is the simple description "high cost." The essential difference between mainstream creditors and "alternative finance lenders" is relatively expensive prices. Moreover, "high cost," unlike usury, is a fluid enough concept to readily include both interest and non-interest charges, such as origination fees, brokerage fees, processing fees, application fees, credit insurance premiums, appraisal fees, refinancing charges, late payment penalties, early payment penalties, and dozens of other creditor inventions which tend to obscure the true cost of a loan.


Excerpted from Taming the Sharks by Christopher L. Peterson Copyright © 2004 by Christopher L. Peterson. Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Meet the Author

Christopher Peterson is an assistant professor of law at the University of Florida, Levin College of Law at Gainesville, Florida. He received his B.A. in philosophy and a B.S. in political science from the University of Utah. In 2001, he received his law degree of the University of Utah College of Law.

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