Drive down the main streets of the more depressed cities in America, and you probably won’t encounter the logos of Bank of America, Wells Fargo or JPMorgan Chase. Instead, you’ll be bombarded by signs that read more like demands: Instant Loans Here! No Credit Necessary! Payday Advance!
These billboards turn out to be a good way to find customers. People are broke: payday lending and other high-cost, small-dollar loan businesses have grown along with the economic desperation caused by the Great Depression and its aftermath. The economy is rough, joblessness is high, and wages are low. The US banking system doesn’t embrace everyone – the high fees and minimum balances imposed by Chase, Wells Fargo, Bank of America and others mean that someone on minimum wage, or living paycheck-to-paycheck, can’t afford to keep a bank account.
But this creates a problem: the US government believes payday lending is predatory, and it is combing the financial system to find ways to do it; the Department of Justice’s attempts to shut down payday lenders and their access to money have stealthy spy-novel names like Operation Chokepoint. The payday lending industry, surprisingly nimble and sprawling in its scope, keeps outrunning the government. In the middle are working-class Americans – shut out of the bland, comfortable worlds of drive-in bank branches and looking for ways to make ends meet while their salaries fall and expenses rise.
Still, anyone in the middle class, accustomed to the bland comfort of a bank branch on every block, the idea of taking out a payday loan seems baffling, or even repellent.
The long and short of payday lending
To qualify for a payday loan, you only need two things: to be too broke to pay your bills, and willing to pay high fees to get money to bridge the gap.
Cash-strapped borrowers go to payday loan shops because they can get money, quickly, without showing their credit score or proving an ability to repay.
“People go into these stores with financial desperation and the loans make it worse,” says Ann Badour, a senior policy analyst with the Texas branch of the Appleseed Network, a public interest legal group. To get the money, you agree to pay the equivalent of interest rates up to 350% on a two-week loan. Borrowers pay a high upfront fee of between $15-$20 for every $100 they need, and agree to pay the balance within two weeks – which is usually the next payday.
One payday loan won’t kill you, but getting behind on your bills tends to be a chronic condition. Most borrowers use payday loans for basic needs, and the more they borrow, the deeper they go into the hole. Invariably their balance gets rolled over into a new loan, with each additional round inflicting more and more fees.
Dubious. Photograph: Jonathan Nicholson/Demotix/Corbis
“The business model is to identify customers and lend to them as much as possible,” said Tom Feltner, director of financial services at the Consumer Federation of America.
It’s designed to be a cycle: two-thirds of the Americans who signed up for a payday loan took out seven or more loans per year, according to a study by the Consumer Financial Protection Bureau. In most cases, the new loans are made the same day as the previous loans are closed.
Nor is payday lending a small niche. It’s sweeping America’s working class. Over 12 million Americans use payday lenders each year, taking out almost $30bn in loans in 2010, according to The Pew Charitable Trusts. That’s three times as many Americans who took out payday loans in 2000.
Payday lenders increasingly force their customers to give them automatic access to their bank accounts to ensure payment. When the borrower renews the loan, the fees come out automatically. This is precisely what makes payday lending so profitable: the guaranteed ability to collect fees. And by the time borrowers get off this debt treadmill, they’ll have paid much more in fees than their initial loan balance.
Reining in a predatory practice
Despite renewed regulatory efforts at the state and federal level to protect consumers, the battle to contain payday lending sometimes looks like an endless race that regulators can never win. When regulators ban one aspect of the short-term loans, another crops up.
The internet in one photo. Photograph: Jack Carey/Alamy
Regulators have been busy. Fourteen states have banned the core aspect of payday loans – the “balloon payment” that requires borrowers to pay the entire balance at once when the loan comes due. Other states have capped interest rates at a certain annual percentage, which would make payday lending unprofitable. Other states have targeted how often consumers can take out payday loans. Washington state limits payday loans to five per year, and Illinois mandates that customers in debt for 45 consecutive days must get a one-week break. These state-led efforts are ongoing.
But because the loans are different, they throw regulators off the trail long enough for companies to profit without interference. “In states like Illinois who put on restrictions, you see a dramatic shift to installment loans,” said Tom Feltner of the Consumer Federation of America. “It’s made us have to broaden what we would consider to be a regulatory response.”
The forever loan
The internet, with its crannies and shadowy alleyways, provides another place where payday lenders can hide from the law. Online payday lenders say they have the right to lend in states where payday lending has been banned or interest rates have been capped, because the physical site of the lender is outside the state; many of them are even on tribal lands outside of US territory.
Outside the law. Photograph: Corbis/Newsport
The online payday loan is a dangerous thing. A borrower can sign up online to get his initial loan deposited into his bank account. The loan gets rolled over automatically, repeated into perpetuity – unless the borrower has the presence of mind earlier to go through a complicated, burdensome process to contact the lender directly. The fees get deducted directly from the borrowers’ bank accounts, even though federal law allows account holders to stop such automatic transactions.
Wall Street and payday lending
While payday lending is typically regulated at the state level, the Consumer Financial Protection Bureau now has the ability to supervise the industry. But unlike the states, CFPB is prohibited from capping fees or interest rates, and the agency runs into the same problems of regulating one product and watching payday lenders switch to offering another.
So the newest effort at regulatory enforcement takes aim not at payday lenders, but the Wall Street banks that assist them.
Wall Street banks have provided $5.5bn in credit to the payday lending industry over the past several years, according to a recent report from the advocacy group Reinvestment Partners. Many current or former executives from banks like Morgan Stanley, Credit Suisse and Bank of America serve on the corporate boards of the biggest payday lenders.
It becomes a symbiotic relationship. Most big banks long ago fled impoverished neighborhoods: 93% of bank closures since 2008 were in zip codes where the median income sits below the national average.
Current and former executives of some of the nation's biggest banks sit on the boards of payday lenders. Photograph: Mark Lennihan/AP
Payday lenders thrive in communities with the fewest banks, according to a study from the Milken Institute. They like having low-income communities to themselves. The banks, having abandoned that turf, profit indirectly by funding the payday lending industry.
The pipes of payday lending
But where banks really offer a lifeline to payday lenders is by controlling the way the lenders process payments.
Banks process the payday lenders’ fees through the Automatic Clearing House, or ACH, the national system for verifying and clearing financial payments. The banks work through intermediaries called third-party payment processors; that means the banks and the payday lenders never technically touch each other. That comes in handy for the banks, who are largely already finding it difficult to cope with the cost of reporting suspicious activity in any financial transactions they’re involved in, under anti-fraud and money laundering laws.
The idea that banks and payday lenders are separate is, some say, a polite fiction. Only banks can give these businesses the access to the payments system that allows the whole scheme to work. The end result is that payday lenders can access customer accounts whenever they choose, and in exchange, the banks pocket handsome fees from a business that’s considered dodgy.
The cases are already piling up. In January, Four Oaks Bank in North Carolina paid $1m in fines to settle Justice Department claims that they gave direct access to a third-party payment processor to process dubious payments for online payday lenders. In exchange for $800,000 in fees, Four Oaks was “knowingly providing banking services in furtherance of unlawful conduct”, according to the complaint.
The Justice Department found that Four Oaks facilitated loans to people in states like Colorado and Georgia, which have prohibited payday lending.
Internal documents show the bank ignored multiple widespread warning signs of fraudulent activity, such as protests by individual customers contesting unauthorized withdrawals from their accounts. The settlement was part of a broader Justice Department initiative called “Operation Choke Point”, designed to penalize banks for failing to perform oversight of this sketchy lending. Over 50 subpoenas have been issued to banks and payment processors in the investigation.
Now add a dash of Congress
This has touched off a partisan food fight. House Republicans recently charged in a letter to the Justice Department that Operation Choke Point signified an effort to “inappropriately target two lawful financial services: third-party payment processing and online lending”, with an “indiscriminate dragnet that is wholly decoupled from any concrete suspicion of fraud”.
Congressional Democrats answered with their own letter in defense of Operation Choke Point, arguing that banks have a responsibility to report fraudulent activity occurring in the parts of the payment system they control. “We urge the department to continue its vigorous oversight,” the letter says.
So far, the Justice Department’s inquiry continues.
How to protect the consumer
Consumer advocates see the crackdown on banks as a good sign for consumers.
The Office of the Comptroller of the Currency, or OCC, which regulates most national banks, delivered guidance on banks’ own versions of payday loans, known as “deposit advance” loans.
Not that kind of food fight. Photograph: Alberto Saiz/AP
The OCC argued that these emergency lines of credit for bank customers must be affordable and take into consideration the borrower’s ability to repay. As a result, three of the largest banks offering deposit advance loans dropped the product.
“The dissolution of bank payday product is an excellent opportunity,” said Adam Rust of Reinvestment Partners, who authored the report detailing links between payday lenders and Wall Street banks. “Now there’s this window to act.”
Increased awareness can also play a role: after Reinvestment Partners released their report, Bank of America announced they would stop funding the payday loan industry.
Recently, some policymakers have floated another option to drive out payday lending: competition.
The Inspector General of the US Postal Service recently authored a white paper suggesting that they could offer small-dollar loans at a dramatic discount, with rates as low as 28%, a relative bargain for low-income people lacking access to credit. Many post offices internationally provide similar services, and here in America, millions use the Postal Service for money orders each year. And over half of all post office branches are in “bank deserts”, – zip codes containing one bank branch or less.
Consumer advocates are naturally wary of a government agency profiting from low-income communities. But if they can deliver a product that would save the working poor thousands of dollars a year in interest and fees, Baddour of Texas Appleseed thinks it could work.
“The most expensive part of the industry they already have in their pocket, a vast network of locations,” Baddour says, citing the 35,000 storefronts, including in rural locations. “It’s an intriguing idea that deserves serious consideration.”
The biggest problem with payday lenders is their ability to grow and spread their branches, blocking out light from other and better options.
“When you have a market dominated with these products, the better options are harder to find, harder to see,” says Baddour.
Category: Payday loans