Loan Sharks

Weighing in at around 2,000 pounds, armed with razor sharp teeth and the ability to swim up to 25 miles an hour, great white sharks are an intimidating foe. In 2017, great whites attacked 88 people. The simple way to avoid these shark attacks is to not go in the water! But what if I told you there was another type of shark that is far more dangerous than the great white? These other sharks, also known as loan sharks or payday lenders, are found in every state and every community, swimming among us. The most recent data shows that 1 in 6 American households have used these services. So what exactly are these loan sharks, and why are they more dangerous than the great whites?

A payday lender is a financial institution that offers something called payday loans. Payday loans are small, expensive loans that are marketed as quick credit but often create long-term debt traps. These loans have extremely high interest rates, and can be tied to the title of the debtor’s car or home.These loans are often given with the knowledge that they will not be repaid in a timely manner, entrapping the debtor in an insidious cycle that will make their current financial situation even worse .

For example, let’s say that you are a young parent with a newborn baby. Your monthly income is about $1,500. After your mortgage payment, grocery bill, insurance payment, student loan payment, car payment, and other miscellaneous expenses, you have only $150 left. Now let’s say life happens and your car breaks down. You now need $1,350 to fix your car so you can get to work! Since you don’t get paid for another two weeks you go to one of the local payday lenders. They offer $1,350 cash on the spot, and with no other viable option, you sign and take the money. But here’s the catch: when you go to repay your loan, you now owe $1,900 because of the high interest rate. Suddenly you have gone from a minor setback to a serious amount of debt–and the amount you owe will continue to climb as late fees and interest rates pile up. You may even have to end up taking out another loan so your things aren’t repossessed!

This vignette is not unusual; in fact, last year 12 million Americans were caught in similar situations through these predatory practices. The business of payday lending has grown to be a $9 billion industry! Sadly this profit is largely based on marketing to those who have little to no financial education, charging 300-400% interest on loans (the highest in the U.S. was 1900% last year), and having so many lending institutions readily available. As it stands today, there are more payday lenders in the United States than McDonald's or Starbucks!

Many low-income Americans utilize these payday lenders for convenience and when they need short-term credit. Many traditional banks don’t fulfill those needs, and even when they do, those services are not effectively marketed to the community that needs it. A study conducted by the Brookings Institution found that high-minimum-balance checking accounts with multiple fees are very expensive for low-income individuals who experience frequent penalties for low balances or for overdrafts. The study also indicated that about half of those surveyed who don’t use traditional banks don’t have enough money to start an account. This leaves Americans struggling to make ends meet in an impossible situation.

Unfortunately, the loan sharks that inundate low-income communities are a dangerous option. In a recent report, the Consumer Financial Protection Bureau (C.F.P.B.) found in an audit of ACE Cash Express (one of the largest payday lenders in America) that their business model was circular. These companies were formed upon the idea that borrowers would not be able to pay back their initial loans, pushing them further into debt. This way of doing business is unacceptable, un-American, and ought to be illegal. Reform is long overdue with regard to the predatory practices of these companies, and there are clear steps we can take to make short term credit available without destroying the financial solvency of American families. There are three major reforms we need to execute.

The first is very simple: schools should teach more finance! Teaching basic financial and accounting practices should be mandatory in high schools. Knowing how to balance a budget, do your taxes, and being informed about the good and bad uses of credit would go a long way in keeping consumers safe.

Second, we need more transparency in the lending process. Hidden late fees and boosted interest rates sneak up on borrowers who are in desperate situations. If payday lenders are confident their product is beneficial to consumers, then they should be able to walk them through the whole process and show them what could happen if they default on their payment. By mandating that payday lenders add a clear and simple fact sheet to all contracts, we can give consumers the tools and resources to make an informed decision with their finances.

Finally, there needs to be a way to responsibly lend to those in need. We should reform these lending procedures so that the loan given is predicated on the amount of cash flow a particular borrow has. For example, a customer with $1,300 coming in every month shouldn’t be approved for the same loan as someone with $2,000 of monthly income. Very simply put, lenders should not be allowed to sign someone up for a loan they reasonably cannot pay back in a timely manner. There should also be caps placed on interest rates to ensure the total cost of the loan is reasonable. The folks on the margins of our society are fighting tooth and nail to get a piece of the American Dream. By standing up to loan sharks we can help our fellow citizens gain financial stability and embark on the pursuit of happiness that our Founding Fathers envisioned.

Reforming loan sharks is only half the battle. As previously stated, traditional banks do not adequately fulfill the needs of poor Americans. Earlier this year Senator Kirsten Gillibrand proposed legislation that would allow every United States Post office to offer low interest, low volume loans. Although well intentioned, I wholeheartedly believe combining banking with the inefficient and prone-to-bungling federal government is bound to fail. However, there are some innovative and forward thinking initiatives that the government can spearhead to begin moving the country in the right direction.

The first, and most optimistic solution, is for banks to offer more resources for low-income citizens. Some ideas outlined by renowned poverty scholar Dr. Rebecca Blank of The Hamilton Project include creating “starter” bank accounts. These accounts would have low fees and no minimum balance. Banks could also begin offering low-dollar loans with lower interest rates than payday lenders. By offering these loans with far less risk than normal, banks could directly compete with payday lenders while helping poor Americans gain access to much needed capital in a safer way. This would be a savvy financial move for banks, expanding their customer base and tapping into an underserved population.

The second idea is to create robust public-private partnerships. Through public policy, we could incentivize traditional financial institutions to serve the needs of low-income Americans. By creating a “Capital Expansion” tax credit, we could motivate banks to offer these services. The tax credit would be linked to how many “starter” accounts a bank opened up within a certain year. Another benefit to this proposal is that regular evaluations of these accounts would serve as a protection to low-income Americans with these new bank accounts, ensuring they are receiving honest and effective service. Similarly, an example of a creative public-private partnership is the current model in San Francisco. The city has now offered to pay for the marketing expenses of any campaign to advertise low-income banking services to underserved communities. These groundbreaking partnerships combine the effectiveness of the free market with the good intentions of the public sector. The ultimate beneficiary? Low-income Americans, communities of color, and other marginalized populations.

The third big idea is to revolutionize the way governments allocate benefits. Currently, families in need receive benefits, such as Supplemental Nutrition Assistance Program, Temporary Assistance for Needy Families, and the Earned Income Tax Credit, in the form of a check. This forces recipients to cash those checks only where that service is offered— Walmart, pawn shops, and, unfortunately, payday lenders. If the government reformed the way benefits are distributed, instead sending the funds through direct deposit, these families would have far more interaction with traditional financial institutions, build credit, save, and even receive financial advisement free of charge through their bank. This simple fix could save poor Americans a lot of money and help them achieve the American Dream and drastically increase upward mobility. A key characteristic of being poor is financial instability. Hours getting cut, leading to a smaller paycheck at the end of the month, can prove catastrophic if families get behind on a payment or two. The unethical practices of payday lenders cripple the financial safety of poor Americans. By reforming the loan sharks and expanding access to safer short term credit we can help hard-working Americans keep their hard-earned money. The American Dream is simple but bold: in this great nation, our tomorrows can be better than our todays. It’s time to lead the way on this issue and ensure that this hallowed dream becomes a reality for all Americans.

SOURCES:

https://www.thebalance.com/payday-loans-beware-of-these-dangerous-loans-1289623
Dr. Jeff Hill - SFL 260 professor.
https://www.responsiblelending.org/issues/payday-other-small-dollar-loans/problem
https://www.consumerfinance.gov/about-us/newsroom/cfpb-takes-action-against-ace-cash-express-for-pushing-payday-borrowers-into-cycle-of-debt/
https://www.consumerfinance.gov/ask-cfpb/category-payday-loans/
https://www.brookings.edu/wp-content/uploads/2016/06/0416_low_income_blank.pdf
http://www.aei.org/publication/this-way-up-new-thinking-about-poverty-and-economic-mobility/
http://www.hamiltonproject.org/people/rebecca_m._blank
https://hbr.org/2017/12/too-many-americans-suffer-from-financial-instability-their-employers-can-help-fix-it