Melanie Trausch

CONSULTING LLC

America's Growing Fringe Economy

Financial services for the poor and credit-challenged are big business

By: Howard Karger | University of Houston

Ron Cook is a department manager at a Wal-Mart store in Atlanta. Maria Guzman is an

undocumented worker from Mexico; she lives in Houston with her three children and
cleans office buildings at night. What do these people have in common? They are all
regular fringe economy customers.

The term "fringe economy" refers to a range of businesses that engage in financially
predatory relationships with low-income or heavily indebted consumers by charging
excessive interest rates, super high-fees, or exorbitant prices for goods or services.
Some examples of fringe economy businesses include payday lenders, pawnshops,
check-cashers, tax refund lenders, rent-to-own stores, and "buy-here/pay-here" used car
lots. The fringe economy also includes credit card companies that charge excessive late
payment or over-the-credit-limit penalties; cell phone providers that force less
creditworthy customers into expensive prepaid plans; and sub-prime mortgage lenders
that gouge prospective homeowners.

The fringe economy is hardly new. Pawnshops and informal high-interest lenders have
been around forever. What we see today, however, is a fringe-economy sector that is
growing fast, taking advantage of the ever-larger part of the U.S. population whose
economic lives are becoming less secure. Moreover, in an important sense the sector is
no longer "fringe" at all: more and more, large mainstream financial corporations are
behind the high-rate loans that anxious customers in run-down storefronts sign for on
the dotted line.

The Scope of the Fringe Economy

The unassuming and often shoddy storefronts of the fringe economy mask the true
scope of this economic sector. Checkcashers, payday lenders, pawnshops, and rent-to-
own stores alone engaged in at least 280 million transactions in 2001, according to
Fannie Mae Foundation estimates, generating about $78 billion in gross revenues. By
comparison, in 2003 combined state and federal spending on the core U.S. social
welfare programs—Temporary Aid to Needy Families (AFDC's replacement),
Supplemental Security Income, Food Stamps, the Women, Infants and Children (WIC)
food program, school lunch programs, and the U.S. Department of Housing and Urban
Development's (HUD) low-income housing programs—totaled less than $125 billion.
Revenues in the combined sectors of the fringe economy—including sub-prime home
mortgages and refinancing, and used car sales—would inflate the $78 billion several
times over and eclipse federal and state spending on the poor.

There can be no doubt that the scope of the fringe economy is enormous. The
Community Financial Services Association of America claims that 15,000 payday lenders
extend more than $25 billion in short-term loans to millions of households each year.
According to Financial Service Centers of America, 10,000 check-cashing stores process
180 million checks with a face value of $55 billion.

The sheer number of fringe economy storefronts is mind-boggling. For example, ACE
Cash Express—only one of many such corporations—has 68 locations within 10 miles of
my Houston zip code. Nationwide there are more than 33,000 check-cashing and payday
loan stores, just two parts of the fringe economy. That's more than the all the
McDonald's and Burger King restaurants and all the Target, J.C. Penney, and Wal-Mart
retail stores in the United States combined. ACE Cash Express is the nation's largest
check-casher and exemplifies the growth and profitability of the fringe economy. In 1991
ACE had 181 stores; by 2005 it had 1,371 stores with 2,700 employees in 37 states and
the District of Columbia. ACE's revenues totaled $141 million in 2000 and by 2005 rose
to $268.6 million. In 2005 ACE:

• cashed 13.3 million checks worth approximately $5.3 billion (check cashing fees
totaled $131.6 million);
• served more than 40 million customers (3.4 million a month or 11,000 an hour)
and processed $10.3 billion in transactions;
• processed over 2 million loan transactions (worth $640 million) and generated
interest income and fees of $91.8 million;
• added a total of 142 new locations (in 2006 the company anticipates adding 150
more);
• processed over $410 million in money transfers and 7.6 million money orders
with a face value of $1.3 billion;
• processed over 7.8 million bill payment and debit card transactions, and sold
approximately 172,000 prepaid debit cards.

Advance America is the nation's leading payday lender, with 2,640 stores in 36 states,
more than 5,500 employees, and $630 million this year in revenues. Dollar Financial
Corporation operates 1,106 stores in 17 states, Canada, and the United Kingdom. Their
2005 revenues were $321 million. Check-into-Cash has more than 700 stores; Check N'
Go has 900 locations in 29 states. Almost all of these are publicly traded NASDAQ
corporations.

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There were 4,500 pawnshops in the United States in 1985; now there are almost
12,000, including outlets owned by five publicly traded chains. In 2005 the three big
chains—Cash America International (a.k.a Cash America Pawn and Super- Pawn), EZ
Pawn, and First Cash—had combined annual revenues of nearly $1 billion. Cash America
is the largest pawnshop chain, with 750 locations; the company also makes payday
loans through its Cash America Payday Advance, Cashland, and Mr. Payroll stores. In
2005, Cash America's revenues totaled $594.3 million.

The Association of Progressive Rental Organizations claims that the $6.6 billion a year
rent-to-own (RTO) industry serves 2.7 million households through 8,300 stores in 50
states. Many RTOs rent everything from furniture, electronics, major appliances, and
computers to jewelry. Rent- A-Center is the largest RTO corporation in the world. In
2005 it employed 15,000 people; owned or operated 3,052 stores in the United States
and Canada; and had revenues of $2.4 billion. Other leading RTO chains include Aaron
Rents (with 1,255 stores across the United States and Canada and gross revenues of
$1.1 billion in 2005) and Rent Way (with 788 stores in 34 states and revenues of almost
$516 million in 2005).

These corporations represent the tip of the iceberg. Low-income consumers spent $1.75
billion for tax refund loans in 2002. Many lost as much as 16% of their tax refunds
because of expensive tax preparation fees and/or interest incurred in tax refund
anticipation loans. The interest and fees on such loans can translate into triple-digit
annualized interest rates, according to the Consumer Federation of America, which has
also reported that 11 million tax filers received refund anticipation loans in 2000, almost
half through H&R Block. According to a Brookings Institution report, 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 for essentially lending people their
own money!

The fringe economy plays a big role in the housing market, where sub prime home
mortgages rose from 35,000 in 1994 to 332,000 in 2003, a 25% a year growth rate and
a tenfold increase in just nine years. (A sub prime loan is a loan extended to less
creditworthy customers at a rate that is higher than the prime rate.) According to
Edward Gramlich, former member of the Board of Governors of the Federal Reserve
System, sub prime mortgages accounted for almost $300 billion or 9% of all mortgages
in 2003.

While the fringe economy squeezes its customers, it is generous to its CEOs. According
to Forbes, salaries in many fringe economy corporations rival those in much larger
companies. In 2004 Sterling Brinkley, chairman of EZ Corp, earned $1.26 million; ACE's
CEO Jay Shipowitz received $2.1 million on top of $2.38 million in stocks; Jeffrey Weiss,
Dollar Financial Group's CEO, earned $1.83 million; Mark Speese, Rent-A-Center's CEO,

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made $820,000 with total stock options of $10 million; and Cash America's CEO Daniel
Feehan was paid almost $2.2 million in 2003 plus the $9 million he had in stock options.

Fringe-economy corporations argue that the high interest rates and fees they charge
reflect the heightened risks of doing business with an economically unstable population.
While fringe businesses have never made their pricing criteria public, some risks are
clearly overstated. For example, ACE assesses the risk of each check-cashing transaction
and reports losses of less than 1%. Since tax preparers file a borrower's taxes, they are
reasonably assured that refund anticipation loans will not exceed refunds. To further
guarantee repayment, they often establish an escrow account into which the IRS directly
deposits the tax refund check. Pawnshops lend only about 50% of a pawned item's
value, which leaves them a large buffer if the pawn goes unclaimed (industry trade
groups claim that 70% of customers do redeem their goods). The rent-to-own furniture
and appliance industry charges well above the "street price" for furniture and
appliances, which is more than enough to offset any losses. Payday lenders require a
post-dated check or electronic debit to assure repayment. Payday loan losses are about
6% or less, according to the Center for Responsible Lending.

Much of the profit in the fringe economy comes from financing rather than the sale of a
product. For example, if a used car lot buys a vehicle for $3,000 and sells it for $5,000
cash, their profit is $2,000. But if they finance that vehicle for two years at a 25% APR,
the profit jumps to $3,242. This dynamic is true for virtually every sector of the fringe
economy. A customer who pays off a loan or purchases a good or service outright is
much less profitable for fringe economy businesses than customers who maintain an
ongoing financial relationship with the business. In that sense, profit in the fringe
economy lies with keeping customers continually enmeshed in an expensive web of
debt.

Funding and Exporting America's Fringe Economy

Fringe economy corporations require large amounts of capital to fund their phenomenal
growth, and mainstream financial institutions have stepped up to the plate. ACE Cash
Express has a relationship with a group of banks including Wells Fargo, JP Morgan Chase
Bank, and JP Morgan Securities to provide capital for acquisitions and other activities.
Advance America has relationships with Morgan Stanley, Banc of America Securities LLC,
Wachovia Capital Markets, and Wells Fargo Securities, to name a few. Similar banking
relationships exist throughout the fringe economy.

The fringe economy is no longer solely a U.S. phenomenon. In 2003 the HSBC Group
purchased Household International (and its subsidiary Beneficial Finance) for $13 billion.
Headquartered in London, HSBC is the world's second largest bank and serves more
than 90 million customers in 80 countries. Household International is a U.S.-based
consumer finance company with 53 million customers and more than 1,300 branches in
45 states. It is also a predatory lender. In 2002, a $484 million settlement was reached

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between Household and all 50 states and the District of Columbia. In effect, Household
acknowledged it had duped tens of thousands of low-income home buyers into loans
with unnecessary hidden costs. In 2003, another $100 million settlement was reached
based on Household's abusive mortgage lending practices.

HSBC plans to export Household's operations to Poland, China, Mexico, Britain, France,
India, and Brazil, for starters. One shudders to think how the fringe economy will
develop in nations with even fewer regulatory safeguards than the United States.
Presumably, HSBC also believes that predatory lending will not tarnish the reputation of
the seven British lords and one baroness who sit on its 20-member board of directors.

What Can be Done?

The fringe economy is one of the few venues that credit-challenged or low-income
families can turn to for financial help. This is especially true for those facing a penurious
welfare system with a lifetime benefit cap and few mechanisms for emergency
assistance. In that sense, enforcing strident usury and banking laws to curb the fringe
economy while providing no legal and accessible alternatives would hurt the very people
such laws are intended to help by driving these transactions into a criminal
underground. Instead of ending up in court, non-paying debtors would wind up in the
hospital. Simply outlawing a demand-driven industry is rarely successful.

One strategy to limit the growth of the fringe economy is to develop more community-
based lending institutions modeled on the Grameen Bank or on local cooperatives.
Although community banks might charge a higher interest rate than commercial banks
charge prime rate customers, the rates would still be significantly lower than in the
existing fringe sector.

Another policy option is to make work pay, or at least make it pay better. In other words,
we need to increase the minimum wage and the salaries of the lower middle class and
working poor. One reason for the rapid growth of the fringe economy is the growing gap
between low and stagnant wages and higher prices, especially for necessities like
housing, health care, pharmaceuticals, and energy.

Stricter usury laws, better enforcement of existing banking regulations, and a more
active federal regulatory system to protect low-income consumers can all play a role in
taming the fringe economy. Concurrently, federal and state governments can promote
the growth of non-predatory community banking institutions. In addition, commercial
banks can provide low-income communities with accessible and inexpensive banking
services. As the "DrillDown" studies conducted in recent years by the Washington, D.C.,
nonprofit Social Compact suggest, low-income communities contain more income and
resources than one might think. If fringe businesses can make billions in low-income
neighborhoods, less predatory economic institutions should be able to profit there too.
Lastly, low and stagnant wages make it difficult, if not impossible, for the working poor
to make ends meet without resorting to debt. A significant increase in wages would

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likely result in a significant decline in the fringe economy. In the end, several concerted
strategies will be required to restrain this growing and out-of-control economic beast. ≈

Howard Karger is professor of social policy at the University of Houston. He is the author of Shortchanged:
Life and Debt in the Fringe Economy (Berrett-Koehler, 2005), winner of the 2006 Independent Publisher
Book Awards in Finance/Investments/Economics.

_______________________________________________________________________________________

Alan Berube, Anne Kim, Benjamin Forman, and Megan Burns, "The Price of Paying Taxes: How Tax
Preparation and Refund Loan Fees Erode the Benefits of the EITC" (Brookings Institution and Progressive
Policy Institute, May 2002); James H. Carr and Jenny Shuetz, "Financial Services in Distressed Communities:
Framing the Issue, Finding Solutions," Financial Services in Distressed Communities: Issues and Answers
(2001, Fannie Mae Foundation); Amanda Sapir and Karen Uhlich, "Pay Day Lending in Pima County
Arizona" (Southwest Center for Economic Integrity, 2003); Keith Urnst, John Farris, and Uriah King,
"Quantifying the Economic Cost of Predatory Payday Lending" (Center for Responsible Lending, 2004).
Organizations working on these issues include U.S. Public Interest Research Group, www.uspirg.org;
Association of Community Organizations for Reform Now (ACORN), www.acorn.org; Coalition for
Responsible Credit Practices, www.responsible-credit.net; Community Financial Services Association of
America, www.cfsa.net; Consumer Federation of America, www.consumerfed.org; Harvard University, Joint
Center for Housing Studies, www.jchs.harvard.edu; National Consumer Law Center, www.consumerlaw.org.

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