Symposium | The Forgotten 40 Percent

Wealth Stripping: Why It Costs So Much to Be Poor

By James H. Carr

Tagged asset-building

Within the public policy arena, the contemporary use of the term wealth stripping has generally referred to financial products and services like payday lenders, rent-to-own stores, and the like that exploit the lack of financial sophistication among economically disadvantaged populations. Awareness of the problem among policy-makers and advocates arguably originated with Michael Sherraden’s 1991 book, Assets and the Poor. Sherraden’s landmark work spawned a virtual avalanche of research, proposals, and innovative initiatives on asset building. Out of that body of research grew significant attention toward wealth stripping. John Caskey’s seminal 1996 book, Fringe Banking: Check-Cashing Outlets, Pawnshops, and the Poor, was the subject’s foundational text, highlighting how the high cost of alternative or fringe lenders strips away the financial resources of the poor. Many other scholars have since followed with different perspectives on both saving opportunities and the wealth-stripping challenges confronting the poor.

Even today, writings on the subject of wealth stripping tend to focus principally on the high cost of alternative financial services. But the Great Recession—driven by the foreclosures that hit minority communities especially hard—demands a broader examination of the issue to include ways in which the failure to impose or enforce consumer protection and anti-discrimination laws can lead to even greater harms. This broader perspective is essential if we are to understand and address the unique hurdles faced by low- and moderate-income households and people of color, who are disproportionately affected by these problems.

Wealth stripping has only increased during the economic crisis. Since the onset of the Great Recession, Americans have lost $7 trillion in equity in their homes. The Federal Reserve estimates the median American family has lost nearly two decades of wealth, or almost 40 percent of their assets. In a separate report, the Pew Research Center estimates that Latinos, Asians, and African Americans have experienced wealth losses of 66 percent, 54 percent, and 53 percent respectively, compared to 13 percent for whites. These losses are largely due to home foreclosures and lost equity.

In the wake of the crisis, it is imperative that we understand wealth stripping to include both predatory financial services and the huge loss in wealth that resulted from foreclosures that stemmed from subprime lending. Millions of households that neither accessed a predatory loan product nor were foreclosed upon have nevertheless experienced exceptional wealth loss due to the concentration of foreclosures in their neighborhoods. Millions of borrowers also now hold mortgages that are valued at more than the price of their homes. While the recently established Consumer Financial Protection Bureau (CFPB) should help in eradicating much of the predatory lending that occurred prior to the Great Recession, the CFPB is not empowered to address the fallout from the financial crisis. Dealing with that aftermath is essential to avoid further substantial wealth stripping as we climb out of the recession’s rubble.

According to the Federal Deposit Insurance Corporation, roughly nine million households are unbanked. Adults in these homes do not have a savings or checking account from a mainstream bank or credit union. An additional 21 million households are underbanked, meaning they have a checking or savings account but rely instead on alternative financial services provided by check cashers, payday lenders, pawn shops, and automobile-title lenders. This translates into roughly 60 million adults who operate outside of the financial-services mainstream. More than half of all African Americans and nearly 45 percent of Latinos and American Indian/Alaskans fall into this category.

The alternative financial-services industry is big business, with an estimated 340 million transactions each year costing customers $13 billion annually. Janneke Ratcliffe, executive director of the Center for Community Capital, points out that check-cashing and payday-lending storefronts outnumber all McDonald’s, Burger King, Target, Sears, J.C. Penney, and Wal-Mart stores and branches combined (33,000 versus 29,000 respectively). The fees these alternative (also known as fringe) lenders charge are steep. Nonbank check-cashing costs on average $40 per payroll check. Although expensive, relatively speaking, that’s a bargain compared, say, to rent-to-own stores, where a computer that retails for $851 can end up costing $4,459 ($49 per week for 21 months or 91 payments). Ratcliffe further finds that a subprime credit card with a $300 limit can come with fees totaling $250.

Initial high-cost fees are not the only or even greatest financial harm that can result from using an alternative financial-services provider. Relying on an auto-title lender, for example, can result in the loss of one’s automobile since the borrower’s car title is pledged as collateral for the loan. The typical auto-title loan is generally only 30 to 50 percent of the value of the vehicle used as collateral, but if the borrower fails to make the full repayment on time, he or she stands to lose the entire value of car, not just the outstanding loan amount. (And if that car is needed for work, then the loss of it can mean the loss of a job.)

Payday loans are widely known for being financially ruinous to their customers. Such loans are generally 14-day cash advances that cost between $15 and $30 per $100 borrowed, and range in size from $100 to $1,000 with the median loan size about $350. In addition to interest rates that typically exceed 400 percent annually, payday loans can trap consumers into rolling over the same debt multiple times, incurring excessive expenses on relatively small initial loan amounts. The Center for Responsible Lending estimates that more than 75 percent of all payday loans are the rollovers of previous unaffordable debt.

In their defense, these lenders claim they serve communities that banks do not. To some extent, they have a point. There are far fewer banks in minority neighborhoods than in white ones. But physical proximity is not the only barrier to greater bank usage cited by lower-income and minority consumers. Many alternative financial-services customers do not trust banks, do not feel welcome at them, do not understand the products they offer, and cannot afford the steep fees they charge. For debit cards, the typical overdraft fee of $34 is triggered by transactions that average just $17. And bank fees have been rising since the onset of the current economic crisis. According to a report by the Pew Charitable Trust, the median extended overdraft penalty fee at the nation’s 12 largest banks has increased 32 percent since 2010.

Disappointingly, there are substantial and growing connections between mainstream banks and alternative lenders. One study found that more than 40 percent of the payday-loan industry is financed by the nation’s largest banks. Moreover, some recent bank products mirror those of the most predatory alternative storefront lenders. Many traditional banks have entered the payday-loan arena, for example, with a product called a “checking account advance” loan. Those loans typically are for a ten-day period and carry an annualized interest rate of 365 percent. It’s worth noting that the nation’s largest banks are able to borrow at a practically 0 percent interest rate due to the Federal Reserve’s monetary policy.

Of course, the most damaging and predatory loan product of all was the subprime mortgage that triggered the ongoing foreclosure crisis. The loss of wealth from foreclosures has been unnecessarily compounded by our inability to respond adequately to the crisis and the continued failures of the federal foreclosure-prevention programs.
The higher numbers of foreclosures among minority households related to predatory loan products has been extensively documented. Prince George’s County in Maryland is the highest-income majority African-American county in the nation and, ironically, also the foreclosure capital of that state. In a recent study on foreclosures in that community, high-income borrowers in African-American neighborhoods were 42 percent more likely to go into foreclosure than typical borrowers in white neighborhoods. High-income borrowers in Latino communities fared worse: They were about 160 percent more likely to experience a foreclosure.

The reasons for the differences in foreclosure rates between residents in minority and nonminority communities are not known; they are not explained by differences in basic money management or loan or product type, since these variables are controlled for. Some possible causes could be a failure to apply for or receive similar treatment with respect to loan modifications, fewer savings to cushion financial shocks, higher levels of unemployment or underemployment, and higher levels of negative equity for minority households. Gaining a full understanding of these causes is critical.

In addition to this direct loss of wealth, neighboring residents in the communities in which foreclosures have been concentrated have also suffered. Distressed home sales drag down adjacent home prices, and improperly maintained vacant and abandoned properties can cause home prices in a community to collapse. (Not all neighborhoods are treated the same by the mortgage servicers who are responsible for the maintenance of their foreclosed properties: A recent investigation by the National Fair Housing Alliance found that foreclosed properties in communities of color were more than 80 percent more likely than those in white areas to have broken or boarded-up windows and other visible maintenance deficiencies.) Failing to prevent foreclosures and maintain vacant and abandoned properties has contributed to wealth stripping, particularly in minority communities. Research by the Woodstock Institute found that African-American and Latino communities in the Chicago area are likely to experience twice the amount of negative home equity (that is, when the value of a mortgage exceeds the value of a home) as non-Hispanic white communities.

Foreclosures have other harmful impacts on community. One consequence is a decrease in property tax revenue as a result of falling property values, which can harm local schools and other essential social services. Large numbers of foreclosures can also cause a loss in community cohesion and stability as families that have lost their homes relocate out of the neighborhood. And large numbers of foreclosures can lead to increasing crime that accompanies vacant and abandoned properties.

Going forward, there are some changes that must at a minimum be made. First, people should be able to access bankruptcy protection in order to maintain their homes. Right now, the family home is the only asset that cannot be restructured in bankruptcy proceedings—though the outstanding debt on a luxury yacht, vacation home, or investment property can be modified. This serves no legitimate public purpose and disproportionately harms those families and communities most affected by the current foreclosure crisis. It has been estimated that bankruptcy protection could have prevented thousands of foreclosures, and at no cost to the American taxpayer.

Second, credit reports should distinguish whether poor credit repayment behavior is the result of a mainstream or predatory financial product. Such a distinction would permit many subprime mortgage borrowers—whose default was due to deceptive loan products, not their unwillingness to pay—to obtain credit cards or other consumer credit, as well as to secure employment opportunities.

Third, policy-makers and regulators should remain aware that access to a full continuum of affordable and reliable financial products and services is essential, and that vulnerable consumers need to be protected. They need to exercise their authority with both urgency and care—urgency in purging the excessive and exploitative costs of fringe financial products and services, care in maintaining the customer-friendly marketing and operations that alternative-lending customers value. This includes affordable homeownership financial products that will be essential to jump-start the housing market and begin the process of rebuilding the enormous wealth loss resulting from the pre-crisis proliferation of reckless and unsustainable subprime mortgages.

The recently established CFPB goes a long way toward addressing the concerns I’ve laid out here. The agency has broad authority over predatory lending in the mortgage markets as well as retail consumer financial services. The worst of the subprime lending practices that were virulent prior to 2008 have already been eliminated and the CFPB has the authority to ensure they do not return. And, for the first time, the federal government, through the CFPB, has direct authority over the financial-services practices of alternative or fringe lenders. But the CFPB is not a panacea. For example, it is not authorized to address the challenges presented by vacant and abandoned properties resulting from foreclosures.

While much progress has been made, a great deal of work still needs to be done. The failure of private institutions to serve all families and communities equally has been an important impediment to disadvantaged families. Getting our leaders to begin caring about such families is essential to creating greater economic equality and a financially stronger America.

This symposium was supported by the Corporation for Enterprise Development (CFED), which hosted its biennial Assets Learning Conference on September 19-21 in Washington, D.C.

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James H. Carr is a Closing the Racial Wealth Gap Fellow with the Insight Center for Community Economic Development and a former executive committee member of Americans for Financial Reform. He has also served as chief business officer with the National Community Reinvestment Coalition and has published and lectured extensively on access to financial services for underserved communities.

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