Book Reviews

Debit Scarred

The poor face myriad obstacles in handling their limited finances. Can reviving the postal bank be the solution?

By Helaine Olen

Tagged BankingFinancePoverty

How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy by Mehrsa Baradaran • Harvard University Press • 2015 • 328 pages • $29.95

To judge by my inbox, the financial world is suddenly clamoring for the opportunity to help the 68 million unbanked or underbanked Americans—people who are only loosely connected, if they’re connected at all, to our financial system. I am the recipient of a nonstop barrage of press releases from everyone from personal finance gurus to startup entrepreneurs who have seemingly decided that their mission is to teach the unbanked the proper skills they need to join the mainstream financial world.

There are mobile payment apps that offer customers “rewards” in the form of gift cards to popular retailers for making a certain number of payments on their bills, and financial literacy programs promoting curriculums designed to teach the poverty-stricken about the miracle of compound interest. Still others trash-talk the financial institutions that are available to the unbanked. Dave Ramsey, who hosts a popular personal finance radio show, begs people to stay away from payday loan shops, those last-chance lenders who make their money by charging their desperate borrowers hundreds of percentage points in interest annually. Ramsey’s words of warning are not subtle; he calls payday loan lenders “scum-sucking, bottom-feeding predatory people who have no moral restraint.”

But all these schemes and pleas have one thing in common: They make the argument that the consumer is responsible for the fact that he or she lacks access to the benefits offered by modern banking. If people could simply learn to pay their bills on time or put money away on a regular basis, the argument goes, they could join the mainstream.

This is balderdash. At best, it betrays a profound misunderstanding of the problems the less well-off face when they attempt to access and use mainstream financial services. At worst, it is a deliberate obfuscation, a way to blame the poor for the consequences of, well, being poor.

As Mehrsa Baradaran’s thoughtful and exhaustive (if somewhat dry) new book, How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy, reveals, people turn to the high-interest, predatory products and loans offered by what is often referred to as the fringe banking system not because they are uniquely ignorant. Instead, they do it because they’ve been cast out and cut adrift by the modern banking system. This banishment has profound implications, not just for these people’s bottom line, but for each and every one of us.

Baradaran is an associate professor at the University of Georgia School of Law and a specialist in banking and contract law. Perhaps as a result, she views the relationship between the banks and the United States government—the representative of the people—as an ever-evolving contract, one that goes back to the founding of the republic. It was Alexander Hamilton, after all, arguing for a national bank, who made the point that banks are “a political machine of greatest importance to the State.”

So regulate the banks so they serve everyone, I can hear you saying. Just do it! It’s a social contract, after all. If only it were that simple. Today, banks treat low-income Americans as financial pariahs for the simple reason that they can make more money serving the wealthy. And—lo and behold!—it turns out to be very easy for a bank to unload a customer who does not have much in the way of personal financial resources.

Today, banks treat low-income Americans as financial pariahs for the simple reason that they can make more money serving the wealthy.

Many aren’t permitted to open accounts at all, thanks to services like the ChexSystems database, which keep track of people who have bounced checks or otherwise exhibited less than responsible financial behavior. As for the rest? All banks need to do is make it costly for them to stick around. Overdraft charges in excess of $35 do the trick quite nicely, especially when they can be levied multiple times until the money is actually replaced in the account, thanks to a concept known as overdraft protection, where the banks cover the charge but make the customers pay for the privilege. That permits the banks to take a heads-I-win-tails-you-lose approach. Either unwanted customers leave or they contribute to the bottom line, the impact on their own personal finances be damned.

The Consumer Financial Protection Bureau has tried to crack down on this racket, requiring banks to ask people if they actually want this sort of overdraft, er, protection for some transactions, but the financial institutions are seemingly forever one step ahead of the regulators. CNN recently reported that three banks—JPMorgan Chase, Bank of America, and Wells Fargo—earned $1.1 billion in overdraft fees in the first quarter of 2015 alone.

And if the customers do leave? It’s all but impossible to live in our society without some access to financial services. So they will eventually almost certainly be forced to turn to predatory fringe lenders and service providers, a group that makes loan sharks seem like ethical and reasonable businessmen. This is no exaggeration. Need a quick spot of money, a two-week payday loan? Here’s what Baradaran reports will happen if it’s not immediately repaid:

If a typical payday loan of $325 is flipped eight times—this usually takes just four months—the borrower will have paid $468 in interest. In order to fully repay the loan and principal, the borrower will need to pay $793 for the original $325.

And it’s not just payday loans. There are title loans—that is, high-interest loans secured not by a paycheck but by one’s car; Baradaran reports that the average borrower pays $2,142 in interest for the privilege of receiving $951 in credit this way. Tax refund? Preparers like H&R Block offer to advance them to consumers on the spot, in return for a one-time payment of $34.95 for a federal refund, and another $13 for getting your money back from the state. Oh, and then there are the social safety net cash-transfer programs that put the funds they offer on prepaid debit cards—whose issuers then charge the cash-starved recipients every time they withdraw money or even check their balance.

I can go on but you are no doubt getting the idea. It’s expensive to be poor, as the cliché goes. The average unbanked family with a household income of $25,000 will spend about 10 percent of their income annually simply trying to access and otherwise manage their limited funds.

It’s our shame that we permit this. But Baradaran isn’t simply trying to get us to pity the unbanked. She has a bigger point to make, one that has profound implications for our democratic experiment. Access to cheap credit, Baradaran argues, is a vital component for enabling equality of opportunity in modern society. Low-cost credit is the juice that fuels social mobility. In the United States, the majority of us borrow money to attend college (though Bernie Sanders would like to change that) and to purchase a home. Without access to inexpensive credit, most of us are going nowhere. When it’s taken away, it’s all but impossible to get ahead.

This is a hard concept for many of us to grasp. We demonize credit here in the United States. We hate our reliance on it. We forget—or perhaps it is better to say we are never taught—that credit was always the engine of the great American middle class. While we like to think of our nineteenth- and early-twentieth-century ancestors as a group of frugal savers, that’s something of a myth. Someone, after all, was buying cars and radios and tchotchkes from the Sears catalog, and many people were doing it via installment plans.

Credit was always the engine of the great American middle class.

And it’s in this past that Baradaran believes we can find the answer to the problems of the unbanked.

Great Britain pioneered the first national postal savings banks in 1861, offering the humblest of working-class men and women interest on their savings. No amount was too small; according to Sheldon Garon, the author of Beyond Our Means: Why America Spends While the World Saves, deposits as small as one shilling—a twentieth of a pound—were accepted. The innovation was so successful in expanding financial services and boosting the economic prospects of the working classes that it was quickly copied by other countries. Within 20 years, nations ranging from France to Japan had set up their own post office-based banking options.

The United States, however, was a laggard. Opposition by the banking industry would prevent the establishment of post office banks here until 1910. Even then, they would not offer the full range of benefits the European post office financial institutions offered their customers. While they took deposits, they were not as convenient to use, and the interest rates were never competitive with more mainstream options like commercial banks and credit unions. The result? After the federal government began to offer insurance on bank deposits in 1934, the postal banks gradually lost their purpose. They were finally ended in the United States in 1966, all but forgotten even before they returned their last deposit.

By then, who needed the post office? Banks were so heavily regulated, they needed to compete by offering free toasters to potential customers. Incomes were growing for almost everyone. The severe inequality of the Gilded Age and the trauma of the Great Depression had receded into distant memory.

And then, beginning in the late 1970s, that world came to an end. Usury laws began their slow collapse in 1978 when, in Marquette National Bank of Minneapolis v. First of Omaha Service Corp., the Supreme Court ruled that credit card issuers needed to follow the interest rate cap set by the state they were based in, not where they were marketing their product. This, in turn, led legislators in places like South Dakota and Delaware to eliminate their caps entirely, correctly realizing that credit card issuers would rush in and set up operations—with jobs—in their states. A race to the bottom commenced.

The government continued to support the banks, but the banks, in Baradaran’s view, stopped supporting us. Attempts to get them to do better by lower-income consumers were less than successful: Baradaran reports that when the Federal Deposit Insurance Corporation convinced 31 banks to participate in a 2008 initiative, the Small-Dollar Loan Pilot Program—a scheme to advance, yes, small loans to lower-income customers—the banks turned around and charged customers the highest amount of interest possible, and otherwise neglected them.

At the same time, regulating the fringe banking industry has also turned into a less than successful effort. It’s a state-by-state battle, and one rarely won by the pro-consumer forces. In Alabama, consumer-rights advocates have been fighting for years—with nothing to show for their efforts—to get the state to reduce its 456 percent interest limit.

In light of these developments, Baradaran’s idea of restoring the post office bank has slowly gained traction in policy-wonk circles. Never mind the futile struggle to get Alabama to force its fringe providers to take less advantage of the poor. Set up a rival institution instead! The postal service’s inspector general has argued for the concept. So, too, has Massachusetts Senator Elizabeth Warren.

There are financial reasons to support the concept—the money from the effort could buttress the postal service’s shaky bottom line—but those aren’t the most important reasons to push it. The truth is, the postal service can almost certainly do day-to-day banking better than the banks. It already has a network of locations in place, so infrastructure expenses will be lower. At the same time, there are no pesky shareholders demanding more and more in profits each quarter, forcing managers to put the squeeze on customers. Loan repayment is less of an issue, since the postal service, like all federal agencies, can garnish tax refunds for repayment.

We might not like the banks, but it’s all but impossible to get ahead without the services they offer. If they can’t or won’t offer services to a percentage of the population, we need to look for other solutions. And we don’t need to reinvent the wheel. The postal service worked quite well as a financial institution at one time in our history, and there is no reason to think it can’t perform that function again.

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Helaine Olen is a columnist for Slate, where she writes the personal finance and money column “The Bills.” She’s the author of Pound Foolish: Exposing the Dark Side of the Personal Finance Industry and the co-author of The Index Card: Why Personal Finance Doesn’t Have to Be Complicated.

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