Preying on the Poor

by Russ Roberts on May 17, 2007

in Standard of Living

This week’s Business Week has a cover story on how companies are making profits off of poor people. It’s actually worse than that. They try and make money off of the working poor.

The main focus is on debt. Companies now have better technology than they had in the past for assessing credit risks. The result is that poor people have more access to credit than they’ve had in the past. How is this a bad thing? Well, it turns out that some people borrow too much and end up unable to pay off their loans.

The article fails to note that this happens to rich people, too.

The article fails to note that lots of poor people now have cars and TVs and houses they couldn’t have before because they didn’t have access to credit.

The article fails to note that in America, companies make money selling things for more than they cost. That results in profit. Failure to make profit for an extended period of time results in bankruptcy and the death of the company. Business Week preys on its subscribers. The magazine tries to be as appealing and useful as possible so it can pay its employers and leave some over for its investors.

The main theme of the article is that sometimes, poor people end up worse off by borrowing money. The fault is the company that lent the money:

"People are being
encouraged to live beyond their means by companies that are preying on
low-income consumers," says Jacob S. Hacker, a political scientist at
Yale.

Preying on low-income consumers? So poor people are mice and companies are owls? Poor people are gazelles and companies are lions? Poor people are bugs and the companies are venus fly traps? People are being encouraged to live beyond their means by companies? Ah yes, it’s not in our genes to want more, it’s something being foisted on us by companies that prey on us. 

It reminds me of the state-run liquor stores in Alabama where my parents live. They are ugly and uninviting. the lighting is harsh. There’s no attempt to make the product appealing. Making shopping for liquor a pleasant experience might encourage me to enjoy myself. Or worse, get drunk. I guess we’re lucky that they let us buy liquor at all in Alabama. Business Week should produce its cover in black and white rather than in color. You don’t want to encourage poor people to buy it.

Here’s my favorite paragraph in the article:

Some economists
applaud how the spread of credit to the tougher parts of town has
raised home- and auto-ownership rates. But others warn that in the long
run the development could slow upward mobility. Wages for the working
poor have been stagnant for three decades. Meanwhile, their spending
has consistently and significantly exceeded their income since the
mid-1980s. They are making up the difference by borrowing more. From
1989 through 2004, the total amount owed by households earning $30,000
or less a year has grown 247%, to $691 billion, according to the most
recent Federal Reserve data available.

Let’s break it down:

Some economists
applaud how the spread of credit to the tougher parts of town has
raised home- and auto-ownership rates.

I think this is supposed to be shameful—those evil economists think it’s good for poor people to have stuff. I like the word "some" implying that most economists are not applauding. I also like limiting the applauders to economists as if no one else thinks this is a good idea. I can think of one other group that applauds that the authors forgot to interview: the people who are able to buy cars and houses and TVs they couldn’t have bought ten years ago when credit was scarcer.

But others warn that in the long
run the development could slow upward mobility. Wages for the working
poor have been stagnant for three decades.

How does having cars and houses slow upward mobility? It would seem to be a sign of upward mobility. Unless you lose them car and house because you can’t make the payments. How often does that happen? The article doesn’t answer that question. It throws in the stagnant wage point just for spice. The implication is that all these loans are the reason for the stagnating wages of the working poor. Or that the poor have enough to worry about. Or that the poor will never be able to pay off their increasing debt. How could they? Their wages are stagnant. It’s actually a non-sequitur. The new access to credit for the poor doesn’t go back three decades. It’s more recent.

Meanwhile, their spending
has consistently and significantly exceeded their income since the
mid-1980s. They are making up the difference by borrowing more.

The first sentence is apparently true. The most common explanations are that we don’t count income well and that we often don’t include government transfer payments when evaluating standard of living. But here’s the best line:

From
1989 through 2004, the total amount owed by households earning $30,000
or less a year has grown 247%, to $691 billion, according to the most
recent Federal Reserve data available.

Spectacular, no? A totally meaningless number. What it tells you is that poor people have more access to credit. Here are some numbers from the same Federal Reserve data that the Business Week article didn’t include:

From Table 1 of the Fed data:

Real Median Family Income (2004 dollars) for the Bottom 40% of the Income Distribution

                               1989           2004           Increase

Bottom 20%              $9,200      $11,100        21%

Next quintile            $21,400    $25,700        20%

So for the data we have (and this is the whole time period the Federal Reserve reports on the web), incomes of the bottom 40% have grown over the most recent 15 year period we have data on.

From Table 3 of the Fed data:

                                Real Family Net Worth (2004 dollars)

                                1989                         2004
                      Median       Mean         Median    Mean

Bottom 20%   $2,600    $36,200      $7,500    $72,600

Next 20%       $35,300  $96,400     $33,700  $121,500

So median net worth has tripled (from albeit a very low number) for the lowest income Americans. For the next quintile, the median is down slightly (4.5%) though the mean is up dramatically. For every other income group (check out the Fed data), real net worth is up dramatically.

So the whole thing can be summarized by saying that the median family in the second lowest quintile has slightly less net wealth either because they have borrowed too much money or their economic fortunes have faltered in other ways or because they are not the same people in 1989 as in 2004.

And finally, from Table 14 of the Federal Reserve data, the median ratio of debt payments to family income for those who have debt:

                                                1989              2004                                          

Less than 20                            13.7%             19.7%
20-39.9                                   16.6%             17.4%
40-59.9                                   15.3%             19.5%
60-79.9                                   17.7%             20.6%
80-89.9                                   15.2%             18.1%
90-100                                    12.0%             12.7%

So yes, indebtedness is up in America. Most of that debt is housing. So people have more debt  but they also have more assets—median net worth over that time period has gone up for every group except the second lowest quintile. So people are borrowing more but their assets are generally worth more.

But check out the last column. Except for the highest decile, the ratio of debt payments to income is between 18.1% and 20.6%. The poor don’t stand out. They’re like everyone else. They have access to credit. Why is this a bad thing?

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{ 22 comments }

David Z May 17, 2007 at 12:52 pm

You know – these are the same people that will complain about the high price of "payday loans."

First, there's not enough credit, and it should be cheaper and easier – now, credit is too easy and the terms are too tough. They can't have their cake and eat it, too.

The problem is, it's not the banks and investors who have made credit cheap.

Methinks May 17, 2007 at 1:00 pm

One has to wonder why the poor risk life and limb to come to America only to fall prey to these predatory companies who want to sell them attractive stuff. Perhaps they are not similarly preyed upon in their own countries.

The article also fails to mention that nobody is holding a gun to these poor people’s heads and forcing credit down their throats. These are all voluntary actions. It does, however, imply that “poor” is analogous to “stupid” and these people can’t possibly be trusted to make their own decisions, so the government needs to step in to “protect” them from liberty.

The article strangely doesn’t seem to address the problem lenders face when their “prey” fails to pay back a loan. “Preying” on someone or something implies that the predator somehow benefits. But some sub-prime mortgage lenders have gone bankrupt when their “prey” defaulted on their loans. How is this benefit to the predator?

These issues remind me of another story. In Russia, people were forced to buy “war bonds” during WWII at the risk of losing their lives if they refused. Needless to say, people were not eager as they were already eating paste and knew they would never be repaid. Eventually, the government did offer a couple of kopecks on the ruble some time in the 1990’s and most people cashed out to buy a loaf of bread on the way home (IF it was available). Now, to me, this is much more like a predatory lending practice. I’m collecting this useless paper now to decorate my office.

Erik May 17, 2007 at 1:13 pm

The same question has been in the news in Sweden the past few days. If you think that the coverage by Business Week, or the American press in general, is silly… Well, I can only recommend that you don't learn Swedish in order to find more serious journalism. It's sad really.

Mr. Econotarian May 17, 2007 at 2:06 pm

It's either "Predatory Lending" if you lend to the poor, or its "Redlining" if you don't.

mopey May 17, 2007 at 2:27 pm

The story about Blue Hippo and their no refund policy smells, but there are still lessons to be learned : saving, shopping around, not making an impulse purchase)

Roxanne Tsosie's Byrider car – she didn't read the terms (she my have misunderstood or been mislead by the salesman but she still has the responsibility to read the terms). Her boyfriend took a $880 loan for an engagement ring.

"Nearly half of Byrider sales in Albuquerque do not result in a final payoff" – So, over half are successful transactions

"Thomas finances much of what she buys, but admits she usually doesn't understand the terms. "What do you call it—interest?" she asks, sounding confused."

" In total, Luisa owes creditors $169,585. "I don't read things. I just sign them," she says."

Connie McBride "earns $47,000 a year… graduated owing $45,000 on student loans. That debt became her main financial burden, she says. The 9.5% interest rate isn't particularly steep, but she tended to view the payments as less pressing than putting food on the table or paying rent… Personal bankruptcy proceedings in 2003 dissolved dozens of McBride's liabilities." – is BW suggesting that the student loan caused her problems and she'd be better off without it?

Does anyone see a pattern in these stories?

one of the comments on the article (by doktor1975) "but for many people in our society the simple allure of having something to make them feel better about themselves is enough for them to make costly financial mistakes."

Does anyone know where I can buy the raygun that makes people buy things?

btw I hope BusinessWeek gets in the business of providing low interest loans

Brad May 17, 2007 at 3:28 pm

Has anyone done a breakdown of the kinds of credit being offered to "the poor"? My hunch is that cell phone contracts and the like are a far bigger component than pay-day loans in aggregate. That is, credit systems aimed at the median consumer but accessible all the way own the ladder.

David White May 17, 2007 at 3:43 pm

Credit is accessible all right. And it's sending us into a "death spiral":

"While nonrevolving credit (automobiles, boats, student loans, etc.) increased by 5.2%, revolving credit (credit cards) increased by a whopping 9.2% in the month of March. The Federal Reserve reports this as a 'good thing,' because until now this has supported the so-called consumer economy. But has it? Until recently, consumption has grown alongside the debt. Now, however, we have higher consumer debt and lower consumption, as reported by the April retail sales.

"What can we conclude from this? … [T]he one inescapable conclusion is that the consequences of the negative savings rate since 2006, the consumers’ willingness to take on more debt and the loss of jobs in the past year have put our economy into a death spiral of increasing debt and declining consumption."

http://www.financialsense.com/fsu/editorials/cherniawski/2007/0511.html

Methinks May 17, 2007 at 4:22 pm

Don't worry, David. Congress is fixing to create its own death spiral by taxing away the income from people who actually do save so that they will have less to save/invest and will spend hours figuring out ways to avoid taxes. While they do that, hedge funds and private equity will move offshore or pass the added taxes on to investors. Notice how the very threat of regulation pushed the fee from 1 and 20 to at least 2 and 20 for hedge funds?

THEN we'll see breath-taking levels of offshoring and job losses resulting from lack of investment. Remember the 70's? It'll be great.

Dale May 17, 2007 at 5:20 pm

Isn't it Jesse Jackson who regularly makes it a point to say that the poor (specifically poor African-Americans) are discriminated against by lending institutions because it's too hard to get loans/credit?

So…which is it? The poor are or are not getting too much credit?

trumpetbob15 May 17, 2007 at 5:27 pm

After just switching land-line phone service, I received one of those calls trying to get people to purchase magazine subscriptions. I wonder if BW is part of that since those services will generally give you a free issue and then hound you to make sure you don't cancel. Now if that isn't predatory, I am afraid I don't know what is.

David White May 17, 2007 at 6:09 pm

Methinks,

Forget the 70s and think the 30s — or worse — as 78 million boomers start retiring in less than seven months and turn "native capital flight" into a stampede:

http://www.actionamerica.org/taxecon/tickfast.shtml

John S. May 17, 2007 at 7:37 pm

My wife is an accountant for one of those "predatory" lenders, and seeing how the company operates has really opened my eyes. Prior to that I was one of those people who (if I thought about it at all) thought gee, it is a little unfair that the poor have to pay such high interest rates. But it's totally justified! Her company has to pay an entire office building full of people to call their customers to "remind" them to make their loan payments each month. Her boss told me one time at the Christmas party what fraction of their loans are at least 30 days late. It shocked me, I'd never have guessed it was that high.

If you make your payments, you build up a good credit rating and you're able to get a better interest rate. Don't make your payments, and you wind up paying the bill collector to call you each month to ask where your payment is. It's as simple as that.

David P. Graf May 17, 2007 at 11:03 pm

I don't think that critics of "predatory lending" are complaining about extending credit to poor people. Instead, their concern is that the lending practice is deliberately designed to snare poor people into taking more debt on than they can afford to pay back. With little expectation of the debt itself being paid off, the companies then make their money back and lots more off of the interest on the original loan. It's akin to the old company towns where workers found themselves perpetually in hock to the company stores and were placed in a condition of involuntary servitude. Does this raise any ethical concerns?

Ryan May 17, 2007 at 11:13 pm

It may well be the case that being "poor" is correlated with being "financially stupid". Perhaps you are uncomfortable with that idea, or perhaps you uncomfortable with the idea of government intervening to assist the financially stupid. But I think there are many cases of the financially, legally or scientifically stupid asking the government to restrict their choices. You can't take it as a given that, in retrospect, everyone will be happy with the choices they've made.

BravoZulu May 18, 2007 at 2:15 am

As an off and on reader of Business Week for many years, I was stunned by this story. I thought I had inadvertently picked up a copy of the New York Times.

Colin Keesee May 18, 2007 at 5:11 am

This article managed to pack several classic economic fallacies into a few pages. The articles choose to decide what is a "high" interest rate. It declared that real incomes had stagnated and it managed to get in the old "rich are getting richer and the poor are getting poorer" boilerplate.

It also included the standard introduction to an article laden with misdirection and half-truths. It included a lead off with an anecdote about a person who has acted foolish. It then went on to include two more similar anecdotes.

When it comes to taxation, the illiberal like to lead their attack through the top income bracket and later on spread their taxation to those who are far from "rich." When it comes to paternalism, the illiberal seems to attack from the bottom. They start at the bottom of the income deciles. They cite examples like we saw in this article as reasons why third parties should be able to decide how financial transactions are conducted. Of course, third party judgments will initially only apply to the poor or disadvantaged who supposedly "need" paternalist judgment. We can all be confident, however, that the power to dictate financial transactions will extend to a larger segment of the population.

Methinks May 18, 2007 at 8:52 am

"With little expectation of the debt itself being paid off, the companies then make their money back and lots more off of the interest on the original loan."

Well, David Graf, then you'll just have to explain why the sub-prime lenders went bankrupt when their customers defaulted.

"It's akin to the old company towns where workers found themselves perpetually in hock to the company stores and were placed in a condition of involuntary servitude."

You're going to have to explain that one. Since the debt was taken voluntarily, how is anything about this "involuntary".

David White May 18, 2007 at 9:23 am

"Since the debt was taken voluntarily, how is anything about this "'nvoluntary'."

It's involuntary because, "Like addicts, we are trapped in the modern debt-based economy. Every institution is part of this web of debt."

http://www.lewrockwell.com/north/north532.html

Eric May 18, 2007 at 12:37 pm

So a Seller has a product/service which it sells to make a profit and a Buyer wishes to obtain the product/service. So the two freely make a transaction.

But in this case Seller is bad. The Seller should have NOT made the transaction, because the Seller(naturally) is much smarter and knows that the product/service would be bad for the dim-witted Buyer.

Isn't this like condemning a robbed man because his possession of money precipitated the evil act of robbery? It’s the person with the monies fault?

Isn't this like condemning Socrates because his unswerving commitment to truth and his philosophical inquiries precipitated the act by the misguided populace in which they made him drink hemlock? It’s Socrates fault?

Isn't this like condemning Jesus because his unique God-consciousness and never-ceasing devotion to God's will precipitated the evil act of crucifixion? It’s Jesus’s fault?

Hopefully through education our current Society our government policy will again affirm that an individuals liberties and freedom of choice is far more preferable than groups deciding what choices are safe to make and good for the individual.

It is wrong to urge an individual to cease his efforts to freely choose what the individual feels is in their best interests because the quest may precipitate a poor choice(based on a groups opinion). Society and government policy must protect ones freedom to choose their own course whether others feel it is a wise choice or not; and allow the individual bare the consequences of their choice.

Mr. Econotarian May 18, 2007 at 12:47 pm

By the way, about "redlining/predatory lender" issue, now sub-prime lenders who are trying to be more careful who they lend to are being accursed of "redlining":

http://www.reuters.com/article/bondsNews/idUSN0931842920070509

NEW YORK, May 9 (Reuters) – NovaStar Financial Inc. (NFI.N: Quote, Profile, Research, a subprime mortgage lender that is seeking a buyer, was accused in a federal lawsuit of denying mortgages to African-Americans, Native Americans and the disabled, court papers show.

The lawsuit by the National Community Reinvestment Coalition, a Washington, D.C. nonprofit, accused Kansas City, Missouri-based NovaStar of policies often known as "redlining."

It said NovaStar denies all loans for applications to buy row houses in Baltimore. It said this results in discrimination against African-Americans and Hispanics.

Lisa Casanova May 18, 2007 at 5:39 pm

David Graf,
Suppose we do decide it's "unethical" to make available to people loans which they might not be able to pay back. Consider three possible solutions. First, we require companies to check into every corner of a prospective buyer's life. We then require the company to decide for the consumer if the loan is really a "good idea" for that person, regardless of whether the person thinks it's good for them. We make lenders legally liable for this, so every borrower can come back, claim the company should never have given them the loan they asked for, and hold the company responsible. This would probably drive a lot of lenders out of the business.
Second, we could cap interest rates. Interest rates are the "price" of borrowing money and reflect the risk the lender is taking. Capping interest rates is a price control. It would have the result of cutting off lending to those who have poor or little credit history.
Third, we could assign everyone a personal babysitter to make all important decisions for them. I doubt you'd find that a good idea, since you'd get one too.
The important thing about the first two solutions is that they have two sets of consequences. They may indeed stop people from taking on debt that they are unable to pay off. In this sense, maybe these solutions protect these people. But it comes at the expense of people who may have made mistakes with credit in the past, have credit damaged by divorce, or simply have little credit history. It's going to become harder for these people, who may have been able to handle credit responsibly and put it to good use, to get it at all. What makes it acceptable to decrease their options and make their lives more difficult? Is that ethical?

Jabra Ghneim May 20, 2007 at 11:12 pm

I have worked for a subprime credit company as a credit analyst for a year. Actually the bank I worked for got acquired by one of the banks in the story. I was outraged too when I read the story because the authors, who obviously are liberal statists, were out to attack private business than present a true picture of what happens.
All the profiles presented in the Business Week story are profiles of people that most likely would not be eligible for credit was it not for the ECOA (Equal Credit opportunity Act). One of my jobs while working for the bank was making sure that our credit portfolio 'did not discriminate' against borrowers based on demography. The Fed and local banking authorities audited us aggressively on a quarterly basis to make sure that we went after and offered loans to people in those categories.
What the story failed to study or present is how the subprime market truly works. The story made it look like subprime lenders go after the poor of the population t prey on them while the reality of the situation is that subprime lenders take calculated risks based on mathematical models of probability and odds. Subprime lenders in general lose money for about 5 years on 'every' borrower and start making money in the 6th or 7th year of the life of the account. Retention is usually difficult when a borrower's credit improves and in many cases borrowers switch. Depending on the segment they fall in in the portfolio 20-35% of the borrowers end up failing and never paying anything. After a passage of 120 days I believe we were mandated to sell the account at a loss.
Many of these losses could be avoided was it not for the existence of the ECOA. Bankers then would be able to avoid extending credit to people like those mentioned in the story.
Without the ECOA somebody with the credit and income of that native American lady on the BW cover would be turned down for credit if creditors were allowed to profile based on her level of education (apparently she couldn't even read or understand the terms-which is really hilarious given that the government even had a regulation regulating the size of the font you have to use in terms contracts and how you should present the terms to consumers which is another point that the BW article failed to mention making it sound like the evil business man was out their to cheat the poor uneducated native of her money). What makes it even worse is that the writers actually say that the car dealer refunded the lady for the 3 months she paid on the car before it got taken away and this is presented as evidence of fraud by the dealer, but what should a dealer do under pressure of extortion? if two BW writers show up at my door telling me that they are writing an article in an international, well-known magazine, about how I stole the money of a poor native American woman, it is only natural that I would do anything in my power to avoid such a thing even including giving the woman a free new car.
It is a shame that a magazine like Business Week, which I have subscribed to since 1988, which used to celebrate free markets, is slowly turning into a liberal, statist rag. I have noticed the trend for a year now and if it continues I am afraid I will discontinue my subscription for the first time in almost 20 years.

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