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The Debt Creators: Shady Lending, Misleading Marketing and Hard Times
The Debt Creators: Shady Lending, Misleading Marketing and Hard Times
An interview with José García
José García is a senior research and policy associate at Demos, a non-partisan public policy research and advocacy organization. He is co-author of Up to Our Eyeballs: How Shady Lenders and Failed Economic Policies are Drowning Americans in Debt (2008). Prior to working at Demos, Garcia was the vice president for policy at the National Institute for Latino Policy.
José García: We definitely think that the role of personal responsibility should be downplayed. Our main thesis is that the deregulated financial market, the increased cost of living, stagnant incomes and lack of safety net, and aggressive lender marketing strategies have led the American public to increase its amount of debt.
Debt is increasing even as we go into a recession; we have seen how people use credit card debt and other types of debt to sustain their standard of living. So, no, it’s definitely not an issue of personal responsibility; it’s an issue of deregulation, income stagnation and bad government policy.
García: It is an issue that touches most Americans. We have seen credit card debt increase almost four-fold since 1989. And it’s not only an issue of the middle class splurging on consumer goods. It’s an issue of a deregulated financial market enabling the credit card industry to push credit cards on more vulnerable communities. This is basically saying, “Yes, we will provide you with credit, but with higher costs in fees and interest rates.” This is an issue that has affected young people, older people, communities of color and low-income communities.
We put a report out that showed that higher-income households get credit cards with, on average, a 12 percent interest rate, while lower-income households get a 22 percent interest rate. This is only one part of the story. One of the main problems with credit cards is that the lenders can change the circumstance of your credit at any moment.
Hopefully we have now entered a discussion with the Federal Reserve Board about how to regulate the credit card industry and stop the tricks and traps that have been the mainstay of the credit card industry.
García: They’ve been able to do it through a marketing onslaught. Credit card companies send out 6 or 8 billion pieces of mail a year in the United States. Older Americans get the brunt of telemarketers. They’re usually in their house and they get pulled into unsolicited phone offers. The companies reach students with booths and tables and freebies on college campuses.
The marketing continues — and sometimes intensifies — in hard times. During the subprime meltdown, we have seen companies actually increase the amount of credit card offers to subprime customers and decrease it to prime customers. This is a story that keeps repeating itself.
García: Andrew Kahr devised today’s credit cards. He was the president and CEO of Providian, and he created the main tricks and traps that have shaped the credit card industry.
He came up with different strategies that created new markets and new income streams. At a time when the industry only marketed to those with strong financial standing, he recognized the profit opportunities in reaching out to low-income customers, female head-of-households, and others who may have had a hard time financially.
Kahr’s main insight was to charge people little by little without their noticing. As such, he created ways of reaching out that were misleading to the public. For example, a Buyer’s Club program, which provided a 1 percent rebate, could be promoted as a discount on “everything you buy,” or, with an occasionally higher rebate, as a discount of “up to 30 percent.”
While the industry was going against grace periods, he proposed a “limited” grace period, constructed, he said, so that “almost no one gets the benefit of it.” He also created an “automatic credit protection program” that was built into your agreement with the credit card and more expensive than any fee. But because it was a variable fee pegged to the size of the credit line, it would not be disclosed in the Schumer box, which describes all the fees. So the general public would not notice that they were going to be subjected to this charge.
One of Kahr’s quotes from 1999 that really tells how the industry behaves, is that the credit card companies needed “to squeeze out enough revenue and get customers to sit still for the squeeze.”
García: Much of it is definitely misrepresentation. The industry also counts on people’s willingness to stay with a product. For example, you have the whole issue of introductory rates, where a customer is charged 0 percent for a period of time with the hope that they will stay with the card after the rate increases.
Another key feature that consumers do not understand is variability of the terms, meaning that because of one mistake — you make a late payment, or you didn’t get that payment in by 1 o’clock today, it got there at 4 o’clock instead — they actually increase your rate.
The marketing obscures variable and difficult terms that you must comply with in order to maintain advertised rates. Fees have also become an increasingly important part of the story. They’ve put in fees for exceeding credit limits, making late payments, even sometimes for starting a credit card. These increase the profitability of credit card companies without people realizing what they are paying.
García: Credit card companies routinely put booths and tables on different parts of campuses — sometimes marketing in spaces where commercial promotions are not permitted — and provide free merchandise, Frisbees, bags, and all types of things to entice customers to come to these tables. They typically employ young people from the college. They say that this card is great, without any discussion about the limits and the actual terms of the lending. It’s more about the free stuff that you’re going to get, even food, which as a college student might be very enticing.
At the same time, universities often play an important role. They often sell information about the students so the credit card companies can market directly to these students through their mail. University book stores often display or distribute materials about different credit cards. Universities also frequently let credit card companies brand their cards with the logo of the university. The use of the logo conveys to the students that they can trust the company issuing the credit card. Universities do this because they receive a lot of money from these credit card companies.
García: A mortgage broker is the person who sells mortgages to consumers. Many people think the broker represents them, but his loyalty and legal duty is not to the borrower, but to the originator of the mortgage product he is selling. That’s who is paying him.
Mortgage brokers have been around for a long time. What is new in terms of the subprime market is that mortgage brokers actually get a higher commission for selling that type of product. In recent years, the products have changed, and the demographic they market to has changed. What we have seen is more mortgage brokers getting into push marketing.
García: It varies a lot. We know that these mortgage brokers have gone through neighborhoods, to different houses, leaving flyers in houses, and actually knocking on doors to ask if the household wants to refinance their house. This is the way subprime mortgages were started in the early 2000s, late 1990s — through refinancing. You basically refinance by changing your mortgage from a 30-year fixed rate to this type of product with hopes that you might actually cash some money out. You take out some of the equity in the house, and get a new loan with worse terms. In the case of 50 percent of people, this money is used to pay credit cards. So people are strapped, a mortgage broker appears on their doorstep and says, “Home values are increasing, you can make some money on your home and pay your debt, or repair your house, and keep paying your mortgages.” Well, they actually offered horrible products to the American public.
García: Mortgage brokers don’t discuss the terms of the loan with the general public. They just say that the home owner will get some money out of the refinance of their homes.
Many of the practices they used were very deceptive. The worst advertised very low starting interest rates without explaining that low teaser rates disguised exploding Adjustable Rate Mortgage (ARM) terms. In the beginning, the home owners got fairly low interest rates, but only at the beginning. Interest rates of 3 percent or 4 percent might jump to 17 percent. Many people were unable to pay these exploding rates.
It was not necessarily an issue of credit scoring, it was not necessarily that these people were “subprime customers.” These were faulty products sold on a misleading basis, even to middle-class and upper-middle-class families.
García: It is extremely troublesome. Higher education has become much more expensive, and we have passed from grant-based higher education to a lending industry. For a long time, that lending industry was mainly based on federal subsidized plans with fixed rates of around 4 percent to 6 percent. There were no fees and if you had problems paying after college you could actually stop paying, with notice to the lender and so on.
This has changed in the past five years. We have seen a dramatic increase in private lending. These private loans come with very high interest rates, fees when you start your loan, and if you have a hard economic situation they don’t necessarily have to give you a grace period for you to get back on your feet. So they’re more predatory.
In terms of marketing strategies, these lenders have actually paid these universities and university officials to be part of their financial aid staff, to give financial aid information to students — basically marketing their products along with those of the university. These private loans come as part of a student’s financial aid package as one legitimate option without any type of information to students about the nature of these more predatory products. We’re close to $18 billion in this type of lending, and it has been extremely troublesome for students.
García: The main issue here is that they’re fixed interest rates, around 6 percent, and they don’t necessarily have start-up fees, so they’re less costly for students.
The Education Department is not permitted to market its loans in the way private lenders do, however. The Republican-controlled Congress in 1994 passed a law prohibiting the Education Department from encouraging or requiring colleges to participate in the government’s Direct Loan program.
More generally, we should be moving away from lending and into grant-based products. Higher education shouldn’t mainly be subsidized by the individual. Broader and easier access to higher education would not only benefit the students but also benefit the economy and our society as a whole. Private lending in higher education has shifted what people go to study, and has had devastating affects on people who don’t finish their higher education and have to go back to work and still have that $20,000 in debt, which was the average in 2007.
García: These are what they call shark loans. For the most part, they have very high interest rates and high fees. In some cases, these are products that are provided by mainstream banks, but not available in communities that have been red-lined. In low-income communities of color, these sharking services have taken over the geographical landscape.
Check cashing service centers, for example, cash checks for you at very high fees — it could be $10 no matter what the check is, it could be 5 percent, 3 percent of your check.
Payday lenders give small loans, usually to be paid over two weeks. You may borrow $200 to $300 with a 400 APR interest rate. You get the loan by signing a blank check with your name and you give it to the lender and they have that as collateral.
Tax refund anticipation loans supposedly lend you the money which is yours, before it gets to you from your income tax refund. These usually come with high fees and high interest rates. These loans especially target people receiving the Earned Income Tax Credit. As a result, that money that people need to survive is being taken by these predatory products; they end up with less money than what the government is sending them.
The commonality of these fringe products is that they have very high interest rates and very high fees, and the fringe lenders make a lot of money out of low-income people.
García: I think a lot of the time you’re in a crunch, maybe you don’t have access to a credit card, maybe you did have access but now nobody in the credit card business wants to lend you money, and you need to pay your groceries or gas and you borrow $200, $300. What usually happens is you will not be able to pay that loan on time — this happens around eight times for every single customer, meaning that they pay easily triple the amount of money that they borrow. And it becomes a very long relationship — a loan marketed as covering two weeks can last nine months while the borrower tries to repay the initial loan.
This is an issue of a lack of safety net a lot of the time. These loans are not to buy flat screen TVs; they are to pay for groceries, to take your children to the doctor, repair your car, buy fuel, anything to keep your family afloat.
García: In the past, the image of a payday lending or cash checking place was an obscure place with very little name recognition in some little corner of a neighborhood.
Now they are national corporations, meaning they are franchised. The actual appearance of these places has changed drastically. Their images are very clear, and they’re targeting middle-income people. They have commercials on local TV and radio stations about how good they are; how they help struggling people and how they’re friends of working Americans. It’s a much more sophisticated marketing operation. Their presence is clearer in communities, conveying the idea that they are just another mainstream service provided to the American public. There’s an issue of geographical location. They’re located very close to their customers, and usually there are more of them in urban areas than McDonald’s or any other fast food chain in the United States. In places like New York, you can see them on most corners in low-income communities. They’re very pervasive.
García: We want an industry that gives clear, consistent and reliable terms. Today, for example, the disclosure from the credit card companies can be 20 to 30 pages full of jargon; we want clear disclosure that is not convoluted. Terms should stay consistent, and not change so drastically when late payments happen or interest rates increase. In terms of the mortgage industry, we’re talking about exploding ARMs, where interest rates go through the roof. The general principles of clear disclosure, and terms that don’t deviate over time from the actual offers, are important.
Second, risk-based pricing needs to be reassessed. In the subprime mortgage meltdown, foreclosures do not necessarily correlate with the risk of the individual borrower or their credit score — the issue was the products. Risky mortgage products, more than risky borrowers, have caused the foreclosures. So the formation of risk-based pricing, with higher interest rates and fees for those believed to be at higher risk of default, needs to be looked at. Consumers should not be charged high up-front fees and interest on the assumption that they will not be able to pay later. And they shouldn’t be charged penalties disproportionate to the risk they pose.
Third, a government regulatory agency should be created to set standards for lending practices. We have different sets of agencies that work to protect consumers, but they have not been doing their job. We think there should be only one agency, whose main purpose is to protect financial consumers from predatory practices. We know we’re talking about a very innovative industry that looks for new loopholes and new ways of price gouging. We think a federal agency that is vigilant and whose sole purpose is to protect financial consumers might actually make a difference.