Unraveling the Greed

I remember during my Hurricane Katrina Exile from New Orleans that I was invited by a good friend and colleague to attend a gathering of social workers and others to discuss the impact of being “unbanked” and hearing about predatory lending practices. For about two years, I did several research papers and gathered quite a collection of stock prices and balance sheet information on DiTech, Advance America, Dollar Financial, and other credit type companies that provide a bevy of financial services to the poor. At the time, I also put Wells Fargo into that mix. I was studying the impact of monetary policy on this little studied area of financial institutions. I basically argued that the increasing reliance on this type of company for debt financing and the potential volatility in their portfolios could explode and impact the larger financial markets. I’m looking back at my paper (dated December 6, 2006) and remembering how everyone thought that a trivial question at the time it was presented.

Here are some questions that I asked in my introduction.

Traditional lenders achieve profits from low operating costs and positive interest rate spreads. Credit Services Companies hold risky assets, charge numerous fees (some not covered by Truth-in-Lending Laws), and have higher than normal interest rates due to the nature of the borrower or the loan. Some of these companies are associated with banks that have fiduciary responsibilities. Others rely on commercial paper or retained earnings to finance loans. Companies such as Dollar Financial specialize in servicing the consumers called the “unbanked” or “underbanked”. They charge fees to cash checks and receive fees from utilities to take payments from cash paying customers. Franklin Credit specializes in subprime lending in the mortgage area.

One of the most interesting trends in this particular business has been the spread of credit service company branches into poor and working class neighborhoods vacated by traditional financial institutions. It is really difficult to drive around a poor neighborhood and find a bank branch these days. It is very easy to find a branch of a credit services company on nearly every block. Credit service companies are also aggressive marketers. GMAC, traditionally the lending arm of General Motors for floor plan loans to dealers and car loans to those unable to get bank loans is the parent company of Ditech; undoubtedly the most over-advertised Credit Service Company on television.

Do these companies respond to interest rate movements and volatility in rates the same way that more traditional financial institutions like banks do? Do their already high spreads protect them? Do their many fees provide them with some insulation from interest rate movement? OR will many of the come crashing down in a period of high interest rates or an economic downturn? What will this mean to the high number of un-banked? The Federal Reserve Bank, GNMA and FNMA have developed an interest in credit sector companies recently. Sallie Mae is under some scrutiny by Congress for its considerable profits. The Fed reports and monitors those credit companies owned by bank holding companies. Their aggregate financial data is published monthly at the Board of Governor’s Website. There appears to be increasing interest by many parties in these financial institutions but little is understood about how their explosive growth will impact the financial system at large.

I basically had to quit the research line at the time and switch to something less ‘kitschy’ as one senior researcher told me. However, I keep going back to my work on predatory lenders when I read something like this in the NY Times:

Bank Accused of Pushing Mortgage Deals on Blacks.

I was aware that there were a lot of lending seminars going on in my neighborhood. I live in the ninth ward in New Orleans. My neighborhood is the very antithesis to the gated suburban community. I am the minority here. These seminars were sponsored most times by ACORN (their HQ is less than a mile from my house) and local churches. I used to get fliers all the time on my front door of the little house I bought with my FHA loan. Wells Fargo has my loan now. My loan probably qualifies under the CRA. I wish I still had the fliers or that I actually had gone to one of the meetings, because I thought it odd that these seminars would be offering chances to meet with actual lenders. I was never motivated to actually go to one.

It came as no surprise to me then to read this in the NY Times article.

Read the rest of this entry »