The Poverty Business: Taking Advantage of the Poor

An article from Business Weekly today spoke about businesses who take advantage of the poor in the US. It is also an insight on how we got into this economic mess. More and more companies gave out riskier and riskier loans to people who obviously couldn't afford to pay them back: When prices started to rise, they stopped paying, and these companies in turn lost profit.

Some highlights from the Article:

In recent years, a range of businesses have made financing more readily available to even the riskiest of borrowers. Greater access to credit has put cars, computers, credit cards, and even homes within reach for many more of the working poor. But this remaking of the marketplace for low-income consumers has a dark side: Innovative and zealous firms have lured unsophisticated shoppers by the hundreds of thousands into a thicket of debt from which many never emerge.

The recent furor over subprime mortgage loans fits into this broader story about the proliferation of subprime credit. In some instances, marketers essentially use products as the bait to hook less-well-off shoppers on expensive loans. "It's the finance business," explains Russ Darrow Jr., a Byrider franchisee in Milwaukee. "Cars happen to be the commodity that we sell." In another variation, tax-preparation services offer instant refunds, skimming off hefty fees. Attorneys general in several states say these techniques at times have violated consumer-protection laws.

What is really interesting are some of the methods that these companies use to take advantage of the poor. A story from New Mexico details how no-credit used car salesmen make their efficient profits:

Nearly half of Byrider sales in Albuquerque do not result in a final payoff, and many vehicles are repossessed, says David Brotherton, managing partner of the dealership. A former factory worker, he says he sympathizes with customers who barely get by. "Many of these people are locked in a perpetual cycle" of debt, he says. "It's all motivated by self-interest, of course, but we do want to help credit-challenged people get to the finish line."

Byrider dealers say they can generally figure out which customers will pay back their loans. Salesmen, many of whom come from positions at banks and other lending companies, use proprietary software called Automated Risk Evaluator (ARE) to assess customers' financial vital signs, ranging from credit scores from major credit agencies to amounts spent on alimony and cigarettes.

Unlike traditional dealers, Byrider doesn't post prices—which average $10,200 at company-owned showrooms—directly on its cars. Salesmen, after consulting ARE, calculate the maximum that a person can afford to pay, and only then set the total price, down payment, and interest rate. Byrider calls this process fair and accurate; critics call it "opportunity pricing."

So how did Byrider figure that Tsosie had $300 a month left over from her small salary for car payments? Barely a step up from destitution, she now lives in her own cramped apartment in a dingy two-story adobe-style building. Decorated with an old bow and arrow and sepia-tinted photographs of Navajo chiefs, the apartment is also home to her new husband, Joey A. Garcia, a grocery-store stocker earning $25,000 a year, his two children from a previous marriage, and two of Tsosie's kids. She and Garcia are paying off several other high-interest loans, including one for his used car and another for the $880 wedding ring he bought her this year.

Asked by BusinessWeek to review Tsosie's file, Byrider's Brotherton raises his eyebrows, taps his keyboard, and studies the screen for a few minutes. "We probably should have spent more time explaining the terms to her," he says. Pausing, he adds that given Tsosie's finances, she should never have received a 24.9% loan for nearly $8,000.

That still leaves her $900 in Byrider's till. "No excuses; I apologize," Brotherton says. He promises to return the money (and later does). In most transactions, of course, there's no reporter on the scene asking questions.

Even major banks and financial instutions have recognized the new market of working poor. Wells Fargo & Co. (WFC ) and U.S. Bancorp (USB ) now offer their own versions of payday loans. :

Mainstream financial institutions are helping to fuel this explosion in subprime lending to the working poor. Wells Fargo & Co. (WFC ) and U.S. Bancorp (USB ) now offer their own versions of payday loans, charging $2 for every $20 borrowed. Based on a 30-day repayment period, that's an annual interest rate of 120%. (Wells Fargo says the loans are designed for emergencies, not long-term financial needs.) Bank of America's revolving credit line to Byrider provides up to $110 million. Merrill Lynch & Co. (MER ) works with CompuCredit to package credit-card receivables as securities, which are bought by hedge funds and other big investors.

Once, major banks and companies avoided the poor side of town. "The mentality was: Low income means low revenue, so let's not locate there," says Matt Fellowes, a researcher at the Brookings Institution in Washington, D.C. Now, he says, a growing number of sizable corporations are realizing that viewed in the aggregate, the working poor are a choice target. Income for the 40 million U.S. households earning $30,000 or less totaled $650 billion in 2004, according to Federal Reserve data.

Very interesting read, and an insightful piece of what has been wrong with this country for the last few decades of wealth abuse. The article covers more angles including credit cards and other lending methods. Check out the entire article if you have a chance.