The Texas Credit Service Organization Loophole

In Texas, there is a constitutional prohibition against charging interest greater than ten percent without the approval of the Texas legislature, and Section 11 of the constitution states that such loans are usury. Predatory lenders circumvent this by registering as "credit service organizations." Using this registration information, Texas Faith for Fair Lending has created maps of CSOs in each Texas senate district. Here is the map for my senate district 14, for example. Only some of the payday lenders that surround my neighborhood are represented on the map, which makes me unsure about how current the information might be. It's obvious from the list associated with the map that most pawn shops don't have to register as CSOs, even though they may make a variety of predatory loans. The only exception seems to be that Austin's EZCorp registers its EZPawn locations as CSOs.

Wells Fargo has the largest dollar amount of deposits in Austin, Texas, so I am going to use it and EZCorp as an example of how this loophole works. You can see from the flowchart in my earlier post how money flows between banks and predatory lenders, including EZCorp and Wells Fargo. Wells Fargo is the lender, and makes a loan brokered by EZCorp that is under the constitutional limit, but for which EZCorp may charge unregulated loan fees. I'm not aware of what EZCorp considers its maximum fees, but many predatory lenders end up charging fees that amount to 400-500% APR.

Texas cities, including Austin, have taken action to regulate predatory lenders via zoning and regulatory ordinances because the state legislature has been bought by lobbyists, namely the predatory lending industry organization misnamed The Consumer Service Alliance of Texas and the law firm Armbrust and Brown.  CSAT has filed a lawsuit against the City of Austin after passage of the regulatory ordinance earlier this year, citing conflict with state law because the ordinance forbids the expensive practice of rolling over loans more than once and sets the maximum loan amount. It is clear from the state constitution and law that only the state government can regulate interest rates, or even join other states that have banned payday lenders entirely. Given the unlikelihood that state government will free itself from the lobbyists' grip, I hope the US Comptroller of the Currency will forbid federal banks from funding these predatory loans, similarly to the way federally-chartered banks were forbidden to finance income tax refund anticipation loans brokered by HR Block, Jackson-Hewitt, et al.

A disturbing national trend is for banks to compete directly with store-front predatory lenders, even to the point of opening branch banks in strip malls that mimic the appearance of the payday lenders usually found there. If there is any limit in Texas on what banks could charge in the way of fees and interest, I'm sure their lobbyists will take care of them. Wells Fargo is one of the banks following this trend, although perhaps not yet in Texas. Both banks and non-banks are being examined by the Consumer Financial Protection Bureau. Director Richard Cordray says, “We look at alternative financial products offered by both banks and nonbanks through the same lens — what is the risk posed to consumers? Practices that make it hard for consumers to anticipate and avoid costly fees would be cause for concern.”

A Bite Out of the Poor

Thanks to Nathalie Martin for her post at Credit Slips, Usury Takes a Bite Out of the Poor, which called my attention to the presentation From the Peril of Predatory Lending to the Hope of Economic Justice: A Religious Social Ethical Perspective that Professor Alex Mikulich made at the Jesuit Social Research Institute at Loyola New Orleans. The title of her post reflects the meaning of the Hebrew word that is usually translated as usury, "to take a bite of the poor." This original meaning of the word gave me a way to think about what I see going on in my neighborhood. I first posted about neighborhood pawn shops, payday lenders, auto title loans, and then posted about providers of tax refund anticipation checks and loans. Probably the RAC and RAL providers have a greater income from the fees and interest on those than on their tax preparation fees, but I still wouldn't include them in the first group, and I had already been thinking about how to categorize other businesses. Now I am able to think of them all as businesses that take a bite out of the poor.

Here is an example of a business model which I was previously unable to categorize. There are used auto dealers in my neighborhood with "Buy Here, Pay Here" signs that are bigger than their signs with their company names. They sell, repossess, and resell used vehicles at high interest rates to people with poor credit. Since I have no access to the numbers for my neighborhood, here are some national numbers gathered by Ken Bensinger of the LA Times.

In this little-known but fast-growing corner of the auto market, dealers command premium prices for road-worn vehicles and finance the sales at interest rates that can top 30%.

In a kind of financial alchemy, they have found a way to turn clunkers into cash cows and make money off the least creditworthy customers: the millions of Americans who are stuck in low-paying jobs, saddled with debt and unable to qualify for conventional auto loans.

For most of those people, having a car is the only way to stay employed, and they'll accept almost any terms to get one.

Buy Here Pay Here lots sold nearly 2.4 million cars nationwide last year, up from 1.3 million a decade ago, according to CNW Marketing Research.

CNW estimates that there are more than 33,000 such lots nationwide, compared with about 20,000 dealerships selling new cars. Buy Here Pay Here dealers make $80 billion in loans every year, according to the Federal Deposit Insurance Corp.

Although dealers are loath to open their books, profit margins average nearly 40%, according to a trade group, the National Alliance of Buy Here Pay Here Dealers. That's twice what new-car dealers make.

 Many of the lots require customers to return once or twice a month to make loan payments in cash -- hence the term Buy Here Pay Here.

 A key reason for the industry's growth in tough times is that dealers can come out ahead whether or not customers keep up with their loan payments.

About 1 in 4 buyers default. In the real estate and credit card industries, that would be bad news. In the world of Buy Here Pay Here, it's just another avenue for profit: The car can be repossessed and put back on the lot for sale in short order. A new buyer makes a down payment, takes on a high-interest loan and the cycle starts anew.

Provided they don't get wrecked, these recycled vehicles just keep paying dividends. At some dealerships, cars have been sold and resold over and over -- three, four, even eight times apiece, motor vehicle records show.

A growing empire

Although little-known outside the auto and finance industries, Buy Here Pay Here dealers are grabbing a bigger share of the market.

What's more, these hand-me-down wheels hold their value remarkably well. The sale price is sometimes higher the second or third time a car is sold, records show -- a testament to the desperation of buyers and the market power of Buy Here Pay Here lots as lenders of last resort.

Default and repossession are so central to the business that many dealers plan on both. They equip cars with hidden GPS devices and remote-control ignition blockers to make the repo man's work easier.

Many pursue their customers for years after they've seized and resold the vehicles. Some keep lawyers on staff, filing dozens of lawsuits each month to recoup unpaid balances and garnish debtors' wages.

 As Professor Mikulich noted in his presentation about payday lenders, the Buy Here Pay Here used car business model likewise "takes a bite out of the poor" and results in injustice.