16.12.10

EXTRACTING RISK PREMIA? Take higher risks, earn a higher return. Everybody who has money to lend had best understand that. It's a law of conservation, however, and it means that if you present higher risks, you pay more to borrow. Straightforward enough, but that's the reality of the poverty industry (check-cashing services, payday lenders, pawnshops, writers of sub-prime mortgages). I first encountered the term poverty industry in a paper about pawnshops and crime that earned its author a prize in the Illinois Economics Association student paper competition. The term poverty industry appears to be the coinage of Mike Hudson, no fan of interest-rate deregulation or the repeal of usury laws, otherwise known as the Corleone Family Full Employment Acts.

All that by way of introducing Book Review No. 35, Gary Rivlin's Broke, USA: From Pawnshops to Poverty, Inc. -- How the Working Poor Became Big Business. Well, not exactly how: it's journalism, and it follows a few of the major players in the legitimate high-risk lending business, some of the homeowners who took out one or another of the loans, and the fate of a few formerly thriving blue-collar neighborhoods now shorn of factories, whose commercial sectors are now the aforementioned check cashers, payday lenders, and pawnshops. Fill out the strip mall with a nail salon, a tanning shop, and a tobacconist and you have Downscale U.S.A. And whoda thought a Wisconsin institution like Thorp Finance would have been a pioneer in the easy credit business.

The major players are not necessarily the wizards of high finance, those who have made it big exhibit all the tacky noveaux-riches trappings, and author Rivlin is clearly sympathetic to the borrowers trapped by the steep penalties for missing a payment, or lawyered out of their houses. He resists the temptation to advocate for new legislation or a populist uprising.

The unspoken message of Broke USA is that a little financial literacy can go a long way. Resist credit. Never borrow from a lender who charges prepayment penalties. Never initial anything you can't read and understand first. (The supposed consumer protection provided by a blizzard of paper allows the lenders to overwhelm borrowers with a lot of stuff notionally "required by the government.") Almost makes declaring your friendship to Don Vito look easy. There's the tradeoff -- usury laws or tighter creditworthiness standards or limits on penalties do not put the poverty industry out of business -- it reverts to its older form.

(Cross-posted to 50 Book Challenge.)

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