Credit is more than just getting loans.  Folks of all income levels use credit for “consumption smoothing” – basically helping match lumpy inflow (bi-weekly paycheck or irregular investment income/liquidity) to lumpy outgo (monthly bills, unplanned expenses, opportunities).    Credit is usually provided by a bank, but a significant portion of the US population is not getting their needs served. Access to credit and financial services is a concern to the FDIC, in a 2009 survey they concluded that 7.7% of all households are unbanked and 17.9% of all households are underbanked. A 2005 paper for the FDIC describes Alternative Financial Services (AFS) as including check-cashing, pawn shops and rent-to-own along with payday lending.  This is in contrast to the Financial Services sector of banks, thrifts (Savings & Loan), brokerages and mutual funds.

The FDIC defines “unbanked” as no one in the household has a checking or savings account.  “Underbanked” means someone has a checking account, but has used alternative financial services at least once or twice per year.  To the above list they also include money orders, and FDIC also considers someone underbanked if they’ve used a refund anticipation loan at least once in the last five years.  Other reading I’ve done notes that overdraft protection can be regarded as a kind of payday loan in that it is a short term loan with very high fees.  The challenge with overdraft protection is that its not always consciously chosen but accidentally done! This is enough of a problem that in November of 2009 the Federal Reserve issued new rules for banks to require customers to opt-in for overdraft on debit and ATM cards.

It’s the fees when annualized that make short-term loans so expensive.  Part of the bad reputation comes from the assertion that customers end up being repeat borrowers and rolling their loans over repeatedly and so paying those high rates for long loans. Do they?  A Washington State Department of Financial Institutions study from 2008 shows that just under 20% of borrowers are one-time borrowers. However that’s for a total of 2% of all the loans, because from there there’s a very long tail of repeat borrowers that get up to borrowing 19 times in a year before any group accounts for less than 1% of the total.  Add them up and 60% of borrowers have borrowed 4 or more times in a year.

Convenience & less hassle seem to be the big market drivers for payday loans.  According to Moneytree, all you need is proof of employment via paystub, though in California and Colorado they must also require an active checking account.   I’ve heard that payday lenders don’t report on your loan so if it goes bad it doesn’t impact your credit score.  The application process is minimal and the turnaround can be less than an hour.  I suppose the mainstream financial system equivalent is a credit card. A quick browse of Moneytree’s website shows a company that offers a huge menu of financial services: check cashing, payday loans, prepaid cards, coin counting, bill pay and more!  It seems to be the interface to the mainstream financial system for people who need it, and that’s what the industry argues: they provide a valuable service to customers who need it and shame on us for turning up our noses and trying to regulate them out of business.

I recently re-connected with a high-school friend whose life has taken a very different direction.  She has much more experience than I with living on the financial edge.  She was really frustrated by the automatic overdraft protection and is the one who told me her bank switched to opt-in recently.  She married a guy who has bad credit and collection issues. They’ve solved that by putting everything in her name but I get glimpses of what life must be like if you have bad credit. She told me that most of the “free credit report” websites are basically honeypots to collect personal data and pass it on to collection agencies.  She made some other comment about things they can’t do, I think one related to travel, because it might get the hubby identified by collections.  They’re both gainfully employed and decent citizens, but I have this image of a twighlight financial/legal status that, while probably not that melodramatic, definitely sucks.

Yesterday I stopped into my local Wells Fargo where I got my 2^nd pitch to change my current account setup and this time I decided to bite out of curiosity.  I sat at the desk with the banker and heard about how I could set up a different checking account that would give me some number of free cashier’s checks and money orders, and if I set up an automatic sweep into savings and kept the money there it could earn 3% interest! Kudos to Wells Fargo for creating a savings incentive and at this miserable time 3% is quite impressive. (Did I ever tell you about the 8% CD I had at Navy Federal back in the 80s? Those were the days….)  I was curious about the heavy pitching of money orders and cashier’s checks,  I can’t remember the last time I got one personally, so I asked.  He said that more and more folks are using money orders and cashier’s checks instead of regular checks because the money comes out of your account at the time the check is issued. Apparently that’s easier for people to manage though he added that it’s much easier to cancel a regular check if it gets lost (so I gather that’s an issue).  He also said that 150 checks is a lot to have lying around if you’re not able to be responsible with them ( I guess from a security standpoint – roommates, family members?  Possibly a self-control standpoint?)   As I walked in the door at home 15-minutes later and fished out a still-undeposited 7-week-old check from a relative (d’oh! I was just AT the bank)  I found myself thinking that yeah, if you’re managing very close to the line the uncertainty of personal check cashing and clearing could be a pain.

Based on the above, my thinking:  if you have bad or no credit score (I’ll lump “in active collection” under this), if you live in physically insecure circumstances where you want to have your finances with your person at all times (so no checks or cards you leave at home), if you are not comfortable with accrual accounting or managing your check register and so live on a cash basis (which I think LOTS of people do: that crazy bestseller Rich Dad Poor Dad is basically about getting off of a cash basis for looking at personal wealth)  or frankly, if you’re just tired of putting your paycheck in a bank where they find a dozen reasons to ding you for small fees because as a small customer they don’t make enough money off you – minimum balance fees, overdraft fees, holding deposits for days, clearing things in the order that maximizes bounce fees and then charging them repeatedly while being slow to notify you – then you are trapped living on a cash basis – little access to credit for the float we all use, little access to automatic bill paying or online purchasing.  No wonder the FDIC is concerned –  is it healthy for our economy to say 25.6% (the Unbanked + the Underbanked) don’t get to be full players?

Hmm, maybe that IS the problem, that in a for-profit banking system, some people are just not profitable enough.  I know a credit union working to serve folks better, but interestingly it’s not tax-deductible (and might even be taxable!) to donate money to them.  Much material for future thinking and blogging!

Mark Flannery & Kathryn Samolyk, 2005, Payday Lending: Do the Costs Justify the Price
FDIC studies on the underbanked
Federal Reserve announcement on overdraft protection
Wa State DFI 2008 Payday Lending Report
FDIC small dollar loan studies
A feast of services from our local Moneytree. Regarding Payday Loans: “As an analogy, while you would not choose to take a taxi from Seattle to San Diego or Denver to Las Vegas, it is common to take a taxi for a short distance, such as from your hotel to a nearby restaurant.”

What I remember of Kantian ethics from college philosophy is essentially this: an act is immoral if it causes a system breakdown when everybody does it. As a computer scientist I automatically think of the tragedy of the commons – I can get away with grazing my goat in the commons, but if we all do it the commons is done for, ergo even though I can get away with it, it’s an immoral act even for just me to do it. If I acquire a fortune and live only off the generated income of my fortune I’m doing quite well by the moral standards of my time. But… what if we were all trying to live off fixed-income investments in other people’s work? Like the Giant Pool of Money… perhaps too many of us have made it good. Somebody has to be generating real value.

This was in the back of my mind when a friend forwarded me a look at Common Good Bank, an effort to start a bank that would not have equity owners but be owned by its depositors. In grad school we talked about other banks like that, most famous is JAK bank of Sweden. Browsing around to see who is behind this effort I found the blog of the founder and eventually figured out he is William Spademen. He wrote a post with the provocative title “Unearned Income is the Root Cause of Poverty”. I thought that was a bit of a broad statement, but given the context already simmering in my brain, it caught my attention. Unearned income… we can’t all live off it and if we’re all trying to, where does it come from? Out of the pockets of others? Making them poor?

On his blog someone commented and said “I rent out a house, is that unearned income?” Spademan replied and hedges a bit but does say “In general, owning land is not a productive activity”. This is very accepted in our society that giving others access to our capital IS providing a value, for which they justifiably pay us interest. Yet how is it that we have that capital in the first place and they don’t? Often it’s what resources or business infrastructure you were born to (Bill Gates, Sr likes to point this out), or what great opportunities you stumble in to so that your hard work actually does pay off as opposed to the hard work of many others which doesn’t. We tell ourselves people who are renting instead of owning are choosing a different risk/reward distribution. But is it really their choice, or their lack of choice?

On an email list I received a link to an animated video called “Money as Debt”. (Warning – this link plays music: http://www.moneyasdebt.net/ ) It’s 45 minutes long and talks about the fractional reserve banking system and how money is created in the system when banks are approved and allowed to write loans at a 9:1 ratio against their equity, and a 1:9 ratio against their deposits since those deposits are assumed to be originated somewhere upstream as debt. It keeps the system in balance, except for the problem of interest. If we’re all circulating capital out of the same pool, the pool needs to keep continually expanding to account for the interest we’re all charging each other. That made sense to me, and what really caught my attention starts at about minute 23, that we can’t simultaneously pay off all our debt because Money IS debt – otherwise we’re back to bartering and time banking. But more intriguing for me was the assertion that this kind of closed system of principal circulating to pay off principal + interest has an inevitable math: (Interest)/(principle + interest) = foreclosure rate. That’s a bit of an oversimplification of all debt to mortgages, but I did a little research and turned up that mortgage debt is about 78% of all debt and consumer debt is less than 10%. Constant economic expansion, and support of that expansion through the creation of new debt is what keeps us ahead of the curve – this year’s circulating principal is more than last year’s.

This has been very tricky for, interestingly, men I know to understand. Women don’t seem to have as much trouble. There’s a difference between creating new value (inventing something, discovering something) and creating additional money (by opening a new bank or changing reserves through open market operations). Perhaps substituting the word “currency” for the word “money” will help keep it straight. I find myself thinking that problems must come when the pace of those two creations gets out of wack: value is created faster than currency or currency is created faster than value. Aha, the Fed validates me: “Inflation is caused by excess growth of money and credit relative to the supply of goods and services in the economy” (via another noisy link!) No wonder monetary policy and managing inflation is so complex – how can we really tell how much value is being generated year to year? Also several papers have demonstrated that the velocity of money – how quickly it changes hands, has changed considerably over the last few decades and also impacts how much total money can be said to be in circulation. And finally, how much control does the Fed really have over the amount of money in circulation when investment banks can invent entire new private debt vehicles (CDOs) and loan back and forth to each other?

With this thread, I don’t have any answers yet, still trying to formulate clear questions. It does seem that built into our monetary system is a need to balance the accumulation of interest, through some combination of expansion or bankruptcy. If we’re unknowingly in a game of musical chairs to avoid the short straw, it seems likely the less educated and well connected will more often end up with the short straw, but I can’t show that connection yet.