The Price of Money

A new state law promises to regulate Tennessee's cash advance industry, but it also permits interest rates that seem outrageous.

by Mike Gibson

On that fateful day in November of 1994, Helen Goins was doubtless unaware of the disastrous domino chain she triggered simply by walking into a Bradley County cash-advance outlet and signing her name to a worthless personal check.

According to court documents, the Cleveland, Tenn., resident wrote the post-dated check for $124, more than she had in her bank account at the time, and in exchange received $100 on the condition that she would make good on its face value within 14 days. Two weeks later, she came in and paid the company $119 cash (the five-dollar difference amounting to a "discount" for timely payment). But rather than leaving the store debt-free, Goins wrote a second post-dated check, this time for $248 in exchange for $200 cash.

And she wasn't finished. Documents allege that over the next 15 months, Goins made nearly 30 transactions at the same outlet, with most of the exchanges consisting of "roll-overs"--two-week extensions of an initial loan effectively purchased at the cost of the interest. By the end of the 15 months, records say, she had paid more than $1,300 for $400 in loans. And yet the check advance lender still claimed she owed $248 on a single worthless check.

By itself, the incident is startling. But consider that Goins claims she patronized four other area check-advance outlets between 1994 and 1996, either rolling over existing debts or incurring new ones a total of four times at one business, eight times at another, and 24 times each at two others. Consider also that her husband William Goins, doing business at some of the same establishments, claims to have paid roughly $2,500 in interest to three check-cashers over the period on $600 in loans.

The Goinses and other area residents have since filed suit against several local check-advance companies in Bradley County Circuit Court. The couple couldn't be reached for comment, so one can only speculate as to whether their plight was prompted by need or simply poor judgment.

And with the suit still pending, their attorney, Richard Fisher of Cleveland's Logan and Thompson, doesn't want to address either the case or the manifold legal issues it touches. His official complaint, however, speaks volumes, alleging (among other things) that the eight co-defendants "charge(d) and collect(ed) exorbitant and usurious interest for the use of money contrary to law."

Tennessee's check-advance industry is under scrutiny for the first time in its relatively brief history. The Goins action is one of a handful pending across the state, charging that most of its practices run afoul of state usury statutes and federal truth-in-lending laws.

In the meantime, a controversial new state law--the Deferred Presentment Services Act, or check-advance bill--will give the industry legal sanction and make it difficult for future check-advance customers to make such claims. While the act (which takes effect in October) purports to regulate businesses that loan money on post-dated checks, placing ceilings on fees and limiting the debt customers can incur, it has been criticized by consumer advocates and a few dissenting legislators as little more than an excuse for usury.

"It's a blatantly awful bill," says Brian McGuire of Tennessee Citizen Action, a Nashville-based consumer watchdog group. "How can you justify allowing a business to charge hundreds of percent interest on a short-term loan?"

"There were just too many lobbyists around; this thing rolled through the legislature like a greased pig," says Knoxville Sen. Bud Gilbert, one of seven state senators who voted against the bill when it came before the legislature this spring.

Gilbert was dismayed not only by provisions he believes protect commercial interests more than consumers, but also by the intensive lobbying efforts and free-handed campaign contributions of the check-advance contingent (The Nashville Banner reported in March that industry leaders had donated thousands of dollars to Gov. Don Sundquist as well as to several legislators who would consider the bill), and by the lack of a state enforcement mechanism that might have curtailed abuse in the first place.

"The argument is that this kind of business performs a service for poor people, but I don't think that's the case," says Gilbert. "Local DAs could have chosen to go after some of these places under the small loan laws. If that had happened, I think they could have put some of them out of business."

But politics aside, many of the industry's defenders argue, sometimes persuasively, that check-advance companies provide a valuable service to people who don't have much access to mainstream lenders.

The debate raises a host of questions as to just what constitutes a "fair" return on a high-risk loan, what role check-advance and other high-interest but highly inclusive money lenders should play in a society where credit is often denied those who need it most, and what role government should play in saving borrowers with poor judgment from themselves.

In his 1994 book Fringe Banking; Check-Cashing Outlets, Pawnshops, and the Poor, Swarthmore economics professor John Caskey makes the case that pawn-brokers, check-cashers, and other small high-interest lenders have found a niche serving customers--primarily low-income families with poor credit--who have fallen through the cracks of mainstream banking and credit services.

Caskey cites surveys that indicate the number of pawnshops and check-cashing outlets have increased almost exponentially in recent years (the number of check cashing outlets, for instance, grew from around 2,200 to more than 5,000 nationwide between 1986 and 1992). Unlike check-advance outlets, which basically give out loans, check-cashing outlets simply cash third-party checks for a set fee. He correlates that explosive growth with a host of nascent social and economic trends, from banking deregulation to rising immigration to an increase in the number of single-parent homes, that seem to have put banking services out of reach for many lower- and lower-middle-income households.

According to David Tarpley, a consumer protection attorney for the Middle Tennessee Legal Aid Society, those same trends seem to have given birth to other enterprises that might be seen as branches of the fringe banking industry, including rent-to-own, car title pawns, and check-advance, an outgrowth of CCOs.

But Tarpley says many of these businesses initially skirted existing state and federal laws, in particular the state's general usury laws, which stipulate that "unclassified" lenders can charge no more than 10 percent interest annually on most loans, and federal truth-in-lending laws, which require lenders to state the extrapolated annual interest rate of a short-term loan.

Unfortunately for consumers, says Tarpley, there is no state agency charged with policing these small creditors.

"Tennessee is a classification state," Tarpley explains. "Unless you are recognized under special legislation for your class of business, any loans you make are subject to general usury. The catch is figuring out who is going to watch out for it. There are some provisions for enforcement under law, but Tennessee has always mostly assumed that such cases will be pursued privately, in civil courts."

Over the last 20 years, industries like title pawn and rent-to-own have, by turns, grown, marshaled lobbying power, and engineered legislation that legitimized their business practices, providing some regulatory strictures but also permitting higher interest rates or affording special legal protections. The 1995 Title Pawn Act, for instance, permits title pawn lenders to charge a fee that extrapolates to well over 200 percent annually.

But Tarpley sees the check-advance industry and its new governing legislation as perhaps the most invidious, permitting interest rates he says run more than twice as high as those in any other lending classification.

In essence, the check-advance bill permits lenders to hold post-dated checks for no more than 31 days at a fee of no more than 17.65 percent of the loan. (Based on a 31-day term, that translates to about a 212 percent annual interest rate.) The law also caps the fee lenders can charge at $30, and caps the amount of the loan at $500 (although given the percentage and fee caps, most lenders are unlikely to advance much more than $200 to one debtor at one time.)

What the law lacks, says Tarpley, is a cap on the number of transactions per customer, and a narrower definition of the term over which that 17.65 percent rate can be extended. (The rate could be applied, theoretically, to a loan of only a few days, effectively yielding an annual interest rate of several hundred percent.)

"It concerns me that this is billed as a 'regulatory measure," says Tarpley. "It's not. What we've got is a license to charge an annualized rate of 700 percent several times a year to the same borrower. If you're going to regulate, you need to regulate. You need to address both the rate and the term."

Check-advance proprietors, however, maintain that not only does their industry provide a vital service at a fair market price, but that in a climate where credit problems have become increasingly commonplace, their role has extended far beyond that of simply providing emergency cash to the desperate poor.

According to Steve Scoggins, state president of Check Into Cash, a cash-advance corporation with 130 stores regionally (including three in Knoxville), check-advance companies comprise a thriving, respectable industry of some 1,000 outlets in Tennessee. He estimates that with more than 500,000 total transactions at an average of about $160 each, check advance outlets, or CAOs, loaned out more than $80 million statewide in 1996 alone.

Scoggins admits the public perception of his profession is generally negative--that many people believe check-cashers take advantage of poor clients with even poorer judgment. "People who don't know the industry think that," he says with some conviction. "There's no truth in it."

The Check Into Cash chain, begun in 1993 by Cleveland, Tennessee native and collection agency proprietor Allan Jones, is one of the "new breed" of CAOs that purports to serve a clientele that is predominantly middle class. Their outlets, with neon-and-fluorescent storefronts that often resemble convenience marts rather than pawnshops or banks, are typically wedged in strip malls and other strongholds of suburban commerce. (CIC, along with Jones, is also named in one of the pending lawsuits.)

Check Into Cash keeps track of demographic and other consumer information through a sophisticated computer system, says Scoggins; the median household income of the chain's customers is around $30,000, and the company won't extend cash to people who don't have what he calls a "banking relationship."

"We've done business with attorneys, nurses, interns, teachers, police, blue-collar workers," he says. "It's not just a clearing-house for poor people. You have to have an active bank account if you want to do business with us."

But though so-called upscale CAOs may have made new inroads, their consumer profile isn't representative of the industry as a whole. "Scott," an Anderson County resident who until recently ran a check-advance service out of his accounting office, affirms that his customers were "generally not very well-off." He adds with a hint of a smile that "everybody had a sob story."

(Scott sold his share of the business to a partner last October, fearful of lawsuits and weary of the attendant hassle. Because he operated without a license and no longer wishes to be associated with the industry, he chose not to use his real name.)

And research further supports the notion that most fringe lenders, from pawnshops to CCOs and beyond, generally serve a less affluent clientele. A pair of late-1980s surveys, one by the Roper Organization and one by the New Jersey Department of the Public Advocate, both found that check-cashing customers have substantially lower-than-average household incomes. Or as one national "fringe bank" CEO said, rather bluntly, to a New York Times reporter, "I could take my customers and put them on a bus and drive them down to a bank and the bank would laugh at them. That's why they're my customers."

It's for precisely that reason, however, that CAO proprietors argue that the marketplace, not government, should determine interest rates on short-term loans. Scoggins, who as president of the Tennessee Cash Advance Association worked with legislators in crafting the cash-advance bill, is generally supportive of most of its regulatory provisions. He proudly touts measures that will prohibit "rollovers" (meaning customers will be required to pay off debts at the end of a term rather than extending them ad infinitum by paying only the fees), limit the number of concurrent transactions to two per client and even forbid stores from lending to potential customers with outstanding debts at other outlets.

But on the issue of interest rates, he's less enamored with the legislative process. (The standard charge on a "deferred payment" at Check Into Cash is about 19 percent for a 10- to 16-day term, somewhat higher than the new law permits.)

"We would have liked the market to determine rates," he says. "This business was built on free enterprise, and that's its strength. We think having responsible regulations is good, and I think this legislation is fairly reasonable for people in the industry and also protective of consumers. But when it comes to rates, the free market should set the tone."

To some, that might sound like stale rhetoric, but it is indicative of the uncommonly high risks--and costs--of a business whose fortunes rely on a clientele that may not always be very reliable. Proprietors cite several plausible reasons why CAOs may need to charge interest rates some might deem excessive in order to remain viable, including high insurance premiums, high ratios of fixed costs per customer, and perhaps most significantly, default rates that far exceed those of "mainstream" lenders.

Scoggins won't discuss the specifics of CIC finances, including customer default rates. But Scott estimates that if only one out of every four of his customers had refused to pay off a debt, his venture probably would have lost money. (Caskey's survey of several dozen proprietors found that default rates usually range anywhere from 10 to 30 percent. Credit card default rates, by contrast, are around 6.5 percent.)

"There's a lot of time and hassle involved with staying on top of it," says Scott, who charged his clients $24 for a 12-day, $100 loan. "I was making money, but I wasn't burning the house down. I've been out of the business since October, and I'm still holding $1,500 in checks I'll never see a penny on."

As for the new legislation, he simply adds, "Basically I think it's going to put a lot of people out of business."

Like Helen Goins, "Susan" (not her real name) only wanted to buy time when she walked into a CAO in Harriman two years ago and signed for a $200 loan. What she bought instead was trouble.

Like many small-town couples with seasonal, blue-collar jobs, Susan says she and her husband, Bob, often have to scramble to make ends meet; Bob is a carpenter, Susan suffers from a chronic illness, and the pair have two small children, ages 2 and 4. "They're very demanding," she says with a weary chuckle.

That month, the check Bob was to receive for a carpentry job ran late, and with rent on the couple's trailer due, Susan says the lure of easy cash was too tempting to pass by. "All they asked for was a check stub and a bank statement," she says. "When you get behind on bills and you're desperate to get them paid, you don't always think about the consequences."

But what began as a one-time quick-fix soon became a habit, a quick-cash addiction. At times, the couple found themselves borrowing from one CAO to pay off another, and Susan estimates they paid the "rollover" interest fees as many five times for every debt they repaid in full.

"The places sort of encourage you to just renew the payments," Susan says. "I know we spent a lot more money on interest payments than we ever received in the first place. It's easy to get caught up in, because it seems like you never have enough money to pay them off."

The couple's financial troubles came to head last year when, during a particularly lean month, they went to four different CAOs and borrowed a total of $800 in a desperate effort to pay off mounting household and medical bills. The weight of the new debts proved to be more than their fragile finances could bear, and three months later, Susan and Bob filed for Chapter 13 bankruptcy.

"There's a lot of things they should change about how they run those things," says Susan, who adds that all of her CAO creditors now receive small monthly payments according to the terms of the Chapter 13 settlement. "They're too easy to use. People can get into so much trouble--a lot more trouble than a $200 check is worth."

Susan's plight may in part help dispel a common misconception about the patrons of CAOs and other fringe lenders--that borrowers who find themselves deeply in debt are in trouble simply because they lack scruples or self-control. Customer surveys show that while some CAO borrowers may obtain cash advances for frivolous or even illicit purposes, many transactions are prompted by a household debt, an emergency, or an unexpected medical bill.

Her experience also bears out that CAO proprietors may not always have the best interest of consumers in mind and perhaps points to the real crux of the check-advance issue. Given that the industry is probably more prone to abuse and predation than its defenders would have us believe, yet more problematic and less lucrative than its detractors understand, does a happy medium of commerce and control really exist? Does the industry merit legal sanction in the first place?

Patricia Foster questions outright the value of CAO services. As US Bankruptcy Trustee in Knox County, she's heard stories like Susan's countless times before and offers a ground-level perspective on the damage she believes check-advance outlets inflict by preying on the financial short-sightedness of a needy clientele.

"There's not a day that goes by that I don't pick up a bankruptcy petition and see several of these places named on it," Foster says. "There are lots of people out there living on the edge, hand-to-mouth, and those are the people they take advantage of."

But some evidence suggests that the pathologies of this fledgling industry will be remedied as it grows and falls more in line, ethically and organizationally, with the practices of mainstream lenders. In both the pawn-broking and check-cashing industries, large national and regional chains, many of which are publicly offered, have established a presence with outlets that are often stricter in their record-keeping and screening procedures than some of the smaller independent operators.

Tarpley says other fringe bankers and high-risk creditors seem to have prompted fewer consumer complaints as their industries have matured, although he's cautious in interpreting that trend. "We have a lot fewer complaints about the rent-to-own outlets than we did 15 years ago, and we rarely have problems with pawnshops. That suggests that some of these industries have improved their track records substantially, but it could also mean people are afraid to challenge what they now see as established businesses."

Yet many observers feel CAOs and other fringe bankers may indeed have a role to play in providing loans to borrowers with few credit options. Jim Wansley, head of the University of Tennessee Finance Department, admits he has only a passing familiarity with the phenomenon, but he speculates that the very existence of cash-advance and other related outlets suggests a need. And eliminating the service could leave CAO customers at the mercy of more undesirable alternatives.

"I tend to believe that if people go to these stores, they're playing a role," says Wansley. "If their clients were able to get these services elsewhere, at a better price, they would do so."

A local financial planner adds, "If a client needs to pay a bill, and they're going to lose their car or mar their credit if they miss that payment, then getting a check advance may well be the best choice."

Caskey, who believes fringe banks are a now-indispensable component of our economic system, suggests that perhaps the most important step in circumventing abuses lies in remedying some of the social ills, such as lower savings rates and lack of banking services for the poor, that allowed the industry to thrive in the first place.

Beyond that, he touts careful, well-considered, industry-specific regulations and emphasizes that states need to put as much effort into enforcement as they expend on the initial legislative process. All of which brings the debate back around to a few crucial, oft-contended points.

"I think the check-advance industry has a place in society," says Knoxville bankruptcy attorney Richard Mayer. "The question is what is a suitable regulatory structure? What is a legitimate interest rate to charge? And my other question is just what did people do before they had these places around?"