Mehrsa Baradaran, How the Poor Got Cut Out of Banking

• Publication year: 2013

HOW THE POOR GOT CUT OUT OF BANKING

Mehrsa Baradaran*

ABSTRACT

The United States currently has two banking systems—one for the rich, one for the poor.1 It was not always this way. In the past, the U.S. government has enlisted certain banking institutions to serve the needs of the poor and offer low-cost credit to enable low-income Americans to escape poverty. Credit unions, savings and loans, and Morris Banks are three prominent examples of

government-supported institutions with a specific focus of helping the low- income. Unfortunately, these institutions are no longer fulfilling their missions, and high-cost, usurious, and sometimes predatory check cashers and payday lenders have quickly filled the void. These fringe banks do not provide the poor with useful credit and further bury them in debt.

This Article tracks the neglected history of government-sponsored institutions designed to offer credit to the indigent and explains how each abandoned its initial purpose. In doing so, the Article highlights the shifts in modern banking that rapidly increased competition among banks and caused homogenization in form. Alternative banking institutions could not survive deregulation and were forced to assimilate and operate like mainstream banks, with heightened profits as their sole objective. The poor were the victims.

* Assistant Professor, University of Georgia Law School. The author thanks Arthur Wilmarth, Erik Gerding, Julie Hill, Kristin Johnson, Peter Conti-Brown, Fred Gedicks, David Moore, Usha Rodriguez, and Jared Bybee for their helpful comments on earlier versions of this draft. The author would also like to thank Brad Lowe, Tim Nally, Danny Brimhall, Jonathan Love, and Seth Atkisson for their invaluable research support. All errors are solely those of the author.

1. The label poor is judgment-laden, paternalistic, and an inadequate description of the relevant group of

   people who are affected by the changes involved in banking. This group includes no-income, low-income, and middle-income individuals who are financially vulnerable in many ways. Poverty is not just about low wages and may not be a permanent condition, and those who are poor do not share common traits. This Article attempts to describe circumstances that affect those that have fewer financial resources and less access relative to others in society. These individuals are often low-income individuals—sometimes minorities or immigrants and sometimes less educated than their more wealthy counterparts—but no single one of these traits is the defining trait of the poor. Although the terms poor, underprivileged, and low-income do not accurately capture this group and have unintended negative connotations, I will use these labels interchangeably throughout the Article.

   This Article proposes the reestablishment of government-sponsored banks to serve the poor. Options include redesigning existing government measures and a novel proposal to use the existing Postal Service branches to offer low- cost, short-term credit to the low-income. Such proposals have strong historic roots and could offer credit services to millions of Americans.

   
   

   INTRODUCTION .............................................................................................. 485 I. BANKING FOR THE POOR: NEEDS AND BARRIERS ............................... 489

   A. The Costs of Fringe Banking on the Poor .................................. 491

   1. Barriers to Banking for the Poor 493

   2. Discrimination and Redlining 494

   3. The Facade of Informality 495

   4. Democratization of Credit? 496

      1. WHEN THE POOR HAD BANKS 498

         1. Credit Unions 500

            1. Born of Necessity 500

            2. An Innovative Response 502

            3. Embraced by the Law 503

            4. Credit Unions Drift from Their Initial Mission 505

            5. Deregulation 506

            6. Community Development Credit Unions 509

         2. Savings and Loans 510

            1. Born of Necessity 511

            2. An Innovative Response 511

            3. Embraced by the Law 512

            4. The S&L Drifts from Its Mission 514

            5. Deregulation 516

         3. Morris Banks and Industrial Loan Companies 519

            1. Born of Necessity 519

            2. An Innovative Solution 521

            3. Embraced by the Law 522

            4. Competition from Other Banks and Loss of Mission 523

            5. Deregulation 525

         4. Common Features of Banks That Served the Poor 525

      2. WELCOME TO POTTERSVILLE 526

         1. Market Forces 527

         2. Financial Deregulation 529

         3. Social and Cultural Changes 531

            1. The Problem Was Solved 531

               1. The Poor Have Access to Credit 532

            2. Too Poor to Bank 533

      3. SOLUTIONS FOR BANKING TO THE POOR 533

         1. Enlisting Mainstream Banks 533

            1. FDIC Pilot Program 533

            2. Community Reinvestment Act 535

         2. Community Development Banking Act 537

         3. Movements Led by the Poor 540

            1. Informal Lending Circles 540

            2. Formal Lending Circles 542

         4. Post Office Banking 544

      CONCLUSION 547

      
      

      INTRODUCTION

      
      

      Poverty in the United States is rising while economic mobility is declining. A complex variety of factors and circumstances cause poverty, making its alleviation a difficult puzzle for even the most committed policy makers. Pernicious poverty implicates every facet of society and the legal structure, but most obviously, poverty is about money—the lack of it, the inability to make it grow, and the inability to borrow it. Low-income individuals have unique financial needs and challenges and cannot be offered banking services as though they are simply rich people with less money. It is on this front that the

      U.S. banking system is failing the poor.

      
      

      A recent study found that over half the population of the United States would not be able to access $2,000 in thirty days to respond to an emergency.2 Further, approximately one-in-four households in the United States (28.3%) are “unbanked”—meaning they have no formal relationship with a bank—or “underbanked”—meaning they do not have access to incremental credit.3 Thus, they must rely on payday lenders, check cashers, or other fringe banking institutions to meet their short-term credit needs. These lenders are often

      
      

2. An Examination of the Availability of Credit for Consumers: Hearing Before the Subcomm. on Fin. Insts. & Consumer Credit of the H. Comm. on Fin. Servs., 112th Cong. 141 n.1 (2011) [hereinafter The Availability of Credit Hearing] (citing Annamaria Lusardi et al., Financially Fragile Households: Evidence and Implications (Nat’l Bureau of Econ. Research, Working Paper No. 17072, 2011)) (statement of Robert W. Mooney, Deputy Director, Consumer Protection and Community Affairs).

3. SUSAN BURHOUSE & YAZMIN OSAKI, FDIC, 2011 FDIC NATIONAL SURVEY OF UNBANKED AND

   UNDERBANKED HOUSEHOLDS 4 (2012).

   usurious, sometimes predatory, and almost always much worse for low-income individuals than the services offered by traditional banks to their customers.

   
   

   Many scholars and policy makers agree that fringe banks have high costs for the poor4 and further dislocate them from traditional banking institutions by preventing them from building up a credit history.5 Many have advocated regulating such institutions or even banning them.6 Proposals include technical regulatory changes aimed at usurious rates,7 increased disclosure,8 and other consumer protection measures.9 Rather than joining the chorus of scholars

   looking to improve payday lending and check-cashing institutions, this Article takes a more fundamental approach: it seeks to examine the gaping hole that these services are currently filling.

   
   

   Throughout most of U.S. history, the credit needs of the poor were met by banking institutions specifically created and designed to appeal to them. Credit unions were a populist innovation designed to give the poor control, choice, and ownership over their money, with the protection of federal insurance.10

   The Savings and Loan (S&L) was created to enable middle- and working-class homeownership.11 Each of these institutions was designed as a cooperative: their defining features were common ownership and forbearance of profit.12 In contrast, the little-known Morris Bank was a for-profit banking venture aimed at the “democratization of credit,” which was envisioned as giving the poor access to small loans.13 Credit unions, S&Ls, and Morris Banks operated outside of mainstream banking and used innovative structures and products to meet the unique needs of the poor. Each of these banks was born of necessity,

   
   

4. See, e.g., JOHN P. CASKEY, FRINGE BANKING: CHECK-CASHING OUTLETS, PAWNSHOPS, AND THE POOR

   7 (1994).

5. See, e.g., Michael S. Barr, Banking the Poor, 21 YALE J. ON REG. 121, 124 (2004).

6 See, e.g., 10 U.S.C. § 987 (2006); N.C. GEN. STAT. § 53-276 (2006); Ronald J. Mann & Jim Hawkins,

Just Until Payday, 54 UCLA L. REV. 855, 858–60 (2007); Paige Marta Skiba, Regulation of Payday Loans: Misguided?, 69 WASH. & LEE L. REV. 1023, 1043 (2012) (stating that fourteen states completely ban payday loans); Scott A. Hefner, Note, Payday Lending in North Carolina: Now You See It, Now You Don’t, 11 N.C. BANKING INST. 263, 285–87 (2007).

1. Pearl Chin, Note, Payday Loans: The Case for Federal Legislation, 2004 U. ILL. L. REV. 723, 744.

2. Mary Spector, Taming the Beast: Payday Loans, Regulatory Efforts, and Unintended Consequences, 57 DEPAUL L. REV. 961, 978–79 (2008).

3. See, e.g., Barr, supra note 5, at 129; Brian M. McCall, Unprofitable Lending: Modern Credit Regulation and the Lost Theory of Usury, 30 CARDOZO L. REV. 549, 551 (2008); Benjamin D. Faller, Note, Payday Loan Solutions: Slaying the Hydra (and Keeping It Dead), 59 CASE W. RES. L. REV. 125, 126 (2008).

4. See infra Part II.A and accompanying notes.

5. See infra Part II.B and accompanying notes.

6. See infra Part II.A–B.

7. See infra Part II.C.

   eventually supported by the government, and expanded across the country. Each then drifted from its initial mission.

   
   

   The drift resulted in part from deregulation. Before the 1980s, the federal and state governments tightly controlled banking by limiting the activities banks could perform.14 Due to changes in both capital markets and political ideologies, banks began to expand their reach and activities.15 The banking sector quickly grew in size and scope and lobbied successfully for decreased government regulation.16 Credit unions, S&Ls, and Morris Banks were caught up in the deregulatory atmosphere of the 1980s and started to compete...