Copyright (c) 2000 University of South Carolina
South Carolina Law Review

Spring, 2000

51 S.C. L. Rev. 589

LENGTH: 37906 words

FOCUS EDITION: THE USURY LAW DEBATE: ARTICLE The Two-Tiered Consumer Financial Services Marketplace: The Fringe Banking System and its Challenge to Current Thinking About the Role of Usury Laws in Today's Society

NAME: Lynn Drysdale*, Kathleen E. Keest**

BIO:

* Lynn Drysdale is a staff attorney with Jacksonville Area Legal Aid, Inc. and Florida Legal Services, Inc. She has been representing elderly, low-income, and working poor clients for twelve years and has experience with consumer protection litigation and legislative advocacy.

* Kathleen E. Keest is an Assistant Attorney General in Iowa and Deputy Administrator of the Iowa Consumer Credit Code. The opinions expressed herein are those of the authors and do not necessarily reflect those of the Attorney General of Iowa, nor of the Office of the Attorney General. Ms. Keest was previously a staff attorney with the National Consumer Law Center and has written extensively on consumer credit issues. She is a member of the American Bar Association's Consumer Financial Services Committee, and she chaired its Interest Rate Subcommittee from 1991 to1994. The authors thank Jean Ann Fox of the Consumer Federation of America and John P. Caskey of Swarthmore College for sharing their considerable stock of information. We also thank Creola Johnson of Ohio State University Law School for permission to refer to her work in progress, and Karen Hayes for production and research assistance.

SUMMARY:
... But in at least one respect, the turning of this century would seem almost eerily familiar to people like F.B. Hubachek, who became General Counsel to Household Finance in 1930 and a well-known name in the new consumer finance industry. ... To avoid appearing to roll over the debt, the lender may ask you to take out a "new loan," in which case you pay the $ 15 fee, but write another check for $ 115. ... As the Department of Financial Institutions' Consumer Credit Division supervisor explained, "There is no incentive for the lender to not allow the customer [roll over] since it results in continuing fee income and more repeat business. ... Though default on a normal consumer credit debt may trigger delinquency fees and collection fees, check loans are the only type of consumer debt we know of which conceivably trigger treble-damages penalties upon default - penalties established by the civil bad check laws of some states. ... " Testimony of the Illinois Consumer Justice Council before the Illinois State Senate Financial Institutions Committee cites a corporate payday lender's press release: ""We target stores in working-class neighborhoods. ... As with the payday loan customer, there are competing profiles of the rent-to-own (RTO) customer. ...

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I. Introduction: A Study at the Intersection of Law, Politics, Morality and Economics

At the dawn of the twenty-first century, in many respects our society would be astounding to those who watched the last century turn. Technological and scientific developments have changed the face of life in ways unimaginable a hundred years ago. But in at least one respect, the turning of this century would [*591] seem almost eerily familiar to people like F.B. Hubachek, who became General Counsel to Household Finance in 1930 and a well-known name in the new consumer finance industry. 1 What we today call the "prime" consumer credit market - purchase money home mortgages and the secondary mortgage market, 2 home equity loans, credit cards, automobile loans and leases that finance the American Dream for most of the middle-and upper-economic quintiles - is a world away from that of 1900. But for parts of what is now called the "subprime" consumer credit market, the century is ending much as it began. After interim decades of reform, some of the credit products in the small-dollar end of this market are throwbacks to that earlier era, and the debate they generated then echoes today.

Known as the "alternative financial services" (AFS) or "fringe banking" sector, 3 this market has become a major source of traditional banking services for low-income and working poor consumers, residents of minority neighborhoods, and people with blemished credit histories. Those who have no concerns about the emergence of this market consider it simply part of a trend toward niche marketing offering a needed and desired service to people previously unable to participate in the credit society - in short, the "democratization of credit." 4 Critics of the phenomenon, on the other hand, call the trend "financial apartheid" 5 or the "second-class" marketplace.

This Article does not attempt to trace the rise of the fringe banking market over the course of this century. One factor in its development, however, has undoubtedly been the emergence of consumer credit as a driving force in the economy. By one gross measure, aggregate household debt 6 rose from $ 653.9 [*592] billion in 1975 7 to $ 4.7 trillion in 1995 8 and $ 5.6 trillion in 1998. 9 Comparing those figures to aggregate annual household income, the 1975 ratio was 24%; in 1995 and 1998, the ratios were an astounding 104%. 10

This growth is a two-edged sword, reflecting the dual character of debt. [*593] Even the two names we give to this product reflect this dual character: "credit" has a positive connotation, but "debt" still rings with a negative one. 11 Credit can be used for productive investment for the household. Without question, a large portion of the increased ratio of aggregate annual income to debt load from 1975 is positive. The level of homeownership in this country has risen to historic highs - 66% in 1998 12 - a fact reflected in of the higher level of mortgage debt. 13 It also reflects a rapid acceleration in attitude changes about debt. 14 There is an increasing willingness to "hock" the home through home equity lending, sometimes for long-term investment purposes such as education or home improvements, and sometimes for consumption - vacations or consolidation of credit card debt. 15 Credit card debt, which grew from $ 19.5 billion in 1975 16 to $ 586.5 billion in 1998, 17 is now used partly for asset building (such as financing the purchase of consumer durables), partly for convenience (such as avoiding carrying cash), and partly to finance consumption (such as groceries, vacations, and restaurant meals). Longer terms on auto loans and the advent of auto leases have encouraged us to buy more expensive vehicles more often. 18 However, debt can also be destructive, as [*594] those who have lost their homes to foreclosure from "equity skimming" loans, 19 or those whose use of a high-rate, short-term lender has led to bankruptcy, can attest. 20

For good and bad, the increasing willingness of Americans to go into debt has been part of the engine driving economic growth in the 1990s. But the rising debt load creates some challenges for credit providers as well. Growth is a goal of many businesses, and unless a credit provider diversifies, 21 growth comes by keeping its customers in debt, getting them deeper in debt, or getting more people in debt. Though the saturation point for debt - from a macroeconomic perspective - is unknown, the higher debt loads go, the more of a challenge it is for businesses that "sell debt" to grow.

All of these strategies have played a role in the development of the subprime consumer credit market, both directly and indirectly. As the "prime" market for credit became increasingly saturated, the "subprime" credit industry developed to move into markets previously considered to be high risk due to lack of credit histories, bad credit histories, inadequate income, or excessive demands on income. In the early part of this new wave, opportunities in this market were created by the absence of traditional lenders. Even the finance company industry, which historically had focused on the theoretically higher-risk, lower-balance loans, moved into higher-balance home equity loans and moved upscale in the process, 22 leaving the small loan territory open.

[*595] The subprime credit market runs the gamut from very small "micro" loans, through auto financing, and into high-dollar home equity lending. 23 Each segment of the subprime market - auto financing, home equity lending, and the relatively unexplored territory of subprime home purchase credit - could be the subject of its own study. 24 This Article, however, focuses solely on the small-sum, short-term segment of the subprime credit market (the "fringe" market). Part II will first describe the credit products offered in the fringe banking market: payday loans, refund anticipation loans, pawns and title pawns for cash advances, and rent-to-own products for retail sale. Part III will discuss their historical antecedents, and Part IV will discuss their market demographics. Litigation and legislative campaigns surrounding some of the products offered in the fringe market are discussed in Parts V and VI. Part VII examines the multiple purposes behind usury laws, which historically have been moral and social as well as economic. Part VII also analyzes the fringe banking marketplace in light of those purposes and notes some of the questions that have arisen about that segment of the market. Finally, Part VIII briefly surveys some possible alternatives to fringe credit products. This Article also asks whether fringe lenders genuinely price for risk, or instead create risk and take advantage of imperfect market conditions. These are questions that must be asked and examined by disinterested parties, not taken on faith. 25

II. An Introduction to the Players in the Fringe Banking Sector

The fringe banking system encompasses most of the functions of the mainstream banking system. This marketplace offers check cashing and payment services that parallel checking accounts in the mainstream system. It also offers the option to obtain cash and defer repayment or purchase goods and defer repayment - in short, credit capacity. 26 Significantly, however, the system does not offer a savings function 27 or the opportunity to create a positive credit [*596] history.

The products in this sector share some common characteristics, the most immediately obvious one being that they are all very expensive. A particularly important characteristic of the credit-providing segments is that their product designs are rooted in an effort to enable the provider to argue that they are not extending "credit." 28 This strategy may allow fringe lenders to avoid several consumer protection and "market-perfecting" laws that protect other borrowing consumers, such as the federal Truth in Lending Act. Further, this strategy may allow fringe lenders to avoid price limits imposed by a state's interest rate ceiling on loans or credit sales; other regulation, including licensing and bonding, can be evaded as well. Finally, such a strategy may successfully dodge regulations that require the disclosure of annual percentage rates (APRs) - rates that may reach triple or quadruple digits on fringe loans.

A. Check Cashers and Currency Exchanges

The fringe banking financial system offers a rough parallel to mainstream checking accounts through check cashing outlets (CCOs) or currency exchanges (CEs). These businesses cash checks, including paychecks and benefit checks, for a per-check fee. They also sell money orders or wire transfers that customers can use to pay their bills. Banking services obtained through these outlets often cost around four times as much as those obtained from mainstream banks. 29

[*597] Some CCOs and CEs now offer fringe credit products as well. Trade association figures indicate that one-half of CCOs currently offer payday loan services, a figure which should increase to two-thirds in 2000. 30

B. Cash Advance Providers 31

The credit function is currently divided among four basic models. Three types of fringe market providers focus on short-term cash advances in small amounts, while a fourth, rent-to-own, serves as the fringe market's version of retail installment sales credit. The advantages stressed by these providers are easy and quick access, even for those with blemished credit histories. 32 Some claim not to pull credit reports, though some fringe lenders do use a specialized fringe credit reporting system. 33

1. Pawns, "Auto-Title Pawns," and "Title Loans"

While pawnbroking is certainly not a new source of credit for the economically marginalized, the latter part of the twentieth century saw both a resurgence of the model and the emergence of a few new twists. A 1994 study of pawnbrokers notes that the number of pawnshops listed in America's Yellow Pages jumped from 4849 in 1985 to 8787 in 1992. 34 The nature of the pawn business also changed. The corner pawnbroker was joined by a corporate presence, and the industry began to look for "merchandising respect." 35 Most significantly for the two-tier marketplace, the industry added a new twist - the auto-pawn, in which the consumer "pawns the title, keeps the car." In all practical respects, such title-pawns offer a species of small loans secured by a nonpurchase money interest in the borrower's car.

[*598] Traditional pawns are structured as pledges, "sales," or "conditional sales" of the borrower's property to the pawnbroker, subject to the right of redemption. The pawnbroker takes physical possession of the pledged property, paying the customer for it. The consumer may redeem the property by paying a higher amount later, usually in one month. In theory, there is no legal obligation to pay the redemption amount. Pawnbrokers generally are not treated as lenders for purposes of the statutes governing small loans. 36 In some states pawnbrokers are totally exempt from usury ceilings, while in others special rate ceilings apply to them. 37

The auto and auto-title pawn loans were designed to take advantage of this special treatment afforded pawn transactions while enjoying the security afforded by taking the consumer's transportation as collateral for a very small cash loan. While a few auto pawnbrokers demand physical possession of the vehicle, such practice obviously creates greater sales resistance. Thus was born the auto-title pawn, or "title loan." The first incarnation echoed the sale/leaseback schemes that have long been used to dodge usury laws. 38 The borrower pledges the title, and the pawnbroker "leases" the vehicle back to the consumer. Some lenders require the customer to turn over a key to the car to facilitate repossession. 39 They commonly limit the loan amount to one-third of the book value of the car, making the loans more than fully secured. 40 While some transactions may involve weekly installments, the typical title loan is a one month, single payment loan.

The APR price tag for such a transaction is typically in the triple digits. For example, in Pendleton v. American Title Brokers, Inc., 41 the consumer took out an auto-title loan and received two advances for $ 100 and $ 400. Her pawn/loan [*599] contract made the loans repayable with interest in weekly installments. She also signed attached leaseback agreements by which the pawnbroker leased back her vehicle under a concurrently running contract. The weekly rental amount equaled 10% of the loan, along with credit insurance and other fees. When all the incidental credit-related charges were tallied, the transactions carried effective APRs of 902% and 977%. 42

The more typical rates on these secured loans are in the 200% to 300% range. The Illinois Department of Financial Institutions recently completed a survey of short-term lending, reporting an average APR of 290% among its licensed title loan companies. 43 A 1998 Florida Public Interest Research Group (PIRG) survey of title lenders found an average APR of 273%. The most common charge for a $ 400 loan was $ 88 a month, or 264% APR. 44 Fees are typically a percentage of the amount borrowed for the one-month loan term. In Florida, where title loans are legal, the percentage is capped at 22% - that is, 22% a month, which translates to 264% a year. 45 Borrowers, however, may believe that their annual rate is capped at 22%. 46 The industry-drafted law may encourage this misperception by requiring that the borrower initial the 22% fee language, but not the language disclosing the APR.

Because auto-title loans routinely require repayment soon after the transaction is completed, many customers cannot make the full principal and interest payment when it comes due. As a result, the loan is often extended for another fee (some contracts allow the lender to do so unilaterally). This cycle of renewals can create a "debt treadmill" or downward spiral effect that is at the root of much of the concern about cash lending in the fringe market. 47 Such a practice also complicates objective assessment of the industry's justification for [*600] pricing based on "risk" and default rates. 48

Some title lenders obtain used car dealer licenses in order to sell the repossessed cars to other consumers on the retail market. Otherwise, vehicles may be disposed of through wholesale auto auctions. "Pawn" laws may not require that surpluses from the sale of a pawned item be returned to the customer, but even if they do, return of a surplus is rare. 49

While pawnbroking is an ancient form of lending, many people believe that title loans (by whatever name) are qualitatively different. Except in a few cities with good mass transit systems, most people need cars to get to work, take their children to day care, or to go to school. For this reason, there is a schism even between traditional pawnbrokers and the title loan industry. 50 ""Somebody forfeits their VCR - life goes on. But you lose your car - that's a different ballgame. Now you're talking about somebody's livelihood.'" 51 Florida's Attorney General Robert A. Butterworth, an outspoken critic of title loans, has also commented on the high stakes involved in the title loan industry. In reference to Florida's legalized 264% rate, he told a national television audience "We've legalized loan sharking. We've made even the Mafia look good." 52

The title pawn industry has grown immensely in the relatively short time it has been around, though it is legally sanctioned in only a few states. 53 Illinois currently has ninety licensed title lenders, most located in the Chicago area. 54 In Florida, one of the states where title lending is most entrenched, title lenders write approximately $ 225 million in loans annually. 55 It is impossible to know how much title lending is going on illegally.

2. Payday, Check, or "Deferred Deposit Services" Loans

Payday lenders make short-term cash loans - generally by taking a post-dated check from which they withhold a fee, and advance the remainder in [*601] cash. Some transactions use delayed automatic debit agreements instead of checks. Deposit of the check or automatic debit is deferred for an agreed-upon time, which may be tied to the next payday (even if only a matter of days), or for a scheduled period of time up to a month. The process works like this: If you want to borrow $ 100 and the fee is $ 15, you give the lender a check for $ 115, postdated to the end of the loan term. The lender gives you back $ 100 in cash. 56 When the loan comes due, you can go back and give the lender $ 115 in cash or money order to redeem the check, or you can let the lender deposit your check to pay it off. If you cannot pay it back in the short turnaround time, you can pay another $ 15 fee to extend it. 57 To avoid appearing to roll over the debt, the lender may ask you to take out a "new loan," in which case you pay the $ 15 fee, but write another check for $ 115. In a practice called "touch and go," 58 lenders may take a cash "payoff" for the old loan that they immediately reloan with new loan funds. Irrespective of whether the repeat transactions are cast as "renewals," "extensions," or "new loans," the result is a continuous flow of interest-only payments at very short intervals that never reduces the principal. For customers who "borrow from Peter to pay Paul" by going to another lender to get the cash to pay off the first loan, this can result in a pyramid effect. To keep Lender Paul's $ 115 check from bouncing, the borrower may end up writing a new check to Lender Peter for over $ 130. The new loan principal is now $ 115 ($ 100 principal plus $ 15 interest on Paul's loan), plus Lender Peter's new fee for a $ 115 loan (which may be higher than the $ 15 fee for a $ 100 loan). This refinancing cycle can snowball the original debt. 59 Upon default, some lenders deposit the check, generating bounced check fees and perhaps a civil bad check penalty, which can be three times the amount of the check [*602] under some state laws. 60 According to an attorney who has represented Texas payday loan customers, some payday lenders compound the bad check fees by having the customers break one loan into several small checks, so that several bounced check fees can be charged if the customer defaults. 61

The most common term for a payday loan is two weeks, and loan amounts are generally under $ 1000. In states that have authorized payday lending, the maximum loan amounts permitted range from $ 300 to $ 1000, with $ 500 being a common cap. 62 A survey by the Indiana Department of Financial Institutions, which regulates payday lending in that state, found an average loan amount of $ 165. 63 Fees may be a percentage of the loan amount, as with title loans, or they may be a flat fee. A few states, such as Indiana, do not have legislation explicitly addressing payday lending, but may have a statutory minimum finance charge comparable to other payday loan fees. Payday lenders in Indiana have been operating under the assumption that a $ 33 minimum finance charge permissible under the Indiana Consumer Credit Code sanctioned their business. 64 A recent Attorney General's opinion disagrees. 65 In states that have no usury ceilings on small loans, payday lenders can operate under existing lending law without need for special authorizing legislation, as is the case with Illinois. 66 The fees for a $ 100 loan range from $ 15 to $ 33.50. 67 For the most common two-week loan term, those APRs range from 390% to 871%. 68 Surveys by regulators in Illinois and Indiana found average payday loan APRs of 533% and 499%, respectively. 69

Because most of these are flat fees, making the loan term shorter than two weeks will raise the APR. The highest-priced payday loan the Indiana [*603] regulators found was $ 20 on a one-day $ 100 loan - a 7300% APR. 70 This element of an APR price tag leads some in the industry (and outside) to argue that APR disclosure is "inappropriate" for short-term loans: 71 "The consumer wouldn't pay 1,800 percent a year to borrow $ 100. But if you tell the consumer that it costs $ 18 to borrow that $ 100 for a period of fourteen days, then it seems fair to them." 72 There are a number of responses to that criticism. First, it ignores the fact that the Truth in Lending Act was enacted to establish a standardized price tag that consumers could use to comparison shop. 73 People think of credit rates in "per year" terms, and the Truth in Lending Act (TILA) requires that all lenders use this standard unit pricing to prevent some lenders from using low-ball quotes to make their higher-priced debt look cheaper. 74 Second, disclosing a loan's APR is important in order to fully inform consumers about the price they pay to rent money. Consider an analogous hypothetical: an apartment renting for $ 500 a month is clearly cheaper than one renting for $ 500 a night. A place to sleep for the whole month of April costs $ 500 from the first landlord, but $ 15,000 from the second. 75 Thus, disclosing the long-term cost of the transaction enables the consumer to readily compare its relative advantages against other available alternatives. 76

However, even with accurate APR disclosure, the already short loan terms of most fringe loans can be manipulated to make these transactions more costly to the consumer than the APR would reflect. This is possible because while over half of the states authorizing payday loans have maximum loan terms, only four have minimum loan terms. 77 Thus, lenders can usually truncate loan terms to maximize costs. For example, a $ 20 flat fee for a $ 100 loan with [*604] a one-month fixed term would cost $ 20. But if the lender writes the same loan for a two week term and then renews it, the debtor will use the same $ 100 for the same length of time, but at a price of $ 40. 78 This may help explain why two weeks is the most common term for payday loans. The Indiana DFI found evidence of this abusive practice when it found loans with initial fourteen-day terms being reduced to seven-day terms upon renewal. Some lenders reduce loan terms even when the borrower's pay period is bi-weekly, making it less likely the borrower will pay it off when due. 79

As with auto-title pawns, payday lenders initially took the position that credit regulatory and disclosure laws did not apply to them. Their argument was (and, in some cases, still is) that their fee is for "cashing a check," not for extending credit. As the legal and regulatory response to this stance has been almost universally unfavorable, 80 some other "new" variations in form are surfacing (or resurfacing, to be more precise). Texas, in particular, is home to payday lenders eager to avoid credit laws through artful dodges. One example involves an ad that reads "Cash in Minutes - Checking Account Required. Not a Loan. 15 Min. approval. No credit check. No hassle." Consumers who respond to the ad pay $ 33 per $ 100 borrowed for two weeks. The fee is purportedly applied toward the "purchase" of one twenty-character "ad." They get to choose the "ad" from a laundry list, including "Go Cowboys" and "Jesus Loves You." The ad is supposed to be placed in a publication distributed by the lender to its customers. After six "cashback ad" purchases, the lender magnanimously guarantees no further ad purchases will be necessary. The APR on these "ad" loans is 860%. 81 A similar scheme ties the loan to the required purchase of a "gift certificate" that must be used to order something of "questionable value" from the lender's catalog. 82

This segment of the fringe credit market has grown quickly. Payday lending was authorized in Iowa in 1995, and by 1999 had eighty licensees. 83 In the decade or so since the postdated check loan business first appeared [*605] (illegally) 84 it has become a growth industry, complete with national chains. 85 About half the states now authorize payday loan services, 86 and the number of licensees nationwide is estimated to be between 6000 and 9000. 87 The industry reported $ 810 million in fee income for 1998 and it projects $ 2 billion in 2000. 88

As noted earlier, in addition to the nationwide chains of payday lenders, check-cashing outlets are expanding into the business. Such lending is even expanding into states in which payday lending has not been legislatively authorized, or under terms that would not be legal under state payday lending laws. Some payday lenders have teamed up with depository institutions based in states with low (or no) interest rate regulation. Because federal law gives national banks and some other depository institutions the right to "export" the law of their home state nationwide, lenders argue that these loans may be made in states in which their terms would be illegal if made directly. Such so-called "rent-a-bank" or "rent-a-charter" payday lending may become a significant barrier to state regulation of fringe market lending. 89

3. The "Debt-Treadmill": Roll Overs and Renewals

Many readers may be too young to remember the old Tennessee Ernie Ford song, "Sixteen Tons," with the lyrics "another day older and deeper in debt." 90 Much of the concern about short-term fringe lending arises over the question of whether it is, at best, a "debt treadmill" or at worst, a downward spiral. The industry argues that it is neither, instead viewing such lending as a bridge enabling passage through temporary setbacks, and these lenders deny that roll [*606] overs are a significant problem. 91 The lenders focus on the convenience of short-term lending: it is handy, quick, and hassle-free; there are no obstacles such as bad credit records. 92 Moreover, payday lenders deny targeting lower-income customers, pointing to the increase in such lending in the suburbs and among higher-income groups. 93

Another justification advanced by the industry is that these loans enable people to avoid the high costs of bounced checks. Both trade association spokesmen testifying at the Lieberman Forum argued that the cost of payday lending is cheaper than bouncing checks. Their position: against the potential insufficient fund fees for bouncing a $ 100 check, which could total $ 50 (one from the merchant and one from the bank), a $ 20 payday loan fee is a bargain. Compared to bouncing four checks to four merchants, the resulting $ 100 to $ 150 insufficient fund fees would dwarf the $ 15 to $ 20 payday loan fee. Furthermore, lenders argue that a bank may close a bank account as a result of bounced checks. Bounced checks and closed accounts "will affect adversely the consumer's credit-worthiness and can create a snowball effect of negative economic impacts." 94 Critics find this argument unpersuasive because most people do not write bad checks when they are strapped for cash. Moreover, the comparison is misleading because resorting to a payday lender often only defers the bounced check charges. In fact, it can compound the problem because some of these lenders use threats of criminal prosecution as a collection tactic or seek treble-damage bad check penalties when these loans default. 95

But whatever weight such arguments bear for the occasional customer, they do not suffice for the repeat customer. Critics of the fringe lending industry fear that it is the industry itself that is likely to create a "snowball effect of negative economic impacts" from servicing high cost, short-term debt. 96 Several egregious examples of abuse illustrate the snowball effect:

[*607]

* A Wall Street Journal article on title pawns reported on a woman who lost her car to repossession after paying $ 400 in interest on a $ 250 loan. 97

* The 60 Minutes segment on title lending featured a customer who had borrowed $ 400 for legal fees in a custody matter and had paid $ 88 a month for fourteen months, totaling $ 1246, to service that $ 400 debt - and still owed $ 330. 98

* Another customer with an income of only $ 600 from social security disability borrowed $ 500 to pay medical bills; after more than $ 2000 in interest payments over the course of a year and a half, he still owed $ 612, and feared he had no choice but to let the lender take his truck. 99

* One Navy household borrowed $ 1700 for mortgage payments: 20 months of $ 370 payments later ($ 7400), the borrower still owed the full principal and interest. Another $ 2070 would be required to retire that debt and protect the family car from repossession by the title lender. 100

* In Kentucky, payment of $ 1000 in fees over six months made no progress in reducing $ 150 of loan principal; in Tennessee $ 1364 over fifteen months paid down only $ 152 of a $ 400 loan. 101

* A Navy captain told the Lieberman Forum of a sailor writing $ 2,893 in checks to cover $ 2,550 in cash advances. 102

Precisely to avoid the treadmill trap, some states prohibit or limit renewals or refinancings on payday loans, 103 but enforcement is difficult. As described [*608] earlier, lenders use "new loans" in a variety of forms to evade this restriction. 104 The Iowa Banking Department has issued an interpretation informing lenders that the prohibition on roll overs means there must be at least a day between loans, but even that has not been a complete success. 105 Finally, even when renewal limitations are observed by lenders, the economic impact on the customer who borrows from Peter to pay Paul is exactly the same.

This recycling of high-rate debt makes it difficult to get a firm grip on the renewal problem. Nonetheless, the findings of regulators in Illinois and Indiana give credence to the concerns about roll overs. Indiana's survey found a 77% renewal rate, with the average customer renewing ten times and a high of sixty-six times. 106 As the Department of Financial Institutions' Consumer Credit Division supervisor explained, "There is no incentive for the lender to not allow the customer [roll over] since it results in continuing fee income and more repeat business." 107 The Illinois study similarly reported that the single use customer is rare. "In fact, repeat business is the main source of revenue." 108 The Illinois DFI found an average of thirteen contracts per payday loan customer, for an average time horizon of six months. For title loan customers, the average time horizon is 3.5 to 4.5 months, with 2.5 roll overs. 109

An industry survey of high-rate, short-term, low-principal loans in Oklahoma found that 82.4% of the 1994 loans were made to repeat or regular customers. The average amount of these loans was $ 284, at an average APR of 142%. 110 These repeat customers were indeed long-term: 53% had been doing business with the same lenders for one to five years, and 29% for more than five years. 111 This was characterized in the study as a sign of "customer [*609] satisfaction," not as evidence of a debt treadmill. 112 The survey also looked positively at the practice of "clustering" these offices, noting the economies realized by a common owner and the convenience to the borrower. 113 However, clustering of commonly owned shops also facilitates evasion of rules enacted to limit the debt treadmill: limits on renewals, limits on multiple loans outstanding at once, and prohibitions on splitting a loan into two smaller loans to get higher fees. 114

The industry's justification of these loans as a "bridge" during "temporary setbacks" ignores the fact that the loan terms often prolong such setbacks. As the Illinois DFI explains:



What [the industry has] failed to mention was that the financial strains placed on consumers were rarely short-lived. Customers playing catch-up with their expenses do not have the ability to overcome unexpected financial hardships because their budgets are usually limited. The high expense of a short term loan depletes the customer's ability to catch-up, therefore making the customer "captive" to the lender. 115

For some, the end result of this "snowball of negative consequences" may be bankruptcy, as borrowers are unable to continue paying renewal fees to keep their check afloat while still meeting other obligations.

The collection tactics used by some fringe market lenders 116 may also play a role in a consumer's decision to seek relief in the bankruptcy courts. Those familiar with bankruptcy courts in Tennessee, a state with one of the oldest and most concentrated payday loan industries, 117 see the industry as a contributing factor in Tennessee's high bankruptcy rates. 118 And even though the Oklahoma survey cast long-term relationships with triple-digit lenders in terms of "satisfied customers," it also noted the high number of bankruptcies listing [*610] fringe lenders as creditors - 13,379 in 1994. 119 Bankruptcy filings in the Northern District of Illinois, home of the majority of Illinois' short-term lenders, show "significant payday loan debts" on 20% to 25% of filings, and press reports from Indiana and California also relate payday loans to bankruptcies. 120 Though most of the recent public debates over proposed revisions to the bankruptcy code have centered on credit card debt as a contributing cause, the correlation between bankruptcy and fringe market debt also warrants some objective research analysis.

4. Collection Practices of Title Lenders and Payday Lenders

The structure of most title and postdated check loans lends itself to more than the usual array of collection abuses. The payday loan business is, in substance, a traffic in cold checks. Default on consumer debt is not a crime - we are past the days of Dickensian debtors' prisons. Default on a car loan or a credit card debt rarely raises the specter of criminal prosecution. But it is accepted knowledge that writing "cold checks" is a crime. Some payday lenders use the threat of prosecution as a collection tactic, though the trade associations' "best practices code" prohibits it, as do the front-office policies of some of the major national payday lenders. 121 Worse, some lenders do not limit themselves to merely threatening criminal prosecution. Payday lenders filed over 13,000 criminal charges with law enforcement officials against their customers in just one Dallas, Texas precinct in one year. 122 Abuse of this "criminal" aspect of writing cold checks in Kentucky was so great that the state's payday loan statute was amended to require posted notice telling [*611] customers that they cannot be criminally prosecuted. 123

What is not common knowledge among payday loan borrowers is that a postdated check given to someone who knows that it will not clear rarely supports criminal prosecution. Indeed, in some states, such postdated checks cannot support criminal charges at all.



Absent fraudulent intent, the transaction becomes essentially one of extending credit to the drawer. If the payee of a postdated, worthless check indicates in some manner that his or her acceptance of the check constitutes an extension of credit to the maker, the transaction does not violate the bad check statute. 124

As a federal district court in Tennessee once noted, one can assume that the borrower does not have enough money in the bank to cover the check - otherwise she simply would not be there. 125 Certainly a lender's exaction of a fee to "defer" deposit signifies the requisite acceptance on his part necessary to remove the transaction from the realm of the criminal bad check statute.

Even in the absence of criminal prosecution threats, however, civil bad check charges can be punitive. Though default on a normal consumer credit debt may trigger delinquency fees and collection fees, check loans are the only type of consumer debt we know of which conceivably trigger treble-damages penalties upon default - penalties established by the civil bad check laws of some states. 126 Thus a lender might seek judgment for repayment of the principal and interest, the regular bounced check fees, triple the check amount [*612] as a penalty, and perhaps other collection fees. 127 The Indiana Department of Financial Institutions reported that at least three lenders filed 700 such lawsuits in two years. 128

The Texas Credit Code Commissioner reports another collection abuse arising from using a check as both a loan instrument and as loan collateral: the lender reports the "bounced check" to a private check collection service to which other merchants subscribe. A customer on a bad check list from such services cannot write checks at these merchants' businesses, such as the neighborhood grocery store, until the customer pays the debt, perhaps including the collection fee. 129

5. Refund Anticipation Loans (RALs)

Refund anticipation lenders advance cash against the borrower's expected income tax refund. They are available through tax preparers, such as H & R Block, or even from used car dealers. 130 Some versions of the refund anticipation loan, especially the early ones, were constructed as a sale or assignment of the right to the anticipated refund. As with other fringe loan forms, RAL lenders designed these transactions in an effort to avoid credit regulation. 131 The overwhelming majority of RAL lending is now performed by major depository lending institutions, including bank subsidiaries of major finance companies. 132 Most RAL lenders do not comply with state usury laws [*613] governing small loans in the borrower's state because they were the first of the fringe lenders to take advantage of a bank's opportunity to issue loans with rates based exclusively on the law of the lender's home state. Not surprisingly, many RAL lenders are located in states with low or non-existent interest rate ceilings. 133

RAL lenders require the taxpayer to file her tax return with the IRS electronically. Tax preparers often charge a fee for electronically filing the tax return itself, typically $ 20 to $ 35, though the range in 1999 spanned from $ 0 to $ 68. Electronically filing the tax return alone will typically cut in half the time a taxpayer must wait for her refund, from approximately four to six weeks to two to three weeks (or even less). The RAL puts the refund, less fees, into the taxpayer's hands in two to three days. Amounts withheld from the proceeds include the loan fee, the tax preparation fee, and the tax preparer's fee for electronically filing the return. Loan fees are typically flat fees, set on a sliding scale based on the amount of the expected refund.

Here is an example of how loan works: TaxxMann, in Lake Woebegon, Minnesota, takes the application from the taxpayer and forwards it to its RAL partner, Seventh Sixth Bank of Delaware. The paperwork signed by the borrower authorizes the lender to open up an account at the bank in Delaware and instructs the IRS to direct deposit the refund into that account. The consumer picks up the loan proceeds, via the tax preparer, in two to three days. The contract includes a right of setoff, so the lender is repaid when the IRS directly deposits the refund into the account (generally within two weeks). The loan is a demand note; thus even if something such as a tax intercept occurs, the consumer is still contractually bound.

The refund anticipation loan offered in 1999 by the nation's largest RAL program, Household National Bank 134 (offered through H & R Block) charged a sliding scale of fees ranging from $ 39.95 for refunds up to $ 750 to $ 89.95 for refunds over $ 2000. 135 Fees in this range translate into APRs ranging from 67% [*614] to 768% for the anticipated two-week loan term. 136

One of the problems with RALs is that people may not understand that they could get their refund in about two weeks or less without the loan by electronically filing the return themselves. More critically, some do not even understand a loan is involved because the loans may be marketed through a misleading catchphrase such as "rapid refund" or "quick refund." 137 Though some tax preparers discourage RALs, given the almost pointless expense compared to electronic filing alone, other tax preparers have financial incentives to push such loans. The used car dealer is one example; the RAL facilitates the car sale. A recent case reinstating claims against H & R Block identified ways in which the tax preparer allegedly profited from RALs, including earning a fee from the lender for each loan referred and the repurchase of a portion of RAL receivables through a subsidiary. 138

The fine print in contemporary RAL contracts contains a hidden collection trap for users. The boilerplate language not only gives the lender a right of setoff against the refund to collect the instant loan (and any prior RAL to the lender that may remain unsatisfied), but also any debts owed to any affiliate of the lender (such as an affiliated finance company's loan), and any RALs still owed to a laundry list of unrelated RAL lenders. 139

D. Installment Purchases: Rent-to-Own

The most mature of the late twentieth century fringe credit segments is the rent-to-own (RTO) industry. Rent-to-own businesses offer consumers the option to acquire household goods, appliances, and electronics through installment payments. 140 The RTO industry is estimated to be worth nearly $ 4 billion annually. 141 Like other alternative financial services transactions, the cost of a rent-to-own bargain is considerably higher than a mainstream retail installment sales price. A consumer buying a $ 300 washing machine from an [*615] RTO retailer may pay something on the order of fifty-two weekly payments of $ 16 (a total of $ 832) which means the undisclosed APR is over 250%. 142

The method used by the rent-to-own industry to avoid state interest rate caps or APR disclosure requirements involves characterizing the transaction as a lease "terminable at will." Industry-drafted legislation, adopted for the most part in forty-five states, has been largely successful in carving RTO transactions out from state laws governing credit sales. 143

The industry and its critics dispute the extent to which the "rent" function dominates over the "own" function. The industry says that fewer than 25% of its customers rent long enough to become owners, 144 while critics cite data suggesting that 87% of customers purchase the merchandise. Documents obtained in litigation against one major RTO company found that 66% of one year's inventory was sold, and some analyses indicate that more than three-fourths of revenue comes from sales. 145 Rent-to-own customers, however, generally do not get the credit price tags that installment purchasers in the mainstream sales finance market receive. Few exceptions exist to this rule because only a handful of states have found these transactions to be within the definition of credit sales. 146 In Vermont consumers can view the credit price tag because Attorney General regulations under the state unfair and deceptive acts and practices (UDAP) law require disclosure of an effective APR (EAPR). 147

Most state RTO legislation requires dealers to disclose both a "cash price" and "total cost to own" if paid in installments. However, most of these laws sanction a deceptive price tag: the "cash price" can be - and most often [*616] is - unrelated to fair market value. Consequently, the "total cost to own" may be double the "cash price" of the goods, but effectively four times the true market value of the goods acquired. 148 Other charges may be permitted, such as security deposits, administrative fees, delivery charges, "pick-up payment" charges, late fees, insurance charges, and liability damage waiver fees. 149

Because it is a "rental," the goods may be repossessed and all equity forfeited. Acquiring goods through rent-to-own can be a Sisyphean task. For example, the RTO "total to purchase" a $ 650 retail washer and dryer might be $ 1500. 150 If the consumer misses a $ 19 weekly payment after a year of payments totaling $ 950, she may lose the washer and dryer and have nothing to show for her $ 950 investment. By contrast, she would have owned the goods if she had signed a contract to purchase them at retail price through fifty-two weekly installments of $ 19 at 89.3% APR.

Even assuming that the consumer successfully completes the RTO transaction, such successes will not her an improved ability to move into the lower-priced mainstream credit market because credit reports do not reflect positive RTO history.

E. Risk and Profitability

Each segment of the fringe credit market justifies its costs in part by its higher transaction costs and in part by the higher level of risk assumed to be associated with lending to fringe market borrowers. The transaction costs are indeed higher, 151 but how much of the differential is compensatory and how much consists of simple opportunism is unclear. The validity of the risk-assumption rationale is likewise uncertain. First, one must consider the possibility that default rates do not correspond with actual loss to fringe market lenders. Second, one must ask whether these transactions in fact create risk, rather than compensate for it.

In the Wall Street Journal and on 60 Minutes, the title loan industry cited [*617] a 10% delinquency and repossession rate, compared to a repo rate of less than 2% for auto sale financers. 152 According to Mike Coniglio, president of the Southern Association of Title Lenders, "Our past due accounts and our repossession accounts are 10 times that of a General Motors Acceptance or Ford Motor Credit. And our rates are not 10 times their rates." 153 However, the average title lender only lends about one-third the value of the used car to begin with, in contrast to the 90% loan-to-value ratio typically found in a prime market used car loan. 154 Moreover, title lenders fail to account for the effect of renewals and their retention of the surplus from any repossession sale. Take the example of Annie Churchwell. Ms. Chuchwell paid $ 2800 over a period of six months on a $ 2000 loan without reducing her debt. The payments she had made were enough for the lender to realize a 127% return on his $ 2000 investment. Further, if the care were then repossessed, the lender would keep the proceeds of the repossession sale-a gain of $ 6,000 in Ms. Churchwell's case. Fortunately, Ms. Churchwell avoided becoming part of that 10% repo figure by deciding to fight back instead of walking away. 155 One of the customers interviewed on 60 Minutes had already paid $ 2000 on a $ 500 loan, but felt he was going to have to let them take the truck back because he could not keep the payments up. 156 The same factor is at play for payday loans and RTO. 157 Because payday loans are not amortized, and because renewal or refinancing costs descend upon borrowers so quickly, a borrower may pay the equivalent of principal plus 217% interest and still default on the loan. Nevertheless, a small claims collection action could seek the full principal and interest, in addition to the NSF fees, and perhaps treble damages and additional collection costs. 158

For these reasons, default rates are not necessarily good indicators of whether the high cost of most fringe market loans is justified. 159 It may be more appropriate to look at profitability by comparing rates of return in these industries to those of standard businesses. If higher prices are to compensate for [*618] higher transaction costs and higher risk, then it stands to reason that compensatory pricing should yield lender profitability comparable with that of the lower risk, less costly provider. The Wall Street Journal reports a 12% return for one title lender, whereas "most bankers, by contrast, are happy with a 1.5% return on assets." 160 Likewise, the Consumer Federation of America cites an investment analyst who follows the payday loan business as reporting a 48% unleveraged return on investment, and also cites a study from the Tennessee Department of Financial Institutions finding that payday lenders enjoy a 22.72% return on assets and 30.37% return on equity. 161 While these figures raise the possibility that the standard justifications for high-priced fringe market loans are not as solid as they seem, further study and evaluation is warranted before any final conclusions are drawn. 162

III. The Early Antecedents to Today's Fringe Banking Market

A. The First Half of the Century 163

1. Cash Loans

As the nineteenth century phased into the twentieth, industrialization in America gave rise to a number of social problems which triggered the reforms of the Progressive Era. Among them, the consumer credit market began to attract the attention of reformers. As wages increased to a point beyond that required for basic necessities, some was left over for repayment of debt. Likewise, the current wave of short-term, small-principal loans "thrives upon high wages and rising standards of living and not upon abject poverty." 164

Many of the credit products offered in today's fringe market have direct antecedents in the late nineteenth and early twentieth centuries. For example, "salary lenders" advanced cash in small amounts for short terms against the debtor's next paycheck. The "5 for 6 boys" lent five dollars at the beginning of the week, to be repaid with six dollars on payday a week or two hence. "Salary buyers" would "buy" the next wage packet at a discount - for example, [*619] advancing $ 22.50 on January 15 in exchange for the "sale" of the $ 25 paycheck due January 28 (an effective 311% APR). 165 Some loans were secured by wage assignments, while others involved unsecured notes backed by threats of garnishment (which at the time could result in dismissal). 166 Indeed, there was even a direct antecedent of today's postdated check loan: some early salary lenders convinced borrowers to sign a bank check in the amount of the loan's principal and interest, even though the borrower had no bank account. The lender explained the check to the borrower as "security." In the event of default, the lender deposited the check, which of course, bounced. The lender then threatened criminal prosecution unless the debt was paid. 167 Today's title loans had their analogues during this early period, as well: borrowers "sold" their cars, which were then "leased" back to them, and collection was facilitated by threatened - or actual - repossession. 168

As now, the loans in this period were short-term, ranging from one week to one month, with two weeks being most prevalent. 169 Price tags were comparable as well. One study in South Carolina found interest rates for white borrowers ranging from 270% to 559%, with black borrowers paying rates ranging from 322% to 955%. 170 While such interest rates were usurious, there was little enforcement because the borrowers had little access to the courts and little understanding of their rights in any event. "The one who suffers most [*620] at the hands of high-rate lenders is the borrower, yet he is almost the only member of society who has done nothing about his plight....The economic condition of the loan shark victim explains much, but not all, of this situation." 171 Social workers, legal aid societies, labor unions, and some well-intentioned businessmen and professionals bore witness to the toll these high-rate loans took on the borrowers. 172 Then, as now, real economic distress accompanied the renewal of midget loans with giant price tags and the related problem of trying to juggle debt - i.e., borrowing from Peter to pay Paul. 173 In sum, the stories of the borrowers on the downward spiral in this "first wave" of fringe lending are not substantially different than those told by fringe borrowers today. 174

The resulting efforts at "combating the loan shark," 175 as this type of lender was unashamedly called then, took several forms. There were, of course, efforts to enforce the usury laws. 176 But that approach deals with symptoms, not causes, so there began a search for nonexploitive alternatives to fringe lending. This effort took place over a reform period spanning approximately half a century - up to World War II. Provident lending societies and credit unions originated in this period, representing the "philanthropic" and "cooperative" approaches. 177 A third avenue sought to develop a framework for a viable commercial industry that would serve the needs of the small borrower. But the reformers recognized that the marketplace of the small borrower was an "imperfect market," making it unlikely that deregulation (then, too, touted by economists) would curb the abuses of the loan shark. 178

[*621] The approach ultimately adopted involved the creation of a legal framework that permitted a return high enough to attract legitimate businesses into the small borrower market, but also included sufficient safeguards to prevent the kind of abuses that were all too evident in the "loan shark" market. 179 The resulting product of this approach was the first draft of a Model Uniform Small Loan Act, which appeared in 1916. 180 The Act applied to small loans of $ 300 or less and allowed for a high rate of return, with a recommended top rate of 42% 181 annually recommended on the smallest loan amounts (later reduced to 36%). 182 But the trade-off for that high rate was strict regulation. To reduce evasions, the Uniform Act had an all-inclusive definition of interest 183 and a provision that codified the common law principle that the law applied no matter what evasive devices were attempted. 184 Deterrence was built into the Act by requiring lenders to forfeit all principal and interest if they charged excessive rates. Additionally, lenders were made subject to criminal penalties for violations of the Act. 185 To address the problem of indefinite payments that never reduced the principal, roughly equal installments were required, which effectively precluded balloon payments. 186

Ultimately, every state except Arkansas enacted small loan laws. 187 By 1930, the resulting small loan industry was estimated to be a $ 255 million industry, making loans averaging $ 140. Over half the states had adopted some version of the Uniform Act by 1930, and there were 3,667 licensees by August 1932. 188

[*622]

2. Retail Sales and the Installment Plan

Industrialization played a more direct role in the development of installment purchases of consumer goods. While furniture and pianos had been brought into some nineteenth century American homes with the help of installment buying, it was the I.M. Singer & Company's successful effort to get sewing machines into the home that appears to have launched the modern era of installment purchases for expensive consumer durables. 189 The Singer Company's newsletter first suggested the concept of "renting" a sewing machine to housewives and applying the rental fee to the purchase in 1856. 190 Credit later came into its own as a mass-marketing tool with the automobile as auto manufacturers developed financing arms that facilitated sales to mainstream America. 191 By 1930 most durable goods were purchased through installment credit. 192

A desire to evade usury laws was probably not the motivation for the original rent-to-own contracts, 193 because installment purchase credit generally was not subject to interest rate caps at that time. This exception was due to the time price doctrine for the sale of goods. The higher price differential charged to those deferring payment for the purchase over time was not considered "interest" for purposes of usury laws. 194 However, through the middle part of the century, most states enacted retail installment sales acts (RISAs). Many RISAs included rate ceilings applicable specifically to retail installment sales, though sometimes maintaining the terminology of "time price differential." 195 Either implicitly through enactment of such legislation or through judicial decisions, most states have now restricted the time price doctrine, bringing most consumer installment purchases under state credit regulatory schemes. 196 Moreover, the price tag disclosures required by the Truth in Lending Act upon its enactment in 1969 made no distinction between "interest" and "time price [*623] differential;" both are a cost incident to credit and must be disclosed as part of the credit pricetag. 197 By the time the modern rent-to-own industry began to grow, credit installment sales were subject to regulation. Therefore, the second wave of fringe lenders were confronted with a regulatory system to evade.

B. The Credit Boom: The Small Loan Lenders Move Upstream

In the 1960s, small loan licensees still made "small" loans, though the maximum loan amount by then ranged from $ 200 to $ 5000. 198 However, bigger-ticket loans began to take an increasing share of the small loan finance company industry's holdings. 199 Today the adjective "personal" no longer defines what used to be called the personal finance industry. Several factors have led to this transformation. Business lending pulled ahead of consumer lending in the mid-70s, and has remained ahead since then. 200 Auto finance, always an important part of the personal finance industry's market, grew from a 23% share of consumer receivables in 1975 to 79% in 1996. 201 Additionally, consumer lending moved from smaller-dollar personal loans to larger-balance home equity loans. 202 The increase in borrowing against the home, as opposed to merely borrowing to acquire the home, 203 was fueled by (1) deregulation of the mortgage market, including home equity loans as well as purchase money loans; 204 (2) new developments in the secondary market for mortgages; 205 (3) appreciation in real estate values in many parts of the country; and (4) the 1986 tax code revision, which eliminated the interest deduction for all debt except [*624] home-secured debt. 206

Because profit margins on small sum borrowing are smaller than on larger loans, and home-secured loans are the most secure in the consumer credit marketplace, the small loan finance company industry moved onward and upward. Subsequently, around the country maximum loan amounts under the old Small Loan Acts were raised or eliminated entirely. 207 When small loan amount ceilings were still relatively low, dual licenses under the small loan acts and Industrial Loan Acts, along with the creation of new affiliated entities to engage in different types of lending enabled small loan finance companies to operate in this higher-ticket market. While finance companies had only a small market share of the $ 5 trillion real estate credit market, mortgage lending still made up 13.5% of their receivables by 1996. 208 In contrast, personal consumer loans were less than 8% of total receivables, 209 whereas in 1975 personal cash loans were 17% of total receivables. 210

In today's market, the finance company's small loan customer often becomes a big loan borrower quickly, sometimes through practices which have drawn criticism. For example, one source of personal finance loan customers has always been the sales-finance transaction. In this type of transaction, a seller sells an item - furniture, a washer, a computer - "on time." The retail installment sales contract between the seller and the buyer is immediately assigned to a finance company. Once the finance company acquires a customer this way, it sometimes tries to turn that person into a longer-term customer by extending new credit: refinancing the original retail installment contract into [*625] a loan under the state small loan act. 211 As one industry analyst described the practice in a conversation with one of the authors, the finance company industry's game plan is not to serve the small loan market, but rather to move the small loan borrower up the "food chain" from the feeder merchant's sales finance contract to a home equity loan. 212

While the finance companies began the move towards high-dollar lending, credit cards began to supplant (and expand) the market for small dollar credit. As the rise in credit card debt from $ 287 billion at the end of 1993 213 to $ 588.7 billion in August 1999 214 illustrates, credit cards are what most Americans now use for short-term, small dollar credit, whether for convenience, need, or asset acquisition.

While there are undoubtedly a complex combination of factors at play, it seems plausible that the abandonment of the small loan marketplace by the traditional small loan lenders on the one hand, and the adequacy of the credit card to serve the majority of America's small-dollar credit needs on the other, created a void that grew under the radar screen of regulators, policy makers, and, for a time, even the mainstream industry. In this void, an industry resurfaced that the first few decades of the century were spent trying to stamp out. That vacuum of intangibles is matched, at least in some communities, by a parallel physical vacuum as some low-income and minority communities remained underserved by traditional banks, or became underserved as a result [*626] of branch closings. 215

IV. The Market for Fringe Products and Services

During periods in which the politically dominant preference is to rely more on the market than legal constraints, it is important to understand whether a particular industry operates under conditions necessary for the proper function of market forces. If smoothly functioning market forces require relative equality of bargaining power, relatively equal access to and comprehension of relevant information, opportunities for meaningful choice, and a basic level of good faith, then a marketplace which lacks such elements raises serious policy questions. 216 It is important, then, to understand who are the customers of the fringe banking marketplace.

The marketplace is not homogenous. For example, the check cashers are more likely to cater to those without bank accounts (though certainly "banked" consumers use check cashers as well), 217 while the payday lenders who take post dated checks or debit authorizations will by definition deal with those who have bank accounts. 218 But the broad outlines suggest that, while some middle class consumers may turn to the fringe banking system for convenience or because of temporary setbacks, 219 the primary target market for the fringe [*627] banking system is one in which market forces may not work well.

The question of who best epitomizes the payday loan customer is the subject of some dispute. Industry data indicates that payday lending is currently concentrated in six states: 3000 of the 6000 licensees reported by the Financial Service Centers of America (FiSCA) are found in Kentucky, Tennessee, Missouri, Mississippi, North Carolina, and South Carolina. 220 All six states are below the median income for the United States, 221 and four have above-average poverty rates. 222

The president-elect of a recently formed trade association for payday lenders, the Community Financial Services Association of America (CFSA), 223 reported the following to a 1999 public forum sponsored by United States Senator Joseph Lieberman:



The typical payday advance customer is a responsible, hardworking middle class American. The

. Average age is 35 years old

. Average annual household income is $ 33,000.00

. Average time in current residence is 4.5 years

. Average time in current job is 4 years

. 33% own their own home

All of them have a current checking account and a regular source of income.

Our customer represents the heart of the working middle class - teachers, nurses, construction workers, state and federal employees and the like.

These are not "poor, disadvantaged" people as is often alleged; these are good people, with a short term financial need. 224

Likewise, the representative of the check casher's trade association (newly [*628] renamed the Financial Services Centers of America (FiSCA)) 225 told the forum that "there is no "target' market for the industry or FiSCA members who provide this financial product," citing data indicating household incomes "from $ 20,000 to $ 25,000 on the low side to $ 35,000 to $ 45,000 on the high side." 226

On its face, the study of the short-term loan industry conducted by the Illinois Department of Financial Institutions at the behest of the state legislature supports FiSCA's position. The report claims the following:



The short term loan industry is not targeting areas of specific personal income levels. We have combined data generated from the U.S. Census Bureau and the Bureau of Economic Analysis to verify that areas with the lowest personal income levels are not being inundated by the presence of these businesses. The counties with the densest population of short term lenders are usually the counties with the highest average personal income levels. 227

However, even a cursory examination of this statement raises questions. Not surprisingly, Cook County, home to Chicago and over 40% of the state's population, is the fringe-lending capital of the state. It sports 202 of the state's 455 payday lenders (44.4%) and forty-seven of the state's ninety licensed title lenders (52%). 228 The Illinois DFI reached the above conclusion by using the county's 1997 average personal income of $ 29,343 - one of the higher county averages. 229 But a county is a broad sample, particularly Cook County, and averages hide the extremes. Chicago's neighborhoods run the gamut from the South Side to the Gold Coast, with a wide range of median income levels. 230 Thus the high county-wide average income may not reflect the true composition of Cook County's fringe banking customers.

Some studies examining the geographic distribution of the check cashing outlet (CCO) and currency exchange (CE) providers on a narrower scale raise a question about the weight that should be given to the Illinois DFI's location- [*629] based findings. 231 For example, the Federal Reserve Bank of Boston looked at multi-census tract areas in cities in New England where check cashers were most densely clustered - Boston, Hartford, and Providence. 232 The Boston study found that the cities with high CCO clusters tended "to have high percentages of low-and moderate-income census tracts and households," 233 high percentages of households below the poverty level, and higher shares of households on fixed incomes (either public assistance or social security). 234 More dramatic is the Woodstock Institute's study of the relative distribution of banks and CCOs/CEs in Chicago, which examines specific census tracts. This study found that the currency exchanges are predominately located in lower income, minority communities. The currency exchange to bank ratio in five predominately minority communities with median household incomes below $ 22,000 exceeded ten to one. The lowest income communities, with median incomes of $ 7908 and $ 12,570, each had twelve check cashers for every one or two banks. 235 A separate rent-to-own study suggests another reason to look carefully at fringe lender locations on a neighborhood basis, for it found that variations in rent-to-own prices were inversely related to the average income level of the census tract in which the rent-to-own was located: the poorest paid the most. 236

Military officials, who are seriously concerned about the impact of fringe banking credit on servicemen, have noted the importance of location: "These high visibility, flashy, neon sign adorned buildings line the roadways [*630] surrounding the military bases, obviously targeting the serviceman." 237 Testimony of the Illinois Consumer Justice Council before the Illinois State Senate Financial Institutions Committee cites a corporate payday lender's press release: ""We target stores in working-class neighborhoods. All things being equal, the higher the concentration of our target demographic in the neighborhood, the more productive the store location will be.'" 238 The testimony also included ads specifically targeted at social security recipients. 239

Turning from the character of the neighborhoods to the characteristics of payday and title loan borrowers, one finds more disagreement with the picture given by the payday loan industry. Though some military personnel are officially considered "neither as "poor' nor as "non-poor'" for census purposes, 240 it is clear that many have little expendable income. 241 For example, a sailor, third-class rank, with a spouse and one child, has a surplus of $ 135 a month after normal bills to meet unexpected expenses. 242 The 60 Minutes story on auto title loans includes a caution from military critics of the industry who have testified in legislative hearings that so many young sailors are worried about their cars being repossessed that it has adversely affected military readiness. 243 The Illinois DFI also noted ads targeting college students and young high school graduates, referencing studies indicating low levels of financial literacy among students. The DFI also found that "people living on fixed incomes are also targeted due to their inability to keep pace in a world of rising costs." 244

The military customers demonstrate the power of generated demand: 245 active duty military personnel can receive interest-free emergency loans to meet financial needs, 246 yet they still turn to fast cash providers in enough numbers to worry military leaders about the fringe lending industry's impact on national defense. While a base commander recognizes that education is part of the problem, the "powerful marketing campaigns these companies have [*631] which make them sound "too good to be true'" is also a big contributor. 247

Whether there is targeting or not, either through location or advertising, the actual customer profile drawn by the payday loan industry's trade association does not match the profile found in the Illinois DFI survey. The average salary in Illinois is $ 25,131 for payday loan customers and $ 19,808 for title loan customers. 248 This puts the payday customer at 60% of Illinois' median income of $ 42,065 and the title loan borrower at less than half (47%) of median income. 249 Given the concentration of the state's industry in Cook County, presumably the majority of Illinois' fringe-loan customers are also there, where the payday borrower would be at 66% of the county's median income, and the title loan borrower at 52%. 250 People on fixed incomes also comprise part of the payday demographic, at least in California, supporting the Illinois DFI's finding on targeting that group. 251 The results of a Consumers Union analysis of occupational data for payday loan customers was consistent with the Illinois findings both as to income and as to the apparent targeting of people on fixed incomes. 252 Of the 83% of the payday loan customers in the paid work force in the population reviewed, Consumers Union found an average annual income of $ 25,417. 253 Two of the top five categories of occupations listed on the self-reported data reviewed were fixed income:

[*632] 1 - retired (6%),

2 - sales/retail (6%),

3 - disability/SSI (5%),

4 - clerks (5%), and

5 - managers/supervisors (5%). 254

The survey of customers of Oklahoma's version of the payday loan industry found the following demographic data:

Education: 73% - 12 years or less
27% - some additional trade school or college Income:
48% - Under $ 15,000
30% - $ 15,000-20,000
17% - $ 20,000-25,000
5% - Over $ 25,000 255

Additional income in the form of "Social Security, Social Security Disability, welfare, Aid to Dependent Children, Oklahoma National Guard, and for students, grants and scholarships" was reported by 18% of the survey respondents. 256

Though these loans are in theory "tide over" advances designed to take the customer to the next payday, these income levels point out a fundamental fallacy in that characterization. A budget analysis helps explain how and why these short-term loans so often lead to the debt treadmill. 257 Senator Lieberman's staff prepared an "Ability to Repay" budget analysis based on both the $ 25,000 and $ 35,000 average income levels. 258 Subtracting only "essential" expenditures from the net two-week paycheck - food, housing, utilities, transportation, and healthcare - left a $ 28 deficit at the $ 25,000 income level, and a $ 134 surplus at the $ 35,000. 259 Factoring in the average payday loan debt (with full pay off, not a renewal fee) due at the end of the pay period, there was a $ 196 deficit at the $ 25,000 and a $ 34 deficit at the $ 35,000 level. 260 Doing the same for the maximum allowable payday loans, the bottom line deficits would be $ 407 and $ 396, respectively. 261 This analysis demonstrates how the short time frames on these loans leave no time to [*633] accumulate any surplus from which to repay a debt, which in turn leads to the insidious downward spiral of renewals. 262

The Illinois DFI study found that title loan borrowers were equally divided between men and women, but that 60% of the payday loan borrowers were women, and both types of borrowers were on average in their mid-thirties. 263 Among payday loan customers, 75% were renters, 15% homeowners, and 10% "other." 264 For title loan borrowers, 80% were renters, 10% homeowners, and 10% "other." 265 As noted earlier, these customers are not one-time users, but rather renewing customers. In Indiana, for example, the customers average about 4.5 to 5 months. 266 A report of an informal survey indicates the average payday loan customer is a twenty-eight-year-old white female with an annual income of $ 14,500 to $ 20,000, employed in a service industry.

The Illinois DFI study collected no data on household size, nor did it examine the racial composition of the payday loan borrower. 267 Without the information on the former, it is impossible to determine where the average payday loan borrower falls on the poverty scale. 268 However, the age and gender findings of the Illinois DFI study and the informal survey cited raise the question of whether single mothers are turning to payday lenders to meet [*634] financial needs. 269 And the specter of "reverse redlining" - high-priced financial services providing most credit and banking services in minority communities - raises much deeper policy concerns. 270

Refund anticipation loans (RALs) have a marketing and distribution system significantly different from the other fringe market products. Obviously RALs are a once-a-year opportunity, and they are not directly available from the lenders. Instead, tax preparers typically market the RALs. 271 Given that a major concern about fringe market lending is the debt treadmill, not the one-shot usage, it would seem at first blush that the one-shot RAL would engender less concern. However, the fact that the high-priced RAL can substantially reduce the Earned Income Tax Credit (EITC) offsets complacency about the natural annual limitation. 272

The recent RAL practice of including a boilerplate right to set off the refund against debts owed to other lenders is also troublesome because the consumer can lose her entire refund without having the right to a court hearing to present any defenses. Thus this practice amounts to a private prejudgment garnishment without an opportunity for notice and hearing. 273

A Georgia study identified users of refund anticipation loans as primarily "low-income, nonwhite and female." 274 The authors of the study point out that "income is of special note; over half of the sample was in the lowest quintile of income distribution." Median income for the sample was below the poverty line for a family of three." 275 The authors believed that "the most striking [*635] finding from the study concerned consumer misinformation. 276 Nearly half the sample did not realize that "quick' refunds were actually loans, although all applicants presumably had to complete truth-in-lending forms." 277 If this kind of correlation between RAL usage and low income levels is representative, a relatively high portion of RAL users may also be eligible for the EITC: over half of those in the Georgia survey were eligible. 278 The study further notes that



The insidious nature of RALs was emphasized by a financial counselor who works with public housing tenants. She noted that the annual federal income tax refund was the only chance many low-income families had to accumulate cash. This is especially significant for families receiving the Earned Income Credit (EIC). With a refund, the family simply gets its own money back, but the EIC represents a net gain. The RAL fee erodes any benefit the family may gain from the EIC. 279

An ethnographic study of the financial practices of low-income households reinforces concerns over diverting big chunks of the tax refund and EITC to triple-digit (or quadruple-digit, as the case may be) APR loan fees. 280 The study found that the reliance on the EITC to stabilize these families' finances was "striking." 281

As with the payday loan customer, there are competing profiles of the rent-to-own (RTO) customer. The RTO trade association's website provides this income picture of the RTO customer:

6.3% - under $ 15,000 income

23% - $ 15,000 - $ 23,999

36.67% - $ 24,000 - $ 35,999

32.17% - $ 36,000-$ 49,999

1.83% - $ 50,000-$ 74,999 282

However, a 1994 study of Rent-A-Center's customers shows a different profile. At the time, Rent-A-Center held 25% of the RTO market share in the [*636] United States. Following an unflattering expose in the Wall Street Journal, 283 Rent-A-Center retained former Senator Warren Rudman, who commissioned a survey of Rent-A-Center's customers. 284 The survey found income figures for Rent-A-Center's customers "well below median household income for the US population" and concluded that demographically "this sample might best be described as representative of the working poor, whose incomes are on the margin of economic stability." 285

Existing data about the fringe banking cash credit market can be interpreted in different lights. While a marketing professor interprets long-term relationships with high-rate lenders as a sign of "customer satisfaction," others may view it as evidence of customers becoming captive to the debt treadmill. 286 Industry spokespersons point to an absence of complaints to regulators as a sign that there is no need for further regulation. 287 But those who have worked with low and moderate income clients believe the absence of complaints is misleading. 288 Myriad complex reasons may inspire customers not to take affirmative action. First, complaining to regulators - particularly financial services regulators - is a relatively rare response by consumers generally, and an extremely rare response among low and moderate income consumers. A far more common reaction is simple resignation. 289 Second, in states in which the high rates are legal, customer calls indicating dissatisfaction with fringe lenders may not even be recorded as complaints or may be deemed "unfounded" because of permissive legislation. Therefore, debt counselors, the bankruptcy system, and small claims filings are more appropriate sources to look to for signs of problems. Large numbers of default judgments against [*637] payday loan borrowers (particularly judgments enlarged with collection fees and treble bad check damages) are probably more realistic sources for information about the depth and breadth of problems.

V. Litigation Challenging Fringe Credit Products

As previously noted, fringe credit products were generally designed with the goal of enabling providers to argue that credit laws do not apply to them. Not surprisingly, this approach has generated both private litigation and public enforcement efforts. The weight of authority involving the cash-loan sector rejects the industry's efforts to recharacterize these credit products as something else. 290 In contrast, the weight of judicial authority has favored the rent-to-own industry's efforts at recharacterization. 291

It is a long-standing judicial principle that substance, not form, dictates whether a transaction is a loan subject to usury laws. 292 Courts follow this principle in an attempt to prevent "the betrayal of justice by the cloak of words, the contrivances of form, or the paper tigers of the crafty." 293 As a Kentucky district court stated:



The cupidity of lenders, and the willingness of borrowers [*638] to concede whatever may be demanded or to promise whatever may be exacted in order to obtain temporary relief from financial embarrassment, as would naturally be expected, have resulted in a great variety of devices to evade the usury laws; and to frustrate such evasions the courts have been compelled to look beyond the form of a transaction to its substance, and they have laid it down as an inflexible rule that the mere form is immaterial, but that it is the substance which must be considered. No case is to be judged by what the parties appear to be or represent themselves to be doing, but by the transaction as disclosed by the whole evidence; and, if from that it is in substance a receiving or contracting for the receiving of usurious interest for a loan or forbearance of money the parties are subject to the statutory consequences, no matter what device they may have employed to conceal the true character of their dealings. 294

Moreover, most consumer protection statutes invoked in challenges to fringe lenders must be liberally construed to effectuate their purposes, 295 among which is the protection of less sophisticated borrowers from more sophisticated lenders. 296 Underpinning these principles is the recognition that [*639] the central premise of standard contract doctrine - that enforceable contracts are mutual, freely negotiated agreements between parties on a level playing field of understanding - do not reflect reality in the complex consumer credit marketplace.

Following these principles, most courts and regulators find the payday and title lenders subject to credit regulation except where specific authorizing legislation has been enacted.

A. Title Loans

Litigation over title pawns has been concentrated in the South, where the industry seems to have first taken hold. In the absence of specific legislation (or in Georgia's case, even in the presence of it for a while), efforts to invoke pawnbroker exceptions to usury ceilings and licensing laws have not been successful for title lenders. 297 The Arkansas Supreme Court upheld the state's challenge to auto-title lending based on the unconscionability doctrine. The court also upheld the state's usury and UDAP claims. 298 Likewise, an Alabama federal court concluded in January 1991 that a title pawn/leaseback arrangement was an extension of credit under both TILA and state law. 299 On the pendent state claim under Alabama's Small Loan Act 300 the court held that the pawnbroker exception to the Act did not apply: a true pawn requires that physical possession of the pawned item be taken; thus a transaction in which [*640] possession of only the title is taken does not qualify. 301 The Alabama legislature subsequently enacted the Alabama Pawnshop Act, 302 which became effective in May 1992. 303 Regulators in Alabama believed that title pawns still did not qualify for the pawnbroker exception under the new Act, leading a title lender to sue the Banking Department for a declaratory ruling. 304 In a five-to-two decision that the majority admitted was a close question, the Alabama Supreme Court held that an auto-title pawn fell within the 1992 pawnbroker statute. 305

Even when the issue of whether a title loan is a legitimate "pawn" is not in question, some courts have found charges to violate state law. For example, in 1992 the Georgia title loan industry obtained legislative approval to place title pawns within the state pawnbroker statute, 306 but a subsequent federal court decision held that the state's 60% criminal usury statute 307 applied to pawn transactions. 308 Moreover, charges allowable under pawnbroker statutes may themselves include a limit, including a reasonableness standard, that an auto pawn or auto-title pawn may violate. 309

The applicability of the Truth in Lending Act to these transactions is, of course, not altered by changes in state pawnbroker laws. Pawn transactions are generally held subject to TILA credit disclosures, as both case law 310 and a 1996 clarifying amendment to the Official Staff Commentary to Regulation Z [*641] make clear. 311

On the back end of an auto pawn or title loan, lenders are beginning to see some constriction in their ability to use advantages sought by resorting to the pawn model. Traditional pawns give pawnbrokers the right to sell the collateral if it is not redeemed without following Uniform Commercial Code (UCC) Article 9 procedures. 312 Even where pawnbroker statutes require return of any surplus, such requirements are rarely followed. 313 However, a bankruptcy court in Alabama noted that neither the state's 1992 Pawnbroker Act nor the appellate decisions interpreting it mentioned the UCC. 314 In the absence of an exclusion, the bankruptcy court applied the UCC to the transaction and held that the title lender had not perfected its security interest. 315 This ruling may inspire arguments regarding the applicability of other UCC Article 9 provisions.

In 1995 Florida enacted a specific title lending statute to authorize that business. 316 The statute allows a 22%-a-month "fee" (264% APR), but specifies that "no other charges" are allowed. 317 The title lending legislation also refers to "repossession" of the collateral instead of the traditional pawn language vesting title to the pledged property in the pawnbroker upon default. 318 The Florida Attorney General issued an opinion interpreting the "no other charges" language as precluding title lenders from imposing repossession charges and mandating return of the surplus. 319 According to the opinion, title lenders violating that provision can be prosecuted not only for violating the title loan statute, but also for usury, theft, and racketeering. 320

B. Payday Loans 321

The argument originally advanced by payday lenders - that they are simply "check cashers," not lenders, and that their fees were not interest but simply [*642] check cashing charges - has not met with universal success. The first appearance of these transactions in the modern era of fringe lending seems to have been in Kansas City. Soon after their arrival, state regulators sought to shut the operators down for illegal lending. 322 Law enforcement authorities in Virginia and West Virginia also took action against payday lenders, alleging they were making unlicensed and usurious small loans. 323 A federal court in Kentucky had no trouble finding the transactions to be loans subject to both the Truth in Lending Act and state usury laws. 324 Subsequently, the Kentucky Supreme Court agreed. 325 Trying to collect a usurious debt at twice the enforceable rate is a predicate act under RICO, which led one court to grant summary judgment on a treble damages RICO claim against payday lenders operating in Kentucky. 326

Indiana's Attorney General has issued an opinion that payday loans violate state usury law and the criminal loansharking law. 327 Indiana payday lenders had been operating under the assumption that a provision of the Indiana Consumer Credit Code authorizing a $ 33 finance charge sanctioned their rates, but the Attorney General's opinion harmonized that provision with Indiana's 36% rate ceiling rather than viewing it as an exception. Payday loans that charge rates more than twice that amount may implicate the loansharking statute as well. 328 In Illinois, a deregulated state, a class has been certified in a case that alleges both TILA and unconscionability claims. 329 The defendant had argued that the unconscionability claim defeated the requirements of [*643] commonality and typicality, an argument the court rejected:



The plaintiff, and other putative class members, took out payday loans at astoundingly high interest rates from the defendants. The defendants have not argued, nor in this Court's opinion can they argue, that the plaintiff and the other potential members were sophisticated consumers. Without a doubt, there is gross disparity in the bargaining positions of the parties. Likewise, the commercial experience of the plaintiff dictates that he was not faced with a meaningful choice when faced with the unreasonable and unfavorable terms of the promissory note. It is the very nature of "payday loans" that members of the population with no other means of securing credit seek out these loans with exorbitant, extreme, and untenable interest rates in excess of 300%. It is because the plaintiff and other putative class members were "forced to swallow unpalatable terms"...that the inference of unconscionability may be made. 330

As with title pawns and title loans, courts have held payday loans to be credit transactions requiring TILA disclosures. 331 The Federal Reserve Board has issued an amendment to TILA's Official Staff Commentary that clarifies that deferred payment checks are loans subject to TILA. 332

Litigation has challenged the "new" payday loan dodges such as "cash back ad," "catalogue," and "gift certificate" sales. 333 Regulators in Texas, Virginia, and Alabama have successfully challenged these dodges, 334 and class [*644] actions are pending in Texas and Alabama. 335

C. Refund Anticipation Loans (RALs)

Between 1982 and 1992, three judicial and regulatory decisions addressed the question of whether the "assignment" or "sale" of the right to an anticipated tax refund constituted a disguised loan subject to credit regulation. Two found such transactions to be loans, while one found them to be sales. The latter decision was a 1986 Georgia Court of Appeals case, interpreting the Georgia Industrial Loan Act and Truth in Lending Act, and concluding that such transactions were not credit under either statute. 336 However, an earlier Kentucky Attorney General's opinion had held that "assigned" tax refunds were in fact loans subject to the usury law. 337 Similarly, rejecting and distinguishing Cullen, a South Carolina court upheld a state regulator's enforcement action against a tax refund "buyer" for violations of the state credit code in 1992. 338 In the intervening years, there has been little litigation about tax refund "sales" as disguised loans, as the majority of RAL cash advances have been extended as loans in name as well as substance. However, some independent small lenders apparently continue to use the tax refund "sale" or "assignment" format to try to avoid credit laws. The Colorado Attorney [*645] General and the Administrator of the Colorado Uniform Consumer Credit Code brought an action for a preliminary injunction against a firm casting its cash advances against anticipated tax refunds in the old style - "purchasing" the refund for about fifty cents on the dollar. The Colorado Court of Appeals recently ruled against the state in Colorado v. The Cash Now Store, Inc., relying on Cullen and one other non-RAL case. 339 Its analysis seems to put the cart before the horse, concluding first that there was no loan, so that it was "not necessary to conduct an extended disguised loan analysis." 340

The facts in the Cash Now case highlight the importance of vigorous enforcement of existing credit regulation in assuring the integrity of the marketplace and protecting honest competitors, as well as consumers. In substance, there was no meaningful distinction between the admitted refund anticipation loans on the market and Cash Now's "assignment" of anticipated tax refunds. Had the Cash Now customer discussed in the trial record gone to one of Cash Now's competitors instead, she would have paid a $ 59.95 finance charge out of her $ 1099 refund and been entitled to a Truth in Lending disclosure telling her that the transaction carried an APR of 159%. While that may not seem like a bargain, her cost from Cash Now was $ 525 withheld from the $ 1099 refund - a whopping (but undisclosed) 3055% APR. 341 This situation demonstrates why it is imperative that courts look to substance, not form, to [*646] assure a level playing field in the marketplace for ethical businesses, as well as the protection of consumers.

The status of transactions like these as credit under the Truth in Lending Act is determined independently of state law characterizations. In 1990, the Federal Reserve Board noted in its Official Staff Commentary that RALs are subject to Truth in Lending; hence the TIL litigation has focused more on how to make the disclosures than on contesting whether any disclosures must be made at all. 342 Similarly, in the absence of the disguised loan issue in the majority of RAL lending, the non-TIL litigation in recent years in this segment of the alternate financial services marketplace has focused more on the marketing of RALs and allegations that some of the tax preparers who sell them act improperly. 343

D. Exportation

A significant area of litigation relates to the right of lenders holding certain kinds of charters to "export" the law of their home state. Because these lenders choose home states with little or no regulation, if such exportations are successful they and their local partners may extend credit without regard to the laws of the borrower's home state. If lenders can make exportation work, there is no need for them to design products that can evade state usury laws; they can simply offer their products openly under the banner of federal preemption.

Under the National Bank Act, a national bank is permitted to export the law of its home state nationwide, preempting any state laws restricting "interest" (defined very broadly) in the borrower's state. 344 The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) 345 put federally insured depositories, including those chartered by states, on a "level playing field" with national banks. Consequently, state chartered institutions assert exportation rights along with the national banks. 346 The RAL lenders were the first fringe lenders to successfully use this vehicle to get around state [*647] usury laws, using tax preparers in the borrowers' states as their local distribution partners. 347

Some payday lenders have followed, obtaining charters in states with no payday loan regulation and teaming up with local distribution partners in states in which their terms would otherwise be illegal. 348 Banks or other institutions holding these "privileged" charters reportedly immediately sell these accounts receivable back to the local partner, taking the accounts off their books. 349 An action pending in California is challenging this "rent-a-bank" payday loan structure. 350

VI. Legislative Campaigns Surrounding Fringe Credit Products

Efforts to evade consumer protection and credit regulation invite litigation. Consequently, legislative and regulatory bodies are in the center of the controversy surrounding fringe lending. Fringe lenders have organized nationwide legislative and public relations campaigns, as well as support and advocacy groups, to influence the debate over fringe lending.

A. Rent-to-Own (RTO)

In this regard, the RTO segment is the most mature among the credit poviders in the fringe market. The Association of Progressive Rental Organizations (APRO) is the "national non-profit trade association for the rental-purchase... (RTO) industry." 351 According to APRO literature:



During the past 15 years, APRO has actively worked to help shape public policy in state legislatures and the U.S. Congress. To date, 46 state laws have passed with APRO's support and input. Since its organization by a handful of company owners in 1980, APRO has become the voice of the industry before government and the public around the [*648] country. 352

Most of the state laws were enacted in the late 1980s, and "through mid-1987...state legislative efforts cost between $ 25,000 and $ 40,000 each, not including campaign contributions by individual dealers to legislators running for office." 353

Minnesota, in many respects, has been ground zero for RTO clashes. Both judicial and legislative battles have been hard fought. APRO participated as amicus in Miller v. Colortyme, Inc., a case in which the Minnesota Supreme Court interpreted rent-to-own transactions as credit sales subject to the Minnesota Consumer Credit Sales Act and state usury laws. 354 Following the loss, the trade association's corporate counsel reported to members that "if the industry can be successful this year or next in D.C., it may be able to get Congress to overrule this one aberrant state whose supreme court has refused to acknowledge the true nature of the rental-purchase transaction." 355

While the Miller case was proceeding, efforts were ongoing in Congress to reform the rent-to-own laws nationwide. Congressman Gonzalez and Senator Metzenbaum introduced legislation which would have applied to RTO transactions important federal consumer protection laws like the federal Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act, and the Fair Credit Reporting Act. 356 This result would have been achieved by treating the RTO transaction as a credit transaction with all of the attendant protections. 357 Also, the bill contained a provision that would have required the lender to disclose to consumers the "cash price" of an item, defined as the "bona fide retail price" that an RTO dealer charged someone in an outright (non-RTO) sale; for dealers who do not make such sales, the "cash price" was defined as "the average