Financial Instability is Getting Much Worse

Some Thoughts on Lisa Servon’s The Unbanking of Middle America

TL;DR 57% of Americans are struggling financially. Nearly half are living paycheck to paycheck. Against this backdrop, alternative financial services are exploding and a decreasing number of Americans are relying exclusively on the traditional financial system.

Why? “Some people are attracted to what they perceive as…superior service, better product mix, and lower costs.” Some people are driven away from traditional banks because of hidden costs that have burned them in the past. Some customers are trapped in a cycle of debt that keeps them on expensive payday loans.

Ultimately, increasing financial instability (the result of stagnant incomes, decreased social safety nets and rising costs) means an increasing number of Americans depend on a wide range of services to try and manage their difficult financial lives. Current economic realities make financial stability less and less achievable for large swaths of Americans and there is only so much financial services can do.

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Overview

The Unbanking of Middle America by Lisa Servon paints a dark picture of an economy that is failing an increasing number of Americans. Against the backdrop of surging financial instability and decreasing savings, more and more Americans are turning to alternative financial services for every-day financial services and for solutions of last resort.

As part of her research, Servon served as a cashier at a check casher and at a payday lender. This gives her a perspective on both industries that go beyond the normal academic papers. In particular, Servon defends the role check cashers play in serving the needs of the un-banked and under-banked.

Check cashers give customers money same day whereas banks usually take three days to process checks. For the cash strapped, speed is important. Of course, check cashers charge a fee for this service whereas banks don’t charge anything to deposit a check. This has led many critics to claim that check cashers extort their customers and the use of check cashers is an example of irrational behavior. However, Servon details that for many people check cashers are in fact cheaper and more predictable. All the fees charged by check cashers are clearly printed on the wall, whereas banks often slap customers with unexpected fees. This combination of speed, lower cost, and transparency makes them very valuable to consumers.

The idea that “check cashers are predators and their customers are self-defeating” clearly isn’t accurate.

While there has been some push back on Servon’s analysis, the idea that “check cashers are predators and their customers are self-defeating” clearly isn’t accurate. The picture for payday lending is not as rosy. While payday loans can serve a useful purpose in a credit crunch (particularly as credit card markets have contracted since the financial crisis), frequently customers get trapped in a cycle of payday loans that is seriously damaging.

Instability is the New Normal

“Nearly half of Americans now live paycheck to paycheck. Nearly half could not come up with two thousand dollars in the event of an emergency. Instability is the new normal.”

When people live pay-check to pay-check, emergencies are devastating. A broken car means you lose your job. A medical bill means you get behind on credit card payments. People become trapped in a spiral. Elizabeth Warren’s studies on bankruptcy show that most bankruptcies are not the result of profligate spending and financial irresponsibility. Rather, they are the result of economic volatility.

“[Warren] found that most people who filed for bankruptcy were from middle-class families affected by economic volatility — job loss, a serious medical problem, or a divorce that left one partner economically vulnerable.”

Frighteningly, our economy is moving increasingly towards freelancing and away from stable, long-term employment. Costs — particularly medical costs and student debt — have also risen dramatically. This is an economy where volatility is high and the risk is born entirely by those least-well equipped to bear it.

“Nearly one in five consumers has medical debt that has gone to a collection agency for nonpayment.”

Servon puts a large onus on financial services to provide better products to the economically vulnerable. However, she concludes that government has a huge role to play in this and develops a host of social safety nets around health, unemployment and housing. Additionally, she talks about aggressive government policies to make it easier for people to save (including making the USPS into a savings bank — not as crazy as it first sounds).

Given the scale and complexity of the problem, I left feeling that the financial services solutions are band aids trying to cover much deeper, systematic wounds.

Some Things I Learned / Thought About

• “57% of Americans (138 million) are struggling financially, compared to the 26% considered underbanked or unbanked.”
• ‘Mainstream banking services are associated with increased financial stability.’ This is true, but it is unclear which is caused by which. According to Servon, traditional financial services can often contribute to financial instability rather than helping customers achieve stability.
• “It costs a lot for banks to collect small deposits [$300+]. They’re interested in providing these accounts only if they can cover their costs by charging fees. But the fees make it irrational for people to save.”
• “In 2014, Americans paid nearly $32 billion in overdraft fees, and $6 billion of it went to the three biggest banks (Chase, Bank of America, and Wells Fargo). That’s just one reason why more than twelve million Americans manage their money without a bank.”
• “Historically, banks made their money by borrowing and lending, which generated interest income. But events like the savings and loan crisis in the late 1980s and early 1990s, when so many banks failed, illustrated how disastrous that model could be. In order to make banks less vulnerable to volatile interest rates, bank examiners encouraged them to find other ways to make a profit. That’s when banks discovered fees
• “Coleman…questions the fixed notion that the answer to poor people’s financial problems is to get them all to open bank accounts…Coleman says. ‘It’s like providing pots and pans as the solution to hunger.’ ”
• “Industry studies estimate that more than $58 billion in check-cashing transactions took place in 2010, up from $45 billion in 1990. Payday lending grew from $10 billion in 2001 to nearly $30 billion in 2012. Some people are attracted to what they perceive as the advantages offered by the alternatives: superior service, better product mix, and lower costs.” Clearly, the demand is there
• Approximately 6% of Americans have had a bank account closed (without their permission) after being blacklisted in ChexSystems. More than 1 million are ineligible for bank accounts. A wide range of “irregularities” can get you on the blacklist, including a minor incident like a $40 over-draft
• The CARD Act of 2009 was a huge win for consumers. Before that, credit card companies could increase rates on existing debt, charge exorbitant hidden fees (now restricted to 25% of credit limit) and extend credit they knew customers would be unlikely to repay. However, these limits contributed to a credit crunch for sub-prime borrowers which in turn increased demand for payday lending
• The South Bronx has one bank per 30,000 residents, compared to Manhattan’s one bank per 2,000 residents. Servon calls this a “geography of financial exclusion,” similar to the idea of food deserts in low-income communities.
• “South Bronx is still the poorest area in the United States. Forty percent of its residents live below the poverty line, and nearly half used food stamps in the year 2010”
• “Even with today’s stringent laws that guard against discrimination, African Americans, Latinos, and women pay more for credit. After controlling for individual, credit, and housing characteristics, research showed that African American females were five times more likely to get a subprime mortgage than comparable white male applicants were.”
• In 2015, “more than 20 percent of small-dollar borrowers had a net income of over $50,000, 43 percent had a college degree, and over a third owned their homes. This is not the picture that comes to mind when we think of someone suffering from financial insecurity.”
• “Seven years ago, the people in Clarity’s database experienced a ‘destabilizing event,’ such as loss of a job, a medical issue, or a car breakdown, every eighty-seven days. Now it’s every thirty days.”
• “Nearly one in five consumers has medical debt that has gone to a collection agency for nonpayment. Although some consumers do owe tens of thousands of dollars, the average unpaid medical debt in collections is $579. That may sound manageable, but in fact almost half of all Americans have to struggle to pay off a $400 emergency medical expense.”
• FDR once proposed a maximum hourly wage above which the tax rate is 100%.
• “For about fifty years, until 1967, the postal service enabled people to make savings deposits.”