Feeding the Local Shark

I wrote a book on the underground economy a few years ago. For about a decade, I observed activity in Chicago’s South Side — our current president’s backyard. I was surprised to learn about the importance of “creditors” — otherwise affectionately known as “loansharks” — who operated an informal lending network in the area. (These people are known for charging exorbitant interest rates.)

Approximately two dozen such people offered small loans to residents and local proprietors — anywhere from $25 to $5,000. The obvious advantage was that you didn’t need a solid credit history. Desperation and lack of financial services were the only requirements. The disadvantage lay in high interest rates (40 percent was not uncommon), but also in the associated penalties: contrary to popular perception, very few cases of failed payment led to physical harm. Instead, you could be forced to pay in kind — e.g., with a television set — or with food stamps and welfare checks (which also function as collateral).

I wondered whether creditors were hurting in the economic downturn. Surprisingly to me, everyone I spoke with reported an uptick in business. Indeed, they reported nearly a 30 percent to 40 percent increase in demand for their services. The reasons hadn’t changed: low-income persons couldn’t walk into a bank and acquire a loan, so the local creditor was the lender of last resort.

I asked a few of them for reactions to the financial crisis. “Imagine that your community actually had adequate services for people who needed credit,” I said. “Like banks or credit unions that provided resources. In other words, what would happen so that you could be put out of business?” Asking people to recommend against their self-interest can sometimes be a pointless task — especially if you are speaking with politicians. But the creditors provided a few interesting responses.

A Clearinghouse for Barter

Andrew said that many people promised to pay him with promises of labor.

I had this one cat who couldn’t make his weekly [payment]. He said he’d fix my car. Another dude said he would cut my hair. I got to thinking: these guys should probably get to know each other. Maybe the dude who fixes cars needs a haircut!

Andrew acknowledged that a clearinghouse for a barter economy might put him out of business. That is, people might not shop for credit, but instead look for someone who had the particular good/service they needed to purchase and then enter into an exchange. I mentioned something called “Craigslist” to him. His response alluded to something called the “digital divide.”

Be Nice?

Timothy attributed his success as a creditor to patience with clients. “You can’t squeeze something out of folks who don’t have nothing. You got to be nice.” He said that he couldn’t afford to impose strict deadlines or pressure his clients because his entire business was local. He couldn’t simply pack up and move to another neighborhood because his operation depended on personal relationships and word-of-mouth. His empathetic ties to clients reminded me of the “originate and hold” model that banks used to follow. I found Timothy’s emphasis on niceties a bit bizarre, particularly given that his average interest rate is 30 percent; and none of the creditors said they would lower interest rates in tough economic times. So at the end of the day, I’m not sure whether decorum is in fact a recession-adjusted commodity.

Gendered Micro-Finance

Carla‘s family owns several bars in Chicago’s low-income neighborhoods. As one of only two female loansharks in the area, she started making small loans to bar patrons. She avoids men.

Women will pay back; they always do. I never have a problem with them unless they’re hooked [on drugs]. Especially when they understand that I’m here to help all the women in the community, they feel like they’re part of something.

People tend to see women as bad risks, but Carla said that their delinquency rates are far lower than their male neighbors. I posed this thesis to the male creditors; most of them smiled (in agreement, I believe), but offered no comment.

Think Small

Carla also said that 75 percent of her business is a response to two kinds of local demand. First, she offers credit to women receiving public assistance who need a bridge loan until their next welfare check. They sometimes pay her back in food stamps. Second, Carla offers small “day-loans” to women who need to find last-minute babysitting. For example, their regular daycare provider may be sick and they need $20 to hire someone so they can get to work.

On numerous occasions, I had seen people’s lives get uprooted in low-income areas because they couldn’t find a few dollars to help them survive until the next paycheck. Until banks, government agencies, and philanthropists understand this situation, they will forever fail to help low- income neighborhoods.


Jo

How do people pay back their loans in food stamps now that food stamp benefits are paid in electronic debit cards that are supposed to only be redeemable at participating grocery stores?

Geoff

What is funny as that most credit card default rates 30% or higher! Not any better than these guys.

Ali

May I recommend reading "Banker To The Poor".

Erin

Reading this post caused me to draw inevitable comparisons to the business of microlending in developing countries. Many successful programs/organizations (like microlending pioneer Grameen Bank) exist to serve this type of community in countries all over the world like Bangladesh, Uganda, etc. Their customers are people (especially women) who are too poor to be serviced by traditional banking institutions, and who often require very small loans to start/maintain a business or something similar. Their repayment rates are quite good, and the practice continue to expand. Perhaps it's time for something similar in the US; although our country has wealth beyond imagining, we need to acknowledge that there are people slipping through the cracks. Wouldn't it be great if there was some place these people could turn for small, short-term loans other than the loan sharks?

Chris Colleran

you could have found out the same basic information by talking to any 'legal' payday/cash loan lender.

frankenduf

the evolution of barter would be to a local/communal money system- this would help insulate poor communities from the impending inflation (bad) or deflation (worse)

Ed

To add to Erin's comment about microlending, an additional attribute is that the micro loans are also at exorbitant interest rates. I participate in kiva.org's program, and it's not uncommon for rates to be 50% or higher to the entrepreneurs because of the risk involved and the intermediaries necessary to administer the process. Of course there the analogy breaks down because the consumer isn't using the loan funds to generate revenue (hopefully profit) but to only pay expenses.

Annie

I've spent a lot of time being one of the working poor (AKA non-qualified for food stamps.) I used to work night shift and when there was an emergency need for a day or two, I'd go sell my plasma. I wish I'd have known where to find these "creditors." Selling your own blood to feed your kid is no joke!

shamus

A few people have mentioned micro-financing ala Muhammad Yunus. A couple sites like prosper.com and kiva.org also come to my mind (though "digital divide" is still an issue).

econobiker

#5 Chris Colleran wrote:
"you could have found out the same basic information by talking to any 'legal' payday/cash loan lender."

And from the article:
"I found Timothy's emphasis on niceties a bit bizarre, particularly given that his average interest rate is 30 percent; and none of the creditors said they would lower interest rates in tough economic times."

Actually payday loan places charge far more than 30% (in fees etc not pure interest) and are far less flexible than the loan sharks described here. The difference with payday / title loans is that you need pay- ie verifiable employment or a vehicle to pawn which seems like many of the people in this article seeking loans don't have...

Bobby G

While I kinda disagree with your humanitarian views at the end of your article (I'm a utilitarian first, humanitarian second, I know... I'm a jerk), your articles are always fascinating and insightful and fun. Please write more often!

jonathan

Just had to say that Off The Books is the best description of real slum economics I've ever seen. I've recommended it over and over and think it should be required reading for anyone who wants to speak or even to be knowledgeable about race, about political solutions, etc.

I worked in consumer affairs and then the criminal justice system in the inner city. You can't view the world the same after that.

One issue your post above doesn't touch directly on is that this lending occurs within a social fabric. I've been involved with direct lending - by individuals trying to assist, by wealthy people trying to help their community - and these have not, in my experience, been good models because there's a vast difference between lending within a community and lending from without. (Your book did get into this in a variety of ways, so I'm not implying you don't know this.)

I would say the best models may be those constructed by immigrant communities. Korean groups that provide capital and organizational support for Korean business - the latter can mean a network of Korean professionals who do accounting, legal, etc. Orthodox Jewish groups that do similar things.

As you know, the communities you describe tear at itself and each other in ways that are difficult for outsiders to understand. I would work with kids in a major American city who could not leave their few blocks without fear of death, who could only travel down certain safe routes to certain public areas. These are astoundingly difficult issues to address but they make real solutions perhaps impossible.

Read more...

Jessica

There is a barter company right outside Atlanta that was recently featured on the local news. You'll have to Google it, apparently I can't post the link here. Anyway, Andrew may have a viable business idea there.

Ali

@ERin: I read Mohammad Yunus's book about the history of the Grameen bank and microlending (Banker to the poor) . Excellent read. There are programs in the US. It actually criticized the welfare programs for causing people to be in a poverty trap because they are not allowed to pursue any ventures. Interestingly enough when Bill Clinton tried to push for microlending in the US, it was destroyed by the party of "individual rights, free market and hard work".

laura

but also in the associated penalties: contrary to popular perception, very few cases of failed payment led to physical harm. Instead, you could be forced to pay in kind - e.g., with a television set - or with food stamps and welfare checks (which also function as collateral).
--------

The only people breaking anyone head was the mob. It would make nosense for a local lender to harm the customers

Hannah

Not my area of expertise and I have a lot of respect for Mr. Venkatesh, but who thinks that women make bad credit risks? Everything I'm ever read about lending and microfinance rests on the fact that women (especially moms) pay back loans or invest charity in food and education and men don't. Did that comment referring to male local lenders? That maybe I could see, although it sounds like the ones interviewed agreed that women are less likely to default.

Also, I take the point that any philanthropists and government need to further internalize the lesson that an important part of any anti-poverty assistance is short-term interventions in emergencies , but I don't think that idea is exactly new to non-profits like the Emergency Fund in Chicago, or credit unions and microfinance org.s geared towards poor and working families.

But, very interesting, thank you!

Kevin H

Ha. Carla could have won a nobel peace prize! Make sure you tell her next time you see her.

wayne Schoech

It seems remiss to discuss loan sharks without mentioning credit card companies. I just had one that I've been using as my credit line for my business (for years without a missed payment) raise their rates from 5.99% to 25%. Though I try to wish everyone well, it's hard not feel a little animosity towards the people (loan sharks?) that cooked the deal up.

Beaufou

This is the medieval system that use to create famines up until the 14th century.
Even Kings eventually got tired of it (Phillip the Fair of France)

WS

#2 and #18 hit the nail on the head. Compared to the banks offering credit cards with completely malleable terms and payday loan operations, these community loan sharks come off looking like Jimmy Stewart.