Policing Main Street

Article excerpt

Byline: Ezra Klein

The poor also need protection.

Sometime this spring, Democrats stopped calling Sen. Chris Dodd's bill "financial reform" and started calling it "Wall Street reform." Most of the reporting focused on the legislation's affect on the upper crust of finance--investment banks, private-equity firms, and hedge funds. But the bill President Obama signed into law last Thursday will have a lot to say about payday lenders, check cashers, and rent-to-own furniture stores--the blue-collar, not-even-Main Street joints.

That's to its credit. Michael Lewis's The Big Short is considered the definitive history of the financial crisis. (Dodd himself told his staffers to read it.) But to understand American finance, you need to understand Ace Cash Express as well as you do Goldman Sachs. Which is why Gary Rivlin's Broke, USA is a necessary companion. While Lewis tells the story of mortgage-backed assets and the bankers who flogged them, Rivlin tells the story of the underlying mortgages and the folks who bought them.

"To me, it was so counterintuitive," Rivlin says. "People with no money in their pockets is good for business?" But they were profitable. By 1996, there were more payday lenders than all the McDonald's and Burger Kings in the land combined.

Welders looking for an advance on a paycheck became unwitting cash cows for big banks. Schoolteachers taking out home loans became the collateral for leveraged bets on housing worked out in London and Greenwich, Conn. But before they were Wall Street grist, the working poor had to first become big business.

Unlike traditional banking, it wasn't about finding good credit risks who could repay their loans promptly. Quite the opposite, actually. The central insight was that you wanted people who couldn't quite stay ahead of the loan. Then you could use late fees and new loans to bleed them. Consider, for instance, the "yield-spread premium." It's an anodyne name for real financial villainy. If the person selling you your loan could lock you into a higher interest rate than your credit score would naturally give you, the lender would give the seller a kickback.

The size of the fraud was immense. An analysis by First American Loan Performance, a San Francisco-based research firm, found that 41 percent of the subprime mortgages sold in 2004 went to borrowers who qualified for prime-rate loans. …