Panel Paper: Banking on Distress: The Expansion of Predatory Financial Institutions during the Great Recession

Thursday, November 6, 2014 : 1:20 PM
Tesuque (Convention Center)

*Names in bold indicate Presenter

Jacob William Faber, New York University
The Great Recession was born out of risky—and often predatory—subprime mortgage lending. Many have argued that the concentration of subprime loans in particular communities (disproportionately low income, black, and Latino) was simply a continuation of practices of exclusion implemented by financial institutions for generations. Mainstream banks avoided these areas and subprime lenders filled the void throughout the 1990s and early 2000s. Some have documented that this two-tiered financial system extends beyond mortgage lending to more conventional financial needs and amenities. Check cashing and other “fringe banking” services are more common in poor and minority communities, while traditional banks are often less common. While representatives of fringe service providers assert they are providing an important service at a justified price, the overreliance on check cashers and payday lenders rather than banks can cost communities millions of dollars in fees each year, make it difficult to build assets or develop good credit, trap people in cycles of debt, and perhaps even invite crime.

To the extent that a lack of knowledge about financial products was responsible for the uneven distribution of subprime loans (and subsequent foreclosures) across communities and demographic groups, the same may be the case for reliance on fringe banking services. Similarly, some have argued that the decision to patronize check cashers and payday lenders is driven not only by the absence of traditional banks in certain communities, but by a lack of trust and comfort with banks. If the subprime debacle further eroded trust in financial institutions in these communities, fringe service providers could benefit.

This paper leverages variation over time within neighborhoods to analyze the relationship between foreclosure activity and changes in the financial services environment across New York State. I find that, indeed, foreclosure activity and applications for new check cashing licenses were concentrated in the same neighborhoods. Furthermore, these neighborhoods tended to have higher poverty rates and larger minority presence. This geographic link between subprime credit and other predatory financial servicers serves as strong evidence for the argument that these actors exacerbate urban inequality. Furthermore, knowledge that communities hit hardest by the Great Recession became even more financially-isolated in its wake provides a strong impetus for wider fair lending and community investment policies.