Pawnshops: Lenders of Last Resort : Credit: A recent study shows that for many low-income people, they’re seen as the only available source for a small loan. Interest rates can run as high as 300%.

Millions of Americans run to the bank or visit automated teller machines when they need cash. They use credit cards when they want to buy clothes, VCRs, or television sets.

But there is an underclass--people with low incomes and no credit history--who visit their neighborhood pawnshop when they need cash or a loan.

An estimated 20% of the U.S. population has no bank account; more than half of this group don’t have credit cards and can’t get bank loans.

“These people are borrowing an average of $50,” said John P. Caskey, assistant professor of economics at Swarthmore College in Swarthmore, Pa. “If you add up in terms of how much dollar value pawnshops provide, they don’t look very important. If you add up how much of the population they serve or the number of loans they make, they are important.”

Because they make loans, pawnshops are a type of bank, often calling themselves “the bank of the little people.”

In 1989, Caskey, a visiting scholar at the Federal Reserve Bank of Kansas City, and Swarthmore student Brian Zikmund looked at the importance of pawnshops in the U.S. economy--the first serious study of the subject since the 1930s.

Their conclusion: Pawnshops are the consumer’s lender of last resort.

Pawnshop customers typically cannot get credit at mainstream financial institutions. They have poor credit records, excessive debt in relation to their incomes, low and unstable incomes or cannot maintain positive bank account balances.

Typically, pawnshop customers borrow relatively small amounts that traditional lenders are unwilling or unable to provide on a secured basis.

“If you look at total consumer credit, the amounts provided by pawnshops remain small,” Caskey said. “They’re lending primarily to low-income people. In terms of the population they serve, the low-income, they’re really important.”

In 1988, about 6,900 pawnshops operated in the United States--one for every two commercial banks. Data suggests that these pawnshops made about 35 million loans, providing what Caskey and Zikmund estimate as 1% of the nation’s consumer credit.

At year-end 1988, credit outstanding at pawnshops was about $689 million, compared to an estimated $371 billion at commercial banks and $87 billion at credit unions.

Although the amount loaned by all pawnshops is relatively small, Caskey and Zikmund assert that they have an important place in the consumer credit market when other measures are considered.

“Because the average pawnshop loan is about $50, even considering multiple loans to a core group of customers,” they write, “pawnshops probably serve several million Americans each year--perhaps as much as 10% of the adult population.”

These Americans pay dearly for pawnshop loans--up to 25% a month in states that put a ceiling on interest and other charges, more in states that do not.

In Alabama, Florida, and Iowa, for example, interest rates on a $51 loan can range from 18% to 28% a month, according to the study.

“What this research shows is that there’s a conflict between what state regulators would like to do and what they actually do,” Caskey said. “Many states, such as in the Northeast, try to set a very low maximum interest rate for pawnshops. The intent there is to make sure that more fairly priced credit is available to low-income groups. The effect, however, is to almost shut down the pawnshop industry.”

Pawnshop interest ceilings in Texas and Oklahoma are 240%; in Georgia, 300%.

“This sounds outrageous, but this means that if a pawnshop can lend at such a high interest rate, you can survive with a small number of loans,” he said. “So you find pawnshops on practically every block in Texas and Oklahoma.”

Oklahoma, with a population of about 3 million, has nearly 400 pawnshops. Pennsylvania, where the usury rate is lower, has a population of about 12 million and only 36 pawnshops.

Usury levels are one factor that contributed to the shift of the pawnbroking industry from the Northeast to Central and Mountain states during the last century.

However, the industry seemed to grow throughout the United States during the 1980s.

“There’s a large fraction of the U.S. population that operates on a very financially marginal basis. I think the fact that pawnshops grew so rapidly during the 1980s may also represent the numbers of people that operate on a financially marginal basis,” said Caskey. “This tells us about the changing social conditions in the United States. Lower income groups did very badly during the ‘80s.”

Another factor that may have contributed to pawnshops’ growth during the decade was deregulation in the banking industry, which allowed banks to close branches in low-income areas.

Phil Balano, owner of Sol’s Loan Office, a Kansas City, Kan., pawnshop, said he is “no authority on harder times or the economy” but asserted his belief that more people visit pawnshops because banks are shying away from smaller loans.

“People who don’t have accounts and need $200 have nowhere else to go,” he said.

Caskey said more research is needed before strong policy conclusions are drawn, but suggested that lawmakers study why a large fraction of the population does not have bank accounts. The effect is costly, he said, because of high pawnshop interest rates and the fact that people without accounts must pay to cash checks and buy money orders.

“There may be indirect indications that we want to make sure more Americans can be included (in banking) and maintain small bank accounts.”

Balano said there always would be a need for pawnshops. After all, people lose their jobs, get sick, or experience a death in their family.