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Consumers Are Smarter Than You Think: What Auto Title Pawns and Legal Funding Have in Common (orig)

January 30, 2011
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5min read

You may have read the New York Times' Christmas Day feature, "Rise in Loans Linked to Cars is Hurting Poor." Part of an ongoing series on consumer lending issues, the piece is well-written, fascinating, and fundamentally misguided.

We could go on at length about its flaws, but fortunately someone has already done the job for us: the prolific Todd Zywicki, professor of law at George Mason University and contributor to the Washington Post's Volokh Conspiracy.

Zywicki's excellent dissection of the Times piece caught our attention for a number of reasons. It provides an entertaining crash-course in how to talk about consumer finance - especially fringe lending - products. Zywicki's analysis is well-structured and well-reasoned, but more crucially grounded in hard data rather than emotional whitewashing.

Finally, at almost any point in his article you could replace the phrase "auto title pawn" with - you knew this was coming - "legal funding," and it would ring just as true.

Let's take a look:

Now, to be sure, auto title pawns have high APRs and raise distinct consumer protection issues from other types of fringe lending products. So one should certainly pay attention to these products and the consumer protection issues that they raise. But if one really wants to understand whether this is a useful product for those who use it, it is important to understand who uses auto title pawns, why they use them, and what would happen to them if the product were not available.

All too often, the popular conversation about legal funding revolves around a few cases where plaintiffs owed high rates of return and took home very small portions of their settlement money. Such cases happen, and they are unfortunate, but they are far from the norm; they will also diminish as the industry matures. Critics who rely on these stories as a reason to regulate away legal funding ignore the broader narrative of who uses it and why. "It is often assumed," Zywicki writes, "that all of those who use various fringe lending products are more or less the same. This is not true." Though many draw an equivalency between title pawn and payday loan customers, he notes, this equivalency is false.

Title pawn customers are typically:

  1. Small business owners ("landscapers, handymen, etc") who depend on their vehicle to operate. Because business is unpredictable, they cannot depend on traditional small business loans, and generally require more money than payday loans provide.

  2. Customers with no bank accounts, which payday lenders require.

  3. Customers who need greater liquidity than payday loans provide.

These are all true of legal funding customers as well: small businesses, for instance, need working capital to keep the lights on while they litigate against a corporation that stole their intellectual property. Though the lawsuit is a valuable asset, banks don't recognize this; the business has no alternative but to seek legal funding.

The same is true of individual consumers, who often have no bank accounts or credit cards, and need more money than a payday loan provides: to pay for surgery, rent, mortgage, tuition, the list goes on. "Those who use auto title pawns have limited options," Zywicki writes, and "use auto title pawns for pressing expenses." Well, so do legal funding customers.

We've worked with thousands of plaintiffs who suffered devastating injuries: accident victims hurled through their windshields, patients whose implants leaked toxins into their bloodstreams, day laborers forced to used banned chemicals. The list, again, goes on.

Many plaintiffs are unable to work after an accident. Many are their family's chief source of income. They could certainly take a low, early settlement offer to pay the immediate bills, but this is a bandaid on a huge bloody wound. Legal funding empowers victims to meet expenses while waiting for larger, fairer, ultimately more useful settlements. Later in his column, Zywicki notes that title pawns present "limited risk of financial breakdown":

To be sure, the risk of an auto title pawn is not trivial - the loss of a car and the potential consequences associated with that. But as a financial matter, risk is limited. The risk of an auto title pawn loan, for example, is limited to loss of the car. Unlike, say, credit cards or credit card cash advances, which can generate finance charges and fees that can cause the balance to increase and potentially dig a hole for consumers, auto title pawns are non-recourse and so the consumer's exposure is limited.

Legal funding is non-recourse as well. The worst-case scenario for any plaintiff is that they lose the lawsuit; this too is not trivial, but it is important to note that plaintiffs who lose will never owe any money back to the funder. 

This is why legal funding rates are higher than those in traditional sources of financing - legal funders assume enormous risk so plaintiffs don't have to. But an expensive deal is not necessarily a bad deal.

Suppose you have two options:

A) Taking $5,000 in legal funding, winning a $50,000 settlement, and paying $10,000 back to the funder, or

B) Taking a $5,000 early settlement offer, using it to pay three months' worth of bills, then going back into debt.

Isn't it an obvious choice? We believe it is, but this gets lost in reductive narratives about high rates and helpless consumers. Which brings us to Zywicki's final point, and perhaps his most important:

Consumers generally understand the costs and risks: Surveys of consumers who use fringe lending products consistently find that although these products are expensive, consumers who use them generally understand that they are costly. They may not be able to state the APR, but they do know the finance charges and other terms. In fact, one common reason given by many consumers for why they use products like payday loans and auto title pawns is that the products are simple and easy to understand. Many of them have had bad experiences with more complex products such as bank accounts and credit cards and so opt for these simpler products. Restricting access to them, therefore, appears to be grounded solely in paternalism, not in a lack of proper disclosure and the like.

Legal funding customers have a crucial leg up over title pawn customers: they are in every instance advised by an attorney. This bears repeating: every legal funding transaction must be signed off by the plaintiff's counsel. No funder will proceed without this approval. "At root," Zywicki writes, "the fundamental problem with the New York Times's article is that people are not as stupid as the Times reporters think that they are." This is an important statement with broad implications: it is relevant to policymakers, plaintiffs' attorneys, and legal funding providers alike.

Consumers are smart. They want options. They want simple options, clear options, and easily accessible options. They want protection but not paternalism, regulation but not restriction. "Auto title pawns raise unique and important consumer protection questions," Zywicki concludes, "but it is unwise to simply dismiss them as 'hurting the poor' without doing even the slightest bit of research to actually understand how the product is used."

He's right, though we might've used a somewhat stronger word than "unwise."

Simple stories are believable stories, but financial products like title pawns and legal funding are rarely so simple.

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