Broke, USA: From Pawnshops to Poverty Inc.

Allan Jones wasn't looking to kick-start an industry when he flew his single-engine Piper Saratoga from his home in Cleveland, Tenn., to Johnson City in the spring of 1993. He only wanted to persuade a man to come work for him. Jones took over his father's small collection agency when he was in his early twenties and built it into a multicity behemoth—"the largest in Tennessee," he'd tell you. But it gnawed at him that nearly two decades later he had no presence in the northeast corner of the state. So when he heard that James Eaton, an old friend of his father's, had been let go after years in the business, Jones jumped into his plane to go get his man.

Eaton was stately, a 56-year-old who wore glasses and smoked a pipe. "He looked to me kind of like Sherlock Holmes," Jones recalls. That made it all the sadder when Jones found Eaton working out of an office in a dilapidated gas station. There, in a shack with paint peeling off the walls, Eaton had set up a meager-looking business called Check Cashing Inc. "I guess I've found myself my man in northeast Tennessee," Jones told himself.

Sitting down to talk with Eaton, Jones discovered that the business was different than he thought. Eaton was loaning cash to people who needed a bridge until the next payday. The school janitor who needed $100 today, Eaton explained, would pay him back $120 when he received his next paycheck.

Jones had built a successful debt collection business with around 250 employees—but he didn't enjoy it. Debt collection meant unhappy people. Watching Eaton run his payday shop and interact with his working class customers, Jones was struck by how friendly it all was. "People would thank him," Jones says. "They would thank him and thank him and thank him."

Jones wondered about the fee Eaton was charging. Wasn't 20 percent too steep for a short-term loan of maybe a week or two? Not really, Eaton explained, if you considered their banks would charge them at least that much on a bounced check.

Eaton declined Jones' job offer—"This is the happiest business I've ever been in," he told Jones, who took away something much more valuable than a new employee. He decided to make a small bet on going into this business for himself. Ten grand, he concluded. He would set aside $10,000 and give it a shot.

Neither Eaton nor Jones invented the payday loan. Moneytree, a check-cashing firm on the West Coast, and QC Holdings (QCCO), a check cashier that originated in Kansas City, Mo., both offered cash advances to customers starting in the late 1980s. But Jones was the first to pursue the cash advance as a stand-alone business with blue-sky potential. "It was like we was filling this giant void out there," he says.

To most people, it looked like a shaky proposition—how likely is it that the customer who can't muster $300 today is going to scrape together the $345 two weeks later to pay off a loan? The key is that she doesn't necessarily have to. The bulk of revenues comes from customers who roll their loans over for weeks, if not months, at a stretch. In 2001 the industry passed the 10,000-store mark and entrepreneurs with national ambitions were still lined up at the door, hoping to get in. At the industry peak, in 2006, there were 24,000 payday stores in the U.S., according to Stephens, an investment bank in Little Rock that has carved out a specialty in subprime businesses. That was more than all the McDonald's (MCD) and Burger Kings (BK) combined.

Jones, 57, stands maybe five foot eight. He's bald with a full beard, and resembles the director Rob Reiner, minus the liberal politics. He still lives in his hometown of Cleveland (pop. 37,000). On our first of two full days together, he wore scuffed cowboy boots and a monogrammed white dress shirt with his belly hung over frayed jeans like a proud accessory. He personally clears $20 million a year from the payday business.

Jones spent a year at Middle Tennessee State University in Murfreesboro before dropping out to work at his father's credit agency. By then, his father, suffering from emphysema, was able to work only a few hours each day, and a rival credit agency had opened in town. "Come home and save the business," his mother asked him, "so we can afford to send your two sisters to college."

Jones didn't need much convincing. He had married his high school sweetheart, who was pregnant with their first child. They were living in a trailer. On his first day on the job, Jones thought his father might have lost his mind. He had recently hired a new manager, but he let him go and announced to Jones, then 19, "You're in charge, son."

The son gamely settled in and began to crack the whip like an old pro. He figured out the average collection agent made 25 calls a day; by his reckoning, a person should reasonably make a new phone call every five minutes. So he imposed a quota of at least 100 calls per day per person. "After that the company really took off," he grins.

Jones was 24 when he bought out his father for $100,000 and named himself chairman, president, and chief executive officer of Credit Bureau Services, a company that he would sell for more than $10 million in 1998. His payday business was starting to move, he explained, and he had decided "to really throw the hammer down."

Three weeks after visiting James Eaton in Johnson City, on the first day of summer 1993, Jones opened Check Into Cash. His first customer was a military man who needed $100 to buy a bicycle for his daughter's birthday. Not long after opening that store, he opened a second 30 miles away. As an experiment, he put a childhood chum he describes as a "lump on the log" in charge of the operation. It made no difference. That store made money just as rapidly as the first. Lawyers from a big firm in Chattanooga advised him that there was nothing in Tennessee law expressly forbidding him from making these high-rate, short-term loans, and he opened seven more stores around the state in 1994. He collected nearly $1 million in fees that year; the stores, including salaries and bad debt, cost only $486,000, leaving him with more than half a million in profits.

To open new locations, Jones hired Steve Scoggins, a local man he had known since they were kids, and gave him a budget of $1 million. After doing some research, Scoggins asked him, do you want 20 good-looking stores or 60 that don't look so nice? Jones chose the 60. In 1995, Check Into Cash generated nearly $1 million in pretax profits on $3.7 million in fees, operating stores in Tennessee, Kentucky, and Indiana.

To grow his payday empire, Jones needed capital, but he had difficulty persuading traditional bankers to do business with him. In the '90s, at least, they were squeamish about venturing into the world of fringe financing. One of the first big chunks of cash he got—$3.5 million from a private equity firm—cost Jones a payday-like interest rate of 14 percent. Check Into Cash opened more than two stores a week through 1997. Jones secured an additional $11 million line of credit from NationsBank at the end of the year, allowing him to open an average of three stores per week through the first half of 1998.

The company hired a new regional manager every time it added 10 to 15 new stores. To keep everyone financially motivated, bonuses were granted based on the performance of those directly below them on the organizational chart. Store managers, who tended to have a year or two of college on their résumés, were flown to the mother ship in Cleveland for four days of intensive training. While there, they were given a policy manual that they were instructed to treat as if it were handed down from the mountaintop. It spelled out in intricate detail the most mundane of tasks, from the proper storage of bank receipts to the number of times a day a manager should phone a bank to see if a customer's postdated check (the check a customer had written when initially taking out the cash advance) was good.

In time the company perfected a system for finding new locations. The Holy Grail was a shopping center anchored by a Wal-Mart (WMT), perfectly placed for when people needed cash to go shopping. A storefront close to a Kmart (SHLD) or Kroger (KR) was also a guaranteed winner. Trial and error taught Jones that he should cluster stores, which allowed for better oversight and a more efficient use of marketing dollars. A new store typically generated enough cash to cover the initial startup costs by the ninth month in business.

Early on, Jones was cautious about how much he would lend a borrower. Gradually he loosened the guidelines, and by the late '90s the company established the lending standard it uses today: A person can borrow as much as one-quarter of his or her monthly paycheck. Predictably, that increased the number of people unable to pay their loans; the percentage of loans the company wrote off doubled from 2 percent in 1993 to 4 percent in 1998. But the company's financial statements from that period show that the increased revenues easily covered the increased losses. Check Into Cash more than doubled its revenues 1998, with profit margins well above 20 percent. That's about when Wall Street dropped any qualms it might have had about payday lending.

Jones loved hosting the investment bankers who began visiting him. He would greet them in an off-the-rack suit he bought at a discount place in town, then usher them into his "conference room"—10 metal chairs around a banged-up, folding banquet table. Nobody minded. "Them numbers are all they ever noticed," he says.

CIBC Oppenheimer initially agreed to serve as the lead underwriter on Check Into Cash's initial public offering, set for 1998. When CIBC put the IPO on hold while the market recovered from the so-called Asian flu, Jones refused to wait. The competition was heating up, and he was anxious for his money. So he persuaded officials at National City, then awakening to the profit potential of subprime, to loan him the $50 million he'd planned to raise through an offering. He liked the idea of keeping his independence. "We have board meetings at Check Into Cash," Jones likes to joke, "but I win every vote one to nothing."

While Jones had taken a tiny idea and made it big, it took another entrepreneur with lots of money and political connections to usher it into the corporate mainstream. His name is Billy Webster, and he first got rich on fried chicken. While studying law at the University of Virginia in the early '80s, his father started talking about the long lines of people queuing up at the local Bojangles' chicken shack. That marked the end of young Webster's legal career. "I graduated law school on a Saturday, and Monday night I'm in the back of a Bojangles learning how to fry chicken, being taught by a 16-year-old black guy from Frogmore, S.C.," says Webster.

Ten years later, Webster and his father sold their holdings back to Bojangles; the pair were operating two dozen stores generating a combined $24 million in annual sales. By almost any standard, if not his own, Billy Webster was a rich man.

For a time Webster got into politics, including a stint as the chief of staff for Richard Riley, the ex-South Carolina governor named Secretary of Education by Bill Clinton, and did a year as a scheduler for Clinton himself. When Webster returned to South Carolina, he was determined to find a business that he enjoyed running. "Basically, I was looking for a consumer service business [that] was mom-and-pop-dominated," he says. "I was looking for an industry that hadn't been professionalized."

When he first heard about the payday business in 1996, Webster liked the sound of it so much that he flew to Tennessee to work a few weeks behind the counter of a Jones competitor called National Cash Advance. "I didn't see an unhappy human being in my three weeks working there," says Webster.

He came away from the experience planning to dominate payday lending in the fashion of Wal-Mart. For additional backing, he went to George Dean Johnson Jr., an old family friend who had opened more than 200 Blockbuster (BBI) video rental stores before selling them back to the parent company for $156 million. Webster showed Johnson two lines on a piece of paper—one showed the cost of a payday loan, the other the rising costs of a bounced check or credit-card late fee. "When those lines crossed," Webster explained to Johnson, and the bank penalties started costing more than the short-term quick loans, "the industry just grew and grew and grew."

Using their connections, the pair secured sizable lines of credit from Wells Fargo (WFC), Wachovia, and NationsBank to start building Advance America. "We basically borrowed $40 or $50 million before we made anything," Webster says. "We had an infrastructure for 500 stores before we had even one."

Advance America opened 300 stores in 1997 and 400 the next year. In 1999, Webster started calling rivals to see who might be interested in selling. Allan Jones took the call while soaking in a tub in his summer home and turned him down. Within a few years, Advance America had more than three times as many stores as Check Into Cash.

The political environment at the time was accommodating. In 1998, South Carolina legislators welcomed payday lenders into their state, as did elected officials in Mississippi, Nevada, and the District of Columbia. By the end of 2000, 23 states had legalized payday lending, and the likes of Advance America (AEA) and Check Into Cash were operating in eight more because no law on the books forbade them to do so. Where a traditional lender was earning a return on investment of between 13 and 18 percent, according to Stephens, the average payday lender averaged 23.8 percent.

As the industry grew, opposition was inevitable—and came most vocally from Jean Ann Fox, the Consumer Federation of America's director of financial services. In a 1998 report, "The Growth of Legal Loan Sharking," Fox assailed what she originally called "delayed deposit check loans," or "check advance loans." She also injected math into the debate. As she read it, the 1968 Truth in Lending Act required any business to express the cost of a loan not only in dollar terms but as an annual percentage rate, or APR. The $15 per $100 that payday lenders could charge in stricter states like Ohio and Washington worked out to an APR of 391 percent. In Arkansas, where payday lenders could charge as much as $21 for every $100 borrowed, the APR was 546 percent. Borrowers in Indiana, with its $33 per $100 cap, were paying the equivalent of 858 percent on a two-week loan.

Webster prides himself on his ability to get along with anyone. Fox, he says, proved to be an exception. "A person says stuff like ' loan sharking,' and it's hard not to take this stuff very personally," he says. He agreed with Fox on at least one point, though: the need to state the cost of payday loans as an APR. Advance America's general counsel had concluded the same after researching the law. Webster could have overruled her, but he figured people didn't care about the APR: They only cared that they could have $300 today.

So in the late '90s, Advance America became the first chain to post its APR. Now Webster regrets it. He argues that his 391 percent APR is a meaningless number—like saying salmon costs $15,980 per ton or advertising a hotel room for $36,500 per year. A flat fee is not an interest rate. He also concedes the public doesn't see it that way. "It has been a millstone around our neck."

Despite the calamity that hit the globe with the implosion of subprime mortgages, payday lending enjoyed a robust 2009—at least in those states where it could still operate freely. Advance America's aftertax profits were up more than 40 percent over 2008; in Cleveland, Tenn., Allan Jones told me that although he has fewer Check Into Cash stores than he used to—1,200 vs. a peak of 1,300—business was brisk in 2009. Defaults were up but so was traffic, and per-store revenues were rising.

The climate, however, has changed. In Ohio, one of payday's strongest markets, voters in 2008 approved a ballot referendum that capped the rates a payday lender could charge at 28 percent annually. In Arizona, voters overwhelmingly supported a ballot initiative that in effect kicked payday lenders out of the state, and that followed on the heels of legislative changes in Oregon and New Hampshire. "I don't know what's changed that suddenly I'm evil," Jones says.

Excerpted from BROKE, USA: From Pawnshops to Poverty, Inc.—How the Working Poor Became Big Business by Gary Rivlin. Copyright © 2010 by Gary Rivlin. To be published on June 8, 2010, by HarperBusiness, an imprint of HarperCollins Publishers.

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