Features May 20, 2010, 5:00PM EST

Broke, USA: From Pawnshops to Poverty Inc.

An excerpt from Gary Rivlin's upcoming book shows how lending against future paychecks went from a single shack to a strip mall staple

By Gary Rivlin

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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.