How the Sneaky Hands of the Big Banks Are Working Overtime to Rip You off
After living through the Great Financial Crash of 2008, just about everybody recognizes that megabanks screwed the economy hard and were rewarded with big bailouts, which further screwed over, well, everybody, in the name of banker bonuses. But Big Finance has been waging its war on the middle class for decades, and many of its most destructive practices don't actually put the financial system in jeopardy. These tactics work because they are so effectively predatory. Banks gouge consumers and get rich—they don't create risks for the financial system, because they result in pure, risk-free profit, converting hard-earned middle-class wages into quick and easy bonuses.
One of the most pernicious of these predatory practices is the overdraft fee. It's one of the biggest revenue streams for banking behemoths today. In 2009, banks reaped over $38 billion in overdraft fees from their own customers, while posting a total combined profit of just $12.5 billion. Without overdrafts, many banks would have scored massive losses last year, and possibly gone under. Instead, they booked epic bonuses.
It can come as a huge shock to get hit with a rash of overdraft fees. You open a bank statement to find that you are not only broke, but deep in the hole thanks to several $30 or $40 charges. Your first reaction is shame. How could I have let this happen? But looking into the ways that banks conduct their overdrafts, you come to realize that you've simply been scammed.
"It abuses consumers and sucks money out of the economy that goes beyond any contribution to society that finance provides," says Rep. Brad Miller, D-N.C. "Overdraft fees are one of the worst abuses. For people living paycheck to paycheck, they have a serious effect on their everyday lives."
Banks are actively deceiving their own customers. According to an FDIC study, 75 percent of all banks don't even tell people they've been automatically enrolled in "overdraft protection" programs. Many consumers don't even realize that their accounts are subject to these charges—they assume that anything that puts them past zero will simply be denied.
It gets much worse. Once banks realized that overdraft fees could be a real cash cow, they developed "fee-harvesting" software, which reorganizes the order of your checking transactions to maximize the number of overdraft fees for the bank. In other lines of financial business, this is called "backdating," and it's considered "fraud."
How the Scam Works
Say you've got $80 in your checking account, and you decide to pay some bills and run some errands. You spend $30 on gas and another $20 on your water bill. Later, you head to the grocery store and spend $81—oops!—on groceries. Banks, of course, could notify you that your $81 purchase was going to send you over the edge and result in an overdraft fee. They don't, because they don't want to risk that you'll deny the purchase and reject the fee.
But in addition to neglecting this safeguard, the bank automatically processes your $81 purchase ahead of your previous charges. As a result, you do not get hit with one unwanted overdraft fee for your groceries—you get hit with three, because your costliest purchase was processed before the others—even though you made the cheaper purchases first.
"Overdrafts are a classic example of a potentially useful idea where the industry ends up going totally overboard," says Raj Date, a former Deutsche Bank executive who currently heads the Cambridge Winter Center for Financial Institutions Policy. "When you step back and ask, as a reasonable business person, would any customer want their fees to be itemized such that their fees would be maximized? No. No customer would ever want it."
This is not how banks are supposed to operate. They're supposed to fuel sustainable, healthy economic activity. That was, in fact, the rationale behind bailing them out. As President Obama said in April 2009: "The truth is that a dollar of capital in a bank can actually result in eight or ten dollars of loans to families and businesses."
Needless to say, that lending didn't happen. In a series of monthly reports, the U.S. Treasury Department noted that bank lending to small businesses fell dramatically from April 2009 through January 2010. After months of bad stats, Treasury simply stopped keeping track of the numbers altogether. The FDIC still tracks those numbers, and they don't look good. As Shahien Nasiripour has noted, the latest figures show small business lending down 4 percent from last year's already dismal levels, putting it lower even than early 2009, before the stimulus package kicked in.
Instead of supporting the economy, banks are making their money with cheap-shot fees, risky proprietary trading and secretive derivatives deals. It's worked, in a sense. By "earning" their way back to health, the nation's largest banks are at a much lower risk of collapse now than when Obama took office. But those earnings have not been good for the economy, as we were promised they would be.
"It's not good from a societal sense, but from a banking industry perspective, it's just a recognition of reality," says banking analyst Nancy Bush of NAB Research. Bush is a Wall Street veteran who supports overdraft programs, but acknowledges they indicate economic trouble. Banks have discovered a way to make money off of people without any money. When everybody's broke, that's a much less risky enterprise than lending to businesses that could use the funds to create jobs, but might default due to bad economic conditions. Banking analysts like Bush are charged with holding management teams accountable to their shareholders, and these fees are good for profits, which mean shareholders are getting what they want.
But this is the exact opposite of what anybody but a shareholder would want a bank to be doing. We don't want banks to be kicking society when it's down, we want banks to be helping us get back on our feet.
Setting The Banks Straight
Agencies have been voicing concerns about overdraft fees for years. The FDIC published a damning study on the practice in 2008, and the Federal Reserve began issuing warnings to the banking industry about unfair overdraft programs in 2004. But up until 2004, overdrafts were generally viewed as a form of short-term credit—the bank is basically lending the consumer money that is paid back with interest. But the interest rates are so egregiously predatory—the average overdraft fee amounts to 1,067 to 3,520 percent (PDF), according to the FDIC -- that they simply would not be tolerated if regulators had to think of them as loans.
So the banking lobby scored a tremendous coup in 2004 when it convinced the Fed that these were not "loans" but "fees," and therefore not subject to traditional consumer protections. The Fed warned that banks needed to change their marketing so that consumers wouldn't think of overdrafts as loans, but didn't require any changes in the way the programs actually operated.
Even this reclassification scheme wasn't enough for Wall Street, which managed to violate even the much weaker consumer protection rules on fees 335 times a year, according to a report by the Government Accountability Office. The GAO also found that consumers who went to an actual bank branch were unlikely to be able to obtain information about basic overdraft terms and conditions, much less comprehensive information about how their checking accounts could be gamed.
The Fed is offering another weak response to the overdraft insanity today. By mid-August, the Fed will require consumers to "opt-in" to overdraft programs, instead of being automatically enrolled without their consent. It's a step forward that will likely limit some of the overdraft profits banks currently enjoy. But it will not require that the programs be fundamentally changed. It will not cap the amount of the fees charged, or the number of fees charged, nor will it require consumers to be notified when a purchase or withdrawal will result in a fee. Banks will take a modest hit from the new rules as consumers choose to back out of the program—but the fundamentally obscene business model will remain.
A more promising development comes from the Wall Street reform bill. A new Consumer Financial Protection Bureau (CFPB) will take over nearly all of the consumer protection rules currently written and enforced by the Fed and the OCC (Rep. Miller was instrumental in getting strong consumer protection through the House). An aggressive director could write strong rules prohibiting abuses, so there is a great deal riding -- $38 billion a year, in fact-- on who President Obama appoints to the post. Right now the front-runner is Harvard University Law School professor Elizabeth Warren. Warren came up with the idea for a CFPB years ago, and has proven herself to be a strong reformist voice of reason as chair of the Congressional Oversight Panel for the Troubled Asset Relief Program. She deserves the post.
But without strong leadership, the banking swindles will continue. If recent history is any guide, there are few others in Washington, D.C. willing to take a stand for citizens when the banking industry comes to pillage our pocketbooks.