House Dems Eye Overdraft Reform

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It happens all the time. A thirsty consumer grabs a cup of coffee with a debit card, unknowingly exceeds the available balance, and gets smacked with a $30 fee for the $3 purchase.

The banks call it overdraft protection — the usually automatic loan fronted by institutions to cover purchases even when checking accounts have run dry. And they consider it a service to customers. But critics argue that the industry has adopted a slew of abusive tactics to maximize the frequency of these loans — and the considerable fees that accompany them.

Illustration by: Matt Mahurin

Now, as Congress is preparing to tackle a series of proposals tightening oversight and regulation of the finance industry, a growing chorus of lawmakers and consumer groups is urging Democratic leaders to include overdraft reform as a part of the package. In an economy where taxpayers have already bailed out Wall Street banks to the tune of billions of dollars, they argue, those institutions shouldn’t be permitted to turn around and slap abusive fees on their rescuers.

“They’re taking the TARP funds and then they’re raising fees and rates on the same people who funded TARP,” Pamela Banks, policy counsel at Consumers Union, said of the banks benefiting from the Troubled Asset Relief Program. “They’re double dipping with the taxpayers’ money.”

But reform won’t come easy. Overdraft fees are a whirling profit engine for banks, and the industry is fighting tooth and nail to keep Congress at bay. Indeed, in a report released last November, the Federal Deposit Insurance Corporation found that overdraft fees range from $10 to $38, with a median charge of $27. And those fees add up. A 2007 report from the Center for Responsible Lending found that overdraft fees bring in roughly $17.5 billion each year — more than the estimated $15.8 billion in overdraft loans that generated them.

Industry representatives maintain that overdraft protections are designed to benefit customers. “In general, people do appreciate and value this service,” said Nessa Feddis, spokeswoman for the American Bankers Association. She said that consumers can easily avoid trouble by keeping track of balances, maintaining a balance cushion or opting into programs where the debit account is linked to a second account or a line of credit to absorb the overdraft. “There are all sorts of ways to to avoid it,” Feddis said.

Critics argue, however, that many of the industry’s practices hit below the belt. Among the most controversial, most banks automatically enroll customers in the overdraft protection program, without their knowledge or consent. Also, most institutions manipulate the order of purchases, often increasing the number of overdraft transactions. And there is no system in place warning shoppers when they’re poised to buy something that will send them into overdraft territory.

A House bill, sponsored by Rep. Carolyn Maloney (D-N.Y.), takes steps to protect consumers on all three fronts — but the bill faces a tough road ahead.

Despite wide agreement that the finance industry is largely responsible for the current economic mess, it retains enormous sway on Capitol Hill, where controversial housing legislation has stalled already this year in the face of industry opposition. Furthermore, Congress has spent hundreds of billions on the banks in recent months, hoping they’ll re-grease the economy by increasing lending. In the wake of those efforts, many lawmakers will likely be reluctant to support legislation that could hurt industry profits, even if those reforms protect consumers. Such proposals will likely be spun as undermining bailout efforts.

Graham Steele, an attorney at Public Citizen’s Congress Watch, said many lawmakers are “spooked by the apocalyptic messaging” of the banking lobby. “They seem to still have traction on Capitol Hill, unfortunately,” Steele said.

The debate highlights the difficulty facing lawmakers pushing to reform the powerful finance industry: In good economic times, there’s a tendency in Washington to stay out of the affairs of banks for fear of impeding an economic engine; in bad economic times, there’s a tendency to stay out of their way for fear of hindering recovery. Ironically, the current economic chaos might make it more difficult for proponents of finance reforms to rally the congressional support to pass the proposed changes.

On Tuesday, Bank of America made headlines by scrapping plans to hike its overdraft fees from $35 to $39 per transaction. BoA spokesman Jim Pierpoint said the decision was made in consideration of the troubled economy, particularly the rising rate of unemployment. The company is also working on a case-by-case basis with newly unemployed customers to review overdrafts, he said. Yet two other recent BoA policy changes — one applying a $35 fee if a customer’s balance is negative for five days, and another hiking allowable overdraft fees at 10 per day, up from seven — will remain in place, Pierpoint said.

Faced with declining revenues, other banks are also tightening the belt on consumer benefits — adopting new fees and reducing borrowers’ credit card limits.

Some Democrats aren’t holding their breath for the banking industry to volunteer overdraft reforms. The Maloney bill would prohibit automatic enrollment in a bank’s overdraft protection program, instead requiring the customer to opt-in to participate. It would also alert debit card users at the ATM or the coffee counter if they were about to exceed their balance, allowing the shopper to opt-out of the purchase to avoid the penalty fee. Finally, the bill would prohibit any reordering of purchases that leads to an increase in overdrafts.

Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, has vowed in coming weeks to take up a series of finance reform bills, including proposals to reform the credit card and mortgage lending industries. Frank spokesman Steven Adamske said Tuesday that overdraft reform is on Frank’s radar, but it remains uncertain if or when the committee would consider the legislation this year.

There is no companion to the Maloney bill in the Senate.

Of the various industry tactics, the resequencing of transactions to maximize overdrafts is perhaps the most obscure. In a hypothetical case, a card-user with $100 in available funds might buy a $75 sweater, a $2 cup of coffee, a $4 hamburger and $30 worth of groceries — going over the limit only on the final purchase. But banks often tally each day’s transactions by order of the purchase amount — largest to smallest — not by chronology. In this example, the consumer would exceed the limit after just the two largest purchases ($75 + $30 = $105), and thus be hit with overdraft fees on the two smaller purchases as well. The result? The bank gets three overdraft fees ($81) instead of just one ($27).

Feddis, said that tactic is precisely what customers want, arguing that the the most vital purchases tend to be the most expensive. “People want their important expenses paid,” she said.

Maloney’s office, though, isn’t buying the argument. “Whether it’s by design or innocent, its effect is to incur more fees,” said Maloney spokesman Jon Houston. “They’re using this as a profit center.”

The Federal Reserve has taken recent steps to protect consumers from overdraft fees as well. In December, the Fed proposed two strategies to give customers more options surrounding overdraft payments. The first would prohibit banks from charging overdraft fees on purchases already made without first giving consumers the choice to opt-out of the program. The second is an opt-in approach, requiring specific consent from the customer before banks could authorize overdraft purchases at all. The final rule is expected before the end of the year.

The Fed’s action could easily be the only overdraft reforms of 2009. Faced with the imposing opposition of the finance industry, some observers say, Congress won’t likely get very far with its finance reform agenda this year.

“I … can’t think of another sector that has proven itself so adept over the years at blocking even minor reforms,” Stephen Pearlstein, the Pulizer Prize winning business columnist for The Washington Post wrote Wednesday. “With so many conflicting interests among well-heeled firms and so many agencies fighting to protect their bureaucratic turf, the most likely outcome is political stalemate.

“Watching the Senate Banking Committee deal with financial regulation,” Pearlstein added, “is a bit like watching a cow chew its cud.”