Thursday, September 10, 2009

Protection racket

In the musical version of Les Miserables, Monsieur Thenardier, the innkeeper, sings about the creative extras he charges his guests
Charge 'em for the lice, extra for the mice
Two percent for looking in the mirror twice
Here a little slice, there a little cut
Three percent for sleeping with the window shut
When it comes to fixing prices
There are a lot of tricks he knows
How it all increases, all them bits and pieces
Jesus! It's amazing how it grows!
Bank executives seem to share Thenardier's billing philosophy.

The New York Times reported yesterday on automatic overdraft protection that is included with many debit cards.
When Peter Means returned to graduate school after a career as a civil servant, he turned to a debit card to help him spend his money more carefully.

So he was stunned when his bank charged him seven $34 fees to cover seven purchases when there was not enough cash in his account, notifying him only afterward. He paid $4.14 for a coffee at Starbucks — and a $34 fee. He got the $6.50 student discount at the movie theater — but no discount on the $34 fee. He paid $6.76 at Lowe’s for screws — and yet another $34 fee. All told, he owed $238 in extra charges for just a day’s worth of activity.

Mr. Means, who is 59 and lives in Colorado, figured employees at his bank, Wells Fargo, would show some mercy since each purchase was less than $12. In addition, a deposit from a few days earlier would have covered everything had it not taken days to clear. But they would not budge.

Banks and credit unions have long pitched debit cards as a convenient and prudent way to buy. But a growing number are now allowing consumers to exceed their balances — for a price.
Overdraft coverage is essentially a loan from the debit card issuer. When the customer attempts to "overdraw" an account (take more money out than is there), the card issuer has two options: to reject the payment or let the customer run a negative balance. Overdrafts are temporary negative balances, usually for limited amounts.

Some banks, such as ING, simply charge the going interest rate for the negative balance. Most banks, however, charge a fee for initially making each overdraft (in Mr. Means' case, $34) AND charge daily fees for continuing the overdraft.

There are other forms of overdraft protection. For example, some banks will let you link your debit card account to a savings account or a credit card. If you overdraw the debit card account, the bank will move funds from the linked account--usually for a fee.

Overdraft coverage can be useful, as it allows customers to make necessary purchases that they might not otherwise be able to make.

However, this convenience usually comes at a cost--the high fees that most banks charge. For a customer with a credit card, the interest rate on that card is typically much lower than the overdraft fee.

Also, debit card users with automatic overdraft coverage are seldom informed that they are about to overdraw their accounts. They only find out when they are contacted about the fee.

Worse, the Times article points out that banks will rearrange the sequence of transactions to maximize their fees.
Ralph Tornes, who lives in Florida, is pursuing a lawsuit against Bank of America for charging him nearly $500 in overdraft fees in 2008 after it rearranged his purchases from largest to smallest. In May 2008, for instance, Mr. Tornes had $195 in his account when he made two debit purchases for $8 and $13; the bank also processed a bill payment of $256.

He claims that Bank of America took his purchases out of chronological order and ran the biggest one through first. So instead of paying $35 for one overdraft fee, he was stuck with three, for a total of $105.
The fees have become a huge source of revenue for the banks.
In all, $27 billion in fee income flows from covering overdrafts from debit card purchases, A.T.M. transactions, checks and automatic payments for bills like utilities; an additional $11.5 billion arrives from bounced checks and other instances in which banks refuse to pay overdrafts...
Because of this, banks are fighting reasonable regulations on this activity.

The most sensible regulation is to give consumers the explicit choice to elect this coverage on their accounts. At that time, consumers would be informed of the fees and limits associated with the service. If the feature is as convenient and useful as the banks claim, people should be glad to sign up for the service.

Another sensible regulation would be to require banks to book purchases and withdrawals chronologically.

Ultimately, however, caveat emptor. Consumers are in the best position to avoid these fees by making sure that they have adequate balances before using their cards. They should also shop around for banks and credit unions that don't charge these fees.


Anonymous said...

"require banks to book purchases and withdrawals chronologically"

I believe that the philosophy behind posting payments by descending amounts is that the larger amounts are more 'important'. You'd rather a check to a grocery store bounce than a mortgage payment.


Anonymous said...

Sorry, can't type.


PS They are posted chronologically. All items received that day are sorted and - usually - posted in descending order by amount. I don't believe that the date the check was written is encoded on the MICR line. So if I wrte a $500 check on the 5th and a $900 check on the 6th and both checks are presented to the bank on the 8th, the $900 check would be processed first.

The alternative is to not sort on amount (post randomly) or post lesser amounts first - potentially bouncing the mortgage payment.

Dave Ribar said...


I should have been clearer. I was discussing these policies in terms of debit cards, which should post almost immediately.

I can understand paying the larger amount first IF there are sufficient funds in the account. If one check is going to bounce, you would prefer that it be the "less important" check. However, if it is possible to pay the smaller but not the larger, would anyone reasonably want both checks to bounce or for there to be two overdrafts?

Anonymous said...

Is it mathematically possible for both checks to bounce? If the larger check bounces, the funds are still in the account to cover the smaller (unless you invoke the 'overdraft protection' feature in which case order is important).

I believe that most banks do try to post deposits before withdrawals to minimize NonSufficient Funds charges.

Adding logic to match checks to balances to minimize NSF and overdraft protection draws when processing the days transactions (at night) is probably not going to happen as it potentially slows the system down too much. Ideally, you would allow the customer to identify 'high priority' payees and their payments are processed first (mortgage, car payment, etc.). Actually, ideally, customers would always have funds on deposit to cover the checks/debits.

Some debit cards clear through the Automated Clearing House (ACH)system and are not processed in realtime, I believe. They are presented to the bank in 'batches'.

I believe that the problem with debit cards is that the merchant may place an Authorization Hold for the transaction amount (sometimes greater than the transaction amount) to insure that the funds are available to cover the transaction.


Dave Ribar said...


Suppose that the person had $800 in her account. The bank processes the $900 mortgage check and treats the $100 difference as an overdraft. The bank then processes the $500 check as an overdraft.

Recall that the account has automatic overdraft protection, so neither check "bounces."