Banking's Cash Cow Should Be De-Horned

Reforming the nation's financial regulatory system, which Congress is expected to take up later this year and early next year, is shaping up as a huge hairball, replete with special interest groups, feuding bureaucrats, television ad campaigns and massive amounts of campaign contributions.

As a preview, Congressional Democrats are considering immediate action on one of the banking industry's more egregious anti-consumer tactics: Charging large overdraft fees to customers who overspend on debit-card transactions.

Instead of denying the transaction for insufficient funds, most banks pay overdrafts up to a pre-set limit and then add a usurious fee of $35 or more for what is, in effect, a very short short-term loan. Overdraft protection is a nice service — if customers ask for it and understand the system — but banks aren't required to tell them about it.

And because many banks carefully time the processing of transactions to maximize the number of overdrafts — for example, counting the biggest transactions first or not counting deposits until four or five overdrafts are incurred — customers who think they have plenty of money in their accounts may find themselves owing hundreds of dollars in overdraft fees.

Now comes Senate Banking Committee Chairman Christopher Dodd, D-Ct., with plans to fast-track legislation requiring banks to get their customers' permission before extending overdraft protection. If the customer declines, his transactions will be denied at the point of sale, causing a little embarrassment but also saving him the overdraft fees.

To be sure, Mr.

Dodd is an imperfect vessel for financial reform. He missed the boat on cracking down on Fannie Mae and Freddie Mac, even as he accepted nearly $134,000 in campaign contributions from the two mortgage giants between 1989 and 2008. He raised $4.3 million for his abortive 2008 presidential campaign from the financial services industry.

But the news, first reported by the Financial Times, that banks stand to raise $38.5 billion this year from overdraft fees, has begun to cause a consumer backlash. Banks defend the fees as necessary to cover their costs; given that most of the work is done electronically, that claim doesn't withstand scrutiny.

The Consumer Federation of America reports that the median bank overdraft fee is $35. Clearly, overdraft fees have become a profit center for banks; you can't pay all those big executive salaries and bonuses if your asset sheets don't look good.

This should be a no-brainer. Yes, customers should act responsibly and monitor their own accounts. And yes, the American Bankers Association says only about 18 percent of their customers incurred an overdraft fee in the last 12 months.

But particularly in an economic downturn that bankers' greed helped create, the industry should not be profiting on the good-faith mistakes of less sophisticated customers. Banks should be required to give customers a clear, easy-to-understand option of adding overdraft protection. If customers don't opt in, then their overdraft transactions should be rejected.

Further, in an age in which computers can instantly track the times of all transactions, each transaction should be processed immediately — not when it best serves the banks' interest.

If Congress can't get this one right, there's little hope for reforming the rest of the financial regulatory system.

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