Consumers accusing banks of charging “abusive” overdraft fees on debit cards cleared a major hurdle recently, when a federal district court judge refused to dismiss their class action suit.
Facing hundreds of millions of dollars in potential damages, defending banks (including Bank of America, Citibank, Wells Fargo, Wachovia, JPMorgan Chase and SunTrust) had contended, among other arguments, that private citizens don't have standing to bring such claims and that federal pre-emption bars consumers from suing banks based on federal rather than state banking regulations.
Senior U.S. District Judge James Lawrence King rejected most of the bank’s key arguments, Federal preemption does not disqualify the suite, he ruled, because the consumers are not challenging the authority of banks to impose overdraft charges – only the way the charges were assessed. (The consumers argued that banks intentionally and unfairly ordered transactions to maximize the overcharges incurred.)
“Plaintiffs do not ask the court to tell the banks how to order transactions,” Judge King wrote, “but simply that the ordering must be carried out as contemplated by the covenant of good faith and fair dealing….There are a number of cases supporting the proposition that when one party is given discretion to act under a contract, said discretion must be exercised in good faith," he added.
Judge King also rejected the bankers’ argument that customers entered voluntarily into debit card agreements that included the overdraft protection terms they are disputing. He agreed with the consumers that the superior sophistication and bargaining power of banks was “obvious” and that banks did not disclose that the debit account terms included the option to decline overdraft protection.
Attorneys representing the plaintiffs said the decision represents a huge victory, turning back a concerted effort by banks to short-circuit the litigation and allowing the case to proceed to the discovery stage.
The Federal Reserve recently adopted new rules requiring lenders to offer the protection only to consumers who affirmatively “opt-in” by requesting it. The new rules, effective for new accounts opened after July 1 and applicable to existing customers 45 days later, also require financial institutions to fully disclose their overdraft services, the fees charged for overdrafts and the right of customers to choose whether they want those services and to cancel the protection at any time. The overdraft requirements apply to ATM and one-time debit charges, but not to checks and recurring debit card transactions structured to make regular payments.
Legislation pending in the House and Senate would go further, limiting the amount and number of overdraft fees banks can charge consumers and specifically prohibiting them from manipulating the order in which transactions are processed in order to maximize the overdraft fees. The House version of the bill also requires point-of-transaction notice to consumers if an ATM or debit transaction would trigger an overdraft, giving them the option of aborting the transaction or incurring the overdraft charge.
In response to this pending legislation and to consumer backlash against overdraft fees, many banks, have already altered their overdraft policies ore are considering doing so. Bank of America, one of the defendants in the suit, announced recently that, beginning this summer, it will no longer charge overdraft fees on debit cards, instead refusing to clear transactions if the account contains insufficient funds.
KEEP ON KEEPING ON
The federal government should continue to support the residential mortgage market, but the nature of the support and the infrastructure through which it is provided will have to change. Treasury Secretary Tim Geithner delivered that message to lawmakers recently as he presented a preliminary glimpse of the policy assumptions that will guide Administration proposals for dealing with Fannie Mae and Freddie Mac – the largest of the institutional shoulders on which federal housing support currently rests.
"There is a quite strong economic case, quite a strong public-policy case, for preserving, designing some form of guarantee by the government to help facilitate a stable housing finance market," Geithner said at a House Financial Services Committee Hearing on the structure of the housing finance market and the future of the GSEs. But any structure for achieving that goal, he added, "can't be the one we have today. It can't be the one we lived with over the last decade."
While rejecting complaints that the Administration is intentionally dragging its feet on submitting a proposal for the GSEs (because of the central role they are playing in government efforts to shore up the sagging housing market), Geithner made it clear that the Administration plan won’t be forthcoming any time soon. "Realistically, it's going to take several months to do a careful exploration of the problems, solutions, alternative models, and to try to shape legislation that could command consensus," he said. "But I don't see why this should take years. There's a huge compelling need to make sure we can design the successor system, and it's very hard … for anybody to argue that we can live with the system as it is now indefinitely in the future."
The Financial Services Committee hearing marked the start of what is likely to be a prolonged and contentious debate over the future of the quasi-governmental government-sponsored enterprises (GSEs) that have dominated the residential mortgage market for decades. The debate pits those who think the federal government should continue to play a role, albeit, perhaps, a more limited one, in the housing finance arena, against those who insist that government should play no role at all in the private housing market. Reflecting the latter view, Rep. Jeb Hensarling (R-TX) has introduced legislation that would either privatize Fannie and Freddie or force them into receivership. The companies have been operating under federal conservatorship since a combination of accounting abuses and the unraveling of the financial markets required a government rescue to keep them afloat.
In the prologue to the congressional debate, housing interest groups are staking out their positions on the GSEs by introducing proposals for restructuring them. The National Association of Realtors (NAR) published a policy statement in January arguing that a government presence in the housing market is both appropriate and necessary. The trade group suggested that Fannie and Freddie should remain essentially intact, converted from their current quasi-governmental structure to federally-owned non-profit corporations. As nonprofits, under the NAR plan, Fannie and Freddie would purchase mortgages and issue mortgage-backed securities, pretty much as they do today, with an explicit rather than implicit government guarantee for some of those securities – namely, those backed by the 30-year, fixed rate mortgages that the NAR argues should remain the cornerstone of the housing finance system.
The National Association of Home Builders (NAHB) also envisions a continued government role in housing finance but the group is recommending that Fannie and Freddie be replaced by a number of smaller entities that would compete to purchase mortgages in the secondary market. The federal government would provide a back-up guarantee for the securities these entities issue, but the first line of defense against defaults would be a fund capitalized by entities benefiting from the guarantee. The government would step in only to cover “catastrophic risks” exceeding the capacity of the private fund, according to the NAHB policy statement.
The most detailed proposal for reforming Fannie and Freddie to date has come from the Mortgage Bankers Association (MBA), which, like the NAHB, suggests breaking Fannie and Freddie into several smaller, privately held entities, operating under a government charter to issue mortgage-backed securities. Based on the Ginnie Mae model, these “Mortgage Credit Guarantee Entities” (MCGEs) would issue a new category of mortgage-backed securities, with an explicit, but limited, federal guarantee, applying only to “core” mortgage products “with well-understood, well-documented risk characteristics,” which an MBA white paper defines as:
- The conventional” single-family mortgages, traditionally supported by the GSEs; and
- The conventional” single-family mortgages, traditionally supported by the GSEs; and-- Multifamily loan products consistent with the GSEs’ underwriting guidelines.
The mission of the new MCGEs would be limited exclusively to guaranteeing and securitizing eligible securities. “This important mission should not be distorted by additional public or social housing policy goals,” the association’s white paper emphasizes.
GETTING BETTER BY GETTING WORSE
Consumers’ debt levels are improving for the first time in decades, as their financial condition worsens. This is not as contradictory as it sounds. The major impetus for debt reduction is defaults on home mortgages and credit card accounts, leaving consumers financially battered but virtually debt-free. U.S. household debt fell 1.7 percent last year to $13.5 trillion, according to the Federal Reserve, marking the first annual decline in household debt since the government began collecting this data in 1945. Defaults obviously weren’t good news for consumers or for lenders, who wrote off an aggregate total of $200 billion in mortgage debt alone in 2009. But these clouds contain a silver lining, according to Joseph Caron, director of global economic research at AllianceBernstein, because “it puts us closer to the point where the consumer can start making a stronger contribution to the recovery,” he told the Wall Street Journal. Shaving debt reduction via defaults is a bit like achieving weight loss through surgery -- draconian but faster than the economic equivalent of calorie-counting.
Even with the reduction in overall debt levels, total household debt levels still represented 122.5 percent of annual disposable income, leaving U.S. households will with “a lot of deleveraging to do,” the WSJ noted in its recent report.
The deleveraging process is getting a helpful nudge from a positive direction – a gradual recovery in household net worth resulting from a rebounding stock market and slowly stabilizing home prices. Household net worth increased by approximately $5 trillion through the third quarter of last year, according to the Fed’s most recent flow-of-funds report -- still well below the peak during the financial boom years, but a welcome signal to economists, who note that every dollar increase in household wealth translates into an increase of three to four cents in consumer spending.
TARPED AND FEATHERED
The Home Affordable Mortgage Program (HAMP), the Obama Administration’s flagship foreclosure prevention program, received another bad review recently – the latest in a long string of them. This one came from the Special Investigator General for the Troubled Asset Protection Program (TARP), who reported that not only is HAMP failing well short of its foreclosure prevention goals, the damage it is doing to the housing market may be outweighing the good it is doing for the homeowners who are receiving assistance.
Among other criticisms lodged in blistering report, Inspector General Neal Barofsky cited poor management, unrealistic targets, and unreasonable standards for measuring the program’s performance.
“Continuing to frame HAMP’s success around the number of ‘offers’ extended is simply not sufficient,” Barofsky wrote, noting that few of these initial offers have converted from “trial” to sustainable repayment plans. According to some reports, more than half of the borrowers receiving trial modifications ultimately re-default.
Barofsky also faulted the Administration for launching the program before it was fully developed and for creating confusion among borrowers and lenders with subsequent changes in the qualifying standards and procedures for reviewing modification requests. The report urged the Administration to rethink the program and the concepts on which it is based. Absent this “thorough review,” Barofsky warned, “the program risks helping few, and for the rest, merely spreading out the foreclosure crisis over the course of several years, at significant taxpayer expense.”
While acknowledging some missteps, Treasury officials defended HAMP’s approach and its results. Permanent modifications shouldn’t be the only measure of Administration efforts to help struggling homeowners, Assistant Treasury Secretary Herbert Allison told CNN-Money, noting that short sales, lender modification programs outside of HAMP, and relocation assistance are also helping many struggling homeowners. “HAMP’s success should be measured by how many eligible homeowners are able to avoid the pain and stigma of foreclosure by reducing their mortgage payments to affordable levels while either remaining in their homes or transitioning with dignity to more suitable housing,” Allison said.
MORE CHANGES
Although Administration officials continue to insist that HAMP has been more effective than its critics acknowledge, they also continue to alter a formula that, by any measure, has failed to make much of a dent in foreclosure levels. In the latest effort to improve those results, Administration officials have announced plans to extend modification assistance to underwater owners whose mortgages exceed the depressed value of their homes, and to provide special assistance to owners who have lost their jobs or suffered income reductions in the economic downturn. In one notable change they have resisted for some time, Administration officials are now encouraging lenders to consider reducing the principal in some modifications, and offering additional financial incentives for doing so.
The Administration plans to use remaining TARP funds to finance these new incentives, which include:
- Increasing incentive payments for modifying second mortgages (targeting what has been a major modification obstacle);
- Easing eligibility requirements for refinancing underwater loans with FHA mortgages; and
- Providing subsidies enabling lenders to reduce mortgage payments for unemployed homeowners for from three to six months. If borrowers haven’t found a new job, or have accepted a job with a reduced salary, the plan requires lenders to evaluate their eligibility for additional assistance.
While acknowledging that these new initiatives won’t help all households facing foreclosure and couldn’t realistically do so, they will make “a material difference” in the housing market, Diana Farrell, deputy director of the White House’s National Economic Council, told reporters.
Responding to the latest HAMP tweaks, lenders expressed their continuing support for Administration efforts to combat foreclosures, while consumer advocates complained that the new initiatives don’t go far enough.
“We are greatly disappointed and disheartened that the Obama Administration is offering little hope to unemployed homeowners facing foreclosure, who are by far the largest group of homeowners facing this,” said Lucy Kolin, speaking for the PICO National Network, a coalition of faith-based community development organizations. “Why do they offer the big banks billions in loans in the TARP bailout program, but offer zero in loans to Main Street unemployed homeowners?” Kolin asked, in an interview with Bloomberg News.
