Providing a welcome jolt of good news to financial institutions, which haven’t had much to cheer of late, the California Supreme court ruled recently that tapping public benefit payments to pay overdraft charges or other fees — a common banking industry practice — does not violate state law or public policy.
That ruling, in a case closely watched by depository institutions all over the country, rejected a class action claim that could have cost Bank of America, the defending bank, more than $2 billion.
The legal action in Paul Miller, et. al. v. Bank of America, began more than 10 years ago, when Miller accused the bank of fraudulently using the Social Security and other benefits payments deposited directly into his checking account to cover overdrafts in that account. A lower court sided with Miller and the class he represented, citing a 1974 decision (Kruger v Wells Fargo Bank) in which the California Supreme Court had ruled that public benefit payments were “protected from the claims of creditors” and could not be deducted from the customer’s checking account to cover delinquent credit card payments. When an Appeals Court reversed that decision, Miller appealed to the state’s high court, which sided with Bank of America, as well.
In a unanimous decision, the court found a critical distinction between its ruling in Kruger and the circumstances in the Bank of America suit. In the earlier case, the court said, the bank was using funds deposited in one account to cover charges in another; Bank of America, by contrast, was offsetting an overdraft in an account with future deposits to that account.”
Plaintiffs had argued that this was a distinction without a difference. The principle the court established in Kruger — that public benefit payments should be protected from the claims of creditors – should apply in this case regardless of the debt the bank was offsetting with those funds. But the court found that there is a “meaningful difference between satisfying a debt external to an account and recouping an overdraft of an account from funds later deposited in that same account.”
The court found additional support for its decision in the state Financial Code, enacted the year after the Kruger decision. Although that statute restricts the ability of banks to withdraw funds from consumer bank accounts to satisfy various debts, it also contains what the court termed an “unequivocal statement” asserting that overdrafts and bank charges “are not debts and therefore are not subject to the limitations placed on a bank’s right of setoff” defined in that statute. “Protecting consumers, including public benefit recipients, from unfair or unlawful setoff does not mean, as plaintiffs suggest, that banks must be prohibited from recouping overdrafts and charging insufficient funds fees,” the court insisted.
Allowing banks to offset overcharges and other fees with public benefits payments does not “diminish” the importance of protecting those payments, the court said. Rather, this practice may actually help consumers receiving public assistance by preventing overdrafts that could damage their credit, subject them to high fees and possibly impair their relationship with merchants.
Bank and credit union trade groups made the same point in amicus briefs supporting Bank of America, suggesting that an adverse ruling eliminating public benefits payments as a source for covering overdrafts and other bank fees, could make it more difficult for consumers receiving those payments to obtain checking accounts, ATM cards and other bank services. But consumer advocacy groups decried the decision as “disgraceful” and “disingenuous.”
“There is not a word in the entire legislative history of the statute that says there was any indication by the Legislature to reverse the portion of Kruger that said exempt funds…cannot be seized by banks through the internal [setoff]procedure,” James Sturdevant, head of the Sturdevant Law Forum in San Francisco, told American Banker. “This is simply the latest example of where the life-support system of the most vulnerable…in this country is sacrificed [on] the altar of greed.”
OVERDRAFT BATTLE CONTINUES
Although California’s Supreme Court ruling ends the threat of a large class action settlement – favorably – for Bank of America, the battle over bank overdraft policies is continuing in Congress. A measure awaiting action by the House Financial Services Committee, would prohibit financial institutions from providing overdraft protection services to consumers automatically (and charging fees for covering overdrafts), as most do. Instead, consumers would have to affirmatively “opt-in” before receiving and being billed for overdraft protection.
Separately, the Federal Reserve Board is considering whether to include the “opt-in” or less restrictive “opt-out” requirement for overdrafts in the revisions to Regulation E the board is currently drafting. Democrats on the House Financial Services Committee are urging the board to adopt the opt-in requirement. “Opt-out will not adequately protect consumers from abusive overdraft practices,” Representatives Carolyn Maloney (D-NY), sponsor of the pending House bill (and chief House sponsor of the recently enacted credit card reform bill), Barney Frank (D-MA), chairman of the Financial Services Committee, and Luis Gutierrez (D-IL), Chairman of the Subcommittee on Financial Institutions and Consumer Credit, said in their May 27 letter to Fed chairman Ben Bernanke.
The opt-in requirement also is consistent with the preferences of most consumers, the legislators said, noting a recent survey by the Center for Responsible Lending, in which nearly 90 percent of the respondents said they wanted the opt-in choice and 80 percent said they would rather have a debit or ATM withdrawal denied at the point-of-sale rather than incur an overdraft charge.
Overdraft charges related to debit and ATM transactions are “particularly egregious,” the legislators said, because they often surprise consumers, who expect transactions to be denied if they lack sufficient funds to cover them, and because the fees are usually “vastly disproportionate” to the amount of the overdrafts.
The letter cited a recent FDIC study, which found that most banks enroll consumers automatically in overdraft programs, and that most consumers are unlikely to change that default arrangement. “The board should align the default with what best protects consumers and with what consumers say they want” the three legislators told Bernanke: “No overdraft coverage for ATM and debit purchases unless consumers explicitly choose it.” The letter also urges the Fed to prohibit “manipulative clearing practices” designed to maximize overdraft fees – an issue that the pending House bill also targets.
Sen. Christopher Dodd (D-CT), chairman of the Senate Banking Committee, also supported the opt-in requirement for overdraft protection programs in a June 9th letter to the Fed, in which he urged the agency to act quickly to finalize the Regulation E revisions. In that letter and in a recent press statement, Dodd expressed concern that banks might try to offset the impact of the restrictions on credit card fees mandated by the credit card reform legislation by “gouging” consumers in other areas.
“While we have just scored a tremendous victory for consumers against unfair and abusive credit card practices,” Dodd said in his press statement, “we are now seeing that a few banks have applied some of the same unscrupulous practices to bank accounts. At a time when so many families are already struggling to make ends meet,” he added, “automatic overdraft charges and other excessive fees are forcing consumers deeper into debt. Banks and consumers should know that these actions have not gone unnoticed,” he warned, “and that I will continue to work to protect consumers from these fee increases and other unfair practices.”
ALIGNING PRODUCTS WITH NEEDS
Conventional financial wisdom holds that un-banked or under-banked consumers operate outside the financial mainstream because they have, or assume they have, no other options, and that they would be better-served by traditional banking products. But a recent study challenges those assumptions. The study, by the center for Financial Services Innovation – a nonprofit affiliate of ShoreBank Corp. in Chicago — found that “un-banked” consumers make rational choices about the financial services they need; that mainstream bank products, as currently structured, are not necessarily less expensive than the alternatives; and that, in any event, convenience and trust (or the lack of it for banks) often trump cost for this population of consumers.
“It is clear that consumers are making trade-off regarding the relative merits of different options, by choosing a combination of services offered by different providers in order to balance cost concerns with the other features they need, such as convenience, accessibility, liquidity, simplicity and certainty,” the study found.
The study suggested several ways in which financial institutions could design products that more tailored to the needs of these consumers:
- Expand access to direct deposit services. This is “one of the best routes to lowering financial services spending,” which, the study notes, is clearly beneficial for consumers. But direct deposit also benefits financial services providers, by making it easier for them to provide lower-cost services and “increasing the stickiness of the customer."
- Increase the functionality of prepaid cards by adding the ability to send money orders and paper checks through them.
- Make it easier for customers to compare the “relative value and functionality” of different products. Financial institutions should provide more detailed and more helpful information as part of the account opening process, the study suggests, to help customers understand the options available and select the most appropriate services for them. Noting the frequent complaints about “surprise” fees, the study suggests, “narrowing the variability of fees is [also] crucial.”
- Add functions that help customers manage their budgets. Among other ideas, the study suggests: Allowing customers to opt-out of overdraft protection (see related item, above); creating a system to notify customers when they have spent a pre-determined amount; allowing customers to set a spending limit on their pre-paid debit cards above which charges will be denied, even if the account has sufficient funds available.
- Strengthen the link between transactional products and long-term wealth-building. “Automatic transfers to a savings account associated with the transactional product can go a long way toward this goal,” the study suggests. “To the extent that transactional products enable the individuals using them to ultimately build creditworthiness, acquire assets and increase their financial prosperity” the study concludes, they will be more successful at meeting the full needs of underserved consumers.”
Congressman Barney Frank (D-MA), chairman of the House Financial Services Committee, is urging Fannie Mae and Freddie Mac to make “appropriate adjustments” to ease newly tightened underwriting requirements for condominium loans that, industry executives say, are further impeding a housing recovery that is already struggling to gain traction.
Of particular concern, Frank said, is the 70 percent pre-sale requirement the two secondary market government services enterprises (GSEs) have established for new condominium developments, a ratio that “may be too onerous than is warranted by credit risk levels,” Frank and Rep. Anthony Weiner (D-NY), said in a letter to the chief executives of Fannie and Freddie. The FHA’s pre-sale requirement, they noted, is only 51 percent.
Now operating under federal conservatorship, Fannie and Freddie tightened their underwriting standards for condominiums in an effort to improve credit quality and reduce risks on future loans. Both companies have been reporting large and continuing delinquency rates and foreclosure losses on their loan portfolios.
In addition to boosting the pre-sale requirement for new condominium projects, the new underwriting standards require lenders originating condominium loans to certify, among other details, that the community association is allocating a minimum of 10 percent of revenues annually for its reserves and that no more than 15 percent of the units are delinquent by more than one month in the payment of common area expenses. The delinquency limit is particularly problematic, industry executives say, because continuing fallout from the subprime lending crisis, compounded by the weak economy, has pushed many communities close to or beyond the 15 percent mark. The stricter underwriting standards are further exacerbating the problem, association managers say, by making it difficult for struggling owners to find buyers for their homes.
The new Fannie/Freddie rules “have had a real chill on the ability to get these condos sold,” Weiner told the Wall Street Journal.
Moving in the opposite direction, the FHA recently announced new guidelines streamlining the approval process for new condominium projects. Among other changes (most taking effect October 1), the new policy allows FHA-approved lenders with “unconditional direct endorsement authority and staff with knowledge and expertise in reviewing and approving condominium projects” to determine project eligibility for FHA financing internally rather than through the traditional HUD-review process. The new guidelines, outlined in HUD Mortgagee Letter 2009-19, also streamline the environmental review requirement for new developments and set presale owner-occupancy requirements at 50 percent.
GIVING MORE CREDIT
Seeking additional leverage to boost the housing market, Sen. Johnny Isakson (R-GA) has proposed expanding the home buyers tax credit Congress approved earlier this year to make more buyers eligible for the assistance.
The $8,000 credit available to first-time buyers “has made a difference,” Isakson, a former real estate broker, said in announcing his legislation. “But we don’t have a recession in first-time home buyers,” he noted. “We have a recession in the move-up market. One of the biggest problems facing the American people today is an illiquid housing market, a decline in their equity, a decline in their net worth and a depression in the housing market that we are obligated to correct if we possibly can.”
Isakson’s bill has attracted bi-partisan support from, among others, Sen. Christopher Dodd (D-CT), chairman of the Senate Banking committee. The measure would increase the credit to $15,000, make it available to all buyers (not just first-time buyers) and eliminate the existing income caps -- $75,000 for an individual and $150,000 for a couple. The measure would also extend the credit (set to expire at the end of this year) for one year from the enactment date, but would still allow buyers who purchase homes in 2010 to claim the credit on their tax return for 2009.