Bank Overdraft "Services": How They Still Cheat You

Are you thinking of signing up for "courtesy" overdraft protection linked to your debit card? Hold off, until you've read this column. Those fees are protection, all right -- a protection racket. A federal district judge, who examined the way the giant bank, Wells Fargo, handles debits, called the practice "gouging and profiteering."

Starting this month, banks and credit unions can no longer charge you overdraft fees automatically. I wrote about those new rules earlier this week. You now have to opt-in to this spurious form of protection, by saying that you agree to the charges. Many banks are running misleading marketing campaigns in an attempt to get you to say yes.

Say no. Please say no. There's a multi-billion-dollar loophole in the rules, which the banks are driving deceptive overdraft practices through. The Federal Reserve, which allegedly looks after consumers, kowtowed to the banks and let the loophole stand. It took Judge William Alsup in a San Francisco courtroom, to lay bare the fraud to the public eye.

When you use a debit card -- for a purchase or to get cash from an ATM -- you're withdrawing money directly from your account. If you're on an automatic overdraft program, your bank will cover debits that exceed your cash on hand, up to certain limits. You're charged a median of $27 each time you overdraw ($35 at big banks) -- even if you were over by just $1 or $5. If you don't repay within a few days, you're charged another $7 to $35.

When you're not in an overdraft program and try to overspend, the bank won't allow it. Your purchase or ATM withdrawal will be denied. That sounds bad but it's actually good, because it helps you develop a better budget.

You might think it's okay to pay a $35 fee, to avoid the embarrassment of having your debit card declined in a grocery line. But one fee rapidly turns into multiple fees, if you're living paycheck to paycheck or on Social Security, with no cash cushion on your account.

Once you're in overdraft, the bank has you in its clutches. It can engineer its payment systems to squeeze you for more charges than you ought to pay. Two years ago, some of Wells Fargo's squeezed customers decided to sue.

Wells, like many other banks, doesn't debit your account in the order the charges arrive. Instead, it accumulates them all day and then posts them in order of size, paying the biggest one first.

For example, say that you have one large utility payment plus six $5 to $10 debits, and not enough money to pay them all. If the bank covered the small ones first, you'd get a single overdraft charge when it reached the utility bill. By paying the large bill first, however, the bank forces your account to run out of money faster. More of your small charges turn into overdrafts, at $35 a pop.

Even if you faithfully make a note every time you debit for coffee and donuts, you'll be caught. There's no way to tell that your balance will deplete at a faster rate than it shows in your check register.

Wells Fargo has another trick. Formerly, it covered all your debits first, then all your checks, then all your automated bill payments. In 2001, however, it started grouping those payments together -- again, paying the largest first. Written checks and automated payments tend to be larger than debits. They use up customers' money faster, which automatically raises the number of overdrafts for small purchases.

In internal memos, Wells predicted that the new payment order -- unknown to its customers -- would yield an additional $40 million in revenues. As an example, one of the plaintiffs paid $111.59 in overdraft fees for overdrawing her account by $23.59.

Banks generally pay third parties to run their overdraft systems, typically paying them 10 to 20 percent of the fees they generate. The more they hammer the customers, the more money they make.

The banking industry argues that people want their largest checks or debits paid first because they're the most important ones. During the trial, Well Fargo alluded to a 1998 survey by Norwest Bank which supposedly proved the point. But the survey was never produced -- an "utter phantom," the judge said, "invented merely for public consumption." Besides, in an overdraft program nothing usually bounces, so the argument has no point.

What was produced in court were hundreds of customer complaints about cascades of overdraft fees.

In finding against the bank, the judge ordered Wells Fargo to pay the California plaintiffs up to $203 million. In a statement, Wells called its method of processing transactions "appropriate and consistent with customers' interests and the laws and rules of governing regulatory authorities."

The bank will appeal. In the meantime, what the judge called "gouging" will continue as usual. Thirty banks have been sued in Florida, for similar practices.

So far, the Federal Deposit Insurance Corporation is the only federal regulator to have addressed this form of bank robbery. A "guidance" issued last week to the 1,171 banks it supervises "discourages" them from paying the largest debit first. It also wants banks to tell customers that there are cheaper ways of getting overdraft protection, such as setting up a link to a savings account or personal credit line.

Carol Kaplan, a spokesperson for the American Bankers Association, says that the Fed and other bank regulators will probably work out guidance consistent with that of the FDIC, but who knows how long that will take?

If nothing else, overdraft abuse proves the need for a strong Consumer Financial Protection Bureau. Even in the midst of scandal, the Fed let the bankers have their way.

More on MoneyWatch:

Automatic Overdraft Protection: Just Say No
Why Elizabeth Warren Should Head the New Consumer Financial Protection Bureau
Big Bank' Sneaky New Tricks