The Fine Print: How Big Companies Use Plain English to Rob You Blind

by David Cay Johnston

  Few taxpayer investments have paid a greater return than the G.I. Bill, which made it possible for one in seven World War II soldiers and sailors to go to college. Taxpayers spent about $59 billion in 2012 dollars from the end of World War II until 1952 to provide more than 2.2 million soldiers and sailors with a college education. Millions more got other education and training.

  The G.I. Bill paid for the educations of 450,000 engineers, 240,000 accountants, 238,000 teachers, 91,000 scientists, 67,000 doctors and 22,000 dentists, among others. In today’s dollars that was about $26,000 per student. The higher incomes those college graduates earned, and the advances their education made possible in every field from astrophysics to zoology, laid the foundation for today’s advances in medicine, biology, software, materials and every other field in which increased human knowledge has made people better off.

  Taxes also lengthen lives. American life expectancy at birth in 1900 was just 47.3 years. One century later it had been extended to 77.2 years, a 63 percent gain. The biggest single reason for that change: public health measures financed by taxes. Publicly funded projects provide clean water and sanitary sewer lines to take away wastewater and treat it. In 1906 the Pure Food and Drug Act and the Meat Inspection Act launched a food safety revolution.

  Opponents of each of these measures in their time said that the costs would be ruinous. They were wrong in every case. The costs of not taxing ourselves would have been ruinous, both in the quality of life and its duration. Diphtheria, pertussis (whooping cough), and measles are still around, but they rarely kill, unlike a century ago when every parent feared them. Polio no longer cripples, putting its victims into braces, wheelchairs, and iron lungs. Smallpox is gone. Tax dollars were central to the development of vaccines, blood plasma, lifesaving drugs, and new diagnostic and surgical techniques. All of this came about because of taxpayer spending to improve the common good through research, education and infrastructure.

  Taxes have made Americans safer on the job and while traveling. They have made us healthier, better educated and more productive; they’ve reduced misery and lengthened lives. Those are big things. But on Council Rock Avenue, we appreciate the small ones, too, as increased taxes have bought us six quiet mornings each week while putting more money in our pockets.

  Rising garbage removal bills are an individual problem mostly in suburban areas, where about half of Americans live, and rural areas, where another fifth of Americans live. In urban centers, though, where the other third of Americans resides, businesses and large apartment buildings often hire cartage firms, and in many cities refuse removal is a basic municipal service.

  The public health and aesthetic reasons for this are more obvious than the economics. Rotting garbage attracts rats and other vermin. It only takes one family that does not, or cannot, arrange for garbage collection to make the whole neighborhood stink on hot summer days. But the economics also favor this approach, as universal service through government lowers costs compared to having competing trash-hauling companies. More trash is collected per mile, per hour of labor, per gallon of diesel fuel. It is also cheaper to prepare and send one bill than many thousands of individual bills.

  In suburbs and rural areas, garbage removal is more often a business in which homeowners and small businesses contract individually with a cartage company. In a competitive market, the ease with which customers could move from one company to another would tend to hold down prices. Any company that unilaterally raised prices would lose customers, or so economic theory holds. But that theory has been buried at landfills owned by the biggest garbage companies.

  The $47 billion that garbage removal costs annually nationwide works out to about $150 per person each year, figures disclosed by the two largest trash-hauling companies indicate. When only residential removal costs are counted, the monthly household bill often runs $40 a month in suburban and rural areas, or $480 annually, plus sales taxes.

  Your garbage bill will typically have add-ons for the costs of fuel and for dumping the trash at a landfill, even when the company that hauls your trash away owns the landfill. Your total bill can easily run $50 a month to have two cans of trash emptied each week and your sorted recycling hauled away.

  These prices should not be climbing, based on what the big trash companies tell the Securities and Exchange Commission and their shareholders. Waste Management wrote in its annual report to its shareholders and the SEC in 2010 that “the solid waste industry is very competitive.”

  But that is hardly the impression one gets when the garbage industry is out touting its stocks to investment advisers for mutual funds, where much of your 401(k) money is probably invested, and to managers of public pension plans, which are backed up with your tax dollars. The garbage company executives talk in the arcane language of the investment industry, but their jargon can be easily translated into plain English.

  Consider what two top executives of Republic Services, the second-largest garbage company, said at a series of conferences for stock analysts in 2009 and early 2010. “[The industry] generates very predictable cash flows,” said Tod Holmes, the chief financial officer. “That’s really the underlying strength of this business, the cash that’s spinning off out of these companies.”

  “Predictable cash flows” means the company experiences a steady stream of dollars that, after paying its expenses, goes into its bank accounts. Cash flow is often larger than profit because profit comes after all costs, including depreciation, which is the declining value of machinery and buildings as they are used up. Wall Street watches cash flow much more closely than profits, which under modern accounting rules can be manipulated, as we have seen from Enron, MCI, Tyco and the recently bailed-out banks.

  In a competitive market, the flow of cash from customers to company coffers generally would be shallow. Adam Smith wrote that in a competitive market, companies should make just enough profit to justify staying in business. Competition would also permit customers to move freely from one trash-hauling company to another, resulting in occasional floods of cash flow and periodic droughts.

  In a market with two big companies, however, competition is diminished. Typically the giants have more power than their customers and their small competitors, even if there are thousands of mom-and-pop operations. When the big guys have this “market power,” they possess the ability to raise prices even when there is no outside force, such as increased amounts of trash to be hauled or general inflation, affecting prices. Even in a weak economy, in the absence of real competition, market power can be wielded to keep prices high, and even raise them. This is most often true when the service provided is an essential one—like hauling garbage before the stink becomes overwhelming.

  CFO Holmes also explained that the big garbage companies managed to raise prices in the face of myriad small competitors by “rationalizing the market” over the past five to seven years. That’s business-speak for avoiding direct competition by carving up markets to minimize competition. That is, the two big companies swapped routes and landfills and also “rationalized” other assets so that each could dominate in particular areas and avoid the competition that would result in stable or lower prices.

  Holmes’s boss, Jim O’Connor, CEO of Republic Services, told a conference hosted by Credit Suisse in 2010 about these deals. O’Connor said that in “rationalizing the business over the last five or six years, we’ve done a significant amount of asset exchanges with, at that time, Allied and Waste Management to improve the profile of the business in various marketplaces.”

  At the same forum Holmes boasted that the company was able to raise prices by more than the rate of inflation. Two years earlier, he had told another conference that “pricing’s the key driver and the key thesis here.”

  In December 2009, O’Connor told another investment conference that the ability to raise prices in real terms was the reason for Republic’s takeover of Allied Waste Industries. O’Connor said Republic was also able to raise prices because the largest t
rash company, Waste Management, also raised prices.

  O’Connor said flat out at one meeting for stock analysts that lack of competition was the major reason his firm could raise prices, even in a weak economy:

  And today, and, actually, for the last almost four years now, we’ve seen pricing flexibility in the marketplace, even in light of a bad economy, and a lot of that due, again, to that consolidation at the top and a different perspective of the major companies to the marketplace.

  Having two companies dominate the garbage-removal business is not the only reason they are able to gouge customers. Another factor is ownership or control of landfills. Small competitors often have to pay the dominant companies to use their landfills; in some places those sites may even be closed to the competition, forcing smaller concerns to go farther to dispose of trash. Economists call this a “barrier to entry,” the very phrase O’Connor used as he told stock analysts about plans to keep raising prices. Republic’s “business platform is much stronger today because of the disposal network,” he said. “And, really, the strategic reason that we did the merger with Allied Waste was to merge both of our disposal assets to what I call securitize the cash flows of the business and the future cash flows of the business, because, again, that’s the barrier to entry, and that will also be the foundation for continued pricing in the sector,” he added.

  Holmes frequently tells stock analysts how predictably lucrative trash removal has become. So what makes it lucrative? “We’re focused on pricing,” Holmes has said over and over in various ways.

  To stock analysts, “pricing” means higher prices for consumers, which can be translated into rising prices for the shares of a company’s stock. There is nothing wrong with raising prices when market forces are at work. But that is not what the garbage-hauling business is doing. Instead, its strategy is to escape competition, which tends to hold down prices.

  At another conference, Holmes described how his company encouraged higher prices when it “bought out” a local Waste Management franchise in Cincinnati, leaving just “two predominant players,” Republic Services and a local family-owned company named Rumke Consolidated. Holmes said the two were very much alike and boasted that Republic was helping Rumke make bigger profits by encouraging it to raise prices higher than it would otherwise. “Maybe they don’t go quite as far as we do in terms of moving our pricing up,” Holmes said, “but they’re certainly riding this wave and I think they’re enjoying it.”

  It’s surprising, isn’t it, how many underlying economics lessons there are to be found as we take out the trash.

  13…

  Fee Fatigue

  The fundamental rule in our national life—the rule which underlies all others—is that, on the whole, and in the long run, we shall go up or down together.

  —President Theodore Roosevelt to Congress, 1901

  13. In the fall of 2011, word leaked out that Bank of America planned to charge millions of customers $5 a month to use their debit cards. Combined with existing fees for customers who did not keep at least $1,500 in their checking account every day of the month, that would bring the monthly charges for a Bank of America checking account to as much as $240 per year.

  That sum is equivalent to what a single worker, at the median wage, takes home, after taxes, for two and a half days of work.

  Other big banks had or were testing similar debit-card fees. But these debit-card fees quickly died because the news media gave huge play to the story, including several nights of coverage on the network news shows. Demonstrations held outside some banks spurred coverage. So did the timing of the fees, which came just three years after the bailouts. Bank of America, which got $45 billion in the first bailouts in the fall of 2008, was cast as a corporate ingrate. The bank’s decision to back down was an excellent (and extraordinarily unusual) example of the power of news coverage to affect big business. Unfortunately, the coverage focused more on the hole than the donut—and it is a very big donut.

  The usual suspects in the financial press defended the bank fees, blaming them on a 2010 law often cited in the news as the Dodd–Frank Act, lopping off the crucial rest of its name. The law, in full, is the Dodd–Frank Wall Street Reform and Consumer Protection Act. Banking industry apologists at Forbes, Investor’s Business Daily, Rupert Murdoch’s Wall Street Journal and their like provided the usual coverage from the point of view of bank executives, ignoring or belittling bank customers unable to keep what, for the median wage worker, would be nearly four weeks of net pay in a checking account.

  Lost in the coverage was another fact: retailers were also complaining of being gouged with debit-card fees by banks. The retailers understood that it cost banks far less to digitally process debit cards swiped at a checkout terminal than processing paper checks does. So why were they required to pay more?

  The journalists writing from the perspective of the banks warned that other costs would go up—that banks would not make loans. That was utter nonsense, of course, since banks must make loans and handle transactions to stay in business. The fact that the six largest banks had a much larger share of all bank deposits after the bailouts than before it also suggested that, at least for the six largest banks, government was a generous friend, not an antagonist or even a referee.

  Before President Obama signed the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010, retailers paid an average of forty-four cents in bank fees each time a customer swiped a debit card. That may not seem like much unless you know that the profit margin in retail is often 3 percent or less on sales, so on a $10 debit-card swipe, the bank fee was significantly larger than the profit margin of perhaps thirty cents. Under the Dodd–Frank Wall Street Reform and Consumer Protection Act, the charge to swipe a debit card could be no more than twenty-four cents (once, that is, the rules implementing the new law were put into effect nearly two years later). Only the smallest banks were exempt from these limits. Retailers said the price cap would help hold down retail prices and improve economic efficiency, which Forbes in particular dismissed with the gusto to be expected not of financial journalists looking out for investors, but of partisans cheering for bankers to rake in fat fees.

  A loss of two dimes in revenue per transaction may not seem like much money. As with the oil pipelines, however, where a penny per day per American in fake taxes adds more than a billion dollars a year to the bottom line, the banks knew better. The bankers said losing those two dimes would be ruinous. Visa and Mastercard say they have issued more than 521 million debit cards, more than two per adult, and that they are used for more than 40 billion transactions per year. At two dimes per purchase, that would add up to more than $8 billion of revenue in a year—more than a dollar per day for each adult in America. Bank of America said losing those two dimes on each debit-card swipe would make its revenue ($93.5 billion in 2011) slip by $2 billion annually.

  Aborting the $5 monthly debit-card fee was a victory for consumers; so was the reduction in swipe fees. Yet these were but skirmishes in a much larger war that consumers are losing.

  A FESTIVAL OF FEES

  Fees everywhere—often morbidly obese ones—are being imposed on bank customers unless they have large savings, checking or loan balances at the same institution.

  Consider, for example, the growing practice of charging a fee to issue a check when consumers take out a loan. The idea that a lender would charge you to hand over money you are borrowing may seem bizarre, but it is exceptionally lucrative. So long as this practice remains largely unobserved it will flourish.

  Sallie Mae, which makes loans to students, charges some borrowers $300 to issue a $7,000 check to their school. Sallie Mae’s practice is to issue checks by semester or quarter rather than once per year. So a student lent $14,000 for fall and spring semesters will get dinged for $600 in fees as two checks are cut. That $600 disbursement fee comes to more than 4 percent of a $14,000 loan, which in turn inflates the interest rate on the amount actually lent because the student is p
aying a posted percentage rate for ninety-six cents on the dollar, not the full dollar. A student on a quarter system with fall, winter and spring quarters pays even more in check fees.

  Here is the fine print footnote in which Sallie Mae discloses (or more accurately, obscures) this charge for sending loan proceeds directly to a college or university, known as disbursement:

  Interest rates for the Fixed and Deferred Repayment Options are higher than for loans with the Interest Repayment Option. APRs for borrowers attending non-degree granting institutions range from 8.00% to 13.76% with an origination fee up to 5.00%. Origination fees mean application or disbursement fees.

  Banks need, of course, to collect enough from customers to justify staying in business and earn a profit. In the long run, only healthy banks can supply the rivers of cash that keep an economy flowing and growing. The historic rule about how much banks needed to service the economy was 3-3-3—borrow at 3 percent, lend at 3 percentage points above that and hit the golf course by 3 p.m. A bank that can borrow at 3 percent and lend at 6 percent should be profitable as long as it makes sound loans that customers pay back. Of course with the rise of credit-card lending in the last half century, the bigger banks got hooked on fatter margins, borrowing at, say, 5 percent and then lending at 14 percent, a margin of 9 percent, or three times the traditional spread between interest out and interest in.

  Most banks do not get that spread, however. That is because each month they bundle all of their credit-card accounts and sell them to Wall Street, which gets the 9 percent spread. And unlike banks, the Wall Street system is part of a growing shadow banking system that is unregulated and largely obscured from oversight. Transparency is always the friend of markets and consumers, opaque practices the secret ally of price gougers, monopolists and thieves.