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

by David Cay Johnston

  Bankers have learned that they can slap on fees, especially fees that were big enough to be lucrative, but not so big that customers would go through the complexities of closing their accounts and moving to another bank. Moving to a new bank is much harder in 2012 than a decade or two earlier. The task is made more difficult with the spread of electronic bill-paying services in which the consumer must keypunch every account name, number and address into her personal computer if she switches banks. And since most banks charge the same, or nearly the same fees, what gain is there in switching? The consumer shrugs and says, The next bank will just gouge me, too. The result has been a climate in which there is little incentive for lowering fees, so fees tend to rise in unison. And that, as shown earlier, is another sign of oligopoly instead of competition.

  Other fees abound. Many banks charge a fee for using a competing bank’s automated teller machine, a device that, when introduced, consumers were told would lower their cost of having a checking account. There are charges for using paper checks and getting copies of checks, as well as annual credit-card fees.

  The biggest pile of gold comes from fees for overdrawing an account. Charge a $5 item when your account has $4.99 and the overdraft fee can easily be $40. Some banks no longer let customers use their savings account to cover overdrafts, but instead require the use of a credit line. M&T Bank, a Warren Buffett bank, charges customers $10 even if they go online and move money in advance of a shortfall from their overdraft account to their checking account. The cost to the bank for such a transfer? The best indication that the cost is infinitesimal is this: moving money from checking to the overdraft account is free of charge. So is moving money from, say, a home equity line of credit to checking, which is free at M&T.

  Overdraft fees nationwide totaled about $20 billion in 2011, according to the Consumer Financial Protection Bureau, the federal agency created by Congress to deal with gouging by banks. A much larger estimate, more than $38 billion, was made by Moebs Services, a private research firm used by the banking industry, for 2009. It found that such fees doubled between 2000 and 2009 as banks raised overdraft charges and more customers incurred them. But as the economy ebbed, so did overdraft fees, down to $31.6 billion in 2011 by Moebs’ estimate.

  Moebs Research also made a finding that raises questions about how well many banks are managed. It found that nearly half of banks imposed overdraft fees larger than their net profits in 2010. That means, in short, that without overdraft fees, the banks would have lost money.

  Consumers could respond to the imposition of these fat fees with political action, which would certainly unsettle bankers. They could demand that members of Congress enact laws to regulate banks in the public interest. A license to run a bank is not a right, but a privilege, one that politicians could limit to those banks that do not gouge customers with high fees. The Federal Reserve policies that let cash-short banks borrow as much as they need are also a privilege, not a right. That privilege could be denied to banks that charge fees that can generate profits of hundreds of thousands of percent, as is the case when the marginal cost is a penny and two charges are imposed (as is Bank of America’s practice), assessing total fees of $47.

  Here, however, the banks have proved politically astute. The banks designed fee systems, like the two Bank of America charges that it slaps on some customers who innocently deposit a bad check, to hit younger people (under age thirty-five) and those with modest incomes. These people tend also to be less sophisticated and have less access to politicians. Four out of five bank customers surveyed by the American Bankers Association said they paid no overdraft fees in 2009. More customers than that overdrew their accounts, but their bank waived the fees in many cases. Moebs Research estimated that just 10 percent of bank customers pay 90 percent of overdraft fees. Some customers, research by Moebs Research and others shows, pay more than $125 a month in overdraft fees month after month. The banks would shun them as customers except for the fees they generate.

  Designing a system so that the people who pay the fees are the very people with the least capacity to get government to listen to their concerns makes sense from the bankers’ point of view. It also shows the nation’s growing disregard for the least among us, a trend exacerbated by the decline of private-sector unions and reductions in money for government consumer advocacy agencies. Vanderbilt University political science professor Larry Bartels has shown that political influence is concentrated at the top. The bottom third of Americans have zero direct political influence on roll call votes, and the next third have almost next to none. Thus it is not surprising that the burden of bank fees falls on the most vulnerable.

  REWRITING RULE 23A

  What should trouble all taxpayers is how Congress and the regulatory agencies are so deeply in the embrace of the bankers’ point of view that they permit not only unconscionable fees, but banking practices that put all taxpayers at risk of having to cover overdrafts by the banks themselves, not for a day or two but permanently. The danger is in how the Federal Reserve interprets, and fails to enforce, Rule 23A of the Federal Reserve Act.

  The Federal Reserve is the “lender of last resort.” Any member bank can borrow whatever cash it needs overnight to avoid overdrawing its own accounts. Banks do it all the time. Bankers don’t have to check their account balances to see if they can cover the funds to be disbursed to you for, say, a new car purchase. No, the bank just makes the loan and, if it needs to cover the cost, it borrows it from others, including the Federal Reserve.

  To make sure banks do not just loot the Federal Reserve, the Federal Reserve has rules. One of them, Rule 23A, requires that banks hold, and pledge as collateral, valuable paper, such as mortgages, on which the balance owed is much less than the value of the property. Bonds will do, too, those issued by cash-rich and profitable companies, as will stocks in blue-chip companies. By demanding quality collateral, the Federal Reserve should be able to collect on its overnight loans even if the cash-short bank fails.

  The Federal Reserve has the power to waive its rules on the quality of the collateral it accepts for loans from cash-short banks. It can, under Rule 23A, accept pretty much any piece of paper as collateral, not just valuable paper like mortgages on which the balance is much less than the value of the property or bonds from cash-rich and profitable companies.

  In recent years, the Federal Reserve has taken less valuable assets as collateral, as you can see by going to www.federalreserve.gov/boarddocs/legalint/FederalReserveAct/xxxx. Just replace the four Xs at the end of the Web address with the year you want to check.

  Among the borrowers allowed to pledge speculative (and perhaps worthless) paper to get cash were Bank of America, Citigroup, General Electric, Goldman Sachs and J. P. Morgan as well as Deutsche Bank (a major force in financing illegal tax shelters) and the British banks Barclays and HSBC. (The initials used to identify the last of those, the old Hong Kong and Shanghai Bank, are understood among its employees to stand for Hugely Successful British Corporation, though in recent years its success is thanks to the largesse of American taxpayers in bailing it out.)

  Nearly all of this dubious collateral was in the form of credit default swaps. Those are promises to make a lender whole if a borrower does not repay a debt. This makes them a kind of financial insurance. But the premiums charged were not nearly large enough to pay off the debts of others if many of them failed to pay back their loans. This makes credit default swaps a kind of gambling, betting that borrowers will not default because if more than a few do the swap will not pay off.

  Historically, speculative credit default swaps did not qualify as proper collateral for overnight loans because, as a kind of gambling, they didn’t meet the standards for good collateral. But in the fall of 2011, Bank of America quietly began shifting these derivatives contracts from the books of its Merrill Lynch stock brokerage to its bank, where the Federal Deposit Insurance Corporation (FDIC) guarantees deposits up to $250,000 per customer. So did other big banks, including J. P
. Morgan. Bank of America’s Merrill Lynch had more than $50 billion in derivatives contracts. That movement from brokerage to bank might seem to be internal shuffling of no interest, or concern, to the public. It’s easy for bank publicists to suggest it is no different from moving money from Bank of America’s left pocket to its right. But it should be of deep concern to every taxpayer. The reason is that credit default swap losses in the Merrill Lynch pocket will cost Bank of America shareholders, but losses in the bank will cost you.

  A borrower pays a small fee to a bank, which then guarantees that the debt will be repaid even if the borrower does not. As long as nearly all debts are repaid as promised, the fees mean profits. It is like selling life insurance on children and young adults. When hardly anyone dies, the insurer makes few payouts and gets to keep not only most of the premiums paid for the insurance, but the income from investing the premiums as well. However, if an epidemic kills many children or a war takes the lives of many young men, the insurer might not have enough money to pay the promised death benefits to survivors. Credit default swaps work the same way. They generate easy profits until a financial collapse means many borrowers cannot repay their debts and suddenly there is not enough money to pay off the unexpectedly large amount of unpaid debt.

  The United States Comptroller of the Currency reported that 97 percent of bank derivatives at the end of 2011 were credit default swaps, the very instruments that made the flow of cash on Wall Street freeze just three years earlier (more on that shortly; see chapter 15, “Giving to Goldman,” page 165). More than 40 percent of these were rated below investment grade. That is, they were speculative investments, some as risky as you placing money on a number at the roulette wheel (though without the prospect of a 35:1 payoff if the marble happens to settle on your number).

  The move from brokerage to bank came during summer 2011 as the credit ratings agencies began issuing downgrades on Bank of America bonds. Those downgrades warned bondholders that the risk of not getting their principal back was on the rise—a valid concern given Bank of America’s huge risks of loss and minute profits in 2011. That year the bank operations lost money but Bank of America turned a paper profit of more than $1.4 billion because of tax rebates from years past. As its bond ratings began to slide, Bank of America started moving its Merrill Lynch derivatives contracts to the bank. That means it could use some of the $1 trillion it holds in deposits from bank customers to pay off those contracts if need be and, in turn, that the government would have to pony up cash to make checking account and savings account customers whole. That is where Rule 23A comes in.

  By waiving Rule 23A requirements and accepting potentially worthless credit default swaps as collateral for loans, the Federal Reserve can keep Bank of America from dying. The dubious Merrill Lynch credit default swaps are given to Bank of America’s bank, which then uses them as collateral to borrow billions from the Federal Reserve. Think of it as trading toilet paper for greenbacks.

  The larger reality is that Bank of America has become a zombie bank, kept alive by infusions of cash. But those loans from the Federal Reserve also menace everyone else’s wealth. Maybe, with enough infusions of cash, Bank of America will come back to economic life as a profitable enterprise without government help. But as the bond rating agencies warned, the risk of failure is growing, not diminishing.

  What makes the Rule 23A waivers astonishing is that it was the separation of risk from reward that brought about the Great Recession in 2008. The relaxation and removal of sound laws took more than two decades of campaign donations and favors for politicians. As chairman of the Senate Banking Committee, Phil Gramm of Texas did all he could to remove laws and regulations that ensured prudent conduct and protected taxpayers. Gramm then left office and became a vice chairman of UBS, the big Swiss bank whose tax-shelter salesmen came onto American soil to sell their criminal products.

  Laws weakened over many years changed America from a land where bank failures were almost unheard of from 1945 until the early years of Reaganism. With prudent rules and actual regulation fading into history, we began to get the bill. You know the headline story: just weeks before the George W. Bush administration was to end in January 2009, Treasury Secretary Henry (Hank) Paulson demanded that Congress give him $700 billion, no questions asked, so he could bail out the firm he had run before coming to Washington. Although Goldman Sachs and other banks had acted imprudently, they were deemed too big to fail.

  Congress gave Paulson the money, but not entirely unfettered, and we got the bill. The Bloomberg news agency, after analyzing a mountain of arcane documents, concluded that the Wall Street bailouts put taxpayers at risk for $14.7 trillion. That is roughly one year of all the work, all the profits, and all the other economic activity of the entire nation. And while the ultimate costs will be in the hundreds of billions or a few trillions (but certainly not a profit, as Wall Street and Washington claim), it should not have happened. Sound regulation would have prevented the need for the bailouts.

  Capitalism without the failures of bankrupt enterprises is not capitalism at all. It is not market economics. It is rather the proof that Congress has turned the United States into a land of corporate socialism in which gains are privatized and losses are socialized. Self-regulation as espoused by Chicago School economic theories (see page 241); the ideological marketing by the Heritage Foundation and others; and decades of campaign contributions and favors for politicians taken together have enabled a system by which the few steal from the many with no risk of prosecution and a virtual guarantee of lavish riches. By wrapping the whole in complicated terms few understand, and by making piecemeal changes, the plunderers have made themselves appear to be beneficiaries of circumstance, not thieves.

  The first time we had a disaster brought on by undoing sound regulation we got the savings and loan crisis of the late 1980s. At that time, a banking regulator named Bill Black understood what was happening and was in a position to make sure others understood. Because of Black’s diligence, more than three thousand people were convicted of felonies, more than a thousand of them high-level insiders at savings and loans that were in many cases criminal enterprises posing as financial institutions. In 2009 through 2011, prosecutions for financial crimes fell to less than half the numbers in the 1990s, Justice Department data show.

  Black has a phrase to describe what happens when the head of a corporation runs it not for profit, but plunder. He calls it “control fraud.” That’s essentially what the Mafia does when it takes over a business from someone in too deep with loan sharks. The mob orders all the supplies it can to be delivered as quickly as possible, carts them out the back door and then the torches the place. The vendors never get paid. Crooked bankers just use accounting rules to mask their crimes and then either put the business into bankruptcy or get the government to rescue it with taxpayer money.

  The Chicago School economists and other promoters of the idea of regulation that favors corporations all insist that control frauds are rare and thus not significant. That position remains plausible as long as officials insist that no one saw, or could have seen, the 2008 collapse coming; as long as law enforcement is kept busy not looking for criminal conduct. But achieving this requires blinders, what we might call wishful denial of obvious facts.

  One set of those blinders was applied to the usually prying eyes of the FBI by the Mortgage Bankers Association (MBA). In 2004 the FBI announced that it had identified mortgage fraud as an epidemic. It identified two kinds of mortgage fraud. One involved people who borrowed money to buy a house they could not afford, hoping they could flip it for a profit before their inability to pay became apparent. The other involved people borrowing to live in a house they could not afford until they were evicted. The FBI also announced that its partner in identifying such frauds was the Mortgage Bankers Association.

  What the FBI missed was that it was banks that were creating the frauds, including some members of the MBA. The fox got the watchdog to look at the eggs instead of
watching the chickens, which were being eaten by the fox family. Bank agents were helping buyers fabricate loan documents. At Countrywide Financial in suburban Los Angeles, the largest source of fraudulent mortgage loans in the country, people fabricated documents to justify loans, making up wage and business profit statements. Loan officers put people with solid credit into mortgages that would force them to make big future interest payments because selling such toxic mortgages paid the officers three times the normal fee.

  Why would any bank make loans it knew could not be paid back? They would not—unless it did not matter to the bank whether the loan was paid back. Thanks to Gramm and other politicians, reward (fees and stock options) had been separated from responsibility to make sure borrowers repaid the loans. Once a loan was issued, it was sold in a package with thousands of other loans to Goldman Sachs and other Wall Street firms, which then sliced and diced the loans and sold them to investors as investments. Among the biggest buyers were state and local government pension funds, which were told the mortgage loans were all top rated and sure to be paid back. When that proved false, the resultant losses to the public employee pension funds meant higher taxes to make up for the money lost to Wall Street.

  The two institutions that resisted the easy profits in packing and selling off these loans were Freddie Mac and Fannie Mae, the two government-sponsored mortgage agencies that right-wing Republicans and Rupert Murdoch’s Wall Street Journal try to blame for the housing crisis. In 2006, as the coming collapse should have been obvious to anyone in banking regulation, the two loan giants were under pressure from Wall Street stock and bond rating analysts plus politicians in both parties to stop being stodgy and get in while the getting was good. Fannie Mae and Freddie Mac did, but with so little and so late that their loan loss rates were much smaller than Wall Street firms like Goldman Sachs.