Market Failure 101: The Legal Ripoff of Opaque Bank Fees

Defenders of unregulated capitalism argue that markets tend to police themselves, as bottom feeders and cheaters get punished by consumers who take their business elsewhere. But this assumes that consumers know they are being victimized in the first place, which often they don't.

Financial services are a case in point. A big reason that banks and other financial firms can so easily abuse consumers and investors is that many financial services and products are not very transparent. It’s hard to know whether you’re getting a good deal from your bank or mutual fund if you can’t easily see the fees you’re paying.

A recent Demos study on 401(k) fees, for instance, shows that some 30 percent of retirement nest eggs can disappear into Wall Street’s pocket thanks to fees that most 401(k) holders aren’t even aware of.

Meanwhile, an updated study by the Pew Center on the States shows that consumers are also getting whacked by bank fees. The report tells a depressingly familiar story -- one that you’d think would have generated a bigger revolt against the banks by now:

Financial institutions do not summarize important policies and fee information in a uniform, concise, and easy-to-understand format that allows customers to compare account terms and conditions. The median length of bank checking account disclosure statements has decreased, but is still cumbersome at 69 pages. For credit unions, the median length is 31 pages. Although shorter, credit union disclosures often do not include information that would allow a customer to compare account fees, terms, and conditions.

Financial institutions do not provide account holders with clear and comprehensive information about overdraft options and their costs. For many bank and credit union accounts, consumers choose from three options for overdraft services: not opting in to such service, penalty plans, and transfer plans. Each option has significantly different features, and fees vary, but financial institutions are not required to provide complete information about what is available. As a result, consumers may not be aware of lower-cost options.

Certain overdraft fees have increased. While bank overdraft penalty fees are unchanged from 2010, as reported in Hidden Risks, overdraft transfer and extended overdraft penalty fees have increased. A higher percentage of bank checking accounts now charge an extended overdraft penalty fee if an overdraft is not repaid in a timely manner. The median extended overdraft penalty fee has increased by 32 percent since 2010. The median overdraft penalty fee at the banks remains $35; at the credit unions it is $25.

All 12 banks either already reorder withdrawals from highest to lowest dollar amount or reserve the right to do so without notice to the customer, thus maximizing overdraft fees. Seven of the 12 credit unions reserve the right to reorder a customer’s transactions from high to low. Some do not disclose their posting order. Since there are no rules governing the order in which financial institutions process transactions, they can maximize the number of overdrafts by reordering deposits and withdrawals in such a way as to reduce the account balance as quickly as possible.

So what can be done about this legalized ripoff of millions of depositors who look to banks to safeguard their wealth, not skim from it: Make such ripoffs illegal, that’s what. And this isn’t exactly rocket science, either, as the Pew study shows. Most of its recommendations for policy change are very straight forward:

Require depository institutions to summarize information about checking account terms, conditions, and fees in a uniform, concise, and easy-to-read format that would be available both online and in financial institutions’ branches.

Require depository institutions to provide accountholders with clear, comprehensive terms and pricing information for all available overdraft options so that customers can make the best choice, including choosing not to opt in to any overdraft coverage.

Require that overdraft penalty fees be reasonable and proportional to the financial institution’s costs in providing the overdraft loan or to the size of the overdraft itself.

Require depository institutions to post deposits and withdrawals in a fully disclosed, objective, and neutral manner that does not maximize overdraft fees—for example, in chronological order.

Does any of that sound complicated? Not really. Simple regulations like these are a way to combat market failures that hurt consumers. But making this happen politically is another story given Wall Street’s clout in Washington.