By Herb Weisbaum ConsumerMan
msnbc.com contributor
updated 11/12/2009 3:54:17 PM ET 2009-11-12T20:54:17

Finally, the Federal Reserve has decided to tackle those annoying and in some cases unfair overdraft fees. But consumer groups say the Fed's action is not enough and say Congress still needs to act.

The new rules, announced Thursday, will prohibit banks from automatically enrolling customers in overdraft protection. Beginning July 1, financial institutions will have to ask you if you want this service, which costs an average $34 per event to cover transactions that would otherwise have overdrawn the account.

“The Federal Reserve Board’s action today on debit card overdraft fees legitimizes an abusive product without providing any substantive protections for bank customers,” says Eric Halperin with the Center for Responsible Lending.

The Fed rule covers only point-of-sale debit overdrafts and ATM transactions, not checks or recurring automatic electronic checking withdrawals.

“Some-of-the-time protection is never as good as round-the-clock protection,” says Ed Mierzwinksi with U.S. PIRG, another consumer advocacy group.

Banks knew the Fed’s rules were in the works and tried to get out in front of them. Wells Fargo and Bank of America, two of the nation's biggest banking giants, recently announced more lenient overdraft policies.

Wells Fargo no longer charges a penalty fee to customers who overdraw their account by $5 or less. Bank of America customers will not be charged if they overdraw by less than $10 in one day.

Both banks have also announced they will limit overdraft fees to four per day.

Chase says it will revamp its overdraft policies in the first quarter of 2010 in order to “help consumers in the challenging economy.”

Consumer groups call these policy changes a good first step. But they still want Congress to pass a law that reins in these penalty fees at all banks.

“These reforms are too little and too late, coming after years in which banks made billions off of overdraft abuses,” says Chi Chi Wu with the National Consumer Law Center.

The Center for Responsible Lending says about 50 million Americans overdraw their checking account each year. In a recently released study, the center estimates banks and credit unions will earn $27 billion in overdraft fees this year, a 52 percent increase from 2006.

”A huge amount of money is getting drained from people’s wallets,” says Leslie Parrish, who wrote the report. “Banks and credit unions have become so sophisticated in driving up overdrafts that Americans now pay more in overdraft fees every year than they do for books, cereal or fresh vegetables.”

Consumer groups also blast the banking industry for creating a system that is deliberately designed to trip-up customers.

“We want the banks to play fair,” says Susan Weinstock with the Consumer Federation of America.

Not surprisingly, the banking industry sees it differently.

“It’s not enough to put an account on autopilot and assume the bank is going to be a private accountant,” says Nessa Feddis with the American Bankers Association. “Overdrafts are easy to avoid, and most people avoid them.”

She cites a recent ABA survey that found 82 percent of bank customers did not pay an overdraft fee in the past twelve months.

Why it’s so easy to slip up
There’s a good chance your debit card has automatic overdraft protection. The banks call it “courtesy overdraft protection.” If you didn’t ask for it, you won’t know it’s there — until you overdraw the account.

The American Bankers Association says most banks give their customers the choice not to have overdraft protection. Of course, you can’t decline something you don’t know you have. That’s why consumer groups want overdraft protection to be optional.

“It should be something the consumer chooses, not something the bank provides as a ‘service’ that ends up being a great profit center for the bank instead,” says Ruth Susswein with the advocacy group Consumer Action.

There is another problem with the system. For years, many banks have processed debits from biggest to smallest, rather than in chronological order. The industry says consumer testing shows this is what customers want because the higher payments are usually more important, such as mortgage, rent or insurance payments.

Critics claim this is done to increase the chances of dinging customers with multiple overdraft fees.

“We think this is totally wrong, against the law and completely takes advantage of consumers,” says Miami attorney Jeremy Alters, who has filed class action lawsuits against numerous banks.

Melanie Garcia, a 23-year-old law student at Georgetown University, is one of the plaintiffs. She claims she was charged overdraft fees on numerous occasions because of the bank’s processing procedures.

Example: On July 31, 2008, she had a balance of $56.42 in her checking account. The next day she made two debit card purchases that totaled $34.97. Rather than clear those transactions, the suit alleges, the bank held them until Aug. 4 when a recurring monthly payment of $102.63 was due to be processed.

That $102 transaction was processed first and created a negative balance. Then the earlier transactions, which would not have overdrawn the account, were paid. Rather than one $35 overdraft fee, Garcia was hit with $105 in overdraft fees.

Garcia tells me she was “shocked” to see that charge on her statement.

“You try to be responsible managing your money, and then you have the rug pulled out from under you," she says.

New laws and regulations needed
U.S. Rep. Carolyn Maloney, who wrote the Credit Cardholders Bill of Rights, is now focused on overdraft fees.

“Consumers should have a right to decide what financial products they buy and have control over their own financial accounts,” says Maloney, D-N.Y.

Her bill, the “Consumer Overdraft Protection Fair Practices Act,” would require banks to make overdraft protection optional.

For those with overdraft protection, it would require notification that an ATM or point-of-purchase debit card transaction would incur an overdraft fee. You would have the choice to proceed or cancel. If you don’t have overdraft protection, the transaction would not be permitted.

Most importantly, the bill requires banks to process checking account debits in chronological order.

The Senate is considering similar legislation. The “FAIR Overdraft Coverage Act” was introduced Sen. Christopher Dodd, D-Conn., chairman of the Senate Banking Committee.

It would limit overdraft fees to one a month and no more than six a year. The bill requires those fees to be “proportional to the cost of processing” them.

Edward Yingling, president and CEO of the American Bankers Association, says his members oppose the bill because it could “encourage irresponsible personal financial management.” If customers can regularly overdraw their accounts without penalty, he warns, it may become too expensive for banks to provide overdraft service.

My two cents
Debit cards make is easy to overdraw an account, especially when two people in the family have cards that draw on the same checking account. We all need to be more careful.

But banks should not be able to stack the deck against their customers to boost the number of penalty fees. And customers should not be required to take a “service” they don’t want and didn’t ask for.

I commend Wells Fargo, Bank of America and Chase for changing their overdraft policies. But keep in mind: They didn’t act until they knew Congress was ready to tackle the problem. That’s why Congress needs to pass a law that requires all financial institutions to play by the same rules — ones that are fair to the bank and the customer.

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