The banking industry, long accused of consumer abuse, now finds itself in the cross-hairs of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Signed into law by President Obama on July 21, the Act takes aim at a number of long-standing bank practices that many deem harmful to consumers.
The biggest change sanctioned by the reform is the new Consumer Financial Protection Bureau, an open-ended regulatory agency which, the Wall Street Journal says, will have “rule-making and some enforcement power” over banks and credit unions. Mortgage lending, specifically, figures to be an area of interest for the new agency.
Here are some ways that banks have historically preyed on their customers – and which the Consumer Financial Protection Bureau is likely to confront:
Many allege that subprime lending, in and of itself, constitutes an abuse of consumers by banks. Suprime loans are made to borrowers who are deemed a higher credit risk (i.e. they have low credit scores). These loans are considerably more expensive than “prime” loans made to borrowers with high credit scores, whether it’s because of higher interest rates, more fees, or both. During the housing boom, subprime lending flourished, with many borrowers receiving loans with low teaser rates that quickly ballooned to double digits, along with terms, like interest-only payments, that pretty much made it impossible for the borrower to make a dent in that debt.
In his book The Housing Boom And Bust, economist Thomas Sowell found that subprime loans rose from 7% of all mortgage loans to 19% from 2001-2006. Other “non-traditional” loans rose from less than 3% of all mortgage loans to nearly 14% during the same period.
Lending Without Income or Credit Verification
Another criticized bank tactic of the last decade involves making loans (both subprime and prime) without doing the appropriate income and/or credit checks. These loans are commonly known as no-doc loans or, in industry jargon, “liar loans.” That nickname speaks for itself: many consumers deliberately lied on their loan applications (or were told to lie by their mortgage broker), misrepresenting their job status or income in order to seem like suitable borrowers. In other instances, lenders knew full well that unsophisticated borrowers were unlikely to repay loans and simply made them anyway in order to collect commissions.
The new law requires that banks and credit unions verify that borrowers are truly capable of repaying any mortgage loans they agree to sign.
Higher Prices Due to Debit Card Fees
A May 28 New York Times editorial focused on the fees that retailers are required to pay Visa and MasterCard on debit transactions. So-called interchange fees, which are sometimes as high as 3% of a purchase, are set by card companies. Nearly 80% of the fees end up in the hands of banks, which “induced the banks to issue more cards.” In 2009, businesses paid an estimated $20 billion in debit transactions to Visa and MasterCard. Many argue that merchants – particularly small businesses – pass along those additional costs to consumers in the form of higher prices.
An earlier version of the financial reform bill included price controls on how high these fees could rise. The amendment would have required the Federal Reserve to set fees at “reasonable and proportional” levels, with the intent of saving small businesses “billions of dollars a year” and, hopefully, reducing prices paid by consumers. The amendment, however, didn’t make it into the final version of the bill.
Hiking Other Fees to Offset Regulation
Banks have already begun responding to tighter regulations (which limit their profits and ultimately increase their costs of doing business) by introducing new fees or increasing existing ones. On June 27, Reuters quoted Senator Charles Schumer saying there was a “trend across the banking industry” involving the elimination of free checking accounts. Now that banks can no longer enforce overdraft fees by default, other streams of revenue are being sought.
According to a statement issued by Schumer, “this is a radical departure from what customers are used to and it is coming too fast for them to even realize what hit them.” Schumer also wrote a letter to Federal Reserve Chairman Ben Bernanke in which he requested that the Fed pay “special attention” to banks during this transitional period, and ensure that customers have “ample time” to prepare for new fees.
Difficulty Switching Banks
It has also become increasingly difficult for consumers to switch banks once they become dissatisfied with their current one. In a Red Tape report, MSNBC discussed “the pain and suffering consumers must face when trying to leave one bank to join another.” Citing a Federal Reserve study on switching costs, MSNBC reported Fed senior economist Timothy Hannan’s conclusion that it was “incredibly difficult” for consumers to get the facts about the costs of switching.
The Fed also found that banks employed a “bargains-then-rip-off” strategy, offering teaser rates and other enticements early on before uncorking overdraft fees and other penalties once they lock a customer into an account.
What is more, once a customer is “locked in,” it is becoming increasingly difficult to get out. Because of features like direct deposit, automated online bill payments and automatic savings plan deductions, dumping your bank has become so much of a hassle, that many consumers end up putting up with fees even though they could avoid them if they opened an account elsewhere.