December 2009 Archives

The underground or "black" economy is rapidly rising, and the fault is mainly due to government policies.

Here is the evidence. The Federal Deposit Insurance Corp. (FDIC) released a report last week concluding that 7.7 percent of U.S. households, containing at least 17 million adults, are unbanked (i.e. those who do not have bank accounts), and an "estimated 17.9 percent of U.S. households, roughly 21 million, are underbanked" (i.e., those who rely heavily on nonbank institutions, such as check cashing and money transmitting services). As an economy becomes richer and incomes rise, the normal expectation is that the proportion of the unbanked population falls and does not rise as is now happening in the United States.

Tax revenues are falling far more rapidly at the federal, state and local level than would be expected by the small drop in real gross domestic product (GDP) and changes in tax law that have occurred since the recession began. The currency in circulation outside the U.S. Treasury, Federal Reserve banks and the vaults of depository institutions - that is, the currency held by individuals and businesses - has grown by 13.3 percent in the last two years, while real nominal (not inflation-adjusted) GDP has not grown at all, and real (inflation-adjusted) GDP incomes have fallen by more than 3 percent. With the growth of electronic means of payment and financial service providers, it would be expected that the currency component of GDP would fall, not rise.

The underground economy refers to both legal activities, such as often found in construction and services industries where taxes are not withheld and paid, and illegal activities, such as drug dealing and prostitution.

Countries such as the United States, Switzerland and Japan historically have had relatively small, nonreporting and/or illegal sectors, a typical estimate being 13 percent of GDP.

Most European countries have had somewhat larger underground sectors (typically 20 percent or so) in part because of the desire to escape higher tax rates. Italy and some of the other Southern European countries are believed to have underground sectors that account for 30 percent or more of all economic activity.

I recall an Italian finance minister telling a few of us at a meeting a couple of decades ago that, for policy purposes, he assumed that "the economy was 40 percent larger than what was reported." In some developing countries and/or highly corrupt countries, underground or "off the books" activities are estimated to be as high as 70 percent of all economic activity.

The FDIC report about the size of the unbanked or underbanked sector in the U.S. should be of concern because those who do not use the banking system often have to pay higher fees to cash checks, pay bills (e.g., money orders, etc.), or transmit funds.

People who keep their savings in cash at home rather than in banks make themselves easier prey for criminals and are more likely to lose their money to fire, flood, or just neglect. Not surprisingly, a majority (71 percent) of the unbanked have household incomes of less than $30,000 per year.

There are many reasons people do not have bank accounts. Banks, because of the "know your customer" and other anti-money laundering regulations, make it difficult for nonestablished people, such as the young and transient, as well as legal and illegal immigrants, to open bank accounts.

Also, many of these same regulations are responsible for the rise in bank fees, which are a particular burden for low-income people. You can be sure that every time Congress passes some new law or the IRS implements some new regulation to "get tax cheats," much of the real burden of these compliance costs will fall on those least able to afford it, while those intent on finding their way around it will do so.

People also avoid having bank accounts because they are vulnerable to asset seizure, judgments, levies, etc. Increasingly, bankers and others who provide financial services are forced by governments to spy and snitch on their own customers, and this is a real turnoff for many people, which causes them to find other ways of maintaining financial privacy.

Many studies have shown that when people believe the taxes they are required to pay are reasonable and the political leaders tend to spend their tax dollars wisely, tax compliance rises, and vice versa. In the United States, there is increased evidence that many tax dollars are not being spent wisely and are often used to pay off political cronies.

Over the past year in particular, the public has become aware that many in Washington who advocate higher taxes and argue that everyone has a responsibility to pay taxes are themselves not complying with the tax laws and regulations.

When you have a secretary of the Treasury and the chairman of the House Ways and Means Committee (the tax writing committee) accused of cheating on their taxes, it greatly undermines the moral authority of the tax collectors, making the common citizens feel like chumps and, hence, much more willing to try to legally avoid or illegally evade taxes themselves.

The evidence is unambiguous; governments cannot increase tax compliance and decrease the size of the underground economy by ever increasing and more onerous regulations.

It is no accident that those governments that allow their citizens a high degree of personal and financial liberty, including financial privacy, and spend taxpayer dollars wisely, honestly and competently, have much smaller underground sectors than corrupt and oppressive governments. Washington, take note.

Not long ago, a mother from Fort Gratiot, near Port Huron, wrote to my office. Her son, she wrote, had opened a bank account and gotten a debit card to use for ATM withdrawals and day-to-day purchases -- a cup of coffee, gas at the local filling station.

But then they noticed some unusual items on the young man's bank statement. He was racking up fees -- big fees -- because he had overdrawn his bank account by small amounts when making debit card purchases.

"On several occasions, he generated over $100 in overdraft fees where the actual amount of the insufficient funds was less than $20," this worried mom wrote.

"We would observe that he had just bought the world's most expensive cup of coffee for example, if a $3 charge generated a $35 overdraft fee, so that cup of coffee ended up costing $38."

Charging $100 in fees for a $20 shortage is nothing short of abusive. That's why I've joined Sen. Chris Dodd (D-Conn.), chairman of the Senate Banking Committee, on a bill to rein in the excessive fees banks charge for often tiny overdrafts, and to prevent banks from imposing overdraft coverage unless a consumer asks for it.

This bill is a companion to the Credit Card Accountability, Responsibility and Disclosure Act of 2009, which President Barack Obama signed into law earlier this year and which targets unfair credit card practices.

Just as banks have sought to squeeze exorbitant fees out of their credit card customers, they have used outrageous overdraft fees on debit cards to boost profits while unfairly punishing consumers.

These tactics are all the more unfair because many consumers have turned to debit cards as a way to safely and conveniently make purchases without the risk of debt that a credit card entails.

Many banks refuse to allow consumers to turn down overdraft coverage and will not stop accepting debit charges after a consumer's funds are exhausted. Many charge overdraft fees on transactions that the bank could easily decline, such as ATM withdrawals.

Some manipulate the order in which they process transactions to increase the number of overdrafts for which they can charge fees -- fees they often charge several times in a single day. The fees they charge can be far out of proportion to the cost of covering an overdraft.

Sadly, that $38 cup of coffee is all too common.

The bill to end such abusive practices would:

Require banks to get consumers' consent before enrolling them in overdraft coverage, and prohibit giving customers who decline coverage less favorable terms on their accounts.

Limit the number of overdraft fees banks could charge to no more than one a month and six a year, and require those fees to be proportional to the bank's costs.

Prohibit the practice of manipulating the order in which transactions are processed in order to increase fees.

Require banks to notify customers when they overdraw an account by the method of the customer's choice -- e-mail, text message or letter.

Require a warning to consumers about to overdraw their account at an ATM or bank branch.

The bill would not require such warnings in ordinary store transactions, but would direct the Government Accountability Office to study whether such warnings are feasible.

Require banks to clearly disclose the fees they charge.

Families are facing plenty of economic hardship already. They should not have to deal with outrageous overdraft fees and deceptive practices. This is one more set of abusive banking practices that Congress should end.

TEMPE, AZ -- More Americans are shunning banks and turning to payday loan businesses for cash, according to a recent report.

The Census Bureau survey shows one in every four American households use check cashers, payday lenders or pawn brokers to get cash quick.

The survey is the first in-depth look at the issue.

It showed that many of those turning away from banks are minorities.  

More than half, 53 percent of African Americans and 43 percent of Hispanics, are now using alternative financial services, buying money orders and cashing checks straight out.

A manager at Allied Cash Advance in Tempe said he's seen an increase in business since the economy fell.

"There are certain times of the year we see a jump, the holidays are one of them," he said.

Some say the payday loan businesses are faster, even though they aren't cheaper.

"It doesn't surprise me. People don't want to jump through all the hoops a bank makes you do with paperwork," said, Manuel Cartajena, a barber working beside Allied Cash Advance.

Patricia, who asked that we not use her last name, said she uses the check cashers for money orders.
 
"Most of my buying and paying of things is with credit card, so I don't need a checking account but occasionally I'm sending out money so the money orders are nice and they're doing them for free," she said.

The survey showed nearly 30 million American's don't have a bank account, and are choosing to buy money orders and cash checks, which means many are not establishing a credit history.

"Because of the way times are now, people's pay are being cut, hours are being cut, they're losing their jobs, they need quick cash" Cartajena said.

NEW YORK (CNNMoney.com) -- Could debit cards be the next cash cow for banks? If banks have their way, they will.

Americans have conducted more transactions and spent more money using debit cards than credit cards this year -- the first time that's ever happened.

Next year, consumers are expected to spend $1.64 trillion with their debit cards, nearly two-thirds more than in 2006, according to the payments industry trade publication The Nilson Report.

And there is no indication this growth is slowing down anytime soon. Not only are Americans increasingly reluctant to take on more debt, but banks are expected to become more stingy with credit cards once new federal legislation takes effect next year, which could make the debit card the preferred form of payment for many consumers.

This hasn't gone unnoticed by large and small banks, who are currently looking for ways to wring any extra dollars out of their business at a time of severe loan losses.

"Banks, just like airlines and local governments, are looking for fee income to fill the revenue gap," said Greg McBride, senior financial analyst with Bankrate.com.

What is shaping up to be an area of focus for lenders are loyalty or rewards programs for debit card users.

A concept that has long been associated with credit cards, increasing numbers of banks have looked to such programs as a way to generate more fees from consumers.

Atlanta-based lender SunTrust (STI, Fortune 500), for example, launched a tiered series of travel debit cards in June that allow consumer and business account holders to earn miles with Delta Air Lines.

Just this month, Wells Fargo (WFC, Fortune 500) expanded its Cash Back program, saying it would allow customers to apply their debit card rewards toward paying down their home equity loan.

And Minneapolis-based U.S. Bancorp (USB, Fortune 500), which has offered debit card rewards as early as 2002, announced last week it was now making its own FlexPerks program, which allows cardholders to earn travel, cash or merchandise rewards, available to many of its consumer and small business account holders.

"We do find our customers are very interested in earning something," said Lynn Heitman, senior vice-president for retail payment solutions at U.S. Bancorp.

Of course, consumers don't necessarily have to pay for the privilege of having, or using, a debit card. Or at least not upfront.

Rather it is merchants that foot the bill, paying anywhere from 1% to 3% of every sale for the privilege of accepting a debit or credit card as a form of payment.

But calls by retailers and small business owners to cap those charges have grown increasingly loud in recent months, prompting some members of Congress to propose legislation aimed at curbing so-called interchange fees.

Should such lobbying efforts prove successful, banks' debit and credit card business would only come under further strain.

Lenders are already feeling the pinch from new Federal Reserve rules issued earlier this month that restrict how they charge overdraft fees to consumers.

"The rules have changed for debit cards," said Gerard Cassidy, managing director of bank equity research at RBC Capital Markets. "What banks have to figure out is how to maintain revenue growth of this product under the new rules and conditions we have to operate under."

Banks, as a result, have little choice but to pick on the already squeezed consumer.

And pushing debit card loyalty programs might just be the most painless means of doing so.

Only half of the nation's banks have some sort of debit card loyalty program in place. At the same time, many consumers have already embraced such offerings, noting that they would have used their debit card to buy groceries or gasoline anyway to make their purchases.

Still, some experts argue that debit card loyalty programs just aren't worth it for consumers.

Not only do they have to pay an annual fee of as much as $55 in some instances, consumers also only benefit if they rack up some significant charges.

Under a typical debit card rewards program, for example, a consumer looking to earn a $100 credit towards an airline purchase would have to spend $33,333, according to research published by consulting firm TowerGroup.

That's not an easy feat for most Americans, notes Brian Riley, research director of bank card services for TowerGroup. The median annual income for a U.S. household stands at around $51,000, before taking into account taxes and housing costs.

"Every remaining nickel you spend will have to go on [your debit card], which is just not practical," he said.

Of course, not all rewards programs are a rip off, although it is rare to find one without some sort of a catch. Customers of East Coast lender Citizens Bank can earn 10 cents on every purchase with their Green$ense debit card, up to $120 a year -- although that means no more paper statements or notices about your account.

Checking account holders enrolled in Regions Financial's (RF, Fortune 500) CheckCard Rewards program may earn 4% cash back on music downloaded from Apple's iTunes store or airline tickets purchased online from Southwest Airlines. To maintain their account, however, customers are required to pay a $5 monthly fee, which can be waived if a customer uses direct deposit or receives their statements electronically.

"Consumers need to have an eyes wide open perspective when it comes to financial services," said McBride of Bankrate.com. "Fees are going to be cropping up, but that also gives you a chance to comparison shop. There may be just as many good deals at the other end of the spectrum."