Do you think the $5 monthly charge Bank of America announced for its debit card customers is all about squeezing the consumer? Think again. What we are really witnessing are the death throes of an industry – the Too Big To Fail Banks. These are the banks that, at the height of the housing bubble, acted like they were hedge funds. They expected to earn 20% a year on their equity, and they rewarded their top executives accordingly, with bonuses in excess of $10 million for the CEO. Now all sorts of forces are conspiring to drag these banks into the boring, and decidedly non-lucrative status of utilities, earning maybe 5% a year on their equity, with their income capped by government decree. The bank executives don’t like this one bit. They see themselves being sucked down into the quicksand of $100,000 annual bonuses, and they are fighting back with everything they’ve got, even if it means making their cash-strapped customers pay ridiculous fees for services that used to be free.

Consider, for example, their counter-productive attempts to maintain the debit card as a cash cow. Just a few years ago, the banks were anxious to give away debit cards for free to anybody who walked in the door. The reason was that the Federal Reserve had given the banks a regulatory waiver that allowed them to provide debit card customers an overdraft line of credit. This gave consumers an ATM card that could also be used for purchases, and even allowed the consumer to buy more than what was available in their checking account. Unfortunately, the banks took this product and turned it into a scam. The consumer was never told what their overdraft limit was, so they no longer could control their checking account balance. Next, the banks set their systems up so that debits and credits to the checking account no longer were processed in the sequence in which they occurred, which is how the consumer managed their checking account balance. Instead, credits were kept back in the queue, and all debits processed first, from the biggest to the smallest. This guaranteed that many checking accounts were going to go into overdraft without any knowledge of the consumer or any means to control it, because the overdraft limit was an unknown number, and the banks kept secret the way in which they processed debits and credits. Once an account went into overdraft, a $35 fee was charged, even if the overdraft was less than $5. So you as the consumer wouldn’t feel so bad about what the banks were doing to you, the banks advertised the fact that they would stop assessing fees if you incurred more than 10 overdrafts a day.

Think about this for a minute. The consumer would buy a cup of coffee with their debit card and unwittingly push their bank balance into overdraft. That incurred a $35 fee, but the overdraft limit wasn’t cancelled – it was still in force. So, again unwittingly, the consumer bought more things during the day with the debit card and incurred up to nine more fees, for a total of $350 in fees for the day. This could go on for days, until the mysterious overdraft limit known only to the bank was reached and the card was temporarily deactivated. The consumer found out at that point that their balance was negative and they might owe $1,000 or more in fees to the bank.

What is really remarkable about this story is that not one executive at any of the big banks ever questioned a product that ruthlessly manipulated their customers into overdrafts and costly fees. And this was a big bank business – probably limited to 20 of the nation’s largest banks – the ones that have become Too Big To Fail. They got that big because they convinced the Federal Reserve and other regulators that they needed to be huge in order to generate the “economies of scale” necessary to build the systems that could manage debit cards and similar products for tens of millions of consumers. Who would have thought that all those economies of scale were ultimately going to be used to defraud the bank’s customers?

This debit card scam became a very big fee business for the TBTF banks, especially the top four – Bank of America, Citibank, Chase, and Wells Fargo. Estimates were that the TBTF banks generated around $4 billion in fees from this business every year, most of this on the back of their poorest customers who couldn’t keep big balances in their checking account in order to avoid the overdrafts. Protests from consumers and consumer groups began to reach Congress around 2007 and 2008, when the banking industry blew up on its own over bad housing loans. Still, the Federal Reserve did nothing to stop this practice. Finally, the issue came up during the Congressional hearings on bank reform, and banks were at long last required to get their customer’s permission first to establish an overdraft limit. This is why you see those pesky alerts on bank websites pleading with you to authorize an overdraft capability on your checking account. Unfortunately for the banks, millions of Americans have learned what a scam this product is, and are simply saying “no thanks.”

Banks Are Watching Their Consumer Fee Income Dry Up

There goes a big chunk of the fees banks earned on checking accounts. Another big chunk of revenue has also been outlawed under the Dodd-Frank financial reform bill and the attached Durbin amendment. Banks are no longer allowed to charge outsized fees to retailers when consumers use their debit card for an over-the-counter purchase. It is estimated that Chase alone is going to lose $1.6 billion in annual revenue from this amendment.

The whole idea of the $60/year charge that Bank of America is now going to assess its ATM debit card users (the ones who make purchases with the card – you can still withdraw cash for free but of course only from a BofA ATM), is that Bank of America needs to make up the lost revenue. Every big bank is doing the same thing, but most of them have been much quieter about it. Citigroup sent a small-print notice to its customers that it made a change to its debit card product. Customers who wish to use the card for retail purchases must maintain a minimum balance of $15,000; otherwise they will be assessed a fee of $240/year. This makes Bank of America look positively generous.

The consumers who have the financial wherewithal are moving their accounts out of the TBTF banks to smaller banks that don’t charge these fees, especially credit unions that still offer free checking and free ATM use. Even if you are wealthy enough, why would you want to keep $15,000 in a checking account with an overdraft privilege? The big banks are offering at best 0.10% interest on checking account balances, which comes to $15 in interest per year, which would not offset even half of the overdraft charge if the balance should mistakenly fall below $15,000. And why would you want a debit card when you can get a credit card for a $60/year fee (though don’t be surprised if that fee doubles within the coming year). At least with a credit card you know what you credit limit is.

Consumers who don’t want to go to the trouble of changing their bank account, but don’t want the $350/day overdraft charges, will simply have to restrict their usage of the debit card to ATM withdrawals. Even so, as Americans get poorer in this depression, many will not be able to afford the basic checking account and ATM cash card, because the monthly fees and balance requirements will still be too high. They will have to join the millions of poor people who don’t have anything to do with the banks and operate in the cash economy, where they are subject to hefty currency exchange charges just for cashing their pay check.

Customers Are Beginning to Drift Away

As for the big banks, they are going to watch their customer base drift away. The debit card used for retail purchases is now destined to become a thing of the past. The banks have made the conditions of use too onerous. Whether the banks realize this or not is open to question. Do the executives at Citibank really believe the average American can afford to let $15,000 sit idle in a checking account? They should know from their own gargantuan data base on millions of customers that Americans rarely keep checking accounts of this size. But if they do realize this, why not simply cancel the ATM debit purchase card altogether?

Something else seems to be at work here, and that something else appears to be the sense of entitlement that banks have to earnings billions of dollars a year in fee income from checking accounts. The TBTF banks, for example, cannot argue that they need to replace all that lost revenue in order to cover their costs. They all got to be a TBTF bank, and gobble up many smaller banks, precisely so they could achieve the economies of scale to build and manage the systems necessary to process billions of transactions a day for millions of consumers.

No, what is really at work here is the belief that banks must be allowed to earn at least 15% a year return on equity, with all the generous bonuses that result from that. Here is what one reporter, Halah Touryalai, of Forbes Magazine, said about the Bank of America fee on debit cards:

That’s exactly what BofA is doing today with that $5 fee. It’s making up for lost revenue…As much as I want to hate BofA (disclosure: I’m BofA customer by way of Fleet) for charging me $60 a year so I can deposit my scrappy journalist’s salary I can’t blame it for making the decision to do so.
BofA and every other major bank is simply making up for lost revenue that it would otherwise lose because of a new regulation stemming from Dodd-Frank.

Do you see the assumption here? BofA is “simply making up for lost revenue.” There is never any question they are entitled to this lost revenue. If a business reporter thinks this way, surely this is the mindset within the financial industry itself.

That is not how the market is thinking about this lost revenue. The consumers who are being asked to make up for the lost revenue are voting with their feet and abandoning the TBTF banks. The regulators have realized the cost to the economy of a failure of a TBTF is so great that they are forcing these banks to carry much more capital, which makes it that much harder to earn 15% returns on this capital every year. The most lucrative part of the TBTF franchise – the trading businesses – are under severe constraints, from losses by rogue traders, from the destruction of so many markets, and from the Volcker rule, which is forcing banks to recognize that trading losses will no longer be backstopped by deposit insurance from the federal government. Even the Federal Reserve is piling on: Operation Twist, which is being used by the Fed to push 10 year Treasury yields down, is promising to flatten the yield curve to such an extent that banks will no longer be able to use their balance sheet to earn risk free money at high rates, while funding themselves with low rates.

A Permanent, Tectonic Shift in Bank Earnings

The stock market is paying attention to all this. The shares of some of these TBTF banks have been pummeled – down 40% in the last quarter alone, and are now trading at levels close to the desperation prices seen in 2009 when so many of these big banks were close to failure. This time, however, bank stock prices may not bounce back as nicely as in 2009, because the reduction in the industry’s earnings capacity is looking more and more like it is permanent. Investors are beginning to understand what some of the Federal Reserve presidents have been saying: banks are utilities. They provide an important service by managing the country’s payment system, which is a utility every much the way the electrical grid is a utility, and by making judicious loans that they should expect will be paid back. For this, they receive deposit insurance and are allowed to borrow from the Federal Reserve. This is the nice, boring business they were in from 1933 to around 1975, earning 5% returns on equity and respectable, but not outlandish, salaries for their workers (bonuses did not exist back then).

Banks are being pushed by market forces, by their impoverished customers, by regulators, and by politicians, back into this nice, boring business again. It is more than likely that the TBTF banks will not be allowed to exist, and will need to be broken up. The management running these banks will have to go; they don’t have the temperament necessary to run nice, boring businesses like a utility. This transformation is now underway and is irreversible, but because the TBTF banks don’t realize this fact, they are going to be scrambling for every possible fee dollar they can think of to keep up the game. The effort will be futile, but painful for consumers who will continue to be victimized by these fees. The banks will begin to throw in the towel when they start lowering their hurdle rates of return – the minimum capital they expect each of their businesses to earn – from 15% to 10%, then 7%, and finally 5%. By then we will see a whole different type of executive running these banks, and the financial sector will no longer represent 40% of the earnings of all S&P 500 companies. That number will be back down to its long term average of about 5% as well.

Banks won’t be the only industry subject to this deflationary crush on earnings. Other excessive earners – such as health care providers, pharmaceuticals, insurance companies, hedge funds, and big oil, will all feel the pinch. Even the college education business won’t be able to impose 7% annual tuition increases on its customers. But banks, being at the top of the pyramid and with the greatest sense of entitlement, will have the hardest time adjusting. As a consumer, you can expect many more insults to come your way.