Christopher Whalen

Why are Bank of America and other large US banks increasing fees for the use of debit cards and other services?

The short answer is regulation. The Fed’s low interest rate policy has a big effect on how banks price all services. Specific to ATM fees, Congress has decided to regulate the fees charged to vendors by banks on electronic transactions, essentially cutting this profit center in half for the largest banks that have $10 billion or more in assets. This fee is still far more than the actual cost to the bank providing the service, but such is life in America’s less-than-free market. Like airlines, the “too-big-to-fail” (TBTF) banks are not really profitable, thus pricing of one product is often skewed to make up for shortfalls in another.

When you look at the TBTF banks, which dominate the industry in the U.S. today, all of them feature business models where monopoly pricing power and the much abused free market operates. The reasons for this are complex, but the power of the TBTF banks – Bank of America, JPMorgan, Wells Fargo and Citigroup – largely stems from the fact that they remain heavily regulated and protected by these same captured regulators led by the Fed. Thus there is no competition for the services these large banks provide.

Despite the gazillions of words written about deregulation in the financial services industry, there is the Bank Holding Company Act of 1956, which provides the Fed with the power to regulate companies that own banks and thus it protects the TBTF institutions from competition. If Google, Wal-Mart and Amazon were permitted to own banks and thereby compete with Bank America et al in the electronic payments business, the cost of electronic payments to small vendors and consumers would plummet.

The fact that the Dodd-Frank legislation mandates some artificial relief for consumers and small businesses is lovely, but the real solution to the problem of the TBTF banks and their monopoly pricing power regarding electronic payments is competition. As former Fed of New York general counsel and White & Case partner Ernest Patrikis told me in a 2008 interview:

What is the rational for the Bank Holding Company Act and thereby making it more difficult for companies to acquire control of banks? I’ll give you two rationales. First is the Fed continues to believe in the separation between backing and commerce, something for which I do not have a lot of respect. Citicorp’s becoming a one-bank holding company and thereby gaining the ability to engage in all sorts of non-bank services was one prime motivation for amendments to the Bank Holding Company Act in 1968.

Which lead me to then ask Patrikis: Well, aren’t we done with the 19th Century? Isn’t Glass-Steagall over and done with? His reply:

No, not really. We still have the Bank Holding Company Act. While Gramm-Leach-Bliley greatly broadened the activities permissible for bank holding companies, it has not been entirely eliminated. Few countries in the world have limitations like that, maybe Japan. Most countries do not impose activity limitations on companies controlling banks. With limitations on transactions between banks and controlling persons, is that limitation necessary?

Much of what banks do today is not special and does require the vast protective apparatus of the Fed and other regulators, but these same regulators also protect the zombie banks from competition. While protecting deposits and other payment system functions is important, these safeguards exist today and would continue tomorrow if Wal-Mart, for example, were allowed to proceed with its wish to operate a bank. But how about Amazon or Google?

While the US banking industry has been successful so far in coercing the FDIC not to process applications by commercial firms to operate near-bank industrial loan companies allowed by some states, the rising consumer uproar over fees for ATM transactions and other services illustrates why we need to repeal the Bank Holding Company Act.

My friend Yves Smith, proprietor of Naked Capitalism, urged readers that use Bank of America to “take their revenge. Move your accounts to a small bank. Cancel your Bank of America credit cards. And be sure to let a bank customer services rep know exactly why you are done with them.”

I have a better idea: Open up the TBTF banks to competition. That will make the TBTF banks a lot smaller. And the regional and community banks will do just fine in this environment. The truth is that smaller institutions are better at underwriting credit and providing consumers with relevant, reliable services. Give them cheaper, more modern tools and services, and smaller banks will actually thrive.

Open up the US banking industry to less expensive transaction processing and other back end services that will come with deregulation of these industries and smaller lenders and agencies will do just fine. Annihilate the TBTF bank cartel in payments and the systemic risk problem will, to use the Marxist-Leninist term, “wither away”.

“Our purpose is to lean against the winds of deflation or inflation, whichever way they are blowing.” -William McChesney Martin Jr., Chairman, Board of Governors of the Federal Reserve System

During his tenure as Chairman of the Fed from 1951 through 1970, William McChesney Martin Jr. saw the transition from America at war, with the government controlling much of the economy, to a peace time economy where wider financial ebbs and flows were possible.  His experience in confronting both inflation and deflation during his term is instructive today.

The carefully managed, low-interest rate policy which the Fed maintained during WWII ended under Martin’s predecessors, Mariner Eccles and Thomas McCabe.  These two Fed Chairmen defied President Harry Truman and raised interest rates to forestall inflation.  Even when the Chinese Red Army attacked American military forces in Korea, the Fed under Chairman McCabe stood its ground and eventually won its independence from the Treasury in 1951.

Martin was picked by Truman to replace McCabe and thereby bring the Fed to heel.  Instead Martin proved to be an independent man who helped make the central bank independent as well.  Martin, for example, defied President Lyndon Johnson and raised interest rates in the 1960s.  See Robert Bremmer’s 2004 book, “Chairman of the Fed: William McChesney Martin Jr., and the Creation of the Modern American Financial System.”

But Martin recognized that the Fed ultimately could not prevent Congress from funding spending with debt and thereby fueling inflation, Alan Meltzer wrote in his classic “A History of the Federal Reserve.” That judgment has been proven correct in today’s market volatility, which is driven by the excessive accumulation of both public and private debt.  But withdrawing liquidity from solvent borrowers risks a repeat of the Bear Stearns and Lehman Brothers failures.

Were he alive today, Martin would probably argue that the Fed should continue to encourage lending to solvent banks and thereby keep the financial system liquid and functional.  I suspect that his successors, like Arthur Burns and Paul Volcker, would agree.  But instead U.S. regulators are apparently encouraging American lenders to reduce credit risk exposure to E.U. banks and corporations, effectively exacerbating the liquidity crisis that has been hitting European markets in recent days.

The head of the credit risk book at one of the largest French banks told me yesterday that his institution has seen a one-third reduction in the volume of credit available from U.S. counterparties.  He directly attributes this change to advice to U.S. banks from American regulators.  The market veteran notes that long-term credit is unavailable for most E.U. banks, increasing pressure on short-term funding pressures in the dollar/euro market.

American officials apparently want to avoid another “AIG situation,” in the words of one well placed banker, thus reducing credit lines to E.U. banks is seen as a way to reduce systemic risk.  But in fact just the opposite may be the case.  The regulators may be fomenting a systemic risk event by going against the advice of Chairman Martin and most of his contemporaries.

Another market observer points to U.S. derivatives dealer banks reducing exposure to E.U.  banks because of continued worries about the PIIGS implosion.  But one wonders how much these particular data points weigh on the credit markets compared with the impact of low or no interest rates on risk taking.  When Bank of New York announces that it will charge large customers for deposits, it begs the question about current Fed rate policy.

I believe that the Fed needs to let the cost of funds rise to restore yield and risk taking to dollar assets, but at the same time make clear to the markets that the volume of credit available to solvent borrowers is unaffected or even increased.  The contraction of money and credit on both side of the Atlantic is the key issue that should have the attention of policy makers.  As Carl Weinberg of High Frequency Economics said on Bloomberg Radio this morning, nothing good comes from contracting credit and money markets.  But low interest rates is driving deflation, in my view.

To the extent that regulators at the Fed, OCC and FDIC are encouraging U.S. banks to arbitrarily reduce credit lines to their E.U. counterparts, that behavior needs to end now.  The chief threat to the global markets remains deflation as debt levels are reduced to practical levels.  Next week, Fed Chairman Ben Bernanke and his colleagues at other agencies needs to make clear in a very public way that the U.S. central bank is not taking steps to make things in the money markets a lot worse than they need to be.

The official version of reality in use this week at the White House says that the U.S. economy is recovering, slowly but surely, and unemployment is falling.  The same perspective says that residential real estate markets are stabilizing and banks are starting to lend more aggressively.  None of these statements are true, but there are quite a few people in the White House who believe them nonetheless.

My view is a bit different, namely that unemployment is likely to remain at current levels during the balance of 2010.  The sharp reduction in credit available to the real economy and the overhang in the mortgage markets are not likely to improve anytime soon.  I spoke about the economic outlook with Larry Kudlow and James Glassman on CNBC last Friday: “Double Dip Fears Mount.”

While the public sector of the U.S. economy received a great deal of assistance due to various forms of stimulus, the private sector never recovered from the first “dip” during 2008 and much of 2009.  Virtually all of the Fed’s assistance from zero interest rate policy has gone to the banks or the U.S. Treasury, with no help for American households and workers.  This means higher unemployment and lower economic activity in coming months or even years.

“When the FOMC tries to boost the economy and credit creation, none of the benefit is working its way to investors or consumers,” we wrote last week in The Institutional Risk Analyst (“Zombie Love: Do Fannie and Freddie Provide Any Benefit to the U.S. Economy?”). “Because the Fed and the White House are allowing the banking sector to heal its collective wounds via zero interest rate policy from the Fed, the banking system is not passing along any of the benefit of Fed easy money.  Thus while the banks absorb all of the subsidies from the Fed and Treasury, U.S. households, businesses and private investors are slowly destroyed.”

“Policy makers in Washington know all of this, of course,” we continued. “Nobody in the Obama White House or the Fed dares to admit in public that the ‘quantitative easing’ by the FOMC is pretty much useless in terms of helping the real, private economy.”

No surprise, then, that Wall Street economists are gradually pushing down their “growth” estimates for the U.S. economy for the balance of 2010 and beyond.  This grudging admission of the truth is mirrored in shrinking analyst estimates for revenue for sectors from banking to retailing to autos.  With growth receding, there is no surprise in reports that investors are fleeing equities, as the New York Times reported on Sunday.

The financial crisis of 2008 and the aftermath raise fundamental questions about money, debt and value in a way that Americans have not seen in over a century.  The response to the crisis by the Fed, focused entirely on Wall Street, begs the question of whether Main Street can survive.  The falling expectations for the economy are translating into truly horrible poll numbers for Democrats and the Obama Administration, but also for all incumbents.  The rate of turnover in the Congress this year could be one of the highest in the post-WWII era.

If the Democrats in Congress take a trouncing as is widely expected, then President Obama may decide not to run for another term.  While that possibility may seem far-fetched, my sources in Washington say that President Obama may seek to become the first American Secretary General of the United Nations.

According to this admittedly speculative scenario, President Obama will choose not to run again so he can take a shot at the UN post.  Obama knows that he never could win the position after two terms.

The other interesting twist that some see emerging after the November election due to the poor economic outlook involves the newly created Consumer Financial Protection Bureau, or CFPB.  The chair of the Congressional Oversight Panel, Harvard Law Professor and bankruptcy expert Elizabeth Warren, is one of the leading candidates for the job, but the banking industry naturally is opposed.

It is becoming clear that the Obama Administration may not pick a candidate for the CFPB job until after the November election in order to dodge this very political issue.  By holding the voting on the new agency head until after the election, members of both parties will be able to extract maximum contributions from the banking lobby.  But I hear that the choice may have already been made.

It may surprise some observers that House Financial Services Committee Chairman Barney Frank may want the CFPB job for himself.  Frank reportedly has already expressed interest to the White House.  Sad to say, Chairman Frank probably has seniority over Chairman Warren.

“Barney did some heavy lifting,” says a source on the committee who is close to Frank.  “He might want a different gig, especially if he loses the chairman’s seat in November.  Frank would not want to hang around in Congress as part of the minority.  Being the first CFPB emperor, however, could be a more interesting gig than, say, eventually being made head of HUD of the FHA.”

You heard it here first.