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October 2008

The Federal Reserve Board responded to the economy yesterday by lowering the target for the federal funds rate to 1% and the discount rate to 1.25%.

The first number is the rate usually in the news. The federal funds rate is the interest rate that banks charge to lend their balances to one another. If one bank wants to loan $30m to another bank, the two companies can negotiate the rate and the lending back and charge the borrowing back the rate agreed upon. By lowering the federal funds rate target, the Fed is saying they’d like to see this interest rate around 1%. The true lending interest rate is controlled by the market, guided by the Fed.

When banks borrow money from the Federal Reserve, the discount rate serves as the interest rate for the loan.

The federal funds target rate hasn’t been as low as 1% since June 29, 2004, having reached that level over a year before on June 25, 2003. A low target rate, and the ensuing availability of easy credit, possibly contributed to today’s credit crisis. But today’s low target rate will have a different effect, according to the policy makers. They believe low rates will increase liquidity between banks and encourage more — but sensible — consumer lending.

It might not be enough. Here’s the important part of the Federal Reserve’s statement yesterday:

Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

“Downside risks” and “will act as needed” probably signal more rate cuts to come in the future. But there isn’t much further you can go from here. The Federal Reserve could cut the target rate to 0%, but that would be a first, I believe. If banks still aren’t lending to each other at that point, the only other option is simply printing money.

Inflation would increase, making it more difficult to afford the same living standards unless inflation is accompanied by growth in salaries. The current jobs market doesn’t make salary growth seem likely.

So what does this mean for me?

The moves by the Federal Reserve don’t affect interest rates on consumer loans. Rates on long-term mortgages will not change dramatically due to changes in the federal funds rate or the discount rate. Adjustable rate mortgages might see a decrease in interest rates. Many ARMs are tied to a different rate entirely, the LIBOR. The LIBOR has been slowly decreasing, as well.

Savers are in for bad news. Interest rates offered by banks for savings account usually follow the movements of the federal funds target rate, but some banks may follow the LIBOR movements. A number of banks have decreased their interest rates recently, and I expect that to continue.


Update: Bank of America settled a lawsuit for $410 million concerning this issue below.

In his documentary film Overdrawn!, Karney Hatch mentions that banks often post your deposits and withdrawals to your bank account in such a way that they maximize the possibility of overdrafts. Even if you believe you have a large enough balance to cover your withdrawals thanks to recent deposits, the banks have a way of calculating debits and credits that can result in multiple overdrafts in one day.

Here is how this works, supposedly. This is the scenario: you know that you have an automatic electronic withdrawal that will be executed today, perhaps to pay your mortgage or cable bill. You realize that you may not have the money in your account so you run to the bank and make a cash deposit to cover the withdrawal. Or perhaps you are aware of the impending withdrawal the day before, so you execute a transfer from one account to another online. In your scenario, the final withdrawal and deposit are executed on the same day.

According to experience with many banks, no matter what time your withdrawals and deposits are processed on any one day, the bank will apply your withdrawals first, from largest to smallest, then apply your deposits. So if you have $100 in your account at the beginning of the day, and you have instructions to pay your mortgage of $1,500, your cable bill of $75, a cash withdrawal at an ATM during the day for $80, a debit card purchase at the grocery store for $10, and a scheduled ACH transfer for $2,000, the bank will process your mortgage first, dropping your account below zero and incurring your first overdraft fee.

The bank will then reduce your balance by the amount of the cash withdrawal. Even though you’re already below zero the bank will charge you a second overdraft fee. Next, the bank will process your cable bill, resulting in the third overdraft fee. Your debit card purchase will be posted next, incurring an average fee of $30 for your $10 purchase. You’ve now been charged $120 in overdraft fees alone.

Finally, the bank will apply your deposit, bringing your account balance positive again.

This technique has been observed, and banks have even admitted to this practice. Yesterday, Consumerism Commentary reader Steve claimed that this is not the policy at Wachovia, nor is it the policy at most banks. So I called Wachovia, Wells Fargo, Citibank, Commerce Bank (TD Bank) and Chase to try to extract the official policies from the customer service representative or salesperson.

Here’s what I found, as of October 2008.

Wells Fargo

Wells Fargo’s policy is to always post ATM withdrawals first, regardless of the time the transaction took place. After ATM withdrawals are posted, deposits and other credits are posted from highest to lowest amount, and finally checks and other debits are posted from highest to lowest. Interestingly, if your starting balance is $0 and you walk into the bank at 9:00 am to make a cash deposit of $100 and at 2:00 pm withdraw $40 from the ATM, according to this policy you could incur an overdraft fee.


I don’t have complete faith in the answer I received from Citibank. The representative I talked to did not understand my questions at first and put me on hold for a long time, presumably to find someone who might know the answer, but returned with an answer that still did not match my questions. Eventually, she told me that cash deposits and ATM withdrawals are posted at the time of the deposit, but ACH and check deposits are posted first. Check payments are posted after all other deposits. It sounds like you’re in the clear with Citibank.


Chase will post your transactions to your account at the end of the day. The bank starts with deposits and ends with withdrawals, both from largest amount to smallest. This policy would avoid overdraft fees as long as at the end of the day you’ve deposited enough to cover your withdrawals.

Commerce Bank (TD Bank)

Like Chase, Commerce Bank (now TD Bank) will post your deposits before your withdrawals. The policy is slightly different. Rather than processing your checks paid from largest amount to smallest, they are posted in the order of the check number, low to high. Commerce Bank assumes you want check number 1001 to pay before check number 1002.

The customer service representative at Commerce brought up an interesting point. First, keep in mind that there is a holding period when you deposit a check. The funds you deposit may not be available on the same day, even if the amount of the check is included in the balance listed online. Additionally, cash deposits have “next day availability,” so even cash deposits won’t be posted to your account until the next business day. Furthermore, on Friday, they consider it to be Monday, The one-business-day rule then stipulates that cash deposits on Friday won’t be available in your account for use until Tuesday!


Like Steve mentioned, the customer service representative at Wachovia explained the policy quite clearly. Wachovia will post your credits first, from highest to lowest amount, and will then post your debits, also from highest to lowest.

According to each bank’s representatives, the respective policies have been in existence as long as they could remember. I would like to contact more banks, like Bank of America, Bank of New York, Capital One, and PNC Bank to determine their policy as well. If I do, I will update this article.

It’s interesting that each bank has its own method of posting items to customers’ accounts. I think this is a practice that should be standardized across financial institutions, and it should be done in such a way that it benefits the banking customer: all overnight credits (ACH deposits, Direct Deposits, checks coming off hold, late ATM deposits) first followed all overnight debits (ACH withdrawals, electronic checks) from lowest to highest amount at the start of the day, then all real-time credits (cash deposits, ATM deposits during business hours) followed by all real-time debits (ATM withdrawals, bank teller withdrawals, debit card purchases) from lowest to highest amount at the end of the day.

Having never worked in a bank, I’m not sure if this policy is feasible, but it would be fair to the customer and reasonable to the bank.


The giveaway to receive one of two free copies of Quicken Premier 2009 has ended.

As I mentioned earlier today, overdraft fees (also known as NSF fees, insufficient funds fees, etc.) are basically interest paid for the privilege of using a bank’s money for a short period of time, a loan. There are ways to avoid them without yelling at underpaid customer service representatives who don’t have the authority to help you with the issue.

It’s better to prevent overdraft fees than attempt to have them reversed after they appear on the monthly statement. Several of these preventative tips are covered in Overdrawn!, the documentary I mentioned this morning. This advice is generally straightforward, and many people might find these tips to fall under “common sense.”

Before taking action, keep in mind that forgoing overdraft protection adds more responsibility to you, the customer, if you want your checks to clear and your purchases to complete.

Don’t accept overdraft protection. When you apply for a new account with a bank, if you have an option of overdraft protection, decline. If the option isn’t explicit, talk to a bank representative before opening the account. The option may be hidden to the customer. If there is no option, even after speaking with a representative, consider opening your account with a different bank.

If you’ve already opened the account, call customer service and as for the “feature” to be disabled on your account.

Track your deposits and withdrawals. By declining overdraft protection, you leave yourself vulnerable to rejected transactions and bounced checks. Keep in mind that deposits via check may take several days to increase your available balances, and track your spending using software like Quicken, the free Quicken Online, GnuCash, or any tracking system works for you (as long as it does work).

Link your checking account to a savings account. Of course, this option is most effective when your savings account carries no maintenance fee and no fee for transfers for overdrafts. Most importantly, the savings account must be funded to cover the overdraft.

Linking a credit card, as offered by many banks, may not be a good idea. This approach encourages taking on more debt. Your overdraft may be considered a cash advance, which on most credit cards carries a higher interest rate than a purchase. If no other options are available, this may be the best way to avoid the accidental NSF fee.

Buffer your balance. Many people manage to keep their checking account as low as possible, either out of necessity as living paycheck-to-paycheck is a reality for many families, or for maximization of interest. To maximize interest income, the prevailing thought is to leave your checking account as low as possible and transfer any unused cash to a high-yield savings account, so more money is working to earn interest.

If your checking account is subject to overdraft fees and if you believe you are prone to making a mistake with your money management, consider trading some potential interest for a safety net in your checking account. Pad your balance by $100, $500, or $1,000 — whatever works for you and your cash flow — to help ensure you won’t accidentally withdraw more than you have. If it helps, don’t record this padding in your Quicken records. This way you may not be tempted to spend your buffer.

Add your tip and win Quicken Premier 2009

If you have any suggestions for avoiding overdraft fees, please leave them below in the comments. By leaving a comment here, you’ll be entered in a drawing for a free copy of Quicken Premier 2009 (for Windows). I have two copies of the software to send to Consumerism Commentary contributors who live in the United States. To be considered for one of the two copies of Quicken Premier 2009, all you have to do is leave a comment on this post, preferably containing a suggestion for dealing with these particular bank fees. I will close the giveaway on Monday, November 1.

Note: the giveaway is now closed and the winners have been notified. Please feel free to leave comments if you wish.


If you are in the area of the University of California, Berkeley, stop by Mulford Hall tonight to see a screening of Overdrawn!, a documentary film by Karney Hatch. In the film, Karney takes a hard look at practices by big banks, primarily overdraft fees. The documentary follows the writer/director as he talks to bankers, a former loan collections agent, a loan shark, consumer advocates, Ralph Nader, and members of Congress in attempt to explain the inner workings of the consumer banking industry to the public.

I took away several interesting points from the film.

The application of deposits and withdrawals

Many Consumerism Commentary readers already know this, but it’s an important reminder. Banks will “apply” deposits and withdrawals in the order that favors the institution. Even if you deposit cash on January 2, if you have checks that pay that day or ATM withdrawals, at the end of the day, the bank will apply your debits before your credits, increasing the chance of an overdraft.

Additionally, the debits are ordered from largest to smallest. If your ending balance on January 1 was $500 and on January 2, you have two checks paid, one for $550 and one for $20, the check for $550 will be applied first. You’ll receive an overdraft fee for the first $50 overdraft. Next, your $20 check will be applied, inducing a second overdraft fee on the same day.

Overdraft fees and interest rates

The Federal Reserve Board as well as consumer groups consider overdraft fees to be loan interest. Overdraft protection, a service offered by banks, is basically a loan extended to the customer. If you don’t have money in your account when your check is cashed or when you use your debit card in a transaction, rather than disapproving the transaction or bouncing the check, the bank does you a favor by letting you use their money for a time.

The size of the overdraft fee does not depend on the amount of the overdraft. Charge $0.05 more than you have in your account or $500 more, you will be assessed a $30 fee, for example. Fund your account back to zero within 24 days, and your $30 fee on a $0.05 equates to an annual interest rate of 219,000%.

Overdraft fees make a payday loan, with typical interest rates of 100% to 1,000%, sound like a good idea.

In Overdrawn!, Karney Hatch beat his bank’s overdraft policy through small claims court. His bank reversed the overdraft fees incurred through his experiment. With the bank’s bottom line always in mind, the company decided it was less costly to credit his account for the fees and court costs rather than face legal expenses.

If you can’t make it to Berkeley tonight for the screening, Karney is taking the film on tour. In addition to college theaters, you can find the film in some locations projected onto the white walls of bank buildings for a unique experience. If a public showing isn’t available for you, you can also order Overdrawn! from Amazon.com or directly from Karney Hatch.


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