Fed falls flat with overdraft protection

In the year-ahead outlook for savings and credit that I wrote for Money's December issue, I reported that things weren't exactly

going to be rosy next year. But I did point out one potential bright spot.

"Customers who have been on the receiving end of 'gotcha' practices that will earn banks $38.5 billion in overdraft fees this year may also get some relief," I wrote. "Many Capitol Hill watchers believe legislation reforming overdraft policies has a good chance of passage in 2010."

As I reported my story, I talked to several sources who felt that credit card legislation, which passed in May, gives overdraft reform some good momentum. Then, last week, the Fed announced new rules that would also limit overdraft fees charged by banks and credit unions. (See fellow Money blogger Beth Braverman's take on five ways you can protect yourself now.)

The Fed rules, which require that banks allow consumers to opt-in to overdraft protection on ATM and debit card transactions, are a step in the right direction. But as consumer advocate Ed Mierzwinski told The New York Times, "Some-of-the-time protection is never as good as round-the-clock protection." Congress still needs to pick up the slack. Last month, both Sen. Christopher Dodd (D-Conn.) and Rep. Carolyn Maloney (D-N.Y.) introduced overdraft legislation, as well. Here's how Congress could do a better job than the Fed:

• The Fed mandates an opt-in program on overdraft protection for ATM and debit card transactions, but it says nothing about checks or recurring electronic payments. Congress could extend the opt-in requirement for all such transactions.

• Both Dodd's and Maloney's bills limit the number of overdraft fees banks can charge per month and per year. The Fed is mum on this issue.

• The Fed doesn't address the issue of merchant holds that can trigger overdrafts. When a consumer uses a debit card to book a car rental, pay for gas or hold a hotel room, merchants often put a hold on the funds in the customer's checking account -- and that hold is typically for a lot more than the amount of the transaction. (Let's say you pay for gas with a debit card. Many stations will hold up to $150 in your checking account, and the actual number won't be reconciled until the transaction clears, possibly a few days later.) Such holds can trigger overdrafts because the consumer assumes that the funds in his or her checking account are available for other purchases. Congress should address this issue; even the Fed acknowledges that "a more comprehensive approach that involves financial institutions, card networks, and merchants may be required to effectively address these problems."

• Any opt-in program should also disclose the annual percentage rate you'll pay for the overdraft courtesy, says Mierzwinski.

Of course, all reform comes with some unintended consequences. We've already seen credit card issuers raise rates, cut lines and close accounts. And you can bet banks will find other ways to nickel and dime customers. As former banking exec Jake Drew told USA Today, "Banks are highly acclimated to exploiting the next great legislative loophole. The best banking reform efforts of the Federal Reserve and Congress, so far, are merely symptomatic and reactive."

Add More Money to your favorite RSS reader. Subscribe at http://rss.cnn.com/moneyfeatures.rss.