The Card Game

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>> Tonight on Frontline... For 30 years, Americans have played a game with the banks, with the banks holding all the cards.

>> Changing the terms, raising interest rates, changing the rules of the games.

>> Consumers use plastic for 100,000 transactions a minute.

It has produced billions in profits, and nearly a trillion dollars in debt.

>> Americans people simply cannot pay back the level of debt that has grown over the last 30 years.

>> And the credit card industry even played a hand in the economic meltdown.

>> You had consumers refinancing their homes to pay off all their credit cards... >> Apply now... >> And then they went back out and filled their credit cards back up.

>> Now, as credit card losses are piling up, the government is stepping in.

>> We need to fix the rules and make them tougher, with a simple, clear, single mission to protect consumers.

>> LOWELL BERGMAN: Why hasn't there been credit card legislation to control some of these abusive practices?

Why did it take a near depression?

>> Lobbying power.

>> Tonight on Frontline, correspondent Lowell Bergman andthe New York Times investigate the battle over "The Card Game."

>> BERGMAN: 20 years ago, credit cards were a stable, profitable part of the banking industry.

But then, a brash new player arrived on the scene who would help change everything, turning a relatively staid business into a multi billion-dollar bonanza.

It was a company called Providian Financial, and its former CEO lives here in this estate modeled after the White House.

His name is Shailesh Metha, and since he left Providian, he has never agreed, until now, to be interviewed about the company.

>> Providian was a very profitable business.

We made over $180 million quarterly profit.

>> BERGMAN: Almost a billion dollars a year.

>> We were making a billion dollars a year.

>> BERGMAN: In profit.

>> In profit before tax.

>> BERGMAN: And while Providian was successful, their name would become synonymous with the tricks and traps that have entangled so many credit card customers.

It made you the poster boy for what's wrong with credit cards.

>> It made us the poster boy.

We were the poster boy, correct.

>> BERGMAN: Metha says he agreed to this interview, because he thinks Providian's reputation was unwarranted.

He believes they were pioneers who gave credit to those who previously did not qualify, the riskiest of borrowers.

>> There were 30 million to 40 million potential households, prospects have no credit cards.

So we said, "How do we meet the needs of these people who do not qualify for a regular credit card?"

>> BERGMAN: So, they're lower income people?

>> So, they're lower income people.

There were bad credits, there were bankrupts, there were young credits, there were no credits.

>> BERGMAN: They were called "un-banked people"?

>> We labeled them "un-banked."

That was the word that came out of Providian, the "un-banked" market.

And then, it became like an industry standard word.

>> BERGMAN: And so, your business took off?

>> And our business took off.

>> I got a Visa Gold with a $1,000 credit line.

>> People treat you differently when you have a gold card.

>> And with Providian, my credit just keeps getting better.

>> Visa from Providian.

We approve.

>> BERGMAN: People jumped at the chance to get a credit card, seeing it as a passport to a more affluent lifestyle.

And Providian was betting that these riskier customers were more likely to carry a balance.

So, what you were going after were the people who weren't going to pay their bill off in full.

>> In full, yeah, and if we do so, then we will be attracting the profitable segment of the credit card industry.

>> BERGMAN: And your hope was to keep them paying, basically, in perpetuity, right?

>> Their... >> BERGMAN: You never wanted them to really pay it off.

>> If they... if... if they make the minimum payment, yes, then that loan will take almost 20 years to pay back.

Absolutely.

>> BERGMAN: And you make more money then.

>> We make more money.

>> BERGMAN: When Providian began, Mehta ran the company with this man, Andrew Kahr, already a legendary innovator in the world of consumer finance.

Kahr spoke to us five years ago.

>> Many of the things that I've been involved with were in the back room, on the operating side.

>> BERGMAN: Kahr had a peculiar genius for enticing new customers with gimmicks that were too good to be true.

>> When you're getting something in the mail several times a week that offers you 0% for six months or whatever it may be, they look at the headlines of the solicitation in the mail.

They spend 30 seconds on it.

And, "Okay, I'm going to be better off at the beginning.

"They're going to give me something, they're going to give me 0% rate."

People believe what they want to believe.

>> BERGMAN: It was Kahr who came up with the ideas and Mehta who implemented them, and their innovations would help change the nature of the credit card business.

So, Providian wasn't alone.

>> Absolutely not.

They may have started it and maybe were the innovators of these bad practices, but they certainly were quickly adopted by everyone else once they started seeing the profit margins.

>> BERGMAN: Robert McKinley is a credit card analyst who followed the rise of Providian.

>> I mean, here they were giving away products with no fee and charging interest rates and making a ton of money.

And so, "Hey, let's do it, too."

And so, you know, it's... it quickly spread throughout the... the entire industry.

>> BERGMAN: One of the many Providian practices that spread was making people believe their credit cards were free by eliminating the then-standard annual fee.

>> We made it look like it's a giveaway, and took it back in the form of...

I used to use the word "penalty pricing" or "stealth pricing."

>> BERGMAN: So, the competition... increase in competition led to the use of penalty fees... bigger penalty fees?

>> Bigger penalty fees.

>> BERGMAN: And you were operating with your penalty fees like everyone else.

>> Well, we all had to make up somewhere, because everybody had to waive the annual fee to stay competitive.

Where do you make your money?

So everybody increased the late fees.

Everybody started increasing the over-limit fees.

When people make the buying decision, they don't look at the penalty fees, because they never believe they'll be late.

They never believe they'll be over-limit, right?

>> We were having some financial issues.

We'd changed careers.

>> BERGMAN: Elizabeth Blascruz learned all about stealth pricing when she got a credit card from one of Providian's competitors.

>> I got an offer for a credit card with a credit line of $500, so I was happy to take that credit card.

And that's kind of when it all started.

I remember when the balance was about $480 or so, and I was late on a payment.

They added on a late fee and increased my interest rate.

Well, that, of course, took it above the $500 credit line.

And with that, they charged me an over-the-limit fee.

That bill had maybe $60, $70 of fees, and every month, it was the same thing.

Unless I paid all that and more, which of course, at the time, I couldn't afford to do, there was no way I could ever get ahead.

>> BERGMAN: Blascruz says she ended up paying $3,000-- that's five times more in interest and fees than the original $480 she actually spent on purchases.

She was caught by the traps hidden in plain sight.

Credit card companies are required by law to explain the rules of the game.

It's called disclosure-- it's in those solicitations that come in the mail.

Even Shailesh Metha gets them.

Open this one for me and tell me what you think.

That's from Bank of America.

And on the back it says 0% intro APR.

>> Yes, but there is an asterisk or whatever that mark, so I have to now read that footnote.

I will have to remove my glasses to read it.

It says, "For this, see disclosure summary insert for details."

Now I have to find a disclosure summary, which is the one here.

So, on the outside, it says 0% intro APR; in here, it says that my APR is 11.9%, 15.9%, or 19.9%, right, and "the APR you receive is determined based on your credit worthiness," so I have no idea which one I'm going to get when they approve me.

>> BERGMAN: So, disclosure, you say, doesn't work?

>> I mean, look at how much time it takes for both of us to go through this.

>> BERGMAN: Yeah, exactly.

>> I think that your average consumer is not going to be able to translate what the real pricing is.

>> BERGMAN: Now, you put out statements like this from Providian.

>> We did.

We did, absolutely.

>> BERGMAN: Well, the criticism is that it's exploiting the customer, the fact that they don't really understand what's going to happen.

>> In a way, I will say yes.

In a way, the pricing was designed that it will require a degree of some sort to understand how many different ways I am paying and what I am paying.

I mean, borrow on a credit card, nobody knows what the real cost is.

>> BERGMAN: That would be true for this man, Don Bollinger.

>> I've always paid my bills, but I was running very, very lean and knew that if anything big happened, that I'd be in serious trouble.

And eventually, it did.

It really started when I found out I had tonsil cancer.

>> BERGMAN: Bollinger won his battle with cancer, but then he lost his job.

>> It was just a train wreck.

Because of a delinquent payment on a totally unrelated debt that I had, one of the credit card companies told me that they were going to increase my rate from, like, 8.9% up to 19%.

When I heard that, I immediately made a phone call and attempted to protest it.

Yes, sir.

I didn't understand at all.

I didn't understand how something not related to their loan, the money I owed them, would cause them to increase my rates.

>> BERGMAN: Soon after, Don Bollinger's other credit card bank also raised his interest rate.

That made even his minimum payments unaffordable and started a downward spiral of missed payments and fees.

>> It's not fair.

It's deceptive.

>> BERGMAN: But credit card companies say the practice has been a legitimate tool to limit their exposure to higher-risk customers.

>> In my cardholder agreement, I said that, "If you are delinquent somewhere else, I have a right to increase your rate."

Now, you may be delinquent on someone else for whatever reason.

Suddenly, my rate will shoot up from 21% to 28%.

>> BERGMAN: That's universal default, it was called.

>> Universal default, because they needed more and more stealth pricing, more and more penalty pricing.

>> BERGMAN: There is a reason why credit card companies have been allowed to make these sudden changes to the interest rate.

In the United States, credit cards have functioned within a system where it's legal for card issuers to charge any fee or any interest rate they want without limits.

>> The credit card industry has always been the Wild West.

The card issuers held all the cards.

They could do anything they want-- $39 late fees and $35 over-limit fees and 30% interest rates.

And yes, it got crazy.

Competition ramped up to such a level that it created an industry that was out of control.

>> BERGMAN: The industry got out of control because, over the last 30 years, regulations on banks and consumer lending that had been in place since the Great Depression were steadily eliminated.

>> The cops left the streets.

There was no one on the beat.

>> BERGMAN: Christopher Dodd of Connecticut is the chairman of the Senate Banking Committee.

>> Where were the regulators in all of this?

>> BERGMAN: He says that for decades both Republicans and Democrats voted for deregulation.

>> Look, I voted for it.

>> BERGMAN: You voted for the deregulation?

>> Yes.

But we were wrong.

And the message out there to the financial industry was, "Go ahead and do what you want.

"The market will take care of this.

The market will protect people."

>> BERGMAN: And that was the dominant ideology of the era, supported not just by Congress and the White House, but by the alphabet soup of bank regulators, like the Federal Reserve, the OCC and the FDIC, all of whom rarely intervened on behalf of consumers.

Some people have said that we had the appearance of regulation, so people thought somebody was watching, but nobody was.

>> Well, that's a fact.

We now know.

There was a lot of regulator power and authority out there, but they walked away from it.

It was an intentional decision where they literally knew they had the responsibility and made the conscious decision not to exercise the powers that they had.

>> BERGMAN: And the result for credit cards was that a system developed in which the affluent paid the least and the most vulnerable people paid the most.

>> This is one of the dark secrets in this industry.

People who are operating closer to the margin, those are the people who get trapped.

Those are the people who produce the enormous revenues in the system.

>> In a strange way, the banks were charging borrowers higher interest rates in order to give the wealthy people a break.

In a strange way, if you look at it, because the people who have money were paying in full, and they were getting the break at the expense of the people who couldn't pay in full.

>> BERGMAN: Mehta resigned from Providian in 2001 after the company had to pay $300 million following a rare investigation by federal regulators.

But if Mehta left the industry, the practices he helped create would live on, spreading throughout the world of consumer lending.

>> The Dow has lost nearly 1,400... >> BERGMAN: And then, the economy started to fall apart.

>> The drop in the stock market yesterday represented more than a trillion dollars in losses.

>> BERGMAN: The collapse of the stock market was triggered by a collapse in the consumer lending bubble.

>> More bad news on the housing front... >> Home foreclosures continue to skyrocket.

>> We are focused on the current economic crisis as primarily a foreclosure and mortgage crisis.

But what most people don't realize is that when sub-prime lending was really taking off, it was because people had credit card debt they couldn't afford, and the outlet was to refinance that debt into a sub-prime mortgage.

>> Find out how easy refinancing can be.

>> Combine all your high rate credit card debt into one easy loan.

Apply now.

>> You had consumers refinancing their homes and taking equity out.

And they would pay off all their credits cards.

>> I've got a four-bedroom house in a great community.

>> BERGMAN: There was a huge push to refinance through ads like this one.

>> Like my car?

It's new.

How do I do it?

I'm in debt up to my eyeballs.

Somebody help me.

>> What was happening is some of these consumers were already running out of rope; this just gave them a little more rope by consolidating.

And then, they went back out and, of course, built their credit cards back up.

>> You know, it doesn't take a rocket scientist to figure out that if you keep borrowing and borrowing in order to consume now, eventually you crash and burn.

>> Employers cut another 663,000 jobs last month.

>> Forecasters have said unemployment will continue to rise.

>> BERGMAN: And today, with double-digit unemployment, those credit card borrowers are increasingly unable to pay.

>> ...the truth, the whole truth, and nothing but the truth, so help you, God?

>> I do.

>> BERGMAN: Don Bollinger, like millions of others, had refinanced his credit card debt into his mortgage.

And so, when he lost his job, the extra debt he took on led him into bankruptcy.

>> That's all the real estate that you have?

>> Yes.

It's been hard.

And it still is.

For some of us, they just make it impossible to do the right thing.

I'm just some guy that's laid off, live out in the country.

But from what I see, it's just greed.

And you just struggle, and you keep praying that Washington will pass something that's going to reach down and help me and it never happens.

>> BERGMAN: In fact, in the U.S. Congress, there have been some who have argued for credit card reform for decades.

>> The list of troubling practices the credit card companies are engaged in is lengthy, and it is disturbing.

>> BERGMAN: But passing legislation to rein in the industry proved to be impossible... >> Consumers are trapped.

>> BERGMAN: ...because the banks are one of the most powerful lobbies on the Hill.

>> The industry got carried away, got arrogant, and they could never be beaten, so they could do whatever they wanted to.

And it was always, when I counted noses, I didn't have the votes.

>> BERGMAN: Senator Richard Shelby is the ranking Republican on the Banking Committee.

While he has never been known as an advocate for credit card reform, he has not always sided with the banks.

Why hasn't there been credit card legislation to control some of these abusive practices?

Why did it take a near depression to do this?

>> Obviously, it's lobbying power.

>> BERGMAN: Lobbying?

>> It's a powerful lobby group up here.

We need to proceed carefully, but we do need to proceed.

>> It's really hard to get a bill through the U.S. Senate when the industry is pouring money into Washington.

It's a very difficult environment to have a reform bill passed.

>> BERGMAN: Nearly every member of the Senate Banking committee has received large contributions from the financial services industry, including the chairman of the committee, Senator Dodd.

The financial services industry apparently has given as much as $30 million to the members of your committee over the last election cycle, $7 million to your campaigns.

>> Mm-hmm.

Lot of good it's done them, huh?

(laughs) >> BERGMAN: Are you saying they're wasting their money giving you campaign contributions?

>> No, not necessarily, I listen to people.

But anybody who thinks they can come in and make a campaign contribution and is going to get an outcome based on that is certainly terribly mistaken.

The need to reform credit card practice has never been more important... >> BERGMAN: Dodd points to the fact that he introduced legislation to take on the credit card industry earlier this year, as did his colleague in the House, Congresswoman Carolyn Maloney.

>> We can stop these abusive practices.

It had gotten to the point that I couldn't even go to the floor of Congress without hearing stories about credit card abuses, and it was really getting out of hand.

We need to protect our consumers, not... >> BERGMAN: Times were different now.

Many Americans were demanding change.

>> The Obama Administration had done its own polling and seen that there was deep anger and hostility out in the country towards credit cards.

And the administration knew that this would be an easy political target.

>> BERGMAN: People are angry out there, right?

>> Yeah, justifiably angry.

I mean, the system failed them.

>> BERGMAN: Timothy Geithner is the Secretary of the Treasury.

>> You know, we can't tell the American people that we're going to forget the damage caused by this and leave this system basically as it was.

We're not going to do that.

>> BERGMAN: But even with the new political realities, it would still be a big battle to get the legislation passed.

>> I didn't even know whether it was going to get out of committee.

Industry people were coming up, "Oh, Carolyn," you know, "we'll work with you on other things."

They were basically saying, "We know we've won, you've lost."

Everybody was smiles.

>> BERGMAN: In the end, the law made it through Congress.

It makes it more difficult for credit card companies to suddenly change interest rates, something that might have saved Don Bollinger and countless others like him from bankruptcy.

>> It ends the most abusive practices, like any time, any reason retroactive interest rates increases, practices that have trapped many Americans in debt.

>> But the real test of change, ultimately, is whether it makes a difference in the lives of the American people.

>> BERGMAN: By the time the bill was ready for signing, the Republicans had joined in, having won major concessions from the Democrats.

>> This legislation, while it is significant, probably the most significant in the card industry's history, it still doesn't go far enough to clean up a lot of the practices.

>> It was an important win in the sense that it said the banks may not completely own the legislative process anymore.

>> BERGMAN: But it wasn't really a great win for consumers.

>> It's a set of very discrete new laws, and the credit industry instantly set to work on how they could run around them.

By itself, that set of rules won't change the game.

>> BERGMAN: One battle the banks won was the ability to keep charging whatever interest rate they want.

>> This credit card bill does not regulate interest rates.

The credit card companies are able to impose an interest rate of whatever they want to charge; for instance, a penalty rate on a credit card if you're 60 days late.

So, here we are in a period of unprecedented unemployment, and everyone who loses their job is going to become 60 days late on their credit card bill.

What sense does it make to let someone, when they're down, get stomped on by increasing their credit card interest rate from 9% to 29%?

And even under this bill, that would still be permitted.

>> BERGMAN: Another major loophole in the law was an eight-month gap between the president signing the law and when the law would go into effect.

>> BERGMAN: Congress gave them eight months to put it into law.

>> My orignal bill had to go... the original bill I authored said it's effective the day the president signs it.

That was my original bill.

But I never would have gotten out of committee with that bill, so we had to change the dates on it.

I would have loved to have done it earlier than that, but I didn't have the votes to do it.

>> BERGMAN: The banks have used this time to full advantage.

They've locked their customers into higher interest rates on existing balances, cut credit lines and imposed more fees and penalties.

Pam Suwinsky is a freelance book editor who recently received a letter from her credit card company.

>> The first letter that I got was from Nordstrom Visa.

"Because you're such a valued customer, we know times are tough, we're making changes to your account."

And I thought, "Hey, this is great.

Maybe they're going to lower my interest rate."

But the small print on the inside said that they were going to raise my interest rate and that it was going to be retroactive to any existing balance that I had.

That alarmed me, but it didn't stop there.

>> BERGMAN: Soon after, the rates on two of her other cards went up.

>> I will say that I panicked.

I called and asked them why they had raised my rates.

What had I done?

And they said, "We just changed our terms."

I was someone who regularly carried a balance, so my minimum payments increased.

And as a result, my expenses tended to be way higher than I had expected them to be.

>> BERGMAN: Credit card companies are also lowering their lines of credit.

That's what happened to this man, Ben Collins, a home builder who relies on his credit cards to run his small business.

>> In the middle of a billing cycle, we received a letter that said our line of credit had been reduced from $35,000 down to exactly what was on the card that day.

Kitchen, we are all squared away on-- kitchen sink, drain.

The cards were useless at that point, so the employees that I have all had to basically be issued petty cash, which is very cumbersome and actually somewhat embarrassing.

It's embarrassing when, you know, you tell your employee, "Oh, don't use that credit card," when, you know, you're perfectly solvent.

They start to think, "Well, is my paycheck going to be good on Friday?"

>> Please hold and the next available specialist will be... >> BERGMAN: Collins called his credit card bank, Bank of America, to protest the cutting of his credit line.

>> And there's nobody that I can speak with at this point?

Okay, well, thank you very much.

They're having extremely high call volumes.

They can't even take your call right now.

So, my guess is the poor little six people in that department are busy now.

They're the few people who don't have to worry about their jobs at Bank of America.

Dead center here.

>> BERGMAN: The new Credit Card Act is not going to help small business owners like Ben Collins.

Their cards are excluded from the law.

>> It's a great oversight because companies like mine are the companies that are going to be the first line of hiring.

And the more difficult they make it for us to survive and thrive in this economy... it's disappointing, and it's left a bad taste in my mouth.

>> BERGMAN: A national survey says that more than 50% of Americans have had similar changes to their credit cards of one kind or another.

This means that tens of millions of Americans are now facing much higher monthly payments on their bills, which is especially tough in a bad economy.

>> I'm hanging on, is where I am.

I am doing as much as I can to increase my income, but at this time I feel more precarious than I've ever felt in my life.

>> BERGMAN: The banks have used this period of time to raise interest rates, cancel credit lines.

What's that all about?

>> The banks are scared of credit card losses, which have been piling up dramatically.

So, one way to deal with those losses is to try and make more money from everybody else, to put the burden on the people who were still paying.

It's really that simple.

>> BERGMAN: Frontline asked the major credit card banks for interviews, and they refused, referring us to their lobbyists, the American Bankers Association.

Nessa Feddis is a senior counsel and vice president of the association.

She says the increases in interest rates and the cutting of credit limits shouldn't be surprising.

>> Congress understood when they adopted the rule that credit cards would be more difficult to get, limits would be lower, and interest rates would be higher for everyone.

But they made the decision that that result was an acceptable consequence, an acceptable tradeoff for the sake of the consumers.

>> The industry is now saying that my bill is causing them to raise interest rates.

I mean, who are you kidding?

What have they been doing?

Changing the terms, raising interest rates unfairly retroactively on balances, changing the rules of the game.

>> BERGMAN: The complaint that led to this legislation is that the credit card industry was abusing its customers.

>> Well, the vast majority of cardholders manage their credit well, but there was a group that was confused, and that's what Congress and the press were reacting to.

>> BERGMAN: And those people, how many of them are there?

Millions?

The confused...

I mean, the people who are going bankrupt?

>> The vast majority... well, most of the people who end up in bankruptcy or who end up with credit card problems, the underlying problem isn't the credit card.

Most customers managed their credit cards well, understood them.

But there was a segment that was confused, and they realized it had to be addressed.

>> BERGMAN: But Senator Dodd and others have said to us, "The industry got arrogant."

You started using all these practices that created this problem.

>> Well, once Congress and the regulators identified the problems, they've addressed it, and the industry's moving on.

End of story.

They'll redesign their model based on the new rules, and based on the new... they're moving on.

>> BERGMAN: Faced with record losses, near collapse and a taxpayer bailout, the banks have become desperate for revenue and increasingly dependent on a still-unregulated source of profits in the card game... >> Debit or credit?

>> Debit.

>> BERGMAN: ...the fees they can charge on debit cards.

Like small business cards, debit cards were not included in the new legislation.

One of the criticisms of the bill is that you didn't include the debit card, which is a companion problem that's growing with consumers.

>> It was never in the bill.

But it was very, very difficult to pass this bill, and it was the feeling that including debit card reform would have killed bill.

>> Will that be debit or credit, Miss?

>> Debit.

>> BERGMAN: There are now more transactions with debit cards than with credit cards.

>> Debit cards right now are growing almost three times as fast as... as credit card usage is in the United States.

>> Can I have a 12-ounce, single espresso?

>> Because of the uncertainty that surrounds credit cards, consumers are abandoning their credit products for debit cards.

>> Norma, your vanilla latte is up.

>> BERGMAN: And consumers feel that debit cards are safer.

>> With debit cards, of course, you're using your own money.

But debit cards can be, under certain circumstances, even more expensive than credit cards.

>> BERGMAN: Because, just like your credit card, there is a trap built into debit cards.

That trap has its origins 20 years ago with an idea popularized by this man, Texas-based banking consultant Bill Strunk.

Strunk convinced banks that they should allow customers to overdraw their accounts and charge them a fee to do it.

What you saw 20 years ago... >> Right.

>> BERGMAN: ...was that people were writing checks.

If they bounced, they would often have to pay more than one fee to the bank?

>> Oh, absolutely.

>> BERGMAN: Plus to the retailer.

>> Plus late fees.

So, I'm saving them the $30 or $40 merchant fee and the late fees and let alone the embarrassment of it.

You know, it's not a nice thing to go home to your wife and tell her that, "Well, they bounced my check."

>> BERGMAN: And Strunk took it a step further by convincing clients to make the checking accounts "free" to entice more customers.

But was it really free?

>> Sure.

No service charge, no nothing.

No maintenance fees, nothing.

There was no charge whatsoever on the account.

>> BERGMAN: Except overdraft fees.

>> That's not in the fee schedules.

That's a separate fee.

>> BERGMAN: But is that what, in the end, would pay for the free checking?

>> Yes.

>> BERGMAN: The fees from that?

>> It would.

The two best marketing words in the United States are "free" and "all you can eat."

People love that.

So they love free checking, and it brought in a lot of customers that didn't have a checking account before.

>> BERGMAN: So why not offer them free checking... >> Right.

>> BERGMAN: ...and pick up the money... >> Other ways.

>> BERGMAN: The concept of paying overdrafts-- loaning customers money when their accounts are empty-- quickly caught on at banks across America because it was so profitable.

And those profits exploded when the banks began to attach debit cards to those free checking accounts, producing billions of dollars in revenue.

They don't charge a fee to give you a debit card?

>> They're free until you make a mistake, and then you'll pay dearly.

>> It's just easy when you have a debit card to use it, but one month I didn't get the deposit from my tenant, and I didn't realize it.

I bought a small pizza for $7 and ended up getting charged a $33 fee.

So it ended up being a $40 pizza.

>> BERGMAN: The bank covered the $7 dollar pizza purchase even though her account was empty, and then they charged her a $33 fee, the equivalent of over 24,000% annual interest rate for a one-week loan.

And, not knowing she was incurring overdraft fees, Wermuth continued making purchases.

All the while, she thought she was getting free checking.

>> When I signed up for the account, they told me that it was free checking.

And I asked if there was any hidden fees, and they said no.

But that month I ended up spending about $365 in fees.

I really felt like I was being gouged, and I called them, and they just don't budge.

>> BERGMAN: Wermuth also tried to get the overdraft protection shut off, but the bank told her it was an automatic service that could not be removed.

>> They just will not make any concession at all.

(phone ringing) >> This is Bill Strunk.

>> BERGMAN: Bill Strunk and the banks insist that, despite complaints like Wermuth's, most customers want the overdraft service, and most banks need it.

>> You need more income.

And I think there might be some improvement we can help you with.

>> BERGMAN: Strunk says his idea was embraced by the banks so they could compete with storefront lenders who offered short-term loans.

They're called payday lenders.

>> Payday lenders were proliferating like you wouldn't believe.

There's a consumer demand for short-term financing that the bankers didn't realize.

I used to ask the bankers, "Well, what are you going to do about that?"

They go, "I don't know.

"I don't know what to do about it.

I can't compete with those people," because they were open 24 hours a day, or seven days a week, or whatever the case may be.

And the point is that there's a demand for this thing.

>> BERGMAN: Across America, there are twice as many payday lender storefronts as there are Starbucks.

They're not regulated by the federal government, but they lend out over $40 billion a year.

California Check Cashing CEO Rick Lake runs a chain of 100 stores like this one, and he agreed to show us how a payday loan works.

>> BERGMAN: You wanted my ID?

With valid ID and proof of employment, and a checkbook, customers can come in for cash.

>> And you've been approved for the max, which is $255.

>> BERGMAN: They write a personal check, and the store holds on to it, agreeing to cash it on the day they are paid.

It's a small, short-term loan.

>> So, you're going to initial here.

>> BERGMAN: Oh, so there's a contract to sign.

>> Correct.

>> BERGMAN: They're not like one of those credit card agreements, are they?

>> They are contracts, but we do make sure that there's 12-point type on them.

>> BERGMAN: And then it's in Spanish as well.

That's it?

That's the whole thing?

>> So, the APR has disclosed, the fee.

You know exactly what the terms are.

There are no surprises, and there's no accumulating interest.

>> BERGMAN: This transaction is illegal for military personnel and is outlawed in 15 states and the District of Columbia because of those fees.

$255.

That $255 cost $45 in fees.

That's the equivalent of an annual interest rate of 460.08% for a two-week loan.

And the big problem with payday loans isn't just the interest rate, critics say; it's that people get trapped in a cycle of debt.

>> I was a single mother, and I would get payday loans continuously for five years.

Every time I got paid, I would pay it off, and I would get another one.

>> Actually, I didn't have quite have enough to meet all my bills, so... >> BERGMAN: This woman told us she came to get a payday loan to pay her off her credit card bill before she got a late fee.

>> So, you know, it's not too good, but, you know, if you're in a jam, you do what you have to do.

>> Whether you like the service or not, wouldn't you like to have the choice of using it?

>> BERGMAN: What people say is that this is a debt trap.

That you wind up at the end of every month taking out another loan to pay back last month's loan.

Not true?

>> "Debt trap"?

To me, the common sense definition of that is there's something unknown about the product.

You've been in our stores, you've seen our posters, you've seen our disclosures.

Did you at any time feel that there was something you didn't know?

>> BERGMAN: But to the criticism that the most valuable customers for you are the people who revolve continuously; that, in the end, the amount of money someone pays back may be far beyond the cost of the actual loans themselves.

>> Lowell, all I can tell you is that it's not the majority of our customers.

>> BERGMAN: But it's the most profitable part of your customers.

>> It's not the majority of our customers.

Now, it's no different than someone who, you know, pays a late credit card.

Would you say that they... they generate the most in fees?

Those that overdraft their bank account generate the most in service fees?

I mean, that is the reality of it.

>> BERGMAN: Well, the reality is that, in a sense, those who least can afford it... >> Right.

>> BERGMAN: ...pay the most in the banking industry in general and credit cards in general.

And it sounds like that's the same in payday lending.

>> It's...

I would say it's true throughout the finance world.

>> BERGMAN: Rick Lake says not only do the poor and those living paycheck to paycheck pay more, but it's difficult for them to find out how much they're paying when they go to a bank because banks intentionally never fully reveal to customers how their overdraft system works.

>> As long as you keep your account in good standing, as a non-contractual courtesy-- that's a big word-- we're going to... we're going to consider paying your checks up to $300, $500 in the overdraft.

>> BERGMAN: You used two words in there, "non-contractual" and "courtesy."

>> Right.

>> BERGMAN: Why those two words?

Why not just simply say, "We're going to," I don't know, "make a deal with you"?

>> Because we didn't want it to fall under other TILA regulations and so forth about lending.

>> BERGMAN: That's the Truth in Lending Act?

>> The Truth in Lending Act.

We didn't want to do that.

>> BERGMAN: The federal Truth in Lending Act requires an institution to reveal the annual percentage rate-- the cost of a loan.

And similar state laws do the same thing.

That's why you saw those posters in the payday lending store.

But the banks are careful to not call overdraft protection a loan; they call it a courtesy.

>> It falls outside of the Truth in Lending Act.

>> BERGMAN: And so, it's basically unregulated?

>> Yes.

>> BERGMAN: And you can charge any fee you want... >> Yes.

>> BERGMAN: ...theoretically.

>> Theoretically, that's correct.

Just whatever the market bears.

>> BERGMAN: So, from your perspective, if the banks were to be fair to their customers, they'd have posters up on their walls?

>> I think that that is the direction that financial services needs to head in, you know, so everyone knows exactly what they're paying and why.

To me, "predatory" means "not knowing."

And I would say that anyone that lends money without telling the consumer exactly what they're paying, that, to me, is my definition of predatory.

>> BERGMAN: Don't banks charge these fees over and over again, sometimes six, seven, eight, nine, ten times a month or more?

>> Some banks do.

>> BERGMAN: And the fees on the tiny transactions, on the small transactions, what you're doing is you're making somebody pay more in a penalty than the actual value of the thing that's bought.

That's why people are irritated by it.

>> They are irritated by that.

It would irritate me to.

>> BERGMAN: I got a $35 cup of coffee.

>> That's absolutely true, that's what happens.

That's why it's the consumer's responsibility to keep up with his checkbook, not the bank's responsibility.

It never has been the bank's responsibility, not from day one.

>> BERGMAN: Why can't the bank deny the purchase at the point-of-sale?

>> They could if they wanted to.

>> BERGMAN: But they don't.

They used to.

>> Some do.

>> BERGMAN: But you do agree that if you apply this fee structure in a way that takes advantage of the individual-- seven, eight, nine charges in a day on a debit... >> That's abusive.

I agree with that.

I agree with that.

>> BERGMAN: Bill Strunk says that many of the big banks have taken his concept of overdraft fees too far.

They do that by not processing checks and debit charges to your account in the order they are received.

They use a computer program so the banks can pick out the biggest amounts first and charge them against your account.

This empties your account faster, resulting in more overdraft fees for each of the smaller amounts.

There's no restriction on a bank ordering it that way.

>> No.

That's correct.

>> BERGMAN: And if they're going to make more money doing it that way... >> That's correct.

>> BERGMAN: That's a big temptation to do it.

>> That's correct.

>> BERGMAN: Scott Talbott is a Washington lobbyist for the Financial Services Roundtable, which represents the largest banks, and he defended this practice.

>> The program is set up to honor what the customers have told us they want.

We've set up on a high to low, right?

We've told you that up front; we were going to process them from high to low.

That's what customers have told us they want: "Process my mortgage first, process my student loan first, "process my car payment first.

And then, all the other transactions, the smaller ones."

>> BERGMAN: Which customers have told you this?

When?

No one ever asked me.

>> As I've told you, you asked me if there was a survey.

There wasn't a survey.

This is the years of working with our customers to find out what they want, and this is what they've told us.

>> BERGMAN: Even if they knew, and you told them at the time, that this may cost you more money in fees?

>> Yeah.

I mean, that's... we don't... again, there was no survey, per se.

We didn't set out... >> BERGMAN: Well, what is it based on then?

What are you basing it on?

>> It's based on years and years of experience with customers telling us what they want.

>> The banks feel a need to try and show profitability right now, and they've gotten so hooked on fees that it's almost like a Pavlovian reaction to a problem.

Oh, you know, losses are... losses are going up.

Well, we know how to solve that.

Let's just put on some more fees.

>> The banks want to be able to continue business as usual.

Indeed, they're scurrying around right now trying to figure out what other tricks and traps they can put in so they can drive up their revenues.

And with no cop on the beat, that's what they will continue to do.

>> BERGMAN: Elizabeth Warren is a law professor at Harvard and an advisor to Congress who has proposed a new way to regulate the banks.

>> We need an agency rather than Congress gearing up every 25 years and writing a few specific rules.

We need an agency that is responsive to the changes in the industry.

>> BERGMAN: In Washington today, Warren's idea has been taken up by the Obama Administration and its Secretary of the Treasury, Timothy Geithner.

>> Banks did a lot of bad things that should not have happened, and we need to fix the rules, make them tougher.

But you need to enforce them more fairly, more evenly across everybody who's in the business of providing a kind of credit product to a consumer.

>> BERGMAN: Geithner is a veteran of the Federal Reserve who once embraced financial deregulation.

But now he's in charge of imposing tougher regulation on the banks.

I have to ask, then.

You were at the Federal Reserve.

You had that authority.

Why didn't you do it then?

>> The Fed got a lot of things right, but the Fed did not move early enough to use the authority the Congress gave it to write stronger rules.

But even with better rules, the system wouldn't have worked well enough.

We got to fix it and make that better.

>> That is why many of us call for the creation of an independent consumer protection agency whose sole focus is the financial well being of consumers.

>> BERGMAN: Senator Dodd and the Democratic leadership in Congress have backed this new proposal.

>> And the administration has sent us a very bold plan for that agency.

>> BERGMAN: The agency would have regulatory powers across the entire industry: credit cards, debit cards, pre-paid cards, as well as mortgages and even payday lenders.

>> The idea is to create a brand-new agency because the current regulators-- the FDIC, the Fed, the Comptroller of the Currency-- have a fundamental conflict, which is on the one hand, they're supposed to look out for consumers.

That is part of their franchise.

But on the other hand, they're supposed to look out for the safety and soundness of the banking system.

And guess what?

When you gouge consumers, you're actually helping the safety and the soundness of the banking system.

>> We have significant concerns with the parts of the proposed CFPA... >> BERGMAN: The very same regulators who had failed to crack down on the banks lined up to criticize the proposed agency.

>> We see little benefit to regulatory consolidation and the potential for great harm.

>> You have a lot of people with a vested interest in what you call "regulatory turf," and they're trying to protect that turf.

>> We suggest as bank regulators we can do it more effectively.

>> BERGMAN: Behind closed doors at a meeting at the Department of the Treasury, Geithner would take those regulators to task.

The meeting included his former boss, Ben Bernanke, the chairman of the Federal Reserve.

>> Ben Bernanke was there, Sheila Bair was there, the other top regulators, and Geithner was using words that we couldn't print in the newspaper, using expletives to express his frustration.

Geithner made it clear to them that in his eyes what they were doing threatened to undermine the legislation.

>> BERGMAN: You got irritated with them.

>> Well, I'd like them to put the interest of the country ahead of the interests of their particular agency, because, you know, you can't look at the system and say it served the American people.

It basically failed.

And we are engaged in a just and necessary fight to basically change the things that were broken in our system and to reform and put in place a stronger set of protections.

>> The breadth of this proposal is, in many respects, shocking.

>> BERGMAN: But Geithner and the administration have more than the regulators to convince; the Republican leadership in Congress and many in the banking industry are opposed.

>> Well, I don't like it because I'm not a liberal.

I don't like the government dictating to bankers.

It's none of their business.

It's a free enterprise system.

Let the market work, and it will take care of itself.

I think this is a tremendous overreach and very disturbing.

>> This is a radical departure from the way we have regulated.

>> BERGMAN: Some in Congress say they fear that the new agency will stifle the free market, damaging the safety and soundness of the banks.

>> I think the safety and soundness of our banking system should be the number-one priority.

>> BERGMAN: The Republicans are united in their opposition to this Consumer Financial Protection Agency?

>> I think that the Republicans are interested in consumer protection.

We all are consumers.

But without safety and soundness, strong banks, there's no banking system, so you've got to have that.

I think that's paramount, number one.

And a close number two would be us as consumers.

>> BERGMAN: Senator Shelby says you cannot divorce protecting consumers from the soundness of the banks.

And if you divide it up, it's just not going to work, and you're going to create, he recently said, a "nanny state."

>> I don't think he's right.

We lived with a system where you had people responsible for safety and soundness doing consumer protection, and they didn't do a good enough job at that.

Consumer protection was diffused around a whole different set of agencies, so it was just a complicated mess.

And we're trying to do it for a simple, streamlining consolidation of that responsibility in one place.

>> BERGMAN: But there's one major issue that neither the proposed agency or the new credit card law will address.

Is there any chance the administration is going to back an initiative to cap interest rates for consumers?

A lot of people are now getting 30% interest rates.

>> There is some risk if you take that approach you're going to end up denying people who would otherwise be able to borrow responsibly access to credit.

So that's the tradeoff.

>> BERGMAN: And this is where Secretary Geithner and the industry agree, that there should be no cap, no limit, on credit card interest rates.

Why shouldn't you be limited in how much interest or how many fees and how big those fees are?

>> If the government were to place caps on interest rates or fees, then essentially what you have is the government setting the market.

The government is determining what the rate of interest or rate of return or the rate of fees should be.

And that will destroy our free market economy, which is the heart of capitalism.

>> We are in a historic low- interest environment right now.

Historic.

Treasury bills are practically at zero interest.

And yet, credit card interest rates are outrageously high.

They have not come down as interest rates have come down.

This is not the normal workings of the market vis-a-vis interest rates.

These are... in effect, they're phony rates that are ginned up by the banks to maximize their profitability.

>> BERGMAN: No one's proposing capping interest rates.

>> No, they're not, and they're not going to.

The Obama administration is very unwilling to do anything truly radical that would hurt the banks.

Nobody's saying you can't charge whatever interest rate you want, at least at this point.

And I don't...

I don't think that's going to change.

>> BERGMAN: While the argument over regulation goes on, the landscape for the consumer in America has already fundamentally changed.

It's simply harder to get a loan of any kind.

>> Between the new rules and the economy, we expect that it'll be harder for people to get credit cards.

So, we do know-- and we're already seeing it-- that small business and companies will have a harder time getting credit cards, limits are going to be lower, and interest rates going forward are going to be higher.

>> When I hear from the industry, "Oh, you're going to remove access to credit," I sort of shake my head and say, "Yes, that's exactly what's needed."

There needs to be less debt in this system.

Americans simply cannot pay back the level of debt that has grown over the last 30 years.

>> BERGMAN: But they bought into this.

This is the American way.

>> Well, if the great American economic value is translated to say, "We must provide debt to people who can't pay it back," then the great American way has lost its way.

>> BERGMAN: A long way from the arguments in Washington about laws and regulations, credit card pioneer Shailesh Mehta knows that that there are some fundamental truths about human nature and money and bankers.

>> Bankers will figure it out to comply and say, "As long as I'm in compliance with what the government says, it's none of anybody's business to tell me what to do."

That's the kind of mindset with which some people work.

"Tell me the rules, and then I'll outsmart you all."

>> BERGMAN: They'll find the loophole.

>> Yeah, because none of you are smart enough.

"You make the stupid laws, and I'll comply and I'll make money."

It's market will bear, you know?

And there are always some desperate people who will take the product.

Lending money to people is never a difficult exercise.

People will take money if you're willing to give them.

>> There's more to explore at Frontline's website, where you can watch the full program again online, plus extra video... >> People had credit card debt they couldn't afford.

>> ...read our extended interviews... >> The underlying problem isn't the credit card.

>> Justifiably angry.

I mean, the system failed them.

>> It's the consumer's responsibility to keep up with his checkbook.

>> Explore some other angles on this story.

What kind of credit products are used by the military?

Are credit unions a good alternative?

And what are the remaining fee traps for consumers, despite new regulations?

Then share your own stories and comments at pbs.org.

>> Next time on Frontline... >> What do you have to say for yourself?

>> How did Bernie Madoff do it?

>> The harder it was to get in, the more you wanted to get in.

>> A lot of middlemen, a lot of skimming.

>> And how did he keep it a secret for so long?

>> Nobody could get to him.

That's how he built his mystique.

>> You see a willful ignorance.

Nobody wants to get in the way and follow this money.

>> Inside"The Madoff Affair."

Watch Frontline.

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With major funding from the John D. and Catherine T. MacArthur Foundation.

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