You load sixteen tons, and what do you get?
Another day older and deeper in debt.
Saint Peter, don’t you call me, ’cause I can’t go;
I owe my soul to the company store…

That’s the chorus to an old coal mining song first recorded by Merle Travis in 1946. When he talks about the company store, he’s talking about the truck system that coal mining companies used to keep their employees in debt. Instead of paying them in cash, workers were paid with vouchers that could only be redeemed in stores owned by the company with prices set by the company, too. If you didn’t have enough scrip to pay for your necessities, then the store would be happy to put it on your tab. Of course, that means you were never allowed to quit working for the company as long as you were in debt to the company store. And without any cash coming in, you couldn’t save up, shop elsewhere, open a savings account or otherwise invest in your own future. That’s why they called it debt bondage.

Keep on Trucking

Fast forward 60 years and the world’s largest private employer is paying its workers with prepaid debit cards instead of with paper checks. The press releases bill it as a convenience for their workers – they won’t have to come into work on their day off to cash their checks, they can get cashback for free at the register when buying groceries and other essentials from their employer. And with less paper, it’s “greener,” too. Greener, perhaps for the Earth. Greener, too, for Wal-Mart, MasterCard and First Data – the latter two of which reap a profit each time one of these cards is swiped. Greener for employees’ wallets? Maybe not.

Yesterday, the New York Times ran a story on the high cost of prepaid debit cards which gave real world confirmation for findings already confirmed by an earlier Consumer Union study on prepaid cards. The article, which noted that prepaid cards have long been the only viable alternative to low-income individuals and immigrants who cannot set up bank accounts (the “unbanked” in industry parlance). Prepaid debit cards deliver workers from the inconvenience and exorbitant fees associated with check cashing stores, low balance fees and overdraft penalties. But with the credit card industry grasping for more ways to increase the bottom line, it seems that prepaid debit cards are quickly becoming equally as unattractive as the seedy payday loan joints.

As well as having “little regulatory scrutiny,” NYTimes highlighted how the hidden fees of prepaid debit cards can add up:

The MiCash Prepaid MasterCard docks cardholders a $9.95 activation fee. Like many competitors, it then charges numerous recurring fees, including $1.75 for each A.T.M. withdrawal, $1 for each A.T.M. balance inquiry, 50 cents for each purchase, $4 for monthly maintenance, $2 for inactivity after 60 days and $1 for a call to customer service.

The Millennium Advantage Prepaid MasterCard goes further, listing an application fee of up to $99. The Silver Prepaid MasterCard advertises that it does not charge for overdrafts as many debit cards do, but it gives itself the option of charging a $25 shortage fee if customers exceed their balance.

Meanwhile, as pointed out by the article, the low balance fee for checking accounts averages out at $10 – a pittance compared to the extensive hidden menu of a la carte fees that are served up alongside most prepaids. In addition to these fees, Consumer Union pointed out the following:

• Dormancy fees levied for inactivity
• Fees for closing account and redeeming remaining funds
• “Loading” fees for adding money to balance
• “Bill pay” fee if card is used to pay recurring monthly expenses (utilities, rent, subscriptions)

With fees for spending money and fees for not spending money, it seems that your damned if you do and damned if you don’t. The inactivity fee discourages saving and the redemption fee ($10 to $15) makes it costly to get your money out to put it elsewhere.

High Bar for Checking Accounts

With everything so grim, why don’t people just get checking accounts? After all, Wal-Mart is also offering employees the option to have their pay transferred via direct deposit. Why can’t these people just pop into their local banks and open up a checking or savings account? It’s not that easy.

For those with thousands of dollars to deposit and a relatively decent credit history, opening a checking account is a fifteen minute task that can even be done online. But for those living paycheck to paycheck, there are quite a few hurdles.

As mentioned above, banks commonly levy low balance fees for checking accounts, which is bad news for those who consistently dip below a few hundred dollars. Also, when blindsided by those fees, consumers can inadvertently overdraw their accounts, leading to the notoriously costly (and unfair, according to most) overdraft fees. In fact, these overdraft fees are so unpopular, many are calling for strict regulations or outright abolition. But even that would have negative effects on low income consumers.  Zac Bissonnette makes a valid point over at DailyFinance:

Here’s the problem with eliminating overdraft fees: It will encourage banks to turn away many low-income, low-asset customers, forcing them into the shadowy market of check cashing services, Western Union money orders, and payday lenders.

[...]

With the exception of high net worth customers, the only way for banks to make money off of checking accounts is to nickel and dime people with bogus fees. That’s how we ended up with the overdraft racket: It was a natural outgrowth of a fundamental shift in the financial habits of Americans.

So here’s my question: If you have a person with a credit score too low to qualify for credit cards and an average account balance of $100 — far too low for a bank to make any money lending with — why would a bank accept that person as a customer?

In an interview with The New York Times, economist Michael Moebs said that 45 percent of the nation’s banks and credit unions earn more from overdraft services than they make in profits. In 2009, banks are projected to rake in $27 billion on checking account overdrafts. Without those fees, many weaker financial institutions could fail.

The ugly truth: banks make a killing off the fees that they charge the lower income, supposedly less responsible consumers. That’s why upstanding customers enjoy free checking accounts, low interest rate loans and tidy returns from money market accounts and CDs – it’s partially subsidized by the fees that other customers are forced to pay. Take those away, and the fees will trickle up and those with little money to offer the banks will simply be turned away.

Blacklisted by Banks

There are more ways you can be denied a checking account than having simply too little money. When you apply for a checking account, banks will run your name and Social Security number through a couple consumer reporting databases. Most often, this is the Chex Systems list. This is different from a credit check and not all banks use the same system. But if you do end up on the list, banks will use this as justification for not letting you open an account. So how do you get on the banker’s blacklist? If you had checks that bounced, overdrew your account or had a delinquent account closed by you or another bank, it’s likely that you’ve made the list. You can also wind up on the list if you’ve been the victim of identity theft. Reported records remain on blacklists for up to five years. Luckily, there is some recourse – you can order your report and dispute items on it just like you can with your credit report. But until you clear your name, you will likely be turned down by most major banking institutions.

Of course, you can open a secured checking account to bypass the Chex Systems blacklist. But you’ll have to save up $1,000 to $2,000 in collateral just to buy the bank’s good faith. Raising that kind of money as someone who has had troubles with overdrafts and low balances in the past is an understandable long shot.

For more info, check out the Chex Systems FAQ.

No Checking, No Cash, No Credit

For low income consumers, as we’ve seen, there is a premium on receiving cash, getting a checking account and even using a prepaid debit card. Taking that into consideration, it’s no surprise that getting credit is nearly impossible. Prepaid debit cards, though they look, feel and act like credit cards, do not help consumers build credit. And with no access to loans from a bank and no revolving credit, there is little means for one to establish credit in order to qualify for a favorable card.

Again, there are cards specifically designed for those with little to no credit history. But just like prepaid debit cards, these cards come with a plethora of fees in order to compensate the considerable risk that the credit card issuer is taking on a lower income individual.  As BankRate points out, these “subprime credit cards” are quick roads to debt:

For example, Continental Finance’s MasterCard promises an initial credit limit of $300. “Great,” you think. “That should help in a pinch.” Don’t count on it. In the same paragraph of the terms and conditions that states the credit limit, it also says that the prospective cardholder promises to pay an “Annual Fee of $49, Account Processing Fee of $99, Program Participation Fee of $89 and monthly Account Maintenance Fee of $10.”

For the mathematically challenged, that maintenance fee works out to $120 a year. Then in bold print, the bank does the math for you: “Your available credit after these charges will be $53 at Card issuance.”

That’s right: Before you’ve even signed your new credit card, you’re in debt $247. And if you’re so desperate for credit that you have the card rushed to you, Continental Finance will add a $25 “Courier Delivery Fee” to your bill.

The alternative? A secured credit card is a good way to go, but again, you’ll have to put up $1,000 or more to buy the lender’s trust. There are also prepaid credit cards where your credit line is commensurate with how much money you’ve paid beforehand, but this model is scarcely  different than a prepaid debit card.

What are your options?

Admittedly, the scenarios presented here are a bit speculative. Wal-Mart is the only known major employer to implement the prepaid debit card payroll scheme. But when one considers that way consumers can pay in the U.S., there seem to be few attractive options for low income individuals. Cash is expensive to attain, and often lands in line at unsavory, unscrupulous and poorly regulated check cashing operations. Prepaid debit cards are laden with fees and limit where and how you can spend your money. Checking accounts are getting harder to attain and credit, as always, is tight as a drum. No matter what you choose, it seems that you are levied a fee for having very limited spending power.

There is a three-way struggle in the financial industry. We see the credit card companies and lenders fighting to remain solvent and profitable in a tumultuous economy where consumers borrow beyond their means and often default. We see consumers, fighting back against hidden fees and unfair lending practices. And we see the government doing its best to regulate an ever-changing, multi-faceted industry with immensely powerful lobbies.   Whenever ground is gained on one front – for example the Credit CARD Act recently enacted under the Obama administration – there is an equal or greater reaction from the opposing force – for example, the new fees and slashed benefits in the post-CARD Act era. Consumers, it seems, have the least clout in this conflict. The only way we can vote is with our dollars – most of which we already owe to the company store.

Related posts:

1. Hit ‘em High, Hit ‘em Low: Credit Cards for the Rich and the Poor
2. Banking 101: Deposit Account Holds
3. The ‘12 Days of Christmas’
4. Debit Cards Vs. Credit Cards: Plastic Showdown
5. Decoupled Debit Cards