Free Checking and Rewards Programs: Poor Subsiziding the Rich?

Those of us who enjoy “free checking” from our banks are likely to stop doing so in the near future, as the government is outlawing overdraft fees that prop them up.    Felix Salmon thinks this a very good thing:

Checking is never free, but in recent years banks have been able to conjure the illusion of free through a system of regressive cross-subsidies, where the poor pay massive overdraft fees and thereby allow the rich to pay nothing.

Kevin Drum concurs and adds:

Basically, what banks have learned is this: it’s mostly poor people who pay overdraft fees. That makes sense, of course: they’re the ones most likely to run out of money, aren’t they? The thing is, it’s easy to fool unsophisticated consumers into not noticing these fees, or into thinking that they’ll never have to take advantage of them. But banks know better. They know to three decimal places how often low-income customers are likely to screw up slightly and overdraw their account by twenty bucks. And when they do, they’re charged obscenely more than the actual cost of servicing the overdraft. So who benefits? I do. I always have plenty of money in my checking account and I’ve never overdrawn it. So the entire debit card system is, for me, free.

This seems obvious enough.  It really is outrageous to charge someone $40 for writing a check for $1 more than they have in their account.   Yes, people should know how much money’s in their account and avoid writing checks for more than that.  But there’s such a thing as proportionality.   And banks have insidious ways of piling penalties upon penalties in overdraft circumstances.   Given that banks have adopted this practice across the board, mere caveat emptor isn’t enough.

Not as obvious is the issue of credit and debit card rewards programs.


Interchange fees are a cross-subsidy too: this time it’s merchants who help pay for the checking accounts of the rich. In fact, they do more than pay for their checking accounts, they pay them a nice tax-free income, when the rich people accept debit rewards cards.


Banks charge merchants far more in interchange fees than it costs to actually run their payment networks, and merchants pay because they have no choice. Visa and Mastercard are functional monopolies, so if you want to do business with them — and what merchant can afford not to? — you have to pay whatever they tell you to pay. This cost gets passed on to consumers, of course, and the poor and working class pay it. The middle class and the rich, however, don’t: they basically get the fees rebated in the form of reward cards.

So you have two cases here of a system that costs money to operate, and in which the costs are largely borne by the poor in order to make them free (or cheap) to the better off. If you can sleep easily at night even after you understand how this works, you have a heart of stone.

Now, this is more complicated.   Rich and poor alike enjoy the convenience of debit and credit cards.  Merchants begrudgingly pay card issuing banks exorbitant fees and pass on this cost to rich and poor customers alike.   Presumably, in fact, the rich pay more since they buy more.    But they also get proportionately more of a rebate in the form of “points” that result in free air travel, hotel stays, and the like.   And, presumably, the rich are more likely to accumulate enough points to be worthwhile and, perhaps more importantly, have the money to take advantage of these “free” perks.   After all, once you get to the destination, you still have to pay for lodging, transportation, food, and whatnot.

While not rich, my wife and I are closer to that end of the spectrum than the other.   And we do in fact accumulate a lot of rewards points through both our personal and professional expenditures.    (Another way in which the well-off are more likely to benefit from these programs is through business travel.  Many companies allow employees to keep the frequent flier miles they accumulate on business.   And employees frequently use personal credit cards for business expenses, which are later reimbursed by the company, accumulating yet more points.)

Drum’s solution:

Simple: fees that are fair and transparent. Overdraft fees should cover the average actual cost of overdrafts plus a small amount. Interchange fees should cover the actual cost of operating an electronic payment network. Credit card interest rates should cover the risk-adjusted cost of actually loaning out money.

Beyond that, get rid of reward cards, which are surely one of the most ridiculous and unjustifiable frauds ever invented. Seriously: banks deliberately overcharge their customers and then rebate a fraction of it in the most circuitous and confusing way possible? And to make it worse, they do it in a way deliberately designed to transfer wealth from the poor to the rich?

I’m sold on the overdraft fees issue and tend to think he’s right on interest rates, although I don’t understand the business well enough to know for sure.

I’m not at all sold on the rewards card issue.  Granted, I benefit from them pretty substantially.   More importantly, though, they strike me as smart business.  The various incentives offered by banks and airlines are, first and foremost, loyalty programs.   While they have the effect of transferring wealth in an absurd direction, the intent is quite reasonable:  to encourage customers to prefer one product or service over a competing one.

Because it offers the best incentives, I use my AmEx Blue whenever possible, turning to a Visa card only when a particular merchant won’t take AmEx.  Similarly, when booking airline flights and car rentals, our default choice is Delta and Hertz, respectively, using competitors only when the cost differential is substantial, because we’re enrolled in their programs.   (Yes, we’re enrolled in mileage programs for every airline we ever use.   But Delta is the predominant carrier on the routes we fly most often and it makes sense to consolidate.)

Now, granted, there are other ways to achieve loyalty, including annual fees.   We shop at Costco more than we might otherwise because we’ve paid for the privilege.  Ditto Amazon, because we’re members of the Prime program.   But those are companies that had already earned our loyalty through excellent prices and customer service (including superb returns policies).

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James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College. He's a former Army officer and Desert Storm veteran. Views expressed here are his own. Follow James on Twitter @DrJJoyner.


  1. john personna says:

    “Those of us who enjoy “free checking” from our banks are likely to stop doing so in the near future, as the government is outlawing overdraft fees that prop them up.”

    Seriously dude, you told me that months ago, but I’ve still got my free checking and free credit cards.

    I don’t doubt that the industry is still floating trial balloons, but I don’t see it happening. Those of us without debt can switch too easily.

  2. john personna says:

    BTW, some banks actually pay you to open a free checking account, tying it to higher earnings on CDs.

  3. Franklin says:

    I’ve benefited from all of these programs. And it’s quite normal in the general sense – money attracts money. Almost every business wants rich customers, and they’re naturally going to reward them.

    The same is true for investment; who has the most money to invest? These are the reasons that I personally don’t mind progressive taxes, although the rest of the tax code is massively f**ked up.

  4. James Joyner says:

    Well, the regulatory changes are imminent now. My guess is that banks will figure out other ways to charge “hidden” fees and prop up free checking.

    And, frankly, the easiest way to do it is what they’ve done for years: charge for checking accounts but waive the fees for those who maintain a sufficiently large balance. Which, shockingly, is more likely to benefit the well-off and penalize the poor. But that’s at least justifiable: Those of us with large balances are providing essentially a free loan to the bank.

  5. john personna says:

    Remember that our current situation is skewed by 0% funds from the government for banks. You’d have to be a pretty bad banker to not make money in that situation.

    I do think there are good arguments for “simplicity” rules, and “simple description” rules on bank services to individuals, but I don’t think the best arguments are tied to class conflict. I think the best argument is that “simplicity” is fair to everyone.

  6. john personna says:

    BTW, if we did have a consumer protection agency similar to the FDA, it would probably rule against all those stupid commercials where you are encouraged to “save more” by spending more with your credit card. The one now with two brothers who compete to spend is particularly egregious.

    I’m not sure we need that level of nanny oversight … but I think it might come down to how many citizens are foolish enough to believe those ads, rather than what the abstract philosophy of it. That is, if many fall for it, then we might need the protection after all.

  7. I’m curious, but what is preventing you, Kevin Drum, or any other high-minded pundit from opening a financial institution and charging what you believe are socially just rates for overdrafts, credit cards, etc? Other than a desire to order others around and tell them what to do. For their own benefit, of course.

    Stupid freedom. The sooner we stop expecting people to be responsible for themselves and submit every facet of their lives to the control of experts from Washington the sooner our Progressive Year 0 Utopia can be implemented.

  8. john personna says:

    Charles, if we didn’t have an FDA, and Patent Medicine types could advertise that “radioactive ring cures arthritis” on TV … would you be making the same argument? “What’s to prevent James and Kevin from opening an honest medical company?”

    To be clear, I don’t think this answer is obvious, but neither is it easy.

    I’m not _certain_ than an FDA like thing wouldn’t be a bad idea. A “consumer protection agency” was recently debated in congress. I believe the current financial reform bill puts the “consumer protection” job with the Federal Reserve rather than with a separate agency. I’m skeptical that they’ll really be for simple and honest relationships. I fear that they’ll OK those “save money with your credit card” ads. YMMV.

  9. floyd says:

    Perhaps, if there is any credibility to the article at all, it should read…
    ” the incompetent subsidizing the competent.”
    When I was poor , it was much easier and more of an imperitive to keep track of my money.
    While I too have moved a little further from the poor end of the spectrum over the years, I am still unwilling to allow the attachment of a “debit card to any of my accounts.
    My wife and I kept a notebook of literally every penny of expenditure and income until it became unnecessary to do so.
    I know a man who uses his debit card for every small purchase and once ran up nearly $200 in fees with no purchase over $10.
    These ridiculous fees can easily be avoided by due diligence and the only possible connection to poverty is that “it is hard to find a diligent man in need”, or perhaps,as Aesop warned long ago….
    “A fool and his money are soon parted.” Rich or Poor!

  10. floyd says:

    Those who consistantly maintain low balance are the true burden on banks and perhaps the overdraft fees are the only entries occasionally shown on the black side of the ledger. So they probably don’t subsidize themselves , let alone their competent peers.
    The fuel guage on my car tells me when it has enough to continue driving, if I ignore it, I had better be prepared to walk, but then, if you’re rich enough …. your hybrid does have a little “overdraft protection” doesn’t it?[lol]

  11. Dave Schuler says:

    Free checking was the exception rather than the rule until fairly recently. And, as the man said there ain’t no such thing as a free lunch. Banks don’t operate as charitable institutions and they’ll take their cut one way or another.

    It would be nice if charges were transparent and plain language agreements would be handy. There would still be a sucker born every minute.

  12. john personna says:

    If I recall correctly, I got my first free checking account right around Regan’s deregulation. I think I got it from a savings and loan.

    Basically the problem any bankster has, who wants to raise fees, is that there are too many out there who will see it as a sufficient inducement to gain an account. Right now Schwab pays me interest on a free checking account. They even reimburse foreign auto-teller fees. They don’t do that because they are nice guys.

  13. wr says:

    Thank you, Floyd, for pointing out the “conservative” answer to every problem — if only those lazy poor people would accumulate a little wealth they wouldn’t have any problems at all.

  14. steve says:

    “Stupid freedom.”

    The key here is transparency. Konzcal has run an off and on series on this issue. The complexity in credit card agreements is difficult for even finance lawyers to read. I would think that if your goal is to maximize liberty, you would want transparency in transactions. This should be true in bank accounts as well.

    Suppose the whole banking industry had some degree of real transparency in the 2000s. Wouldnt it have been nice to know the value of the shadow baning system that was being created?


  15. floyd says:

    Apparently, Your reading skills are deficient. You are the one using such derogatory words as “lazy”. Since I found myself sitting on the curb without a dime or any means of support at the age of 12 , I think I know a little about what it means to be “poor”.
    Being responsible leads to prosperity ,encouraging bad habits , like overdrafting accounts, leads to poverty.
    It is clear that your condescending attitude implies that the “poor” need you to support them since they are too inferior or incompetent to learn fiscal responsibility. I think you are a bit smug to look down the ever increasing length of your nose at “those people” for whom you would rather “give a fish than allow to fish “.
    You go ahead and encourage “laziness” if you choose, but it is a far better service to encourage diligence and self-suffiency.
    Charity for the poor is admirable, but it is simply bad judgment to suggest that being “poor” is an excuse to pay a $26 overdraft fee for a $1 purchase. A “poor” person is just as capable of checking his account balance before a purchase as you are.
    Would you support a person’s right to write bad checks just because he is “poor”? OH! Perhaps you might, since that is just what our present government does everyday, elected by those who support that philosophy.
    I have been financially poor, but I chose to hear the voices principle, instead of the blathering agents of co-dependency.

    BTW, I think your debit card aught to fail for insufficient funds instead of triggering an overdraft penalty, or at least allow that option in your contract. Penalizing an empty account makes little sense anyway. An ounce of prevention is still worth a pound of cure.

  16. John Personna, why don’t you try to address what I actually wrote instead of trying to change the subject, or is it that you cannot?

    Dr. Schuler and Steve, I’m all in favor of transparency and will happily patronize your bank if you offe r competitive rates with transparency. Of course, that may be difficult if you have to engage bribing Senators and Ccngressman as the major banks seem to do today to advance their interests at the exense of ours. Perhaps if the government didn’t think that everything under the sun was under their purview the rent seeking might be a little more controllable. Say, do we know yet who got the TARP money?

  17. john personna says:

    Charles, you wrote:

    “I’m curious, but what is preventing you, Kevin Drum, or any other high-minded pundit from opening a financial institution and charging what you believe are socially just rates for overdrafts, credit cards, etc?”

    And that’s what I replied to, with an FDA parallel.

  18. john personna says:

    BTW, Floyd is at least being honest. He knows that unregulated banks don’t protect everyone. He’s saying if people can’t handle it, screw ’em.

  19. floyd says:

    I think it’s John personna who said… “if people can’t handle it, screw ‘em”.

    Although crude and dispassionate, the statement is unambiguous, and therefore has some merit.
    I maintain that self-control is a virtue and that there is no empirical evidence that improvement can come without consequences.
    Until you can learn to drive responsibly… walk.
    Until you can handle a debit account …. use cash.
    I have refused to accept debit cards, without regard to the “rewards” to encourage their use, or the penalties for their misuse, and am doing just fine without them.
    Don’t touch the hot stove , don’t play in the street, don’t stick you finger in the socket, don’t drive drunk… there are consequences people! The person warning them isn’t saying “screw’em”….. they’re screwin’ themselves.

  20. john personna says:

    I think it would be easier to warn them if we made consumer banking and credit rules simple and transparent. If a car application said it offered 15% interest, it wouldn’t include a “(***)” that pointed five pages back to say that it could be raised to any level the bank saw fit, when they noticed any change in borrower’s credit situation. There are cards that do that now.

    It doesn’t affect those of us who pay off our cards either way, but it’s pretty hard on people trying to get their house in order.

  21. floyd says:

    I agree, a credit card contract shouldn’t be more than one page long…..
    As Kingfish used to say…
    ” Yes suh Amos, ya know the big print giveth and the fine print taketh away!”

    But then…
    Any new law should have one purpose only and that purpose should stated in the title.

  22. john personna says:

    excellent … i have achieved agreement with floyd