Junk fees or junk policy?

The new Director of the Consumer Financial Protection Bureau (CFPB) Rohit Chopra launched an inquiry into so-called “junk fees” on financial products, such as bank overdraft fees, late payment fees, and the myriad fees assessed when closing on a home purchase. And to be sure, nobody—including us—likes being dinged with an unexpected fee. But an overly-broad regulatory crackdown on bank charges could undermine the market discovery process that maximizes consumer access to the financial system and avoids forcing responsible consumers to subsidize higher-risk customers.  

Consumers today feel bombarded by complexity and confusing price terms, and financial services are no exception. Sellers must balance our desire to pick-and-choose what we pay for against the simplicity of an all-inclusive price. “Pick and choose” pricing can result in a bewildering list of seemingly small “ticky-tack” fees. One-size fits-all-pricing requires us to pay for services we don’t actually use. Striking this balance between simplicity and value is not as simple as it looks.  

In many industries, pricing is all in – a single upfront price entitles us to the full range of what may be a complicated bundle of services. Typical pricing plans for cable TV, cell phone service, or internet service providers are examples. We choose the package we want up front, pay a price up front, and we’re done.  

Competition leads to upfront pricing when that is what consumers prefer. For example, early cell phone pricing schemes were complex, with separate prices for incoming calls, outgoing calls, text messages, and who knows what else. Competitive pressure to attract consumers who found such plans confusing, along with changes in technology, led to the much simpler unlimited plans that prevail today. Jeff Bezos built a trillion dollar empire by offering unlimited “free” shipping for one upfront annual Prime membership fee.  

Other goods and services are sold with more complex pricing, with an upfront price for the basic service, and additional, optional fees for additional services. Air transportation is one example. Before airline deregulation, prices were all-inclusive, including baggage handling, food, and often a first-run movie. Competition brought discount airlines offering lower up-front prices for ordinary Americans who just wanted low-cost transportation without subsidizing services they didn’t need. Today we pay one price for a seat and additional fees if we want to check baggage or purchase food or beverages. More complex pricing is much cheaper for ordinary travelers. And consumers can choose free checked bags and cancellation from Southwest, or to pay Spirit Air for a bag of peanuts.  

Unbundled pricing is particularly attractive when only some consumers choose certain services, because unbundling allows those who want additional services to obtain them without shifting the costs to others who do not. All-inclusive vacation packages are a particularly bad deal for someone who does not drink, because the upfront price must cover the often significant alcohol consumption of those who do.  

So-called “junk fees” on consumer financial services are often are designed to impose costs on consumers who generate them rather than forcing others to subsidize their behavior. Credit card late fees deter late payments and their associated costs while only world travelers pay foreign currency transaction fees. A single upfront price would require the rest of us to subsidize both delinquents and globe trotters, hardly an equitable outcome.  

Striking the balance between two things consumers value — transparency and simplicity — is a delicate task. But the sorts of regulatory interventions that Director Chopra is now contemplating often make discovering the best balance more difficult.   

Ill-conceived limits on bank fees can harm consumers. For example, when regulators limited on access to overdraft protection, banks scaled back free checking, imposed new fees, and eliminated services. Similarly, the Credit CARD Act limited the ability to impose higher costs on riskier borrowers, forcing all consumers to subsidize later payers and reducing credit access for higher-risk consumers.   

And what about that long itemized list of fees when you purchase a home, such as appraisal, credit report, and flood insurance fees? That too is required by arcane provisions of federal law, which effectively prohibits lenders or third-parties from offering a “bundled” suite of all those services in one package for a guaranteed price. Removing this restriction would be a good place for the Bureau to start.   

Of course, consumers need access to information about both the structure of pricing and the details of the fees that matter to them. But marketplace competition over pricing structures is far more likely to satisfy consumer preferences than the dictates of the Bureau-ocracy.  One “fee” we are confident will never be disclosed is the cost of complying with CFPB regulatory requirements. The Bureau should make sure we aren’t paying for junk.    

Howard Beales and Todd Zywicki are former senior staff members at the Federal Trade Commission and members of the Consumer Financial Protection Bureau Taskforce on Federal Consumer Financial Law last year.