Direct Deposit: Fix it Carefully

Direct deposit of wages and benefits is one of the great financial innovations of the last 30 years. It saves employers and benefits providers millions of dollars in both the purely administrative costs of writing checks and the hassle of replacing checks that are lost or stolen; it provides workers and benefits recipients with quick, safe and reliable access to their funds; it encourages those who are unbanked to move into the financial services mainstream; and, when the payors use their market power to cut good deals, it can mean higher quality financial services at lower prices for lower-income recipients.

In 1996, Congress told the Treasury Department to pay all recurring payments to individuals, such as Social Security and military and civilian retirement benefits, electronically. This mandate has been modified and scaled back, and the transition was not always successful. Nevertheless, Treasury's experience during Hurricane Katrina, when those with direct deposit got their funds, even if with a short delay until they could access their bank account, whereas those relying on checks often went months without funds, convinced the Department to make a new push to move everyone to electronic transfer, through direct deposit to either a bank account or to a well-designed, consumer friendly prepaid card.

But no good deed goes unpunished in the financial services world. High cost lenders noticed that the income stream of Social Security recipients could now be tapped into reliably, notwithstanding the federal prohibition against assignment of such benefits, by directing the recipient to direct deposit the check into an account the lender could tap first. When lenders engaged in similar behavior in South Africa, taking entire government paychecks to repay high-cost loans, the government responded with a major overhaul of the regulation of credit, complete with limits on interest and fees. Here, the Social Security Administration is attempting a more nuanced approach, asking for information about a specific type of arrangement, the master/sub account, which has facilitated high-cost lending and other abuses. As SSA noted in its request for comments, "by obtaining information about these arrangements . . . we can revise our payment procedures to help beneficiaries avoid some of the unfortunate outcomes that may result when they enter into agreements with some payday lenders."

So far, the payday lending industry is not commenting. It will be important that SSA, as well as Treasury and others interested in direct deposit, keep their eye firmly on the difference between direct deposit and the ability of some to abuse it. The abuses need to be stopped. A direct deposit system that cannot be hijacked is better for payors and recipients. But as SSA recognizes, the process of preventing abuse must also preserve the functionality of a very effective system.