Laura Rowley Money & Happiness

Over a 12-month period, the nation's banks garnished more than $170 million in federal benefits such as Social Security and disability payments on behalf of creditors, even though federal law specifically prohibits the practice, according to a new report by the Inspector General of the Social Security Administration (SSA).

A Spreading Crisis

Last November, I wrote a column about the problem, in which banks freeze the accounts - sometimes repeatedly -- remove the funds, and hit the account holder with non-refundable fees. For one in five seniors, Social Security is their only income, and for two-thirds of retirees, it accounts for most of their income.

The issue began back in the mid-1990s, when the government mandated direct deposit of federal benefits to save money. As of last December, the SSA had electronically deposited more than 80 percent of Social Security and disability payments. The crisis has mushroomed amid rising consumer debt levels, and the growth of third-party debt buyers who flood the civil courts with claims and exploit advanced technology to track debtors.

Last year, several senators asked the SSA Inspector General to investigate the scope of the problem, and it published the audit earlier this month. "We estimate approximately $171.4 million in garnishments could be attributable to beneficiaries receiving direct deposit of Social Security benefits and additional direct deposits," the report states. Another $6.3 million was deducted from accounts that only contained Social Security benefits.

Worst-Case Scenarios Only

The Inspector General polled a small sample of 25 financial institutions, which included the nation's 12 largest banks (although they weren't named). The report looked at the worst-case scenario - seniors whose funds had disappeared. It didn't examine how many seniors had their accounts frozen and later gained access to their funds through administrative or legal appeal.

"A good proportion of people who are doing without temporarily -- and that may be days, weeks, or months -- are not even captured in the [report]," says Margot Saunders, counsel with the National Consumer Law Center (NCLC), who testified before the House Ways and Means Committee on the issue in June.

Meanwhile, banks charge non-refundable fees of $100 to $150 to freeze the account, and often overdraft fees, because the seniors continue to write checks or make debit payments without realizing the money has been frozen. Seventeen banks that responded to the SSA Inspector General's audit reported collecting just over $1 million in fees for legal processing and non-sufficient funds between September 2006 and September 2007.

Regulatory Confusion

Why do some banks violate the Social Security Act? Although consumer advocates say that the federal law is clear, and electronic deposits are easy to track, industry representatives disagree. "When you're talking about volume and subjectivity, it's much harder than it seems," says Nessa Feddis, vice president and senior counsel for the American Bankers Association in Washington, D.C.
 
Feddis says debt collectors hit the large banks with up to 6,000 default judgments a month, which require a response by a specific deadline. Moreover, federal law does allow Social Security benefits to be garnished for alimony or child support, and the banks can't always tell whether the judgment is for that purpose, she says. If they decline to freeze the account, they can be held liable for ignoring the state court order.

Additionally, the rules aren't clear on what a bank should do with commingled funds, Feddis argues. "If you get a $500 gift and $500 from Social Security, and you take $600 out, is what's left exempt or not?" Feddis says. "The banks have to figure out whether to freeze the funds or not, for how long, and what to do if they get a deposit a month later. It's gets a little frustrating, because we are trying to do the right thing. We have worked with Congress and regulators to come up with a single, simple regulation."

Protective Measures

Despite meetings this year among the banking regulators, those rules haven't been issued. In the meantime, states are stepping into the void with their own strategies to shield consumers. New York governor David Paterson is expected to sign legislation this month that would automatically protect the first $2,500 of a depositor's money from being frozen if the account received Social Security funds through direct deposit in the previous 45 days. California and Connecticut already have similar laws.

Account freezing "continues to be the number one call that we receive to our legal hotline and the numbers of filings and judgments are going up every year," says Claudia Wilner, attorney with the New York-based Neighborhood Economic Development Advocacy Project. "We really like the [legislation] for ease of administration and protection of the account holder. It would be great to see a system like that in place all across the country."

But in most other states, consumers are left to fend for themselves. Henry Woodward, attorney with the Legal Aid Society of Roanoke Valley, says he continues to see the problem of frozen account in Virginia.

"The usual bank account garnishment doesn't run more than a couple months at most, because after losing a month's money most folks know to call Social Security and cancel their direct deposit," says Woodward. "The government says [direct deposit] is the way to keep money safe, a statement that has been dripping with irony the last ten years. It's not a good idea to push it until they can protect it."

Congressional Action at Last?

Some members of Congress agree. Last April, Sen. Herb Kohl (D-Wis.) introduced the Illegal Garnishment Prevention Act, which would prohibit the use of funds to promote the direct deposit of Social Security benefits until adequate safeguards are established to prevent their attachment and garnishment.

Saunders says back in 1994, when Congress passed the direct-deposit law, the NCLC asked for protections for low-income recipients of federal benefits to ensure they couldn't be garnished.

"No one knew what we were talking about," she recalls. "But the problem has become more severe in recent years because of third-party debt buyers and technology. It doesn't make sense that taxpayers should be spending hundreds of millions of dollars to keep the elderly and disabled out of poverty and allow [creditors] and banks to make a profit off those people when garnishment is not legal."