I described the effects of the Durbin Amendment to the 2010 Dodd-Frank Act in addition to a general overview of why current levels of regulation hurt the economy. The Amendment gave the Federal Reserve the power to limit interchange fees, which they did at around 24c per transaction for “non-exempt” issuers. When the Durbin Amendment was first mooted, based on the Australian experiences, we predicted that none of the savings to merchants would be passed on to consumers and that it would bring an end to credit card rewards programs and free debit cards. Now, thanks to a study by David Evans et al. of the University of Chicago Coase-Sandor Institute, we know that that did happen, and that consumers are worse off to the tune of around $200 per household.
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The problem arises when politicians intervene to regulate the interchange rates that retail merchants pay. Regulating payment card fees has political appeal to elected officials who are told by retailers who claim to be speaking on behalf of consumers. These merchants tell the political class that if they pay lower, regulated interchange rates, they will pass those savings on to consumers.
In country after country, the reality is quite different. Sure enough, retail merchants benefit from the lower fees. But those benefits are passed on to the retail merchants’ shareholders, not to consumers as promised. Consumers end up paying higher fees — either through “checkout fees” (surcharges at the register) or higher banking fees.
Price controls are never a good idea, yet they seem to be a staple of policymakers across the globe. Inevitably, they result in dislocations in the market that frustrate both consumers and producers. If prices are too low, shortages emerge leaving consumers in the cold and producers disinterested in serving that market. High prices create gluts, as unwanted goods sit on the shelves while producers are enticed to produce even more. So it should be no surprise that Sen. Dick Durbin’s (D-Ill.) attempt to control fees on debit cards has done little to help consumers, while the retailers who lobbied for the law are quietly pocketing billions. One study found that the Durbin Amendment transferred more than $8 billion from banks to retailers.
The Global Economics Group issued a press release announcing a new study examining the impact of the Durbin amendment on consumers. The study finds that consumers will lose more than $22 billion as a result of interchange caps. Dr. David Evans, lead author of the study will be discussing his findings at an upcoming conference on the Durbin amendment in Washington D.C. on November 6.
U.S. District Judge Richard Leon, in a court filing, said he agreed to the Fed’s request to grant a delay until an appeals court rules on the case. Judge Leon’s decision means fees will remain at existing levels while the court considers the Fed’s challenge.
The U.S. Court of Appeals signaled it wanted to move quickly to consider the case: A schedule filed this week requires the Fed and others involved in the case to file a series of briefs by early December.
Since Judge Richard Leon issued his shocking decision on July 31 that called for even more draconian price controls under Dodd-Frank’s Durbin Amendment, some legal commentators have given the judge the benefit of the doubt. They concede the Durbin Amendment is bad law, but they say Judge Leon was correct in his interpretation of the amendment, which basically mandates the Federal Reseve not set price caps on what banks and credit unions charge for interchange fees on debit cards at any rate higher than retailers would like to pay them.
These commentators, some of whom I respect a great deal, simply overlook the incredible sloppiness in Leon’s ruling in NACS. v. Board of Governors of the Federal Reserve. Leon’s decision is filled with unprofessional snark, misconstrues economic terms in the statute’s language and limits its research of “legislative intent” to the “intent” of one member of Congress who voted for the legislation: Sen. Richard Durbin, D-Ill. Leon’s ruling forces the Fed to construe the law in a way that almost certainly will foment a constitutional challenge – similar to the lawsuit TCF Bank filed after the Fed’s more stringent “proposed rule” in late 2010 – involving the 5th Amendment property right to seek a return on capital invested.
Credit cards, debit cards and now newer technologies like PayPal have revolutionized a critical gear in our economy: payment. The ability to securely and effortlessly engage in consumer transactions — whether an online purchase or filling the gas tank — facilitates commerce. For buyers, conveniences like better record-keeping of purchases, fraud protection and faster transactions are all real and tangible benefits. For sellers, there are advantages to these payment technologies, not least of which is higher sales volumes.
Service providers for electronic payment transactions design, build and own costly networks and valuable intellectual property. They incur costs for the services they provide and they deserve to charge a market-based rate to their customers.
The notion that statutory or regulatory set price ceilings for these services would yield a net benefit to the economy presumes that the private market has failed and that a government-imposed price is closer to what the market price should be; which presumes that the “should be price” is knowable to these regulators. But one should not confuse the economics of mobile payments with the natural desire of every buyer to pay less for the services they enjoy.
Last week, a U.S. court struck down the debit-card transaction fee cap that the Federal Reserve Board set in 2011. While this decision argues that the Fed was too lenient in setting the cap, it also points to the fact that regulators struggle to balance the political objectives of lawmakers (and in this case merchants) with the evidence the Fed deemed appropriate for consideration in rulemaking.
Can the European Commission do better? Merchants believe so because the swipe fee caps proposed in the E,U. are even lower than the U.S. swipe fee caps. But, such a simple-minded determination of “better” disregards the value of the service being provided and embraces a view that the government can set a price more effectively than the market.
Proposals to cap interchange, or swipe, fees rest on bad economics, ignorance about payment systems and rent-seeking by large retailers. Interchange fee caps are a money grab for big merchants (which is why merchants lobby for them), but are an unambiguously bad idea for consumers, small businesses and the overall retail economy.
According to the European Commission, the interchange fee is part of an “inefficient” system that “unduly” raises costs. In reality, however, there’s nothing inefficient about these fees. They’re simply prices charged for an immensely valuable product: electronic payments processing. Charging some (but not all) of this price to merchants instead of consumers avoids deterring card usage and preserves the benefits of electronic payments for everyone.
Electronic payment systems offer much more than just an efficient payment mechanism. They also provide merchants with fraud protection and valuable logistical tools, reduce labor costs and alleviate the cost of offering in-house credit. Properly understood, the price to merchants of accepting payment cards — often decried as a wasteful and unjustified tax on commerce — simply reflects the considerable benefits offered by electronic payments.
So what happens when governments intervene? Consumers suffer. Confronted with the loss of billions of dollars in interchange fee revenue, banks and credit unions have responded by increasing the cost and reducing the quality of consumer bank accounts. The Durbin Amendment to the Dodd-Frank financial reforms (which limited debit interchange fees to incremental processing costs) clearly harmed consumers. Previously, access to free checking had grown from less than 10 percent of accounts in 2001 to 76 percent of accounts by 2009 — but by 2012, only 39 percent of banks offered free checking accounts. And monthly service charges on non-interest-bearing checking accounts have increased 25 percent since 2011. These new bank fees have particularly hurt lower-income and younger households, causing many to drop out of the banking system altogether.
In countries that have capped interchange fees, retailers simply haven’t passed the savings on to consumers. And in the U.S., the Durbin Amendment has actually driven up interchange fees for smaller merchants.
In short, Interchange fee caps don’t actually benefit consumers — only large retailers and politicians looking for a photo-op.
If you think there isn’t enough competition in the payments industry, just wait a few years – there will be a lot less in the U.S. and European Union. Before I explain why let’s take a survey of the state of competition. No, the payments card industry is not a perfectly competitive industry that would warm the cockles of your micro-econ college professor’s heart. But then, what is?
In the U.S. we have Visa, MasterCard, American Express, and Discover, not to mention PayPal, several PIN debit networks, and a lot of startups, all slugging it out. In the EU the state of competition varies by country, but Visa, MasterCard, American Express and often some domestic systems are competing. Visa (either International or its European doppelganger) is the big dog in a lot of places. But Visa has a lot more competition than the leading player does in a lot of industries. And considering that payment card schemes have enormous network effects and scale economies, if anything, there’s a surprising amount of competition.
There’s been a lot of talk about even more competition, and challenges to the established players, in the U.S. and EU.
The Europeans have never been very happy that Visa and MasterCard – both perceived as U.S. companies (yes, this is odd given that Visa Europe is owned by European banks, but there you have it) – are the leading pan-European players. Then they got very worried when the efforts to create the Single European Payment Area (SEPA) picked up some steam. The Brussels-based Eurocrats and politicians fretted that Visa and MasterCard would wipe out the many domestic schemes. As a result there was a big push to create a homegrown pan-European system. The Monnet project, for example, consisted of a group of European banks that were considering giving Visa and MasterCard a run for their money.
In the U.S., the PIN debit networks consolidated and there was talk that they would compete with MasterCard and Visa. The telecoms started Isis, which was originally going in with a low-fee model. There have also been a slew of startups, from the long-gone Revolution Money to the on-a-hot-streak LevelUp, which have gone after the establishment with interchange-fee-buster models.
Sounds great: pretty competitive, and getting even more so! But leave it to the government to mess up an industry. Consider what’s happening in Europe. The European groups that were considering challenging MasterCard and Visa have all bit the dust. They needed revenue to enter. But with the European Commission insisting that it was going to stomp down interchange fees – possibly even to zero – they have abandoned those efforts. Meanwhile, the domestic schemes are facing a world of hurt because they are likely to lose the ability to compete with MasterCard and Visa by offering higher interchange fees. In perhaps the weirdest development of all, the European Commission has proposed legislation that will prohibit merchant surcharges for MasterCard and Visa but allow them – ‘encourage’ is probably a better word – for the three-party systems such as American Express and Diners Club. Yup – stigmatize the underdogs.
The legacy of the Durbin amendment continues: A U.S. District Court has now ruled against the Federal Reserve Bank in a lawsuit brought to the court by merchant groups. The ruling claims that the Fed disregarded the intent of the amendment by inappropriately inflating debit card transaction fees above the average cost of the fees. While there is no doubt that this ruling will be appealed and continue to play out in the courts, the consequences of this decision will be significant. If the ruling stands, the implications for the checking debit card and prepaid debit card markets could devastate the economics of these businesses.
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