Interchange Fees: The Latest Dialogue

Includes: AXP, BAC, C, COF, DFS, MA, V
by: Rortybomb

Cause you love it: more on interchange fees. Lots of people talking about interchange fees recently:

Matt Yglesias: Once you keep in mind the fact that the median household income in 2008 was slightly above $52,000 it’s not at all obvious to me that this is any kind of scam. Instead, it appears to be a classic positive sum business interaction. Credit card companies use interchange fees to cut into retailers’ monopoly rents and then rebate a share of the fee to consumers via reward programs, and on net consumers benefit and the median household appears to benefit….Now it’s true that in this particular case my conscience is pricked by the fact that poor consumers end up losing out. At the same time, do we really think it’s feasible to conduct distributive analysis of every new business model and only accept the ones that are beneficial to poor consumers?

Megan McArdle: I never understood why the progressive consumer finance types got so worked up about interchange fees, which are essentially a knock-down fight between two very powerful business lobbies, not a cosmic injustice perpetrated against the American consumer….To be sure, the current system benefits the wealthy most. But that is broadly true of many business models; shall we outlaw Costco because the poor cannot afford lavish pantries and large chest freezers in which to store their warehouse-club bounty?

Kevin Drum Beyond that, let’s make it clear what I’m proposing. I don’t want to eliminate interchange fees. Card payment networks cost money to operate and there’s nothing wrong in theory with using interchange fees as a way of offsetting those costs. In fact, I’m not sure I even want to limit interchange fees. What I’m opposed to is their invisibility. All I want to do for now is bring them into the open.

So let’s step back for a second. Plastic is becoming the new form of checking for the 21st century. Right now the Federal Reserve steps in and backstops the clearing risks on the checking system to make sure that checks clear at par. If I write you a check from Bank A you can cash it at your account at Bank B for the value of it. This is not a state of nature event; it happens because the government steps in. If interchange regulation is a bad thing at a meta level, then so is this, and we should roll back that checking regulatory enforcement to the late 19th century.

Money is an object that acts as a store of value for payments of debts, goods or services. Is it necessary that a private corporation collects 2%+ of value in order to move this money from place A to place B? If interchange was low and self-regulated through market mechanism, maybe we can hand wave this. But the United States’ interchange fees are among the highest in the world and are increasing.

This is why interchange regulation has always been about debit cards and not credit cards. Debit cards move my money, my value, from place A to place B. A credit card is a short term loan. As a risk manager, I’d advise against using interchange to subsidize the credit risk of a credit card, but that’s a their problem. However, by contract, merchants can’t discriminate between the two.

Now there are additional problems with this outside the generic problems. One is that it functions as an inequality machine. Nobody here seems too moved by this argument, so let’s move on. It’s worth noting that there’s been a debate on whether or not this would really exist, and now we have an additional measurement. Another problem is that it blurs the line between transactional and revolving debt. If you are moved by behavioral arguments about how people function with credit that’s a problem.

I’m more interested in how that blurring destroys the normal supply/demand function. Markets are abstractions over the ability to contract, and once the ability to contract is twisted we can get all kinds of neat distortions later down the road. For instance, competition seems to increase interchange. Since my wallet is filled with plastic cards already, the only way to get me to switch to another card is to promise more rewards. The only way to promise more rewards is to soak the merchants. The merchants would normally charge more for that credit card….except they can’t. By contract. They have to sign these contracts because of the excessive market power. That’s where the problem enters.

Matt mentions “retailers’ monopoly rents” but that’s completely backwards. There’s plenty of reasons to believe that the largest firms pay less in interchange than smaller firms. I tried hard to quantify and confirm this, but nobody releases this data or will go on the record, so I will just say that it is widely assumed places like Walmart’s grocery store pays less in interchange than a local grocer. A grocery runs on razor thin margins and this wipes them out.

And it is small businesses that get hit by these the most, not “retail monopolies.” In fact, it has been a hilarious pleasure of mine to talk about progressive economic reform of finding ways to check monopoly power with owners of small businesses over the past year fighting on this topic. Small business owners! When do they ever get in the fight for regulation!?!? It goes like this:

Small Business Owner: I’m really getting screwed on these rates. I can’t put any pressure on banking system but I also can’t discount or not accept these cards. We’re way past the point where I get “lift” from the new business and I don’t know what to do.
Mike Konczal: It sounds like you think that the government needs to pass a regulation here; that there is a genuine market failure and that only the government can stand in to check the power of finance and monopolists.
Small Business Owner: I can’t even believe I’m talking to you about this. I’m normally very conservative, I don’t do things like this.
Mike Konczal: It’s ok. This is a safe space to experiment. But you just have to tell me what the government needs to do.
Small Business Owner: Ok….it’s like the government needs to….the government should…’s like I’m paying a crappy government tax to the credit card companies!
Mike Konczal: Hmmm. That’ll do, I guess.

And notice how elegant of a solution we got with the Durbin amendment. Instead of some complicated mechanism we simply say “merchants can give a discount if you use your debit card.” Maybe they will, maybe they won’t. This will probably open the door to all kinds of new innovation: a check-out line if you use pin debit is one idea just off the top of my mind.

Like Matt, I’m not particularly interested in regulation. But I’m not sure what we’d “tax” here in order to rectify this. Probably the tax-free benefits that cardholders get, which sounds like a nightmare. And I do think when it comes to the means which we use for exchange the government should have a simple mechanism to watch the rate, and give merchant the power to engage the payment system on equal footing by giving them a fair contract and means to price discriminate. Not a bad job for Liberalism.