Here Comes the Interchange Counter-Offensive

One thing I was prepping for when reading the legal research on interchange recently was having to answer for the disaster that was the Australia experience with interchange. Everyone knows that it’s been a disaster, right? That’s a meme that has been repeated so much I assumed that, even if exaggerated, there would be a there there.

What surprised me was not that it was exaggerated, but that it doesn’t seem to be there at all. To get a sense of how the normal language on Australia goes, here’s Todd Zywicki with his paper on interchange:

A recent analysis of the evidence by economist Joshua Gans concluded that, in fact, there was no discernible reduction in the use of credit cards in Australia after the change.139 If that is true, and if there has been no discernible decrease in retail prices, the net result of Australia’s intervention will have been to simply redistribute wealth from consumers to merchants with no apparent offsetting social benefits.

And it’s already having pushback from the sources he quotes. Joshua Gans, whose analysis Zywicki quotes in that paragraph above, call the paper “extremist” and notes “the broad conclusions of the paper are flawed.” Here’s his response to the quote above:

Actually, that is not what was found. It was found that the capping of the interchange fee likely did have an impact on retail prices and that the net effect was no redistribution of wealth from consumers to merchants. Zywicki argues that, in Australia, the reforms harmed access to credit. But that is clearly not the case. Credit card usage remains undiminished as a result of the reforms. Also credit card debt was undiminished so there is no evidence of a difference in the composition of card users. Instead, it is better to say that the intervention was broadly ineffective. But that also means that big concerns of its negative impact in the US are unwarranted when looking at the Australian example. Basically, the broad conclusions of the paper are flawed.

Ouch.

Felix Salmon takes on the rest of the paper here, and you should read it. A few extra points:

– Maybe the paper brings it up and I missed it, but according to Kansas City Fed: “the level at which interchange fees are set in the United States is among the highest in the world.” (I believe from on background sources that they are the highest in the world, but let’s go with the KC Fed here.)

Why is that? Why wouldn’t it be one of the lowest? If given a satisfactory answer to this, I could switch my mind. But I have yet to hear one.

– There’s a lot of talk about cash to credit subsidy, but the real issue is debit-to-credit subsidy. I prefer to use my pin debit card because I like having two levels of identification to prevent fraud, and I imagine small businesses prefer that too. Why do I have to subsidize someone else’s airline tickets? Why does my grocer’s margins have to be eaten into in order to fund rich people’s reward card and the airline industry?

If it was just cash-to-credit subsidy, businesses could just not accept plastic. But the rules currently don’t allow for discounts for debit.

– Felix brings up that interchange isn’t about credit risk management. True that. It shouldn’t be, but it also can’t be, because the credit card rate is so close to the signature debit card rate, and the signature debit card rate reflects me actually moving my money from point A to point B, not me getting a short term revolver loan. Felix digs up the graphs that try to trick you on this, but the updated graphs he finds are correct.

– e21 recently put up a defense of approaching the interchange market, noting the market-based logic that “Allowing vendors to price discriminate further increases the possibility of transparent pricing. As Amy Finkelstein has shown in her analysis of EZ-Pass pricing; when hidden charges are built into prices, they become less salient, encouraging EZ-Pass operators to charge higher prices. Similarly, as long as we are unaware of the pricing difference between cash and credit or debit purchases, merchants are free to charge higher and higher prices.”

The Finkelstein paper is excellent. Now price discrimination usually implies a similar product: a student with id pays $6 to see the same movie in the same theater as the adult that pays $10. People who pay with rewards cards do in fact get benefits, and thus cash, that is paid for by the business that someone paying with pin debit does not. So it’s a double bad effect in terms of hiding prices.

– This is not a rounding number debate. Again from Felix:

At Target, for example, interchange fees represent the second-largest store-level expense, behind payroll. The costs are similarly eye-popping at Home Depot, where officials say they top the price of health care insurance for employees. “The amount of money we’re spending on interchange would put 10 associates in each of our stores,” Dwaine Kimmet, vice president of financial services for Home Depot, said at a recent conference on credit card fees.

– My new favorite comment. I like telling the story of Jinger Duryea, president of CN Brown, which owns Big Apple convenience stores across Maine, who talks about how if you charge a newspaper she loses money and she has no legal recourse against this loss except by going off the credit card grid. Why shouldn’t she be able to impose a minimum?

Here is Zywicki in the Washington Times with his answer:

Merchants argue that they lose money on consumers who don’t purchase enough to make a card sale profitable to the merchant. Perhaps, but merchants engage in all kinds of activities that guarantee that they don’t make money on every customer who walks in the door – from the customer who uses a sales clerk’s services without eventually buying anything, to free returns, to operating during hours when few customers shop. Yet even though merchants lose money on those who browse but don’t buy, they make a business decision that those occasional losses on some customers are justified by the overall business value of providing helpful service and free returns. The decision whether to accept payment cards is no different.

Read that again. First of all merchants don’t argue this, they give credible examples with numbers. Second, the decision isn’t to accept payment cards but to discount debit cards. And third, the idea that the credit card duopoly has both better knowledge and better incentives than the business owner into how to run their business is striking. I think the knowledge and incentives of the business owner himself are far better aligned to decide whether or not to impose a minimum.