What went wrong?
First, there was the Durbin amendment’s naïve belief that while the banking industry could not be trusted to put consumers first, merchants would behave better. There is no mechanism in the amendment that even attempts to force retailers to pass any savings from the lower fees on to consumers. In addition, the amendment affects only debit cards: Credit-card interchange fees remain entirely unregulated, meaning that merchants will experience no difference in the costs associated with over half of purchases involving interchange fees.
This blockquote denies the power of markets in two crucial ways. Can you find them?
The first is that it assumes that our retail markets are simply not competitive enough to pass savings from inputs (including payment system inputs) to consumers. Is this our reality, one where Walmart is simply not running around drinking everyone’s margin milkshakes? No, it is not. We don’t need to regulate the attempt to force retailers to pass on savings to consumers cause that’s why we have a market economy in the first place.
The second has to do with what is going on with credit-card interchange fees. The idea “that merchants will experience no difference in the costs associated” with credit cards, since the bill only regulates debit cards, is wrong, since debit cards and credit cards are in competition with each other. Right now, in your wallet, they are in an eternal struggle for you to pick one over the other, and because merchants can’t discriminate between the two the credit card is winning a rigged game.
If merchants can price discriminate between the two, that creates a market for credit card interchange pricing. You’ll reach for the credit card if it has an advantage in consumption smoothing that the debit card didn’t have, and the merchant will pay a market rate price for this extra “lift” to their sales.
This design isn’t an accident, nor was it an accident that merchants weren’t allowed, by contract, to discriminate between the two previously. There’s a reason the Federal Reserve had to level this playing field. Because before competition lead to higher interchange, since the only way to get a new card in your wallet was to offer better gimmies, and the only way to pay for those gimmies was to soak the merchants.
But proponents of the legislation also ignored Australia’s experience, which shows the dire result government intervention has for consumers. After Australian interchange fees became subject to government price controls in 2003, annual fees on credit cards shot up 22 percent, while fees on credit cards that gave consumers rewards skyrocketed by up to 77 percent.
If this is referring to the Mastercard funded Charles River Associates study on the impact of interchange reform in Australia, there are some problems. For one, they don’t look at the actual credit card products outside annual fees. It is likely that interest rates plummet as cards become competitive on rates, not fees. We don’t know about Australian consumer prices, including rates of inflation.
Joshua Gans, who has studied Australia in depth, 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.”
If Australia is the worst case example, it’s not a worst case.
A really important thing that I keep in mind with these studies comes from, of all places, Tyler Cowen writing about David Card’s work on the minimum wage. “Gordon notes that the government can make an employer raise nominal money wages, but can’t stop him from turning off the air conditioner.”
Yes, raising interchange fees might not raise prices that much, but you are also almost certainly getting an inferior product too. Weaker ingredients, cheaper labor, shabbier service, etc. So lowering interchange fees might not lower prices 1:1 when we look at the aggregate data, but whatever weaker product you were getting will become better, and that’s hard to quantify.
Durbin and other lawmakers intended to punish greedy banks. Instead, what they accomplished was giving a financial boost to the retailers (are they any more morally upright than the bankers?) and almost certainly penalizing the consumer with higher fees. It’s a lesson worth remembering for the next time a proposed piece of legislation justifies price-fixing by touting future consumer benefits: While the price-fixing will be real, the benefits may turn out to be a mirage.
The Federal Reserve’s job is to regulate the mediums of exchange, and checking cards are now a central part of our system of exchanges. This isn’t about punishing some people; it’s about making a system of payment that can build the real economy. Visa raised its fees 18-40% (depending on merchant category) earlier this year with no loss of market share. Competition is backwards here because of distortions in the contracts that merchants sign. It was time to fix this, and Dodd-Frank did.
And we know some consumers will benefit. The distortion in prices is deeply regressive, forcing people who don’t have the millionaire’s card (or don’t have access to the formal banking system period) to pay for the ultra-benefits that come with that card, as many studies have found:
All in all, an excellent reform.