New York Times Disappointing Article on Credit Card Interchange Fee Reform.

Edward Wyatt has a disappointing article in the New York Times on interchange reform.  Felix Salmon takes it apart, noting: “By my count, he gives the banks’ side of the story eight different times, by quoting bankers directly or just recounting what “banks contend”. By contrast, the merchants get cited only twice, and their argument doesn’t really get parsed at all.”

Felix’s post is really good.  Since I think the Durbin amendment is a pretty elegant solution for this market problem, I wish some other things were included in the article.  Let’s include some stuff that you wouldn’t get from the article.

First, interchange rates in the United States are among the highest, if not the highest, in the developed world. From the Minneapolis Fed, circa 2006:

Second, if you want to know why small merchants are pissed, why don’t you ask one? Here’s a story that could have been included, a quote I gathered while trying to parse the numbers of this reform in the early days:

“Credit cards are the lifeline of my business as customers use plastic for everything from; a cup of coffee, to a pack of gum, to a tank of gasoline. Credit cards and debit cards are easy to use, but what customers don’t know is that every time they use a credit card, I pay a fee. For example, a customer purchases a local newspaper (75 cent retail) my profit is 9 cents. If the customer is using a debit card I would pay 25 cent for the transaction fee plus .08% interchange fee. If the customer puts down a Visa credit card the transaction fee would be 19 cents plus 1.68% interchange fee. Regardless of the payment option I lose money on the sale.”

–Jinger Duryea, President of CN Brown which owns Big Apple convenience stores across Maine

Third,  many studies have found that there are regressive transfers in the way the current system works,where people who pay with cash, debit cards or generic credit cards go to pay for rewards for the ultra cards:

Fourth, there’s references to competition in the article, but competition works backwards in this space.  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. Merchants, by contract, can’t discriminate between debit cards and credit cards.  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, as we see in this market.

Fifth, the article makes references to debt cards being less safe.  They should probably mention that theproblem there is signature debit cards, which are actually a fairly unsafe way of paying for something.   From Adam Levitin’s great post Visa’s Identity Theft (I Mean Superbowl) for Life Promotion:

In the midst of the Bears’ ignominious defeat at the hands of the Packers, I saw a commercial advertising Visa’s Superbowl for Life promotion.  It’s a sweepstakes.  Users of Visa’s signature debit and credit products are automatically entered with every purchase, but you can also enter by writing in.  If you use a Visa PIN debit product (Interlink), however, you do not get a shot at the tickets.

The estimated odds of winning:   1 in 9,685,871,298.  Compare that with the odds of having your identity stolen by using a signature debit product.

The loss rate (frequency * loss) is 3.75 times higher for signature debit than for PIN debit.  (Other studies put it 7 times higher.)   So for a one in 9.6 billion chance of getting Superbowl tickets for life, with an estimated retail value of $493,678, a consumer is quadrupling his or her chances of identity theft loss. That strikes me as a dubious bargain…

I mention all this because Visa has been arguing that network rewards are an important reason for letting consumers choose the network over which their debit card transactions are routed in opposition to the Fed’s proposed Durbin Interchange Amendment rule-making.

This Visa argument is pretty silly from the get-go, as consumers don’t choose what networks are on their debit cards (the bank does–the debit card comes with the deposit account), much less how the routing will go (more complicated, but a combination of the order of routing flags on the card and the networks handled by the merchant’s processor).

But it’s not just that the Visa argument is silly.  It’s actually dangerous. Visa’s Superbowl for Life promotes the use of an inferior technology (signature debit) that poses real risks to consumers. Why? Because signature debit is more profitable for banks and by offering banks higher swipe fees, Visa is able to increase its transaction volume and hence its own revenue. Visa’s PIN debit product, Interlink, has the highest PIN debit swipe fees around, but they’re still less than Visa’s signature debit swipe fees.

Sixth, the article makes many references about how this is a gift to the Walmarts and Home Depots of the world, the new talking point of the banks.  But most merchants believe, and there’s some evidence to indicate (as well as common sense), that the largest players get the best discount on interchange.   The banks themselves guard this data viciously, so we can’t tell.  But if Walmart can negotiate better terms for interchange, and they negotiate cutthroat rates on everything else they use, they can undercut local, smaller grocers and businesses on interchange.  They can undercut them on the price of money.

And that is what this is about.  How much does it cost to use money in our society?   The Federal Reserve’s job is to oversee the mediums of exchange, and debit cards are the new checks, and like checks, they should be required to clear as close to par as possible.  Regulating debit cards as a normal medium of exchange and then let credit cards do whatever.  If consumers value float, if business like “lift”, a price mechanism will naturally produce itself.   It solves a market problem by creating a market.  How cool is that?

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13 Responses to New York Times Disappointing Article on Credit Card Interchange Fee Reform.

  1. HH says:

    The distorting factor in all these bank regulation issues is the government’s determination to feed revenue into the banks so that they can earn their way out of the losses of the real estate bubble. Shoveling money into institutions with unsound practices and bad management simply encourages them to fail again on a larger scale. This is very bad policy.

  2. K. Williams says:

    “The banks themselves guard this data viciously, so we can’t tell. But if Walmart can negotiate better terms for interchange, and they negotiate cutthroat rates on everything else they use”

    They guard the data “viciously”? What does that even mean? That they bite your hand if you go poking around? That they’re cold to you on the phone? Would it be better if they guarded the data sweetly?

    • J. Torres says:

      It means that they keep interchange rates a secret and won’t, under any circumstances, reveal which merchants pay which rate. Try to keep up.

    • chris says:

      That they bite your hand if you go poking around?

      Corporations don’t have teeth, but they do have lawyers. I would bet that it means that they *sue* you if you go poking around.

  3. K. Williams says:

    “It means that they keep interchange rates a secret and won’t, under any circumstances, reveal which merchants pay which rate. Try to keep up.”

    Oh, you mean they guard their proprietary data. I’m positively shocked.

  4. roger says:

    You mean, they guard their proprietary data and pay lobbyists to lie about it to reporters who can’t check it. Why, I’m positively shocked!

  5. John Bennett says:

    The issue here is who should pay the operating costs of credit cards. The argument is between the banks and the merchandisers. The beneficiary of the card is left out of the picture, except to the extent to which he shares the cost with all the non-beneficiary users of the cards. Something smells wrong about that to me. Most economists would say efficiency would benefit if the beneficiary paid. So let him pay the cost. He would then have the choice of paying cash, using a cash card, or using his bank card or paying the full cost of the credit card. Competition would reduce credit card costs now that the user will know what the card costs him, but they would still be higher that cash cards or bank cards. That is a good outcome.

    • chris says:

      ISTM that the best market solution would be to ban the contract terms that prevent merchants from giving a cash premium or otherwise passing the interchange fee to the customer, and then let customers decide whether the convenience of the card is worth the cost. Giving them the illusion of a free ride distorts the incentives and this is one case where a well-informed market might actually reach an efficient outcome, so it’s worth a try, I think.

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