Inside the Black Hole

“Would you like to save 10 percent on your purchase today?” Surely you’ve been asked this question more than once before and you know exactly what the cashier means. She wants you to open up a credit card with her store in exchange for an immediate discount.

But what is a store-branded card? It must be a credit card, because you get an access to a credit line, but it feels different, because you can only use it at the stores of the particular retailer whose logo it displays. And above all, is opening up such an account worth the discount? Well, in order to answer this question, we should first learn exactly what this type of card is.

Store Card Basics

Store card (also known as a “private-label” card) is a type of credit card that is issued by or on behalf of a particular retailer or group of retail stores and can be used for purchases only at that retailer or group of stores. In all other respects, private-label functions like a credit card, although there can be other differences as well.

The above definition sounds quite simple, but things can easily get confusing. Some stores, especially the big-box retailers, often offer several different, but similarly looking, store-branded payment cards. For example, Wal-Mart offers gift, private-label and regular credit cards, all of which bear the retail giant’s logo. Yet, these are very different payment products and you need to be able to differentiate among them. The table below gives you a side-by-side comparison:

*At time of writing.

As you see, these three products are very different from one another.

The CARD Act Effects

The CARD Act of 2009 changed the rules on store card promotional pricing and APR (annual percentage rate) increases. However, although it was initially proposed, the final version of the act released issuers from the obligation to collect financial documentation to verify each store card applicant’s income and ability to pay back the loan. Instead, issuers can now use statistical income estimation models.

The new regulations set limits on the types of promotions merchants can offer, including putting an end to one of their favorites: marketing cards with no monthly payments required for up to a year, but charging interest throughout the promotional period. Under the CARD Act either consumers must make at least a minimum payment each month or issuers must offer such an arrangement that no interest accrues over the promotional term.

The Takeaway

Whether a store card is a good payment option or not very much depends on the circumstances. If, for example, you are offered a 15 percent discount on a $2,000 TV set, applying for the card probably makes sense, as you would immediately save $300. However, if the rebate is $10, it’s probably not worth it, considering that the benefit would be offset by the slightly negative effect the application would have on your credit history.

On the other hand, for your day-to-day needs, regular credit cards are typically the better choice, as they are usually issued on better terms and their rewards programs, if available, cover a much wider array of merchants and purchases. So, if you did open a private-label account and unless you were offered discounts or promotions on an ongoing basis, I don’t see a reason to keep it open after the initial rebate is applied.

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I’ve been looking for an excuse to write about the difference between credit and debit cards for a long time and a new card launch is giving me the perfect one. I really needed some kind of a pretext, as I just couldn’t shake off a vague feeling of guilt for wasting time writing about something that, in spite of all evidence to the contrary, seemed to me to be quite obvious.

Let’s start with the news.

Fifth Third Bank Launches Combined Credit and Debit Card

Fifth Third Bank is introducing a new MasterCard-branded card that will combine its users’ credit and debit card accounts. The Duo Card, as the new product is called, will be the first of its kind in the U.S., the bank claims.

Here is how Fifth Third is telling us its new card will work:

With the Duo Card, customers can choose to make purchases using either a line of credit or funds available in their checking account. To draw funds from their checking account, cardholders would simply select the debit option at the point of sale and enter their PIN, or they can withdraw money from their checking account at an ATM.

To draw funds against a line of credit – like a traditional credit card – consumers need only select the credit option at the point of sale and sign to complete the transaction.

It is not quite clear how signature-based debit functions. Fifth Third:

Unlike traditional debit cards, the Duo Card’s signature transactions are not directly tied to the customer’s checking account, so no cash is in jeopardy should the card be stolen or compromised.

I really don’t know what to make of that. If the signature-based debit payments are not directly tied to the user’s checking account, what are they tied to? The transaction amount must be credited to the payee’s account and someone else’s account must be debited for the same amount. Moreover, Fifth Third’s website unequivocally tells us that PIN transactions are debit, while non-PIN transactions are credit, leaving no room for signature debit.

This brings me to the debit / credit confusion that I’ve been reluctant to write about.

How Is Debit Different from Credit?

The first time I heard someone mention in passing that when she used her debit card in a signature type of a purchase transaction, she was in fact using her “debit card as a credit card,” I simply dismissed her as financially uneducated. But when a friend of mine, who is very much financially sophisticated, said the same thing, I knew that the issue had less to do with financial literacy than I had initially thought. When I began paying closer attention, I realized that the confusion was quite widespread.

The Duo Card announcement and the information available on Fifth Third’s website, if anything, add to the confusion.

So let me bring some order into the discussion and define the difference between a debit and a credit card. When using a credit card, you are spending money that is lent to you by the card issuer. When using a debit card, whether in a PIN or a signature transaction, you are spending your own money that is held into the checking account to which your debit card is tied. Simple as that. The fact that you are signing a receipt when making a payment with your debit card, instead of entering a PIN, does not make it a credit card.

The Takeaway

Naturally, this article will be read by millions and the debit / credit confusion will get even deeper be cleared up once and for all. Still, it wouldn’t hurt if banks tried to help, rather than add to it.

That said, I really like the idea behind the Duo Card and hope that other banks will follow suit, so that we won’t have to keep carrying more plastic than we need to.

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CNNMoney’s Catherine Clifford is exercised, with some reason, about the complexity of monthly merchant processing statements. She correctly points out that they can be long and full of different rates that can make no sense to anyone but a qualified accountant. Actually I would disagree with that assertion. It is my firm belief that some of the statements I’ve seen over the years would be equally incomprehensible to accountants, as they are to laymen who don’t know how to read them.

But having described the statement complexity issue and quoted several experts who confirm it, Clifford does not even attempt to explain why this is the case, except for quoting one of her experts who accuses processors who “purposely provide confusing or ambiguous statements” of being “clever.” There is more to be said than that, so let me give it a try.

Why Are Monthly Processing Statements Complex?

There may be some clever processors who try to confuse merchants, but in reality the complexity comes from the huge variety of interchange fees that Visa and MasterCard set for transactions involving their cards. There are many dozens of such fees, which are collected by the card issuing banks, not Visa and MasterCard and certainly not the processors. Processors often list the interchange at which each transaction was settled, so that the merchant gets all relevant information. The side effect of course is that these additional data can pile up, especially in the case of merchants with high transaction counts.

Interchange fees vary by card type and payment processing environment (that is, card-present or card-absent, each of which have sub-groups). For example, a credit card transaction processed at a restaurant gets a lower interchange than one completed online. A credit card transaction featuring a rewards card has a higher interchange than one involving a non-reward credit card, regardless of the payment setting. Then there are various business-to-business, commercial and purchasing cards, which have even higher interchange than rewards cards. Additionally, debit cards have lower interchange than credit cards.

What you need to understand is that the processor pays the interchange to the issuer and then collects it, plus its own fees, from the merchant. Now, this could be done very simply by charging one flat rate for all transactions and you wouldn’t have to list all these confusing interchange rates in the statement.

Why Not Charge a Flat Rate?

This could be as simple as it gets, everyone would understand it and no one would get confused, right? Yes, but it also would be extremely disadvantageous to the merchant. See, if the processor were to charge a flat fee, it would have to make sure it was higher than the highest possible interchange, otherwise it would lose money on some transactions.

As it happens, some processors, most notably PayPal, but also UniBul, are actually doing it, losing money on some transactions, that is. But there is still a problem. Even as it is losing money on some transactions, a processor charging a flat fee must make sure that on the whole it is generating more income than it is losing. What inevitably ends up happening is that the flat rate is set so high that the aggregate processing fees the merchant is charged each month are typically substantially higher than they would have been, had the merchant account been set up using an interchange-plus type of pricing model, which is incomparably more complex.

To pre-empt an accusation of being clever, I should say that we introduced our flat rate pricing model not because it is the best one for merchants to use – on the contrary, in discussions with merchants and in our blog we regularly tell anyone who would listen to use interchange-plus – but because it is simple and that is what many merchants want. We tell merchants what we believe is best for them, but ultimately the decision is theirs and we accommodate.

The Takeaway

The biggest reason merchant processing statements are complex is that processors provide merchants with detailed transaction information. If we weren’t doing it, we would’ve been accused of hiding information and so misleading merchants.

However, once you understand how your pricing model works, you will find it much less confusing. For example, with interchange-plus, which as mentioned above is the most cost-efficient pricing model, what you need to focus on is the rate your processor charges you, which is the same for all transactions, regardless of card type or environment. The total rate will still vary from one transaction to another, because the interchange will vary, but there is nothing you or we can do about the interchange, as it is set by Visa and MasterCard (and as of late, by the Federal Reserve) and is non-negotiable.

At the end, a processing statement is only confusing until you learn how to read it. I would argue that it only takes a few minutes to get a handle of it, which would be time well spent.

Get a personalized credit card rate for each of your transactions!

Get the lowest possible credit card processing rate for each individual transaction! Our interchange-plus pricing model gives you:

• Processing rates calculated separately for each transaction to ensure that not a single one of them is overcharged.
• No more mid-qualified and non-qualified fees.
• No fixed monthly fees.

The Federal Trade Commission has filed charges in relation to the $10 million credit card scam that we first learned about a month and a half ago, we learn from the New York Times. The NYT article tells us that the charges against the bogus companies set up to facilitate the fraudulent transactions were filed back in March, three months before the FTC announced the scam in a press release.

It was a very elaborate scheme, involving more than 16 dummy corporations the scammers had set up in various Eastern European and Central Asian countries, including Lithuania, Estonia, Latvia, Bulgaria, Cyprus and Kyrgyzstan. The criminals then opened up more than 100 merchant accounts in the U.S. to process the payments. In order to do so, however, they had to convince the processing banks that their business was legitimate. Here is how they did that, according to the NYT:

[F]alse storefronts were set up on the Web, pretending to sell electronics or office supplies, in case a bank investigated.

The perpetrators also rented a street address from a company that provided that service and had their mail forwarded to another company that scanned and forwarded it a second time as e-mail, the suit says.

Once the merchant accounts were operational, the criminals started to charge small amounts to credit and debit card accounts whose information they had stolen. Most of the charges were for $9, although the amounts could be as low as $0.20 and as high as $10, according to Steven M. Wernikoff from FTC’s Midwest Region Office.

The criminals succeeded in stealing so much money mostly because the small individual charges either went unnoticed by many of their victims or they simply didn’t bother to dispute them.

Yet, with so many fraudulent transactions, complaints were bound to pile up and eventually the FTC received more than 1,000 of them. Interestingly, there “were more complaints about the 20-cent charges because they looked really odd,” according to Wernikoff.

The FTC’s investigation lasted for nine months, however the identities of the individuals who masterminded the scam are still unknown. No one is defending the companies in this law suit either. Less than $100,000 has been recovered so far from the U.S. assets of the false companies. The FTC hopes to recover some of the money transferred abroad, but it is unlikely that it will meet with much success there.

Apart from its sheer scale, the most striking thing about this scam is the discipline and patience with which it was executed. The criminals had detailed understanding of how the credit card processing system operated, had identified its vulnerabilities and knew how to exploit them. It must have taken them months just to lay down the groundwork of setting up U.S. corporations and opening up e-commerce websites and merchant accounts for them. They must have known that eventually the whole thing would be found out, but that it would take months for it to happen. In the mean time they managed to steal money from 1.3 million people. This must be some kind of a record, but I’m also wondering if we have learned the full extent of the scam. Take a look at your January statement. Maybe you’ll see a $0.20 transaction from Link Services or Site Management.

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Swipely, a social shopping network, is the latest entrant in the increasingly crowded field of social networks who offer users the ability to share their credit card purchases with friends, we learn today from ReadWriteWeb’s Adrianne Jeffries. After several months of private beta testing, today Swipely opened its doors for everyone.

Given the track record of similar services in the recent past, Swipely has its work cut out for them. To say that its competitors have had a hard time both convincing a skeptical public and protecting users’ personal information would be a huge understatement.

You may remember, for example, what happened with Facebook’s ill-fated Beacon project. It was supposed to “help people share information with their friends about things they do on the web,” according to Facebook’s founder Mark Zuckerberg. A month after Beacon’s release, Zuckerberg was already apologizing for making “a lot of mistakes building this feature” and simply doing “a bad job with this release.” Eventually, Beacon was shut down and Facebook had to pay $9.5 million to settle a lawsuit alleging privacy violations.

Earlier this year, Blippy, another start-up that offers users a platform to share credit card purchases with others, accidentally revealed the credit card details of some of its users on Google. As announced on Blippy’s blog:

In early February, due to a technical oversight on our part, some raw transaction data appeared within the HTML code on some Blippy pages for about half a day. Raw transaction data is the messy one-line sentence that appears on a bank or credit card statement.

Half a day of course was all the time needed to cause the trouble:

Google had crawled and indexed a portion of Blippy’s pages. Even though the sensitive information was hidden in the HTML and not visible in plain view, the Google crawler observed it and recorded the information to put into its search index. Google effectively took a snapshot of Blippy during that half day period.

Undaunted, Swipely is going ahead with its own service and says it has learned from others’ mistakes. Here is how it works, as explained by Jeffries:

Swipely collects purchase information from more than 4,000 banks and credit card companies, using the Localeze database to match transaction codes to physical locations. Users can also forward email receipts to Swipely or install a Gmail plugin that pulls receipt data automatically.

You can broadcast all your purchases, all your purchases from a specific store, or pick individual purchases to show on Swipely, Twitter and Facebook.

…

The data is used to target users for ads and discounts. Users can also search for all the comments for a store or item, similar to user reviews on a site like Yelp or Amazon.

Swipely founder Angus Davis acknowledges the obvious – that convincing people to trust them with their personal information will be hugely challenging. His major selling point seems to be Swipely’s potential to save users money. Whether people will buy into it remains to be seen.

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