Into the Black Hole

The European Commission (EC) has had Visa’s and MasterCard’s cross-border inter-bank fees in its crosshairs for quite a while now. Back in 2007, the Commission banned MasterCard from charging cross-border fees on transactions within the European Economic Area (EEA) — the EU’s 27-member states as well as Norway, Liechtenstein and Iceland. Then five years later, in May of last year, the EC issued a “supplementary statement of objections” (SSO) related to Visa’s multilateral interchange fees (MIFs) whose linguistic and substantive qualities I reviewed at the time (I did confess to being an ardent admirer of Eurospeak). Back then I wondered why the EC had decided to deal separately with MasterCard’s and Visa’s cross-border fees, but it turns out that there was even more to come.

Earlier this week the EC informed us that it had launched yet another investigation to establish “whether MasterCard may be hindering competition in the European Economic Area (EEA) with regard to payment cards, in breach of EU antitrust rules”. The EC’s concerns had once again been raised by “MasterCard’s inter-bank fees and related practices”. So, one might ask, hadn’t the issue already been dealt with? Well, no, the EC’s latest investigation has to do with transactions made with cards issued outside the EEA. Still, I can’t help but wonder why the original investigation in 2007 would not have covered both card networks and all of their cross-border transactions. So, if this whole thing sounds to you like a huge waste of time and money, you’re not alone. But let’s take a look at the EC’s latest.

Investigating MasterCard Inter-Bank Fees Again

The investigation will focus on payments made by people from outside the EEA who use their MasterCard credit and debit cards when inside the area. Here is what the EC is investigating now:

(i) inter-bank fees in relation to payments made by cardholders from non EEA countries — as opposed to fees for cross border transactions within the EEA that were already prohibited in 2007 (see IP/07/1959 and MEMO/07/590). Such fees apply for example when a US tourist uses his MasterCard credit card to make a purchase at a merchant in the EEA;

(ii) all rules on ‘cross-border acquiring’ in the MasterCard system that limit the possibility for a merchant to benefit from better conditions offered by banks established elsewhere in the internal market and

(iii) related business rules or practices of MasterCard which amplify the Commission’s competition concerns (like the “honour all cards rule” which obliges a merchant to accept all types of MasterCard cards).

These fees and practices may restrict competition. The inter-bank fees are generally passed on to the merchants, leading to higher overall fees for them. Ultimately, such behaviour is liable to slow down cross-border business and harm EU consumers.

In addition to its anti-trust enforcement action, the EC will come up with a proposal for regulating the inter-bank fees.

What to Expect

The EC is characteristically vague in describing its objective in the case. The statement talks about things like “level[ing] the playing field between payment card providers” (that is mentioned twice) and providing “legal certainty”. But I confess to being hugely disappointed — surely the EC could have done better than that and come up with something like “supplementary statement of objections” to throw at MasterCard, just as they did to Visa, whose case is still being reviewed. But linguistics aside, the Commission was much more explicit in the Visa case when it spelled out its objective thus:

The Commission has reached the preliminary conclusion that MIFs [multilateral interchange fees] reduce price competition between banks by creating an important cost element common to all acquirers. The Commission considers that Visa’s MIFs harm competition between acquiring banks, inflate the cost of payment card acceptance for merchants and ultimately increase consumer prices.

And if Visa was found in breach of EU antitrust regulations, the company could face fines of up to 10 percent of its global turnover. Now the BBC reports that the EC is considering applying the same remedy in MasterCard’s case:

Mastercard, which said it would “fully co-operate” with regulators, could be fined up to $740m, or 10% of its 2012 revenue, if found guilty.

So the fine itself would be quite significant, but even more damaging to Visa and MasterCard would be the permanent loss of the cross-border fee revenue. Moreover, if the EU wins the case, it is very likely that the U.S. authorities will take similar actions; in fact they would probably end up doing it even if Visa and MasterCard won in Europe, unlikely as it is.

The Takeaway

So, in all probability, the end of the cross-border fees is nigh, however clumsily the objective might have been achieved. And that’s a good thing for consumers who have been paying up to three percent in such fees, in addition to any currency conversion fees that are also applied to cross-border transactions. It is true that the number of U.S. card issuers which have voluntarily discarded these fees has been increasing over the past few years (for a long time Capital One was the only major issuer who charged no cross-border fees on most of its cards), but it would be much better to know that we don’t have to worry about them at all. And yet, isn’t it incredible just how tortuous a way the EC has taken in its effort to do the right thing here?

Image credit: Europa.eu.

Today’s attack on the fiendish conspiracy, otherwise known as interchange fees, to milk merchants of all of their profits comes to us courtesy of Bill Leichsenring — a restaurateur writing for the Des Moines Register. In his piece, Leichsenring largely sticks to a familiar script: a heroic entrepreneur builds a successful business from scratch and against all the odds, only to see all of his profits eaten up by an insidious and omnipotent service provider with whom one cannot negotiate and from whom no quarter can be expected. Of course, the plot is not exactly watertight, but since when did fiction writers become willing to let the facts get in the way of a good story?

I’ve always been skeptical about the level of consumer interest in the interchange issue. The reality is that most Americans don’t know what these fees are and the rest either don’t understand or don’t care all that much about them. Now, that is not to say that consumers have no horse in this race. On the contrary, the Durbin Amendment, which prompted the Federal Reserve’s decision to cut the debit card interchange fees last year, caused an overall increase of the cost of banking services, as card issuers were desperately trying to make up for the huge shortfall in their revenue streams. Yet, it is difficult for the retailers to rally consumers around a cause to which they are largely indifferent, which is why exercises such as Leichsenring’s are intended mostly to keep the merchants and their lobbyists up in arms, as well as to keep the pressure on the legislators and judiciary, which are now grappling with the credit card interchange issue. And that is why such writings should be addressed.

Interchange Fees Are Bad, Heroic Restaurateur Edition

In making his case against the evil interchange coalition, Leichsenring recruits the help of his father who “founded our original restaurant in 1940″ and “faced many challenges”, but crucially, “credit card swipe fees was not one of them”. So we seem to be meant to believe that, had the author’s father been accepting credit cards when he first opened up his restaurant, things may well have turned out much less successfully. Never mind all the evidence that consumers actually enjoy the convenience of using credit cards and spend more when they do so.

Here is the core of Leichsenring’s argument, which should by now be quite familiar to those of you who follow the discussion:

We talk about a free market and the ability to compete, but there’s no ability to genuinely understand the swipe fee system and certainly no ability to negotiate its terms.

In my opinion it’s set up that way on purpose by the credit card companies and the big banks. They created a system that benefits their bottom lines at the expense of small businesses and our customers.

First of all, I would argue that there certainly is the ability to understand the interchange fee system; all you have to do is some reading. More importantly, there is a reason why credit card acceptance is not free, which is what the retailers really want: there are costs involved in the maintaining of programs for issuing bank cards and servicing cardholders, as well as for the actual processing of card payments in a timely and secure manner. And yes, the card issuers, payment processors and card networks do need to make a reasonable profit — much as Senator Durbin might dispute that need — to make the whole project worth their while.

How Big of an Issue Is That, Really?

But I think that the most important aspect of the interchange issue is not truly appreciated by those few consumers who are following the debate. In fact, I don’t think that many of the retailers themselves fully realize just how insignificant of an issue this really is. Actually, Leichsenring himself unwittingly gives us an indication of that insignificance, even as he does his best to convince us otherwise:

I doubt our customers have much of a sense of how expensive it is for businesses to accept credit cards, understandably so. But swipe fees cost our restaurants more than $60,000 a year, exceeded only by the costs for labor, product and utilities.

Firstly, you need to understand that the $60,000 figure is the sum of the payment processor’s charges and the interchange fees, which are collected solely by the card issuers. And don’t let that number startle you — this is the total annual charge for the author’s two restaurants, one of which has a 600-person capacity and the other one — the newer location — is presumably not much smaller and quite probably larger. So we are talking about a fairly large operation. More importantly, Leichsenring himself puts things in perspective by telling us that his payment processing costs are a smaller expense item not only than the costs of labor and product, but also the utilities. And here is a question for you: when was the last time you heard restaurateurs complain about the cost of electricity? After all, it is obviously high enough to provoke their displeasure, it is non-negotiable and it is set by corporations whose monopolistic status puts the reviled credit card companies to shame. I don’t get it. But then, no one said this should make any sense.

The Takeaway

The point is that the interchange issue is, well, a non-issue. In a previous post I offered some basic calculations to show you just how much a retailer could save by accepting a rewards card — another favorite target for the interchange bashers — at the rate of a regular one:

The vast majority of this merchant’s Visa credit card transactions would be processed at one of these two interchange rates: the one for rewards cards — 1.65% + $0.10 — and the one for non-rewards cards — 1.51% + $0.10. As you see, the difference between these two rates is a grand total of 14 basis points! To put it another way, if in our example the merchant’s average ticket amount is $75 — and it may well be lower than that — the difference between a rewards and a non-rewards card would be 10.5 cents! That is what the huge problem is about.

Moreover, even if we reduced the rewards interchange rate by a whole percentage point — which might be what is currently under discussion — the merchant in our example would save a grand total of 75 cents. But there is something to be said about these rewards cards that somehow has been left out of the discussion. Many big restaurant chains — not to mention all of the big-box retailers — actually have their own rewards and / or prepaid card programs — of course managed by a card issuer — that they actively promote. Now, I ask you, if payment cards were such a huge issue, why would retailers go out of their way to make you use them?

Image credit: Lovelandpolitics.com.

The Consumer Financial Protection Bureau (CFPB) is “[a]nswerable to no one”, declares George Will in the title of his latest op-ed and then proceeds to inveigh against the consumer watch dog through the entirety of his piece. As he goes through a laundry list of grievances, Will becomes increasingly exasperated, eventually getting almost as worked up as Paul Krugman usually gets when commenting on a choice Wall Street Journal op-ed. It is quite something to behold.

But apart from its amusement quality, Will’s op-ed raises important questions about the CFPB’s legality and remit. The former issue is beyond my area of expertise, but it seems to me that as a practical matter, now that Obama is reelected, the only way for the CFPB to be taken down would be through a Supreme Court decision and I have no idea how likely this is to happen. On the other hand, whether or not its set-up is constitutional, I think that the CFPB’s role is an important one. While the bureau did launch itself into some dubious projects, like its attempt to simplify credit card agreements, on the whole the CFPB has thus far performed quite well.

‘CFPB’s General Lawlessness’

George Will has no doubts about the bureau’s legality:

The CFPB’s director, Richard Cordray, was installed by one of Barack Obama’s spurious recess appointmentswhen the Senate was not in recess. Vitiating the Senate’s power to advise and consent to presidential appointments is congruent with the CFPB’s general lawlessness.

The CFPB nullifies Congress’s power to use the power of the purse to control bureaucracies because its funding — “determined by the director” — comes not from congressional appropriations but from the Federal Reserve. Untethered from all three branches of government, unlike anything created since 1789, the CFPB is uniquely sovereign: The president appoints the director for a five-year term — he can stay indefinitely, if no successor is confirmed — and the director can be removed, but not for policy reasons.

Not only is the CFPB illegal, Will tells us, but its spending is out of control:

One CFPB request for $94 million in Federal Reserve funds was made on a single sheet of paper. Its 2012 budget estimated $130 million for — this is the full explanation — “other services.” So it has been hiring promiscuously and paying its hires lavishly: As of three months ago, approximately 60 percent of its then 958 employees were making more than $100,000 a year. Five percent were making $200,000 or more. (A Cabinet secretary makes $199,700.)

Unsurprisingly then, the author’s solution is for the whole thing to be dismantled, which “would affirm the rule of law and Congress’s constitutional role”.

Take the CFPB Down?

I am quite sympathetic to Will’s criticism of the CFPB’s “uniquely sovereign” status and of the bureau’s apparently unchecked power to receive huge sums of money from the Federal Reserve. Yet, flawed as its set-up may be, and despite all the foolish projects it has embarked on, the CFPB does serve a useful purpose.

The bureau’s most important contribution so far has been the creation of the Consumer Complaint Database, which contains data from the consumer credit card complaints filed with the CFPB. Once received, each complaint is then sent on to the appropriate card issuer, which has 15 days to respond to it and is expected to resolve and close the case within 60 days. I did go through the process and found it to be a quite simple and straightforward one. More importantly, the card issuer against whom I filed the complaint responded immediately and the whole issue was resolved within a week. In contrast, when I initially called the bank about my issue, they were much less cooperative. So a listing into the CFPB database is a stick with which consumers can prod an unenthusiastic issuer toward a resolution of a real-life problem.

Similarly positive was the bureau’s decision to levy a fine of $25 million on Capital One and to force the issuer to refund $150 million more to its cardholders over the bank’s use of deceptive practices in selling the so-called “add-on products” — things like payment protection plans and credit monitoring. Even if you thought that you had successfully fended off the series of sales pitches you were subjected to the last time you called your card issuer, you could still find yourself signed up for something you didn’t want and that could sometimes cause bigger problems. Following the Capital One fine, some issuers decided to stop hawking such products and the others will surely reconsider their sales practices.

The Takeaway

So the CFPB should not be dismantled, as Will wants, but it should be revamped. The employee salary issue should certainly be looked into and some kind of control should be implemented. More importantly, some kind of an accountability mechanism should be established to help the CFPB keep its focus on issues that actually need dealing with and leave alone things that have already been quite well regulated.

Image credit: Washingtoncitypaper.com.

Last week I commented on a UMass Amherst economics professor’s article in the New York Times in support of the Durbin Amendment-mandated lowering of the debit interchange rates that took place last year. Now, people write things in support of that piece of legislation all the time and I don’t usually respond to them, but what had made Nancy Folbre’s article stand out from the crowd was the fact that she had repeated a particularly egregious argument first advanced by Senator Dick Durbin – the author of the eponymous amendment. The gist of that argument, as spelled out by Dick Durbin himself in a letter to Wells Fargo’s CEO, is that the card issuers’ profits far exceed “any reasonable measure of the cost to Wells Fargo of conducting debit transactions.” So Dick Durbin, supported by Nancy Folbre and many others, was in effect telling a publicly-traded U.S. corporation how much it should charge for its services!

This morning Folbre follows up on her last week’s piece, this time dealing with the complexities of Visa’s and MasterCard’s credit card interchange structures. While I do accept her premise — the two card networks’ interchange structures are indeed hugely and unnecessarily complicated — I disagree with her conclusion that “strategic price complexity”, as she calls it, affects merchants to the extent that she claims it does.

Credit Card Interchange Structures Are Unnecessarily Complex

Interchange fees are the portion of the card acceptance fees paid by the merchants and collected by the card issuers. The other major component of the car acceptance fees are the fees charged by the payment processors. Visa and MasterCard set their interchange fees independently and update them twice a year. They are published on the two companies’ websites and the current versions can be found here and here. If you are like most people, you would have no idea what to make of these fee tables when you first looked at them, and MasterCard’s is especially confusing.

Now, in defense of the card networks, there is a good reason why we don’t just have, say, four or five interchange rates. For example, Visa’s CPS/Small Ticket interchange fee for credit cards is 1.65% + $0.04, whereas the equivalent non-small-ticket rates are 1.51% + $0.10 for non-rewards and 1.65% + $0.10 for rewards cards. The reason this makes sense is that if your average ticket amount is low, say $10 (which wouldn’t be unusual for a coffee shop), the fixed per-transaction component of the interchange rate becomes much more important that the percentage one. So a lower fixed fee benefits the small-ticket merchant. More generally, card-not-present rates are higher than card-present ones. This also makes sense, because e-commerce and MO / TO rates of fraudulent and charged back transactions are substantially higher than card-present ones and so a risk premium is justified. There are other examples and it should also be noted that the Durbin Amendment itself caused the biggest single expansion in these two lists’ histories. Still, even after one accounts for all legitimate reasons, the fact is that there are just too many interchange fees, especially on MasterCard’s list. But how much of a problem is that?

How Much of a Problem Are Interchange Fees?

Folbre’s latest piece revolves around a comment on her previous NYT post. In it, a small business owner tells us that there is no way of knowing how much he would be charged for each card payment he accepts. Here is how the merchant puts it:

You see, each card carries a different fee for the merchant. But how can a merchant ever know what the card is to ask the customer to use a different or cheaper card that carries less fees for the merchant? You can’t. There is nothing on the cards to delineate the literally thousands of types of cards and fees associated with them.

That statement is correct – there is no easy way of telling how much accepting a particular type of card would cost you. But let’s ask a different question for a moment, and one to which we do have a ready answer: how much of a difference is there between accepting one type of card or another? Let me preface my answer by noting that the vast majority of interchange rates in the two networks’ lists do not apply to this particular merchant, and that is the case with every merchant type.

So let’s use Visa’s table – I know, I’m taking the easier route, but let’s keep things simple. The rates to which Folbre’s commenter should pay attention are all to be found on page four (there might be some exceptions if the odd customer decided to use a commercial type of card, but these would be very rare), and even there most of the rates do not apply to his type of business. The vast majority of this merchant’s Visa credit card transactions would be processed at one of these two interchange rates: the one for rewards cards — 1.65% + $0.10 — and the one for non-rewards cards — 1.51% + $0.10. As you see, the difference between these two rates is a grand total of 14 basis points! To put it another way, if in our example the merchant’s average ticket amount is $75 — and it may well be lower than that — the difference between a rewards and a non-rewards card would be 10.5 cents! That is what the huge problem is about.

The Takeaway

I think that MasterCard and Visa have only themselves to blame for the outrage over their interchange fee structures. Even if the two networks could offer a reasonable explanation for the multitude of rates on their lists — and they may well be able to do that — the fact would remain that regular people would still be able to make neither head nor tail of it all. And — as Folbre’s commenter makes it clear — when people don’t understand what is going on, they are very likely to feel cheated. So yes, whether or not their complexity is justified, interchange tables need to be downsized.

Image credit: Philip Taylor PT.

A UMass Amherst economics professor is arguing in today’s New York Times that the lowering last year of the debit card interchange fees — the portion of the card acceptance fees that is paid by the merchants and collected by the card issuers — was the right thing to do. The article is loaded with phrases that are sure to appeal to a large segment of NYT’s readership: “Wall Street dominance”, “fierce opposition from large banks”, “too big to fail”, etc. Furthermore, and for good measure, the article is chock full with statistics and references to outside sources (no less than 25!), lest we dare doubt the ineluctable conclusion.

And yet, for all her efforts, Nancy Folbre — the author — somehow fails to even mention the most conspicuous side effect of the Durbin Amendment — the part of the Dodd-Frank Act that led to the reduction of the debit interchange. In their effort to make up for the lost interchange revenue, the affected card issuers (financial institutions with assets of less than $10 billion were exempted) started charging higher fees for other services or introducing fees for services that were previously free. As a direct result, no big bank is now offering a free checking account and, overall, the cost of banking has increased. And this was all easily predictable and predicted, both on this blog and elsewhere! So how is that a positive outcome?

Interchange Fees and ‘Actual Cost’

Here is how Folbre describes the purpose of the legislation at issue and the fees it regulated:

The Durbin amendment of the Dodd-Frank financial regulation bill was intended to lower the interchange fees that banks collect on debit card purchases. These fees were considerably higher than in other countries, and far exceeded the actual cost, estimated by the Federal Reserve Bank at about 4 cents per transaction.

The “actual cost” thing is one of the amendment champions’ favorite arguments. You may recall that Sen. Durbin himself used to love to inform Bank of America and Wells Fargo what their cost of processing debit transactions was. He too was citing Federal Reserve data, however, at 7 cents per transaction, the senator’s figure was almost twice as high as the one cited by the professor. Neither has provided a link to the Federal Reserve report at issue.

But Sen. Durbin had gone much further in his letter to Wells Fargo than Prof. Folbre in her NYT piece (and we did analyze it at the time). The senator had calculated the profit the bank had made from collecting interchange fees on debit transactions in 2010 and then had estimated how much that total would have been if the new interchange structure had been in place back then. Under the new rules, Sen. Durbin informed Wells, the bank’s revenue in 2010 would have been lower by slightly more than a billion dollars than the actual figure. However, unlike Prof. Folbre, Senator Durbin was much more direct in making his point. And it was a revelation to me and many others.

Profit as a Four-Letter Word

So here is what Sen. Durbin’s calculations led him to conclude:

This amount [$1.22 billion] far exceeds any reasonable measure of the cost to Wells Fargo of conducting debit transactions.

Think about it for a moment. A U.S. senator was telling a publicly held corporation that their profits were exceeding “any reasonable measure of the cost” of doing business. I wish the senator had told us, and the bank’s shareholders, just what was a “reasonable” amount of profit. And, by the way, why restrict yourself to the cost of payment processing services? Why not tell grocery chains what the “reasonable” price of, say, lettuce is? There is a big business world out there in need of the senator’s wisdom.

But back to Prof. Folbre’s NYT piece. While acknowledging that retailers have benefited from the interchange reform, she neglects to mention that the merchants haven’t exactly been eager to share the windfall savings ($7 billion a year or so) with their customers, as they had promised. And, by the way, the bulk of the windfall went to the biggest merchants, think Wal-Mart, Target, etc. Nor does the professor find it necessary to bring up the topic of the vanishing free checking accounts and the rising fees of other financial services, which are all direct results of the Durbin Amendment, which forced credit card companies to develop new revenue sources. Well, if she did, Prof. Folbre would have had to acknowledge that consumers have been on the losing side of this reform. I’m sure she would denounce the banks for charging all these fees, but the fact remains that we have to pay these fees now and we didn’t have to do so prior to Durbin.

The Takeaway

What needs to be recognized is that the damage to consumers is already done and it is unlikely to be reversed, even if the Durbin Amendment ends up being scrapped, together with the rest of the Dodd-Frank Act. All these new fees are here to stay. What caused the whole thing was a government-mandated redistribution of revenues from one industry to another, something the government has no business doing.

Image credit: Rcrihelp.blogspot.com.