April 6, 2011

April 6, 2011 | Commentary on Regulation

Debit Card Fee Caps: 41st Century of Price Controls

In 1979, economists Robert Schuettinger and Eamonn Butler wrote a book called “Forty Centuries of Wage and Price Controls,” detailing 4,000 years of disastrous attempts by governments to control market prices.   Next month, the Federal Reserve is expected to add a 41st century to that litany of failure. The target: debit card “interchange fees.”

Interchange fees are the fees banks charge retailers for processing debit card transactions. These charges vary widely, but average about 44 cents per transaction, or 1.14 percent of total purchases.   Overall, the fees generate about $14 billion for the banks that issue debit cards.   

 The stores that pay these fees have long complained that these fees are too high. And, they say, faced with the market power of banks and credit card firms, they have no ability to bargain them down.    This claim was always suspect, to say the least.   The merchant’s coalition petitioning Congress wasn’t all Mom and Pop stores – among its leaders were giants such as Wal-Mart. And anyone who thinks the folks from Bentonville can be pushed around by anyone just hasn’t been paying attention.

Nevertheless, after much lobbying, a provision was tucked into last year’s Dodd-Frank financial regulation bill instructing the Fed to set caps on these fees  After a hasty review of the marketplace, the Fed proposed capping interchange fees at a flat 12 cents per transaction  -- about a quarter of today’s level.    The Fed is expected to finalize this rate before the July 21 deadline mandated by Dodd-Frank.

The price cap was no doubt seen by Congress as an easy way to score political points.  In the wake of the 2008 bailouts, big banks have been political lepers, so why not transfer a few bucks from them to help out local retailers?  But, as Schuettinger and Butler could have predicted, this was no free lunch.  Already, banks across the country are limiting the benefits they offer to cardholders.    In the past week alone, JP Morgan Chase, SunTrust and Wells Fargo have announced that they will no longer be offering rewards to some or all customers.  More are expected to follow suit.

   

And it’s not just card rewards programs that are at risk.  Debit cards may be harder to get in the first place – depriving consumers of one of the most beneficial personal finance innovations in recent years.   The fee cap – along with other new banking regulation -- is also causing banks to increase fees on a wide range of other services, from ATMs to checking accounts to make up their lost revenue. 

 

The net effect will not only be to make banking more expensive, but cause many lower-income Americans to drop their bank accounts entirely.   Jamie Dimon, CEO of JPMorgan Chase, projects that as many as 5 percent of consumers to discontinue their accounts, becoming “unbanked.”  No wonder organizations such as the NAACP have joined industry groups in sounding the alarm on the new rules.

 

On the other side of the ledger, it’s not clear how much retail consumers will save – if anything.   Merchants won’t be required to pass on their windfall to customers (nor should they be, unless we want price controls at the retail level as well).   At least some retailers are already counting on substantial gains – Home Depot for instance is predicting an additional $35 million in profits from the fee caps.  But regardless of how the spoils are distributed, consumers will suffer, as the caps interfere with market pricing, increasing inefficiency across the board.

 

Recognizing the oncoming train wreck, Congress is having a case of buyer’s regret over the fee caps, with proposals moving in both houses to stop them from taking effect.   On March 14, Senator John Tester, a Democrat from Montana introduced a bill calling for a two-year delay of the new rules while their impact is reassessed.  The next day, Rep. Shelley Capito, a Democrat from West Virginia, introduced a bill calling for a one-year delay.  Both these bills have widespread support from both parties.

 

Congress, however, should go further.   Rather than just delay price controls, they should be eliminated entirely.

 

The problems caused by this ill-considered amendment to last year’s financial regulation bill presents a case study in how interference in the marketplace ends up hurting not just businesses but consumers.   This 21st century attempt at price controls worked no better than the others tried over the past four millennia.   Isn’t it time policymakers learned the lesson?

About the Author

James L. Gattuso Senior Research Fellow in Regulatory Policy
Thomas A. Roe Institute for Economic Policy Studies

First appeared in Bloomberg