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October 14, 2012

A Swipe at Consumers

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Today’s consumers take credit cards pretty much for granted.  Once used only for major purchases, Americans now use the cards routinely, for even the smallest of purchases.  It’s been a plastic revolution that has made life easier for millions of consumers.

But the cards have sparked numerous hard-fought political and legal battles as well.  Merchants have long grumbled that the “interchange” fees they pay for processing credit card transactions are too high.  For the past seven years, a class action lawsuit aimed at lowering these fees has percolated through the courts.    Last summer, a settlement was reached, under which the lawsuit would be dropped in exchange for, among other things, $7 billion from the defendants.    But many retailers still aren’t happy with the outcome – and are urging the deal be scuttled.  They want court-imposed controls on the practices and fees of credit card firms and the banks that actually issue the cards.

Rhetorically, the retailers paint this as a David v. Goliath battle, with powerless merchants at the mercy of huge financial institutions.   But these would-be Davids include some of the largest enterprises in the world, such as Wal-Mart and Target.  And many of the banks are small, community-based institutions.

Legally, the suit is an antitrust enforcement action.  It claims that Visa, MasterCard and the banks that issue credit cards conspired to make merchants pay artificially high interchange fees.   But it’s clear that the disaffected retailers are seeking more than punishment for alleged wrongdoing.  They are seeking a fundamental policy shift, hoping to impose via court order what they have not been able to get Congress to enact by law.

Retailers can’t be blamed for wanting to shift the costs of credit cards. With interchange fees averaging 2 percent of transactions, billions of dollars are at stake.  But court-imposed limits would not help consumers.    Look at what happened in Australia, which in 2003 imposed limits on interchange fees.   The theory was that merchants would pass on the savings to consumers.  It didn’t work out that way.  Not only did retail prices not drop, but credit card fees increased by some 22 percent (and up to 77 percent for “rewards” cards).  Moreover, several credit card issuers left the market, reducing competition—thus making the fee hikes easier to make stick.

But you don’t have to go down under to see the consequences of price controls.   Last year, the Federal Reserve imposed interchange fee caps on debit cards in the U.S., as required by the Dodd-Frank financial regulation act.   Again, the idea was to help consumers.  But there’s no evidence that any of the $8 billion in reduced retailer fees ever made it to their customers.  

On the other hand, consumers are paying more to their banks, which are searching for ways to recoup the revenue losses from the fee caps and other new regulations.   In the months following adoption of the debit fee caps, several banks announced new, direct fees on debit card use.  Other fees are going up too—a just-released study by Bankrate, Inc., shows free checking is becoming a thing of the past.   It’s now offered by fewer than four in 10 banks, compared to the 76 percent offering it before passage of Dodd-Frank.

Are these new fees sustainable?  Perhaps not.  Despite what some behavioral economists say, consumers are not irrational.  They will shift their business to banks that don’t issue credit cards, and can offer lower fees.  And banks in turn will cut back credit card offerings rather than take losses.   This shrunken credit card market will hurt consumers, merchants, banks and the economy.

The credit card revolution has changed the way commerce works – making purchases easier, products cheaper and transactions more secure.   It should not be jeopardized by ill-conceived price controls.  

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--James L. Gattuso is the Senior Research Fellow in Regulatory Policy at The Heritage Foundation’s Roe Institute of Economic Policy Studies.

First moved on the McClatchy News Tribune Wire.

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