Interchange fees: The latest salvo

June 7, 2010
Tyler Cowen and Matt Yglesias have not had time to read Todd Zywicki's 63-page paper on interchange fees; it certainly doesn't need to be nearly as long as it is. But the fact is that you don't need to read all that far past the abstract to realize how silly and contentious it is.

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Tyler Cowen and Matt Yglesias have not had time to read Todd Zywicki’s 63-page paper on interchange fees; it certainly doesn’t need to be nearly as long as it is. But the fact is that you don’t need to read all that far past the abstract to realize how silly and contentious it is.

For instance, Zywicki spends a lot of time making the argument that “the increased revenues merchants receive from shifting credit losses on sales to card issuers by itself exceeds interchange costs” (his italics):

Visa and MasterCard card issuers alone wrote off almost $50 billion in uncollected credit card debt in the U.S. in 2008, and $65 billion in 2009—more than 5% of the total volume of credit card purchases by their cardholders last year. This uncollected debt represents revenue or profits that merchants would not have received without issuing banks assuming the credit risk for those transactions and suffering the loss. In essence, these losses reflect revenues the merchants received from card issuers for sales that were made but not actually paid for by cardholders…

To the extent that a part of the interchange fee represents an allocation of the cost of increased credit risk to merchants (who undeniably benefit from the increased revenues it represents and who otherwise would have to bear that risk themselves), merchant claims that any portion of these fees above the “direct administrative costs” of operating a credit system are unjustified and meritless.

You can see why it might be hard to wade through 63 pages of this stuff, especially when Zywicki’s arguments are as disingenuous as this. Interchange fees are not, never have been, and never should be an attempt to charge merchants for the credit risk of their customers. The $65 billion of credit-card write-offs in 2009 is a large number — but it is significantly smaller than the total amount of interest charged by credit-card issuers. The extension of credit, for credit-card companies, is a profit center, not a loss center. If you’re just looking at the credit side of things, the card issuers should be paying merchants for bringing them new transactions from which they make so much money, rather than the other way around.

You also need to do a lot of footnote-chasing, with this paper. Consider:

Supporting the importance of risk-shifting for credit cards and their value to merchants is the fact that while total (credit card plus debit card) interchange fees collected have, on average, increased slightly, interchange rates on debit cards—which entail almost no credit risk—have been declining.

This surprised me, so I followed the footnote, which took me to this blog entry, written by a colleague of Zywicki. The blog entry, in turn, pointed me to Chart 3 in this paper. Here’s the chart in question:


The first thing you note is that the CAGR on the right hand side shows debit-card fees rising by 0.5% a year on average, not falling. And the second thing you notice is that the chart ends in 2004, long before the spike in debit-card fees that everybody is complaining about.

VISA1web.jpgBack in January, Andrew Martin published a much more up-to-date chart, which I blogged here: a glance at it makes clear that if you’re only using data on interchange fees which ends in 2004, you can’t be taken seriously in this debate.

At heart, Zywicki’s argument is that merchants benefit from payment cards, therefore they have nothing to complain about. But this is silly. Yes, merchants benefit from these cards. But that doesn’t mean that the card issuers can or should be able to continue to ratchet up interchange fees. The reason for the Durbin amendment isn’t so the level of interchange fees, so much as it it’s the rate at which they’re rising: these things were profitable for the card issuers when they were much lower than they are now, and all the recent increases have been pure gouging, made possible by the Visa/Mastercard duopoly.

Zywicki spends an inordinate amount of time arguing that payment cards are a good thing, that handling cash is expensive, and various other assertions which no one has any objection to. What he doesn’t do is provide any good reason for rising interchange fees: debit cards, in particular, should be significantly cheaper than cash, for merchants, and increasingly they’re not. Still, he gives it the old college try:

A small increase in interchange fees would make participation in the network more expensive for merchants, but it would also enable banks to enhance their card offerings. Thus, this would tend to increase the number of consumers using that network’s cards and thus make the network more attractive for merchants.

Those ungrateful merchants — they just can’t see that rising interchange fees are good for them!

A lot of the rest of the paper is devoted to the old arguments about how if you stop banks from making money in secret, through interchange fees, then they’ll just start making money more transparently, through higher annual fees and interest rates on credit cards. Which may or may not be true, but it’s a good thing either way, I think. Maybe it will help to swing the pendulum away from credit cards and back towards old-fashioned personal loans, as a way for individuals to borrow money. And yes, it’ll mean lower profits for the banks. I’m perfectly happy with that.

Update: Zywicki responds in the comments. I still don’t follow his argument: I don’t see why merchants, if they extended credit themselves at non-zero rates, would have have lost money rather than made money by doing so. But check out his comment for yourself.


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