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By: HBC Wed, 09 Jun 2010 02:46:40 +0000 Interchange fees should be standardized, and independently audited. That definitely isn’t the case at present, which is how a lot of the confusion on this topic arises. Merchants are paying all kinds of different amounts to various service providers, some of whom are banks and none of whom basically do very much to deserve any of the fee amounts they suck out of the system.

By: Zywicki Tue, 08 Jun 2010 21:40:39 +0000 Oops, obviously I meant “epithet” not “epitaph.”

By: Zywicki Tue, 08 Jun 2010 21:16:49 +0000 Felix:
Thank you for taking the time to read my paper. I look forward to hearing your contributions tomorrow.

Having said that, I think you’ve misunderstood my paper a bit. The point is a bit more subtle, I think, then you’ve grasped. It is certainly more subtle than the straw man arguments that you claim that I make.

First, I am not arguing that credit risk is overall a money-losing proposition for card issuers for exactly the reason you state–purchases is what generates a customer base for issuers. What I am arguing is that merchants want to argue that the only costs that matter are the marginal costs of processing transactions. That ignores the costs of credit risk. Once that variable is considered, with respect to credit cards, it is not obvious at all that merchants are being overcharged on interchange fees. For reasons discussed in the paper, merchants likely would have issued much of this credit in-house (or foregone sales) and would have suffered similar, and probably larger, credit losses. The argument is not one about charging merchants for the credit risk of their customers (I’m not sure why you read it that way, actually) but to recognize the benefits that merchants get from credit cards. From there it is just a Coasian bargain if credit card issuers can bear risk at lower cost than merchants.

I think maybe you’ve also missed the larger conceptual point here because you’ve misunderstood the purpose of the credit-loss point which is not to justify cost-based pricing: the details of the pricing (rising interchange fee rates) flows out of the two-sided market analysis (newspaper subscription and advertising rates bear little relationship to the relative costs of servicing those two groups), the credit-loss point is related to the fairness point.

For reasons described in detail in the paper, I believe you are simply wrong about the supposed benign value of annual fees. The return of annual fees would be a major disaster for consumers and would substantially reduce competition in the credit card industry. They are also regressive in that they bear no relation to the amount a person uses their card or the amount they charge. I don’t see any reasonable argument to the contrary.

As to whether these costs will be passed on to consumers (“which may or may not be true”) the only research I’ve seen is the Australia experience. And I don’t know of anyone, especially supporters of interchange regulation, who doubts that costs to consumers would rise. It appears that you have some reason to doubt that result. If so, I’d be interested on your basis for equivocating on that point.

As for the final block quote, that is a hypothetical example used to illustrate a theoretical point–I think you’ve simply misread the purpose of that analysis.

As for your charge that this is a duopoly–are you saying that there is an antitrust violation here? If so, why do you think the DOJ doesn’t sue? Are they simply unaware of it?

And if it is a duopoly, what exactly is the supply restriction that you see going on here? Are you saying that there are sustainable economic rents somewhere in the system–which is my understanding of the effects of monopoly? Are you saying the rents aren’t dissipated somewhere in the system, perhaps on the consumer side of the market? Are consumers victimized by the interchange duopoly too? If not, what exactly is your theory as to why the purported duopolists only inflict their harm on merchants rather than consumers? How do you square the arguments of those who say that the problem arises from what amounts to hypercompetition in the consumer side of the market in the form of benefits, etc.?

Or are you just throwing around the term “duopoly” as an epitaph? Because I don’t really see the sustainable rents in the system, the output restrictions, or the logic of how the monopoly rents are supposedly being extracted here.

As for the debit card point, I relied on the research by Tim Muris (former FTC Chairman) and Tom Brown and was not aware of your subsequent blog post with the new data.

The basic problem overall is who bears the cost of payment systems. Merchants like the legacy systems because they are able to externalize the underlying costs of those systems on consumers and taxpayers. Consumers bear the costs of having to go to the ATM, the risk of loss and theft of cash, and much of the costs and risks of using checks. The government prints money and requires that checks be cleared at par, thereby allowing merchants to externalize all of those costs.

The complaint of the merchants, it looks like to me, is that unlike those subsidized systems they have to pay for the benefits of payment cards and they’d like to be able to externalize those business costs onto the rest of us. I understand why they like that. I just don’t understand why the rest of us would.

The real question is whether they should be able to force consumers to subsidize their business costs through higher annual fees, higher costs, and lower quality payment cards. I think not. If you want interchange fee regulation, then that’s the argument you need to be willing to make.

By: FelixSalmon Tue, 08 Jun 2010 21:07:51 +0000 billyjoerob, I’m not talking about legality here, I’m talking about payments. It’s perfectly reasonable for the national payments system to be regulated, no?

By: AdamJ23 Tue, 08 Jun 2010 16:19:09 +0000 billyjoerob- I don’t think it’s particularly easy to distinguish between gouging and profit-maximizing most of the time. But when you start seeing marginal costs drop and yet prices still increase it starts to smell like a rat. Not to mention credit cards are charging merchants to assist the credit card company in extending credit- a profitable activity in and of itself. In a competative marketplace that really shouldn’t happen- card companies should be competing to get merchants to use their cards. And low and behold there’s a duopoly in play. Neither Visa nor Mastercard is going to compete on interchange rates- they know they’ll just force the other card company to drop their rates too and not gain any significant market share- neither company will win in a pricewar like that. So instead of a pricewar, they raise interchange rates, and wait for the other card company to follow- which they do, because its more profitable to raise prices then try and eek out a slightly larger market share with price competition. Plus, merchants cannot realistically refuse to accept the major credit cards and they can’t put the costs directly on the credit card using consumer- they have to hide and spread the costs between all customers. Merchants can’t forward the costs solely onto their credit card customers because they’re risk losing those customers- consumers get pretty nasty when they start seeing new fees pop up on their bill- even if the fee is completely warranted. Card companies can keep increasing interchange fees simply because consumers are ignorant of the hidden cost and merchants hands are tied.