Will US courts take aim at credit-card interchange?

By Felix Salmon
January 12, 2012
Dan Freed has an amazing story today about credit-card interchange fees -- the ones which weren't touched at all by the Durbin amendment in the Dodd-Frank bill.

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Dan Freed has an amazing story today about credit-card interchange fees — the ones that weren’t touched at all by the Durbin amendment in the Dodd-Frank bill. But it turns out that the courts might yet prove even tougher than Congress: various suits working their way through the legal system could end up costing the banks hundreds of billions of dollars in settlement costs — plus a reduction of interchange fees to something approaching international norms.

The threat here is very real: Visa has already put more than $4 billion in a litigation escrow account, and the card companies’ potential liabilities are much smaller than those of the big banks. Deutsche Bank analyst Bryan Keane says that total damages “could total a couple of hundred billion dollars”, and that’s backed up by some back-of-the-envelope math:

JPMorgan’s 10-K gives no specific numbers regarding its exposure, but notes that, “based on publicly available estimates, Visa and MasterCard branded payment cards generated approximately $40 billion of interchange fees industry-wide in 2009.”

Those numbers cited by JPMorgan would appear to point the way to a very large settlement, since the case covers eight years and counting — from 2004 through the present. Eight times $40 billion is $320 billion, and an influential 2005 report on price-fixing by Purdue University economics professor John Connor that looked at 700 cartels going back to the 1600s found a median overcharge rate of 25.5%. But even if one assumes an overcharge of just 10% — the figure used by the Justice Department in its antitrust cases — that would suggest $32 billion of overcharges over eight years. That number, however, would be trebled, as is the rule in antitrust cases, meaning damages could conservatively be estimated at $96 billion. If Bank of America had to pay roughly 10% of that, as per its 10-K, the bank would have to cough up $9.6 billion.

Freed includes this helpful chart, showing just how high US credit-card interchange fees are when compared to the rest of the world.

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Note that the smallest bar, over to the right, is for the EU as a whole. If Germany is at 1.5, Spain is at 1.1%, and the UK is at 0.8%, then there have to be a lot of countries at or very close to zero in order to bring the overall average down to 0.3%.

Now that Congress has decided quite clearly that it’s not going to regulate credit-card interchange fees, it stands to reason that merchants are going to take their case to the courts. This one will run and run, I’m sure: there won’t be any checks written for a very long time yet. But it’s a huge contingent liability for the banking sector, just as negotiations over a mortgage settlement come to a head. If I were a bank shareholder, I certainly wouldn’t count on credit-card interchange fee remaining at its current inflated levels indefinitely.

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