“The Federal Reserve Board’s final rule [on debit card swipe fees] is an improvement from its initial proposal,” concluded William Cooper, the CEO of TCF Financial, a small bank (by today’s standard, anyway) in Minnesota. “The Fed’s rule is an irresponsible abdication of its legal duty,” countered Lyle Beckwith of the National Association of Convenience Stores.
So who’s right? The price-fixing directive, inserted in the Dodd-Frank financial reform law by Assistant Senate Majority Leader Dick Durbin, required the Fed to set ceilings on fees charged to merchants for the use of debit cards that were “reasonable” and “proportional.” We have no idea what that means. What we are sure about, though, is that the swipe fee debate was rooted in a misunderstanding about the economics of electronic banking. And that the whole messy business, pitting giant retailers against giant banks, offers a cautionary tale of government-by-lobbyist.
Every time somebody uses a debit card to buy a burger or pay the orthodontist’s bill, the bank that issued the card and the electronic network that processed the transaction take a cut. The trade associations representing retailers have been claiming for years that these fees are higher than the banks’ costs, and that consumers ultimately must pay the piper. The banks, for their part, muttered darkly that if the merchants don’t pay, they’ll be forced to charge more for related services like checking. And there the matter stood until the merchants used some last-minute leverage to add the “reasonable and proper” provision to Dodd-Frank.
Once the law of the land, the Fed was, of course, obliged to figure out what it meant and to set maximum fees accordingly. In their first try, they set the ceiling at 12 cents-per-swipe, about a quarter of the current average. The banks howled, and managed to convince the Fed to set the fee at 21 cents, plus a nickel per hundred dollars of the transaction.
What, apart from a recalculation of the relative power of the warring lobbies, explains the yawning difference between the Fed’s first and second computations of reasonable and proper? Here’s a clue: In a market in which two distinct, co-dependent parties (here, consumers and merchants) benefit from the same service, economics offers no easy way to calculate how a competitive market will (or ought to) apportion the costs.
Once you look, you’ll see that such “two-sided” markets are everywhere. “Free” TV charges 100 percent of costs to advertisers and nothing at all to viewers. At the other extreme, Microsoft charges the full cost of the Windows operating system to PC users and nothing for the array of services provided to independent software companies that build applications for Windows. While one can produce models predicting who will pay what portion, they are no better than the underlying assumptions.
In the case of swipe fees, the Fed concluded that the tariffs far exceeded the cost of managing the electronic networks needed to facilitate them. But it didn’t – and couldn’t – assess how swipe fees fit into the constellation of payments services benefitting all parties to the system. So it punted.
Maybe banks will revise their fees to recoup the lost revenue. Maybe they won’t, and incentives to speed the transition from paper payments to electronic payments will diminish. Maybe retailers will pass on the savings to customers. More likely, the efficient ones operating in the most competitive markets will, while others won’t. Our guess is that the evidence will be too ambiguous to tease out of the blizzard of data, leaving each side to claim the high ground as the consumer’s friend.
So what’s the moral here? Legislatures and regulators should leave well enough alone unless there is clear evidence of anti-competitive market power. And if they do intervene, it should be to reduce the market power, not to fix prices.
Ah, but we dream. As long as influencing regulation is a cheaper and often more effective alternative to winning profits the old-fashioned way, businesses would have to be stupid to ignore the opportunities offered by big-money politics.
(This post was also published on Forbes.com.)