Every now and then, we try to adhere to the purpose of this blog by focusing on some egregious example of the unintended consequences of a regulation. The latest example is the debit card fiasco.
As you will recall, led by Senator Dick Durbin, Congress included a provision in the Dodd-Frank law that limited the amount of debit card fees that banks could charge to merchants. They had previously been charging about $.48 per transaction, but the law now allows a maximum of $.24. Economist and others warned that, if banks were required to reduce debit card fees, they would offset these losses of revenue by other charges to consumers. That has now come to pass.
Shortly before the law's October 1 effective date, Bank of America announced that it planning to adopt a fee of $5 per month for depositors using debit cards to make purchases. Other banks are testing similar fees, although at lower levels. The B of A fee, in particular has drawn a tremendous amount of media attention and reported outrage from consumers, who have threatened to take their business elsewhere.
The response from Democrats has been predictable. Since the didn't believe the warnings that restricting debit fees to merchants would lead to price increases elsewhere, they are shocked, shocked when banks follow through and actually raise such prices. Senator Durbin said,
" After years of raking in excess profits off an unfair and anti-competitive interchange system, Bank of America is trying to find new ways to pad their profits by sticking it to its customers. It's overt, unfair and I hope their customers have the final say. Earlier this year the Federal Reserve determined that the interchange fees Visa and Mastercard fix for big banks grossly exceed the cost of processing a debit card transaction by some 400%. These hidden fees were designed to boost big-bank profits by charging small businesses and merchants every time a debit card was swiped."
President Obama also criticized the increase, saying, "“You don’t have some inherent right just to, you know, get a certain amount of profit, if your customers are being mistreated, ... this is exactly the sort of stuff that folks are frustrated by.
The Federal Reserve rulemaking did determine the cost of processing a debit card transaction. But it considered only the costs. Thus it stated "As required by the statute, the final rule establishes standards for assessing whether debit card interchange fees received by debit card issuers are reasonable and proportional to the costs incurred by issuers for electronic debit transactions."
Neither the Dodd-Frank Act nor President Obama considered how business actually operate. Businesses earn profits -- there is no basis for determining that they should not include a profit element in their fees to merchants. If the pricing of interchange fees now excludes all elements of profit, the banks must recover those lost profits form the other party to the transaction -- the consumer. Contrary to the President, businesses do have the inherent right to earn a profit -- that's what the whole capitalist system is about.
Obama's remark betrays a fundamental problem with his presidency -- his distrust, in part based on his years as a community organizer, of the American business system and his effort to restrict its freedom of operation. His response in an informal interview undermines all the grandiloquent language in his teleprompter speeches and demonstrates his fundamental antagonism to American business.
Showing posts with label Crediit Cards. Show all posts
Showing posts with label Crediit Cards. Show all posts
May 26, 2010
Credit Cards and Internet Service: Joint Products Continue to Raise Controversy
When I practiced law, I spent much of my time defending a computerized reservation system (CRS) against claims of monopoly pricing. After four years of litigation, we won a four-month jury trial, in which the jury found that we weren't a monopoly, and weren't engaged in unjust pricing. Now, the same economic issues involved in the CRS litigation are again front and center in two current regulatory disputes.
The basic economic issue with CRSs arose from their nature as what economists call "joint products." This is defined by Wikipedia as "two or more products, produced from the same process or operation, considered to be of relative equal importance" The CRS produced a reservation transaction that equally benefited the airline that provided service and the travel agent who made the booking (and ultimately the consumer). Since it is recognized that cost allocation of common cost is entirely arbitrary, the pricing of CRS services was controversial for many years. In the early days of CRS, travel agents paid a little, many airlines got a free ride, and the vendors lost substantial amount of money. The vendors were able to get significant booking fees from some smaller airlines, who complained of discrimination. After the CAB adopted regulations requiring nondiscriminatory fees, all airlines were required to pay booking fees, and the CRS's became highly profitable. The vendors then engaged in intense competition for placement in travel agencies, which resulted in competing away some of the profits generated from airlines in increasing discounts to travel agents.
The battle over pricing of joint products is now again being fought in Washington -- this time over Internet services and credit cards. Both are joint products. The Internet is similar to the classic example of a joint product -- a newspaper. Indeed, it is so similar, that it is quickly displacing newspapers. The Internet connects suppliers and users, both of whom contribute to the cost of the systems. Users pay fees to the telephone or cable company that provides Internet service. Websites also pay fees for their connection to the Internet, and offset these fees by collecting revenue from advertisers, or sometimes subscription fees from viewers.
Some vendors use substantially more bandwidth than others. Sites such as YouTube that provide video or movies are obviously intensive users who absorb tremendous amounts of Internet capacity. The whole "net neutrality" issue arose when network providers suggested that they might charge more for high consumers of bandwidth. This was quickly labeled discrimination by vendors that might have to pay more, and the battle has been fought under the appealing banner of "net neutrality." But it is really a battle over pricing -- heavy consumers are trying to avoid a pricing structure that reflects their impact on the network. They want all users priced equally, thus forcing light users to subsidize bandwidth hogs. It is not very reasonable to require users who use the Internet for e-mail and browsing news articles to pay as much for their Internet service as young people who use the Internet for watching movies and playing games.
The credit card issue is similar. Credit cards are a joint product, providing equal benefits to both merchants and users. Again, the traditional pricing structure charges both beneficiaries. Subscribers usually pay annual fees, plus interest of bills were paid in a timely manner. Merchants also paid in the form of discount fees, equal to a small portion of the amount charged by the consumer. MasterCard and Visa discount fees were usually somewhat less than 2%, while American Express charged more -- sometimes 3% for merchants, and even higher for smaller companies such as restaurants.
Merchants have fought for years to restrict these fees, and have recently found some success. In early May, the Senate adopted an amendment to the Financial Reform bill that would require merchant fees for debit cards to be "reasonable and proportionate" to the actual cost of processing these transactions. (The amendment does not apply to credit card fees.) Of course, this runs right into the question of how to allocate the common costs of a joint product. The House bill does not contain a similar provision, so the amendment may not survive the conference committee.
It does seem that merchants may be paying too much, not because their prices exceed some cost standard, but because credit card companies are competing away much of their revenue from merchants to attract new consumers. Rewards cards are the prime example of credit card vendors using revenue from merchants to give points that consumers may use to redeem merchandise, or even simply to pay consumers one or two percent of the total amount charged. Of course, in the current economic environment, the card companies are suffering tremendous losses, and can reasonably argue that they need to maximize revenue from both merchants and consumers in order to survive.
I will do some more research on both credit card and net neutrality issues, and continue to blog on these questions.
The basic economic issue with CRSs arose from their nature as what economists call "joint products." This is defined by Wikipedia as "two or more products, produced from the same process or operation, considered to be of relative equal importance" The CRS produced a reservation transaction that equally benefited the airline that provided service and the travel agent who made the booking (and ultimately the consumer). Since it is recognized that cost allocation of common cost is entirely arbitrary, the pricing of CRS services was controversial for many years. In the early days of CRS, travel agents paid a little, many airlines got a free ride, and the vendors lost substantial amount of money. The vendors were able to get significant booking fees from some smaller airlines, who complained of discrimination. After the CAB adopted regulations requiring nondiscriminatory fees, all airlines were required to pay booking fees, and the CRS's became highly profitable. The vendors then engaged in intense competition for placement in travel agencies, which resulted in competing away some of the profits generated from airlines in increasing discounts to travel agents.
The battle over pricing of joint products is now again being fought in Washington -- this time over Internet services and credit cards. Both are joint products. The Internet is similar to the classic example of a joint product -- a newspaper. Indeed, it is so similar, that it is quickly displacing newspapers. The Internet connects suppliers and users, both of whom contribute to the cost of the systems. Users pay fees to the telephone or cable company that provides Internet service. Websites also pay fees for their connection to the Internet, and offset these fees by collecting revenue from advertisers, or sometimes subscription fees from viewers.
Some vendors use substantially more bandwidth than others. Sites such as YouTube that provide video or movies are obviously intensive users who absorb tremendous amounts of Internet capacity. The whole "net neutrality" issue arose when network providers suggested that they might charge more for high consumers of bandwidth. This was quickly labeled discrimination by vendors that might have to pay more, and the battle has been fought under the appealing banner of "net neutrality." But it is really a battle over pricing -- heavy consumers are trying to avoid a pricing structure that reflects their impact on the network. They want all users priced equally, thus forcing light users to subsidize bandwidth hogs. It is not very reasonable to require users who use the Internet for e-mail and browsing news articles to pay as much for their Internet service as young people who use the Internet for watching movies and playing games.
The credit card issue is similar. Credit cards are a joint product, providing equal benefits to both merchants and users. Again, the traditional pricing structure charges both beneficiaries. Subscribers usually pay annual fees, plus interest of bills were paid in a timely manner. Merchants also paid in the form of discount fees, equal to a small portion of the amount charged by the consumer. MasterCard and Visa discount fees were usually somewhat less than 2%, while American Express charged more -- sometimes 3% for merchants, and even higher for smaller companies such as restaurants.
Merchants have fought for years to restrict these fees, and have recently found some success. In early May, the Senate adopted an amendment to the Financial Reform bill that would require merchant fees for debit cards to be "reasonable and proportionate" to the actual cost of processing these transactions. (The amendment does not apply to credit card fees.) Of course, this runs right into the question of how to allocate the common costs of a joint product. The House bill does not contain a similar provision, so the amendment may not survive the conference committee.
It does seem that merchants may be paying too much, not because their prices exceed some cost standard, but because credit card companies are competing away much of their revenue from merchants to attract new consumers. Rewards cards are the prime example of credit card vendors using revenue from merchants to give points that consumers may use to redeem merchandise, or even simply to pay consumers one or two percent of the total amount charged. Of course, in the current economic environment, the card companies are suffering tremendous losses, and can reasonably argue that they need to maximize revenue from both merchants and consumers in order to survive.
I will do some more research on both credit card and net neutrality issues, and continue to blog on these questions.
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