Crippling Credit Cards

There’s no question these are tough times for retailers. Consumer spending is weak, and the hangover from the housing collapse could tip the economy into recession. There’s a jolt on the way from rebate checks, but retailers are gazing at a different pot of gold — credit card fees, in particular the interchange fees used between banks in the MasterCard and Visa systems. Unfortunately, their proposed solution, now embodied in federal legislation, would have serious unintended consequences for consumers and could worsen the country’s economic problems.When you use a Visa to make a purchase, the merchant submits the transaction to an acquiring bank, which then submits it to Visa. Visa sends the transaction to the bank that issued the card, which deducts its interchange fee and pays Visa. Visa pays the acquiring bank, which pays the merchant. Cardholders are later billed by their issuing banks. MasterCard also works the same way, though it uses a different network.This system works well because there is competition among issuing banks to sign up customers and competition among acquiring banks to sign up consumers. There is a division of labor that creates market efficiency.American Express and Discover don’t use interchange fees because they serve both the acquiring and the issuing functions. Notably, however, American Express charges substantially higher fees than Visa and MasterCard. Amex charges higher fees because they sell themselves as a premium brand and merchants believe they will acquire and retain higher-end customers who will spend more as a result. Discover, on the other hand, charges lower fees to merchants, but is the least used credit card company because many merchants don’t think accepting Discover will improve sales.Merchants who choose to accept AmEx do so because it makes business sense for them — the additional sales they make cover the higher fees and more. On the whole, however, the verdict of the market, given the success of Visa and Master-Card, seems to be that it’s more efficient for the acquiring and issuing sides to be separate. But as fees become a growing part of the bottom line for many merchants, merchants are looking for ways to trim them. Many merchants have addressed this issue with market-based solutions like negotiating an exclusive deal with one credit card company at a reduced fee or by steering transactions onto PIN-based debit networks.Presently these rates are determined in a free market — merchants negotiate with the payment networks and choose which cards to accept based on customer demand and what makes sense for their business. Merchants who want to slash the fees they pay while accepting popular cards are planning to run around the market by calling for Congress to intervene.Reps. John Conyers of Michigan and Chris Cannon of Colorado have introduced the so-called Credit Card Fair Fee Act of 2008, H.R. 5546, to impose price controls on interchange fees. The bill would empower a panel of unelected bureaucrats to set fees at below market rates.In Australia, where regulators did what this bill proposes, slashing interchange fees well below their market level, the result has been a dramatic decline in cardholder benefits — reward programs and the like — and an increase in annual fees. This has driven a double-digit increase in the use of more expensive charge cards from companies like American Express and Diners Club. As a result, merchants are paying more on many transactions, and there is a push for regulation of the three-party payment systems.If something like Conyers-Cannon were enacted, consumers would face higher interest rates, less-generous rewards programs, and could see the return of annual fees as banks scramble to make up for the lost revenue resulting from the interchange price control. Customers would have fewer choices of cards and some customers would be unable to be approved for credit cards.Crippling Visa and MasterCard through regulation would decrease consumer choice and buying power, and ultimately hurt the merchants who are calling for it. No merchant is forced to accept Visa or MasterCard. Their near-ubiquity is not the result of any market abuse, but rather follows from the terrific value proposition they offer to both consumers and merchants. In fact, credit cards, with their existing fees, are already considerably cheaper for merchants than accepting cash, which has associated costs of theft, security, and handling.The merchants know that accepting credit cards allows them to retain customers and make far more sales than they could otherwise. They are willing to pay, and should remain willing to pay, transaction fees, including interchange, for those benefits. Congress should avoid the temptation to impose price controls on this well-functioning market.Mr. Kerpen is the policy director for Americans for Prosperity.

Crippling Credit Cards

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