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Dodd-Frank Gotterdämerung: The Durbin Amendment Rollback

posted by Adam Levitin

As early as this Tuesday we might find out who runs this country.  Is it Wall Street and the financial economy or the real economy of consumer citizens and retailers?  We will know the answer to this question based on what happens when the Senate votes on a bill to unwind a Dodd-Frank Act provision that would prevent banks from charging anticompetitive debit card swipe fees.

This provision, known as the Durbin Amendment is a bellwether for the state of political power and thus financial regulatory reform in the United States. Banks are working furiously to roll back the Durbin Amendment, and their success or failure at doing so is a measure of the political power of financial institutions. If the banks win, it will not just be the traditional story of the banks' routing the consumer groups. If the banks win, it will show that the financial services sector is more powerful than the largest retailers in the US.  (Heck, the US Chamber of Commerce is on the banks side on this, which might say something about the Chamber's funding. It's certainly not from all the small businesses over which they weep crocodile tears.) 

Three years ago, we had an unparalleled financial disaster.  Wall Street's Frankenstein destroyed trillions of wealth and caused serious and lasting social harm. A generation's retirement savings were destroyed, which will cause all sorts of labor market issues, and household wealth in entire communities (particularly communities of color) was gutted. Neighborhoods, cities, and counties have been crushed with foreclosures.

It took two years before Congress mustered a response, the Dodd-Frank Act.  Dodd-Frank is flawed and imperfect in many regards, but it was certainly a step forward toward protecting the real economy from the financial economy.  But now comes the the counterrevolutionary onslaught with the goal of going back to business as usual, as if nothing had happened.  The tip of the spear is the somewhat unlikely issue of debit card interchange (swipe fee) regulation.  

The Dodd-Frank Act includes a provision known as the Durbin Amendment that regulates the debit card swipe fees paid by merchants to banks.  (See here, here, here, here, here, here, here, here, here, here, here, here, and here on it.)  Debit swipe fees had no real direct connection to the financial crisis. Instead, they've been an $17B annual antitrust problem that has existed for over a decade. As early as Tuesday we might see the Senate vote on whether to delay implementation of the Durbin Amendment (which in DC speak really means to kill it).  (Sadly, the Fed itself seems to be quietly hoping that the Senate will deep six the Amendment.)

The fact that debit card swipe fees have gotten to the state they're in is itself a testament to the political power of banks in the United States. In other countries there are no debit swipe fees (Canada), they run in reverse, meaning the banks pay merchants (Australia), or they have been regulated for antitrust violations (EU). 

And in the US?  Here, however, prior to the Durbin Amendment, the financial services industry had managed to head off any legislative attempts to address the issue and to bottle up antitrust litigation in the courts.   The result?  We pay higher costs and get a worse debit product than any other developed country. Here's some pretty good signs that the US debit card market is broken: 

  • Swipe fees are higher in the US than in any other developed country. 
  • US debit cards are less secure than debit cards in any other developed country (we lack chip altogether and many cards don't have a PIN)
  • US payment card technology generally lags the rest of the world. Put differently, the debit card swipe fee system discourages innovation. The current system is cozy for banks, so there's no incentive to innovate the rock the boat.  A physician friend recently related to me that when he used is US payment card in Sweden, the Swedes stared at him "as if [he] were wearing a 1980s Sony Walkman" or some other antiquated technology. [Before anyone starts yapping about Google Wallet in the comments, let's remember that nothing about Google Wallet requires swipe fees. Instead, Google Wallet is an acknowledge that the current swipe fee system lacks of clear value proposition for merchants. Merchants might like Google Wallet because it means that they are funding rewards that will generate future sales at their stores. The current system makes merchants fund rewards that generate future sales at airlines. Why should Safeway pay for United frequent flier miles? What's the sense in that?] 

Now this is just bare bones evidence of why the system is broken. It doesn't present a positive case for the Durbin Amendment as a solution. The Durbin Amendment aims to foster price competition, beneath a price ceiling. Most of the objection to the Durbin Amendment has focused on the price ceiling and how it is calculated. Such objections are reasonable. I don't have a lot of confidence that the Fed's price ceiling calculation makes a lot of sense (I think the only defensible price ceiling for interchange is zero).

But the arguments about the Durbin Amendment have never really been about whether it is narrowly tailored or perfectly crafted. They've always been an argument that the market doesn't need regulation, period. This explains why staunchest defenders of the current debit swipe fee system have been libertarian academics like Richard Epstein and Todd Zywicki?  

And this is where it all circles back to Dodd-Frank. Over the next few years, we will see a sustained attempt to roll back all the Dodd-Frank Act. Not because Dodd-Frank got the regulatory particulars wrong (as it did in cases), but because of an objection to regulation period. The Durbin Amendment is the first regulation in a chain of dominos. Momentum matters, so don't think that the Durbin Amendment's fate is unrelated to your own pet financial regulatory issue. 

The politics of regulation is where Congress really got it wrong with Dodd-Frank. The fundamental assumption underlying Dodd-Frank is that the financial crisis's root problems stemmed from a market that had out run regulation and that the fix was to be found in adding or subtracting some regulations.  In other words, Dodd-Frank diagnosed the financial crisis as a regulatory problem. And there were certainly regulatory failures involved in the crisis.

But the real problem wasn't the regulations or financial economics, but the political economy of regulation.  Put in lay terms, the problem was political not regulatory or financial. In most instances, federal regulators had the power pre-Dodd-Frank to have cracked down on many of the practices that led to the financial crisis, in both the mortgage market and the derivatives market. They simply failed to exercise those powers. What's more, Congress and particularly the regulatory agencies themselves engaged in significant deregulation. The OCC is probably the worst actor in this regard via preemption without equivalent federal regulation, but the Fed might be a close second. (See this pair of amazing papers by Saule Omarova on the OCC's regulation of bank derivative activities and the Fed's regulation of bank-affiliate transactions, which let the federal deposit insurance guarantee leak out to cover all kinds of speculative behavior.)  

The fundamental problem in financial regulation is that bank regulators and large parts of both political parties in Congress have been effectively "captured" by the financial services industry. I won't spell out here what Simon Johnson and James Kwak (and Bill Black before them on S&Ls) have covered in detail, but remember what happened to Tom Daschle for opposing the banks on the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA)? Head on a pike. Huge money poured in from out of state to oppose his reelection bid. Sadly, the most of the academic economics work on financial regulation--and a good deal of the legal work--is virtually oblivious to the elephant in the room, as if regulation occurred in an apolitical space.  

Dodd-Frank didn't fix the dysfunctional political economy of financial regulation. And even if the Volcker Rule had been adopted in full measure (rather than gutted by Scott Brown), it wouldn't have made any difference. The last financial regulatory measure that really addressed the political economy problem was the Glass-Steagal Act of 1933.  

No one every conceives of the 1933 Glass-Steagal Act as a political economy move, but by splitting the investment banks from the commercial banks, it divided the financial services industry, which meant (1) that each segment had much less weight to throw around, and (2) they could be played against each other.  That was the story with the passage of the Trust Indenture Act of 1939 (William O. Douglas got the commercial banks to support the legislation to screw the investment banks out of the indenture trustee business), and the story of a lot of turf war litigation between commercial banks, investment banks, and insurance companies. All of that ended with the Gramm-Leach-Bliley Act of 1999, which created a financial services lobbying Vultron, much more powerful than the sum of its parts. In retrospect, the political economy effect might have been the most important aspect of Gramm-Leach-Bliley. The Volcker Rule wouldn't undo this political economy effect.

So we're still in a situation in which the fate of financial regulation is decided not on its merits, but by political clout. In this regard, the Durbin Amendment is rather unusual--there's a heavy-weight counterbalance to the banks in the form of retailers. Such counterweights don't exist for many other issues, however. (Witness bankruptcy cramdown's fate.) But that makes things all the more worrisome. If the financial services lobby can defeat the retail lobby (with some consumer allies), I think we can expect to see a great deal of Dodd-Frank get rolled back. We're going to go back to partying like it's 2006. 

And that's why I'm going to predict what's next on the menu if the Durbin Amendment is rolled back:  an attempt to revisit the Credit CARD Act. If there's a Republican Senate and White House in 2012, I'll lay down money that a CARD Act repeal is way up on the agenda.

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