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Zywicki's Interchange Settlement Balderdash

posted by Adam Levitin

I was really hoping that I would be able to go at least a year without having to call Todd Zywicki out for his comments on some consumer finance issue.  But it's not to be. Zywicki has weighed in on the interchange settlement, proclaiming it to be great thing for consumers.  Mission accomplished.  

How does Zywicki reach his conclusion?  By claiming that:

[the settlement] does affirm the core principle that interchange fees should be set by free markets and consumer choice rather than by judges or politicians, thereby preserving the engine behind one of the marvels of the modern age: the evolution of a 24-hour globally-connected system of instantaneous, secure, and ubiquitous payments system.

Let's put aside the fact that other countries have more advanced, more secure, faster, and more ubiquitous payment systems than the United States without oppressive card network rules and price-fixing.  Apparently this is an ideological matter. The settlement affirms the primacy of free markets and consumer choice, Zywicki claims. How? Zywicki isn't long on the details, but the answer would be that it preserves the current interchange fee system.  In short, the settlement is a victory for consumers because it accomplishes next to nothing.  

It's long seemed to me that Zywicki understands free-markets to mean "whatever the banks want," but a more principled free-market view would argue either for discounting (or surcharging) at every level of the payment system or at none of them (on the basis of inaccurate discounting creating deadweight loss). Consider the current system:
  • Consumer-Issuer:  discounting via interest rates, fees, etc.
  • Issuer-Acquirer:  discounting via interchange fee
  • Acquirer-Merchant:  discounting via merchant discount fee
  • Merchant-Consumer:  restrictions on discounting (surcharging)

The system should allow each level to set its own prices (I always thought an essential part of the free market was setting your own prices, but apparently that's not so), or have them set by a politically responsive process (much as the Fed, by statute must have par check clearing for members).  Zywicki is very upset by what he sees as political/judicial intervention in the free-market, but isn't enforcement of the law an essential part of markets operating?  (Perhaps not if you don't believe in antitrust law.) In any case, if free market is what he wants, the answer isn't the current system, but a system that allows everyone to set their own prices, in other words, permit merchants to discount or surcharge as they see fit.

What about consumer choice? Consumers are perfectly free to choose how they pay in the current market--and don't have to internalize any of the costs of their choices.  This is good for the card networks, but aren't we supposed to want people to internalize their costs?  Or does that principle of economics not apply when banks benefit? 

Zywicki is also concerned that merchants will abuse surcharging. If he read the proposed settlement, he would see that for all of its flaws, it puts a cap on surcharges, that is, at the most, the merchant's cost. If anything, the settlement is so restrictive, that there won't be surcharging. So much for abuse there. As it stands, a merchant can already violate network rules and surcharge, so permitting limited surcharging isn't opening the door to more abuse. And the truth is that merchant's don't want to surcharge. Sure, there's always the scenario of the local monopolist who surcharges like mad, but that local monopolist is going to do that to everyone, irrespective of means of payment.  

Zywicki also makes some rather bold claims that the Durbin Amendment has merely resulted in banks recouping their lost interchange revenue in deposit account fees. I don't know of any empirical evidence that clearly supports this conclusion.  He cites to the BankRate 2011 Checking Account Survey.  The survey methodology is not clear, but it seems to be measuring the percentage of institutions offering free checking, not the percentage of no-fee accounts.  And it isn't even clear what counts as "free checking"--is it whether I am actually charged a fee or whether a fee is possible based on the balance?  Still, even accepting that fewer consumers have fee-free accounts today, it's hard to pin all of that on Durbin, and is really a reflection of the competitive problems in banking--that a large number of banks are able to charge fees for offering identical service to their fee-free competitors is a sign that something is off in the market. 

I'll be the first to concede that we do not know the total effect of the Durbin Amendment. But there's really no basis for assuming that fees merely shifted. It's possible that they did, but it's also possible (and better supported by the little evidence we have) that the banks simply became less profitable. If it were merely a matter of fee-shifting, the banks wouldn't have cared about Durbin. Indeed, if they were able to price higher for deposit accounts, they should have--they owe that duty to their shareholders. The Durbin Amendment's small bank/credit union exemption, however, means that smaller banks aren't squeezed by Durbin, so they are able to maintain lower deposit account fees, against which the large banks have to compete.  That structure should prevent fee shifting. Indeed, we know that some banks like BoA, tried to do shift fees, but they had to retract their fees in the face of consumer opposition.  And perhaps most fittingly, TCF Financial, the bank that sued over the Durbin Amendment, has now backed away from its checking account fees.  That's consistent with a story of the Durbin Amendment forcing fees to more transparent parts of the consumer finance system, with the result of lower bank profitability, rather than shifted fees.


The demise of "free checking" is due to the very low interest rates that are currently in place. Banks used to get some benefit from "free checking" accounts because they were also interest free accounts - the bank had the use of the checking account deposits and usually didn't have to pay interest on that money, or if interest was paid, it was well below the usual rate for bank deposits.

Now, with interest rates on savings far south of 1%, there is very little interest income for banks from monies they hold on deposit. That's just a reality of the banking business at present.

If interest rates on savings go back to, say, 5%, "free checking" will miraculously revive.

I live in Hong Kong and certain businesses (e.g. Travel Agents, smaller electronics retailers, etc.) do impose a surcharge of a few percent on credit card transactions. I am not sure if this practice is permitted under the merchant agreements here, but it is fairly widely done.

You may be right about the free market principles, but as a consumer, this seems like a big step back. I like being able to externalize the cost of payment onto merchants and other consumers. How else am I supposed to get free air miles?

Zywicki has long been a shill for banks and their payment-card cartel (coordinated through MC and Visa). He opposes any reform which might promote competition between banks by simply asserting that banks competing is "anti-consumer."* Zywicki then argues (as I wrote back in 2009) that:

"...banks' revenues (and profits) are fixed by cosmic forces so that the mix of fees they charge can change but not the total amount. (Cosmic forces no, political forces, very likely!)" See http://truthonthemarket.com/2009/12/08/moving-the-ball-forward-macroeconomic-considerations/

*Zywicki's fellow-traveler Tom Brown actually exhumed the old socialist argument that competition increases transaction costs and therefore reduces efficiency as part of his defense of the banking cartel. Of course Todd "free markets" Zywicki let that pass unremarked. (Brown also showed that he's either dishonest or shamefully careless by attributing his own straw-man argument directly to me, even though I had actually written the opposite.) See http://truthonthemarket.com/2009/12/09/debunking-the-cross-subsidy-theory/

I second Mark's comment.

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