Financial regulation hits your wallet

Phil Kerpen President, American Commitment
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Credit or debit?  It’s become a familiar part of the check-out ritual for retail transactions.  Many of us, even though we are using bank debit cards, choose the “credit” option, which is actually a debit transaction that runs over the same Visa or MasterCard network that processes credit card transactions.  There are lots of valid reasons for choosing “credit” but many big merchants want to take the “credit or debit” choice away from customers.

Regulations would mean lower fees for merchants but less choice for their customers.  And while such regulations have no conceivable connection to the housing bubble or the financial meltdown, they are hitching a ride on the so-called Wall Street Reform bill that will soon be voted on in the U.S. Senate.

The provision that would take away the choice of credit or debit is labeled “no routing restrictions” and shreds the legitimate private contracts that Visa and MasterCard have with merchants that assure customers the ability to choose how their transactions are processed.  Instead, within one year of the bill passing, new regulations would prohibit any “contract, requirement, condition, penalty” that would prevent merchants from choosing how every transaction is processed.

In effect, the federal government is tearing up legitimate contracts – that have served consumers very well – to allow merchants to choose “credit or debit” for us, based on what’s best for them.  It is terrible news for consumers who rely on the value-added features of their cards that are only available when transactions are routed over credit networks.  Perhaps the most familiar consumer perk is winning airline miles, shopping credits, or cashback points.  But many other consumer benefits are available for credit shoppers including fraud protection, a better audit-trail including a signature, and other features like integrated lines of credit and transaction-timing flexibility offered by some banks and credit unions.

To the extent some merchants still allow consumers to choose credit, the transactions would be subject to new federal price controls.  These price controls will reduce the transaction fees by as much as 90 percent, by requiring the fee be based on the “incremental cost incurred” by the bank or credit union that issued your card.  That might sound like great cost savings, but government cannot make things less expensive by imposing price controls without serious consequences, as we should have learned from Nixon-era wage-and-price controls.  When prices are artificially suppressed, the consequence is a precipitous drop in supply.  In this case, by pushing costs toward the marginal cost of an individual transaction, banks and payment networks are unable to justify the enormous capital expenditures necessary to build, maintain, and innovate.  They are also starved of cash for more routine operational expenses like staffing call centers.

These severe price controls, combined with the new routing power given to merchants, are designed to destroy the “credit” option and force all debit card transactions onto cheaper debit networks that don’t offer meaningful fraud protection or other valuable services.

Moreover the “incremental cost” language creates the precedent that price controls for network transactions should be set at or near the marginal cost of running the transaction, which ignores the enormous investment required to build, maintain, and support the underlying network. That is a very frightening precedent for every network industry from railroads to the Internet, which could have capital investment destroyed by applying the same regulatory model of pushing transactional charges toward marginal cost.

The new rules are in section 1075 of the massive Dodd-Frank Wall Street Reform and Consumer Protection Act, and were added on an unusual amendment vote on May 13.  The amendment, sponsored by Sen. Dick Durbin of Illinois, got 64 votes (60 were needed) including 17 Republicans.  The Republicans who supported the amendment put the interests of politically connected merchants ahead of their professed free-market principles, and the interests of consumers.

In effect, the federal government is, at the behest of merchants, overturning a market arrangement that has served consumers well.  And they are doing it inside a bill that is supposed to be a response to the financial crisis.  The Senate still has an opportunity to reject these provisions by voting no on the deeply flawed Dodd-Frank bill.  If the bill is enacted, repealing the debit card price controls should be included in any “fix bill” worthy of the name.

Mr. Kerpen is vice president for policy at Americans for Prosperity.