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Perspectives on the Durbin Amendment: Prof. Todd Zywicki

Oct. 18, 2011
Personal Finance
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We’re not shy about our views on the interchange market: we think it has some systemic flaws, namely that the only people with the incentive to keep swipe fees down – retailers – have very little power to do so, and that it is dominated by a small number of powerful players, which can create inefficiencies.

That’s not to say that we think the Durbin Amendment is a panacea. You need only look at Visa and MasterCard’s response to its implementation to see that post-Durbin interchange isn’t exactly a shining example of free market efficiency. In particular, the amendment only regulates debit card fees, not even prepaid fees, which limits its effectiveness and distorts incentives. Still, if we had to distill our reams of ink spilled on Durbin to one position, it would be that interchange reform is a tentative step in the right direction.

But we talked to Professor Todd Zywicki of George Mason University Law School, who has somewhat different views on the Durbin Amendment. “Anyone who’s ever taken a single economics class can see it’s a bad idea,” he says, “The government is picking winners and losers. The winners are big-box retailers, and the losers are consumers.” And in the spirit of bringing analysis from both sides of the debate, here are some of his thoughts.

1. The Durbin Amendment will shift the way we bank.

As larger banks raise fees on checking accounts and debit cards, which some say is a necessary reaction to the Durbin Amendment, more people are switching to credit unions and local community banks. That in itself is not a negative, but Zywicki argues that banks, facing lower revenues, will close branches and lay off workers.

They will become less consumer-friendly, more prone to fraud, and less likely to offer products such as mobile or online banking. The Durbin Amendment exempts small financial intuitions with assets under $10 billion, which covers almost all credit unions, community banks and online banks. However, Zywicki believes that they will not emerge unscathed from Durbin: “Most experts believe that this two-tier pricing system will fail.”

Zywicki also predicts – and we’re already starting to see this – a shift from debit cards to prepaid or credit cards. A study from the Boston Fed shows that as debit cards become more expensive, credit card use rises. Because credit cards have higher interchange fees than debit cards did, even before Durbin, retailers won’t save as much as they think they will. Zywicki adds that a shift away from debit harms consumers, because credit cards inevitably lead to credit card debt, and prepaid debit cards often come laden with hidden fees.

2. Price controls just won’t take.

Zywicki provided a number of examples of price controls in the banking system. He outlined a three-part reaction to price controls: term repricing, product substitution, and rationing. The first means that one fee is simply repackaged as another: interchange fees are shifted onto consumers in the form of debit usage fees. The second, product substitution, can be seen in banks’ concerted efforts to push people away from debit cards. The third and final element means that fewer institutions will offer debit cards as we know them, whether because banks increase fees and slash rewards, or simply stop issuing debit cards.

Zywicki cites the precedent of interest rate controls: most states have limits on the interest rate your credit card issuer can charge. In the days before interest rate caps, credit cards had low annual fees but high APRs. As interest rate regulation swept the country, annual fees rose accordingly. When a landmark Supreme Court case effectively ended interest rate caps for national banks, annual fees subsided and free credit cards returned. Zywicki thinks we’ll see a similar effect from interchange regulation: the old interchange fee will simply become a new one.

Visa’s third-quarter earnings call kicked off that reaction: the card processor will introduce a new network participation fee, levied on any merchant that wants to accept Visa cards at all. Priced correctly, that flat fee can essentially replace interchange fees, negating any change in retailers’ costs.

What’s more, it will hurt small retailers more than larger ones. “This is a largely flat fee that will scale down as processing volume goes up, so big-box retailers will pay less and small merchants will pay more, unlike the current per-transaction system that essentially scales with volume,” says Zywicki. Even ignoring that Visa will charge a different fee based on the merchant’s size (and given that larger retailers currently pay lower swipe fees, it’s likely that they’ll pay a lower NPF), the flat fee means that if a merchant doesn’t process many transactions – like, say, a coffeeshop owner whose clients often pay with cash – will basically pay more for each transaction.

3. Even if retailers do benefit, consumers won’t.

In a competitive market, lower costs mean lower prices: if Joe’s sandwich shop can afford to undercut Mike’s to get more customers, it will. In theory, then, savings from interchange fees will be passed onto consumers. But markets almost never work the way they do in an econ textbook. Zywicki cites the case of Australia: post-interchange reform, retailers did not charge lower prices. He expects that Durbin will give merchants a “massive windfall in the short run,” as they pocket interchange savings without dropping their prices.

In the long run, though, Zywicki isn’t sure they’ll see much benefit. “Merchants benefit from debit cards,” he says, “because it’s much simpler than carrying around cash, and some people can’t or don’t want to use credit cards.” And if banks succeed in luring consumers to credit cards, the retailers might actually pay more in swipe fees.

Zywicki’s not alone in doubting Durbin

Everyone has a bone to pick with the Durbin Amendment, from retailers (the cap is too high) to banks (the cap exists), from academics (two-tier pricing doesn’t work) to other academics (monopolistic markets are inefficient).

The disagreement doesn’t stop with just the Durbin Amendment. Many in Washington, from President Obama on down, think that Bank of America’s debit usage fee is irrefutable proof that banks are profit-motivated to the point of not caring about their customers. They urge customers to vote with their feet, leaving for the greener pastures of community banks and credit unions.

Others, on both sides of the aisle, believe that debit usage and network participation fees are a direct result of government intervention. Sharing Professor Zywicki’s perspective are Sen. Jon Tester (D-MT), whose bill to delay the Durbin Amendment failed to overcome a Senate filibuster; Representatives Jason Chaffetz (R-UT) and Bill Owens (D-NY), who introduced a bill to repeal the amendment altogether; and Representative Randy Forbes (R-VA), who cites the amendment as proof that government regulations are too onerous. Federal Reserve Chairman Ben Bernanke, with characteristic restraint, simply says he’s unsure if consumers will be helped or hurt.

Clearly, there are myriad – and strong – opinions about the Durbin Amendment, both on the merits of the legislation itself and on the overall premise of federal regulations. We will continue to showcase different ideas and opinions relating to financial regulation; if you’re interested in writing an article or giving an interview, please contact us at