Friday, February 24, 2017

Why Consumers Should Hate the Durbin Amendment

The earliest records of human history have documented example after example of failed attempts by governments to impose price controls on the marketplace, and yet politicians today are still experimenting with them. As far back as 2830 BC, Egyptian rulers attempted to set grain prices as a means of preventing starvation and famine. They failed miserably, and yet here we are over four more millennia later using similar policies.
Credit or Debit?
When a consumer uses a credit card, the risk of nonpayment shifts from the store to the bank.
One of the latest price-fixing crusades occurred as part of the Dodd-Frank Financial Reform bill passed by Congress in 2010. Control efforts are typically undertaken in the name of protecting the consumer. In reality, the so-called Dodd-Frank “Durbin Amendment,” which established government price caps on the fees retailers are charged when a customer uses a debit card, was enacted for the sole purpose of reducing costs on Fortune 500 corporations. With Dodd-Frank reform on the horizon, this amendment should be the first one to go.

The origin and history of the Durbin Amendment is well documented. For years, retailers have complained about the costs imposed by banks when consumers use debit and credit cards. The fees, which were established by the marketplace, act as an insurance policy for banks.
When a consumer uses a credit card, the risk of nonpayment shifts from the store to the bank. The moment a customer swipes a card and the transaction is approved, money is transferred from the bank and lender to the merchant. Should the creditor fail to pay, costs are incurred by the banks, not the retailer. Part of the risk is mitigated by an “interchange fee.”
Merchants select the lowest-cost networks, leading to increased fraud and  additional costs on card-issuers and consumers.
As more and more consumers use credit and debit cards to make purchases, interchange fees have become little more than a rounding error on every bill for companies like Walmart and Walgreens, which did what most major corporations do when faced with a market problem – they turned to their lobbyists to fix it.
The CEO of Walgreens, an Illinois-based company, went to Sen. Dick Durbin (D-IL) and got more than a sympathetic ear – they got a champion for their cause. Mr. Durbin went to the Senate floor crying big, crocodile tears over the cost of interchange fees. “I had the CEO of Walgreens contact me last week,” Durbin said, “ turns out the fees that Walgreens pays to credit card companies is the fourth largest item of cost for their business.” The Senate quickly adopted the Durbin Amendment, which mandates that the Federal Reserve, rather than the market, establish the rate of the interchange fee. But the amendment went even further, establishing layers of price controls and market dictates.
The Durbin Amendment also includes a routing provision that functions as an additional price control, which, like the interchange caps, is an example of government interference in a well-functioning market, leading to price distortions that benefit retailers at the expense of community banks, credit unions, and other financial institutions. It also ultimately hurt the very consumers it was supposed to help.
Network Routing Provisions
Before 2010, card issuers would enter into exclusive contracts with networks based on the various features they offered, including security, reliability, and acceptance rates. Networks were free to compete against one another for these arrangements.
Consumers select cards based on features offered by the networks and the confidence that their cards will be honored by merchants at the cash register. But the Durbin Amendment complicates this, adds more regulation, and requires all debit cards in the U.S. to participate in a number of unaffiliated networks, allowing merchants, not consumers, to dictate which networks are used.
Contrary to their promises, the vast majority of retailers have not passed on their Durbin Amendment windfall by lowering their prices.
Merchants therefore select the lowest-cost networks, often leading to increased fraud and the imposition of additional costs on issuers and consumers. In many instances, cardholders who are concerned about the risk of fraud are either misled or kept in the dark about which network is used to route their transactions. By heavily emphasizing cost minimization, merchants weaken market incentives to invest in strengthening fraud protections, quality improvements, and secure debit networks, despite the fact that consumers value these innovations.
The network routing provision is also a great example of anti-competitive, free-riding behavior. Forcing an issuer to allow unaffiliated networks to process debit card transactions, based on a merchant’s preference, is similar to requiring a Coca Cola vending machine to also dispense Pepsi and Dr. Pepper products. Just as Coke and Pepsi are allowed to compete for the right to place vending machines in high-traffic areas to sell their products to consumers, debit networks should be free to compete on price, quality, acceptance rate, and other factors that might convince issuers and cardholders that they are the best option for routing debit transactions.
Promises, Promises
A government-mandated free-riding allowance may benefit big box stores and large retailers by artificially driving down their costs, but it is not in the best interest of consumers. It also runs counter to free market principles that lie at the heart of the U.S. economy.
It would be a folly to uphold the Durbin Amendment’s routing provisions.
Merchant groups argue that consumers benefit from the backdoor routing price controls. However, prominent studies conducted by the Federal Reserve Bank of Richmond and other researchers demonstrate that, contrary to their promises, the vast majority of retailers have not passed on their Durbin Amendment windfall by lowering their prices. Consumers do not benefit from lower routing costs and are actually harmed by the reduced emphasis on network quality and security.
It is no surprise that merchant lobbyists would cast the anti-competitive features of the Durbin Amendment in a different light in order to preserve the billions of dollars in annual savings they have accrued since its adoption in 2010. It is also understandable that some policymakers would be initially attracted to proposals that preserve the elements of the Durbin Amendment that have received less attention in recent years, and thus may appear less objectionable.
In reality, however, the network routing provisions are simply another backdoor price control imposed on a well-functioning market that benefits one industry at the expense of another, while ultimately harming consumers.
Given that the pitfalls of artificial price controls are well-understood by economists and policymakers, it would be a folly to uphold the Durbin Amendment’s routing provisions. The Durbin Amendment must be repealed in its entirety to fully eliminate its adverse impacts on the U.S. economy and consumers.

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