Summary
Retailers are waging a no-holds barred campaign seeking government regulation of card acceptance fees and interchange. A barrage of advertising and inflammatory op-ed pieces such as “Retailers, consumers squeezed” make a revival of the “Credit Card Fair Fee Act” later this year more likely. If it or similar card payment fee regulation was enacted, card issuers, networks and acquirers would be hurt.
Analysis
In a deep recession in which unemployment and business failures are rising, Overstock.com president Jonathan Johnson contends credit-card fees are driving retailers out of business, putting employees on the street, harming consumers and creating a credit crisis. Whoa! Each of these inflammatory charges is preposterous.
Credit cards help generate incremental retail sales. In a healthy economy and even more in a recession, retailers pressure financial institutions for more accommodative credit and look to innovative retail credit programs to prop up sales.
Overstock.com promotes its very own Visa credit card, trumpeting no annual fee, no consumer fraud liability, a grace period and rewards, all funded by Johnson’s decried interchange fees.
Why would Overstock.com promote a product its president alleges puts retailers out of business and employees out of work? Lo, its credit cards generate business and when they’re used at any of the 30 million merchants accepting Visa, interchange revenue for Overstock.com.
Electronic payment systems enable Internet merchants’ existence.
Overstock.com’s president complains about the lack of payment guarantees. Amex, Discover, MasterCard and Visa products provide payment guarantees for most purchases. However non face-to-face purchases have significant fraud risk and therefore, generally, do not come with payment guarantees. For a price doubtless they could.
Johnson contends payment systems aren’t competitive or regulated. The electronic-payment-system market unlike regulated utilities, is vigorously competitive at every stage in the value chain: card issuing, the networks, acquiring and processing. Retail payment systems are more competitive than at any time since the inception of general purpose payment cards in the early fifties. Competitors include four commercial full-suite networks Amex, Discover, MasterCard and Visa, e-commerce gorilla PayPal, Amazon FPS, Danal, and Mobilian, as well as a host of challengers touting lower merchant acceptance fees, such as Noca, Secure Vault, Moda, Moneta, Revolution Money, National Payments and Tempo.
But in retail payments cheaper often is not better.
Much of Johnson’s frustration stems from two-sided payment networks’ asymmetric pricing, which is not intuitive, and the fact buyers’ payment preferences generally trump sellers’. Many two-sided network markets charge one side more to maximize total value delivered. In software, browsers are free while developers pay. Bars often offer women free or discounted drinks. Content providers charge subscribers less than advertisers.
Payment networks use interchange to balance the spend and acceptance sides of the network, to maximize total value for merchants and cardholders. Higher merchant fees up to a point, mean greater consumer benefits and spend and therefore network value.
Interchange is set lower where it increases transactions. For instance, with utilities consumers’ payment preferences don’t matter. Regulated utilities don’t lose business by not accepting additional payment products. So to boost acceptance in 2008 MasterCard and Visa lowered utilities’ interchange. For ATM transactions interchange flows to the acceptance side of the network, often to merchants with ATMs.
Overstock.com president’s charge credit cards caused the credit crisis is ludicrous. Johnson is directing his ire in the wrong direction. Government was the culprit.
With a view to increasing home ownership, government systematically weakened mortgage credit standards. GSE Fannie Mae’s and Freddie Mac's acquisition of subprime, alt-doc loans and home equity lines increased from 15% of mortgages in 2001 to 37% in 2004. Securities collateralized by subprime mortgages soared from $18.5 billion in 1995 to $507.9 billion in 2005. The U.S. Department of Housing and Urban Development instructed Fannie and Freddie that 45% of homebuyers whose mortgages they purchased between 2005 and 2008 should be "low-and moderate-income," 32% from "central cities, rural areas, and other underserved areas," and 22% from "very-low-income families or families living in low-income neighborhoods."
Reducing credit standards had the desired impact. Home-ownership rates began a sustained climb from 64% in 1995 to a peak of 69% in 2004.
But it had other effects, as well. It boosted housing demand and inflation.
The Fed’s loose monetary policy also fueled the housing valuation bubble. Real fed funds rates were negative from 2001 through June 2005. Higher prices should have reduced demand, but instead they caused underestimation of high-loan-to-value mortgage risk, spurred credit and demand, and fueled speculative home purchases.
Johnson contends interchange caused issuers to recklessly lower credit standards. In stark contrast with the mortgage industry, credit card companies did not dramatically and systematically weaken their credit underwriting criteria.
While higher fees enable credit-card issuers to take more credit risk, finance charges and administrative fees are far more important than interchange to granting revolving credit to riskier consumers.
Interchange is a major revenue source for credit, debit and prepay payment products. It enables prepaid products for the un and underbanked. It funds benefits 160 million American credit cardholders take for granted such as grace periods, cash back, frequent flyer miles, and no annual fees, as well as covering fraud, processing and credit loss costs. Interchange spurs additional card payment use.
Many retailers want by government intervention to get lower fees than they can get in the market. Regulating payment systems as public utilities would stifle payments innovation and competition, punish cardholders with higher fees and lower benefits, and suppress payment network value.
