Draconian Dodd-Frank Durbin Debit Controls Need Not Be More Destructive, Court Rules

As the weather finally turns to spring, the D.C. Circuit Court of Appeals today blew a nice cool breeze of common sense.

A bipartisan three-judge panel unanimously overturned district Judge Richard Leon’s July 31 ruling that the Federal Reserve had not made the price controls stemming from Dodd-Frank’s Durbin Amendment draconian enough. Today’s decision by Clinton-appointed Judge David Tatel found that the Federal Reserve “reasonably construct[ed]” the law in considering costs in setting the price caps, and the ruling in fact opens the door to allowing banks and credit unions make retailers pay more of the costs of processing debit cards.

In the wake of cybersecurity attacks on credit and debit cards, this ruling came in the nick of time. In what I had called incredible chutzpah, the trade associations for some of the nation’s largest retailers argued in federal court even after the Target breach that retailers should pay less for fraud prevention and cleanup after fraud losses. That, of course, would mean that innovation would continue to lag behind and even more of the costs of payment processing would be shifted to consumers, as they had ever since the passage of this amendment, which had been inserted into the 2010 Dodd-Frank financial overhaul by Senate Majority Whip Dick Durbin.

The interchange fees that banks and credit unions charge merchants for debit card transactions — what retailers pejoratively call “swipe fees” — have been subject to price controls ever since then. Dodd-Frank’s Durbin Amendment, which came about as a result of heavy lobbying by Target, Wal-Mart and other big retailers, states that the debit interchange fees charged to retailers must be “reasonable and proportional to the cost incurred by the issuer [bank or credit union issuing the card] with respect to the transaction.”

CEI opposed the Durbin Amendment from the start, because we believe price controls are a violation of individual property rights and turn out to be impractical. But many who voted for the Durbin Amendment believed that the price-setting process would be similar to rate regulation of electricity and phone service, in that the fee set would allow for infrastructure and service costs plus what is judged as a “reasonable rate of return.”

What happened, though, was that ever since the Fed began implementing the provision, the retail lobby has argued that the provision not only bars banks and credit unions from profiting on the fees charged to retailers, only a very limited portion of costs could actually be recovered in the fee.

The result has been both a massive cost-shifting for debit card processing from retailers to consumers — a sharp reduction of free checking for low-balance account and the virtual end of debit card rewards — as well as much less resources from retailers to fight hacking and cyber attacks. If the retailers prevail in this lawsuit — arguing in part the fees still allow banks and credit unions to recover too many data security costs — that they are now deciding whether to appeal, consumer costs would rise even further and make card purchases even more vulnerable to attacks.

In the ruling, Judge Tatel made similar points to the ones I had made in OpenMarket and the Credit Union Times on the flaws in Judge Leon’s decision just after Leon’s ruling came out. Yes, the Durbin Amendment is “convoluted” (Tatel’s words). But the fact that its language did not explicitly bar “fixed costs,” means that the Fed is within its authority to consider them in setting the price controls.

In fact the court’s instructions to the Fed to reconsider defining the term “incremental costs” in the stature is not necessarily to small consolation prize to the merchants it may seem. Prominent economist William Baumol, who now holds posts at Princeton and New York University, has explicitly defined “incremental costs” to include fixed costs in works such as his paper with Gregory Sidak on “Stranded Costs.”

But the Durbin Amendment’s status quo has still meant the virtual end of free checking and is stalling needed innovation to fight security breaches. There are some promising innovations in payment technology, including Bitcoin and similar digital currency, but the Durbin price controls may kill the profit motive necessary to get these innovations into the hands of everyday retailers and consumers.

Congress should repeal this “convoluted” (again, the Court’s words) and draconian measure as well as the many other destructive provisions of Dodd-Frank. Let’s follow the court’s example and keep this cool breeze of common sense in public policy blowing.