Interchange Price Controls: Gift to Big Merchants, Lump of Coal for Consumers and Community Financial Institutions

On Thursday, the Federal Reserve — at the direction of Congress in the Durbin Amendment to the Dodd-Frank financial “reform” bill — will give a giant gift to some of the nation’s biggest retailers. This present is in the form of of direct and indirect price controls on the interchange fees they pay to financial institutions to process debit cards payments

Yet unless Congress acts to delay or repeal the Durbin Amendment, consumers, community banks, and credit unions will be getting a large lump of coal in their stockings by next December as the expenses of running an efficient payment card system are shifted almost entirely onto their shoulders. Consumers have already seen the costs of this rule through the loss of free checking as a result of banks’ anticipation of an estimated 60 to 80 percent loss of revenue from merchant fees. Moreover, the price controls and other provisions of the Durbin Amendment will like reduce investment and innovation to counter emerging hacking and security threats to the payment system.

The Durbin Amendment regulates the debit card issuers as public utilities — something they are not, as the amendment itself makes reference to a “the number of payment card networks” — but it sets price controls more severe than even rate regulation for local phone companies and utilities by not even explicitly allowing for profit.

Thus, as argued by a lawsuit challenging the Amendment from Minneapolis’ TCF National Bank, the fee controls likely violate both the Due Process and Takings Clauses of the 5th Amendment because they deprive banks and credit unions that issue cards of their property rights to a return on capital invested. The Supreme Cou,rt in its 1989 case Duquense Light Co v. Barasch, affirmed that  a government-set “rate is too low if it is so unjust as to destroy the value of the property for all the purposes for which it was acquired.”

The Durbin Amendment likely crosses this constitutional line by requiring the Federal Reserve to set interchange fees at a rate “proportional to the cost.” And the measure expressly discourages some costs from being considered by the Fed. Expenses such as paying employees to service the complex payment system and long-term fixed costs in setting up the sophisticated infrastructure may be excluded.

In fact, amazingly, the Merchants Payments Coalition, which represent Wal-Mart, Walgreens (who Sen. Durbin admitted — on the Senate floor — lobbied him for price controls), and some of the nation’s biggest stores, says that the cost for retailers should be “at par” or zero. Even Ebeneezer Scrooge or the Grinch couldn’t come up with a more self-serving call for corporate welfare.

And consumers have already started paying for the merchants’ “free lunch.” At banks of all sizes, free checking accounts are disappearing, particularly for lower-income consumer who don’t have linked accounts or can’t maintain higher minimum balance thresholds.

And given the experience of other countries with interchange price controls, consumers will likely lose even more without reaping any significant savings from retailers. The Government Accountability Office of the U.S. Congress found last year that after Australia enacted fee controls on credit cards, Aussie consumers faced “reduced rewards and raised annual fees,” and that there was no “conclusive evidence” that any of the retailers’ $1.1 billion in savings had been passed on to consumers.

The Durbin Amendment will also hurt community banks and credit unions. Durbin and his supporters make much of the fact that the bill officially exempts financial institutions with less than $10 billion in assets from the price controls. But both the Credit Union National Association and the Independent Community Bankers of America remain in opposition to the bill, recognizing that government controls of the market rates of credit and debit card networks will adversely affect all financial institutions that issue these cards. And smaller financial institutions are not exempt for the the other, indirect price controls in the bill, such as the routing rules that also compromise consumer privacy and data security.

Obviously, the Fed should interpret the mandates as flexibly as it can and not be bound by the vague language of some of the measures. But Congress can’t absolve itself of responsibility for this burdensome and regressive measure. This includes normally conservative Republicans, such as the duo from the state of Georgia, who speak out correctly against price controls in health care but voted for the controls in the Durbin Amendment after lobbying from Atlanta-based Home Depot

It should enact a bipartisan repeal — or at the very least delay — the Durbin Amendment at its first opportunity. It should gift-wrap this legislation by titling the bill, as I have suggested before in The Wall Street Journal, the “Free Checking Restoration Act.”

Photo credit: tidewater eyesores’ flickr photostream.