The Unintended Consequences Of Credit Card Regulation

When you try to regulate things, you’re really regulating people. If there’s one crucial lesson to keep in mind about regulation, this is it. And these days, when regulations cost us over $14,000 per household each year, according to my colleague Wayne Crews’s calculations, it behooves us to consider the unintended consequences of each new regulation, however benevolent its intent. A good place to start is the new regulations on credit card interchange fees.

Counterintuitive as it may seem, merchants who accept credit cards have always paid credit card companies for their use, not the other way around. For an explanation why, watch the classic movie The Card, starring Alec Guinness, about a rakish young entrepreneur who invents an early version of a credit card, the Universal Thrift Club. The merchants who accept the card get more customers because of the availability of credit and the convenience of using a card, so they pay the people who provide that boost to their business.

But retailers, like the ones in The Card, have always balked at that arrangement. Large merchants like Walmart have complained for years about the charges. Small merchants also can often feel squeezed, as they see a portion of their profits go to the credit card company on swiped transactions. Yet, complaining that they would have kept that money had they transacted in cash, they often forget that without accepting cards they might well not have made those sales at all. Not all small retailers forget this. Any food truck owner who has used Square is grateful to pay the 2.75% fee charged per swipe – the same charge that big retailers balk at.

The problem is that small merchants were touted as the proverbial poster child for a campaign, funded largely by large retailers, to impose strict, one-size-fits-all limits on credit card interchange fees. And they were aided in this campaign by groups and individual activists that dislike the very idea of credit cards and banks at all, such as the Roosevelt Institute and Professor Adam Levitin of Georgetown Law.

For the unintended consequences of hard limits on credit card interchange fees, we can look to Australia, one of the first countries to impose such limits. In 2003 the Federal Reserve Bank of Australia reduced the cap on interchange fees from 0.95 percent to 0.5 percent per transaction. Regulation after regulation has been heaped on top of this, with absurd results such as travelers now being charged separately for each leg of an airline flight even if the entire flight was booked all at once. In addition, Australian retailers have ended their card reward programs.

America has followed suit with the Durbin Amendment to the 2010 Dodd-Frank Act, giving the Federal Reserve the power to limit interchange fees. When it was first proposed, we at the Competitive Enterprise Institute argued, based on the Australian experience, that none of the savings to merchants would be passed on to consumers and that it would bring an end to credit card rewards programs and free debit cards. Now a study by David Evans of the University of Chicago Coase-Sandor Institute and colleagues confirms that that’s exactly what’s happened, and that consumers are worse off to the tune of around $200 per household.

It’s worth noting, though, that banks have adapted to the new regulations in various ways. Prepaid cards loaded with funds from the user’s account, which are exempt from the interchange fee cap, have soared in use, as banks have promoted them to their customers.

The main casualties have been features especially attractive to customers with the least in their accounts — free debit cards and free checking accounts, of which the number offered by banks has roughly halved. Meanwhile, the Mom ’n’ Pop stores that were the poster child for the Durbin Amendment have seen the fees charged to them actually rise within the cap.

The worst result of all this will be reduced access to credit for large segments of America’s population. In a country where Sergey Brin and Larry Page founded Google by maxing out their credit cards, this should give us pause.

Ultimately, the real problem is that no one in government ever seems asks to ask the most important question about regulation — not what are the intentions behind it, but what real effects will it have on real people. Again, card interchange fees would be a good place to start.