CEI Led Regulatory Comment on Debit Card Interchange Fees and Routing 

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[email protected]  

February 22, 2011  

Ms. Jennifer J. Johnson, Secretary  

Board of Governors of the  

Federal Reserve System  

20th Street and Constitution Avenue, North west  

Washington, DC 2 0 5 5 1  

Re: Debit Card Interchange Fees and Routing  

Docket No. R-1404 and RIN No. 7100 AD63  

Dear Ms. Johnson:  

As non-profit public interest groups that support consumer choice and competition and oppose  price controls in any sector of the economy, we are pleased to respond to the Federal Reserve  Board’s (Fed) proposed rules regarding debit card interchange fees and routing.  

We understand that section 1075 – also known as the Durbin Amendment – of the Dodd-Frank  Wall Street Reform and Consumer Protection Act imposes a nine-month deadline for  implementation. We believe, however, that slightly missing a deadline is less consequential than  rushing through a regulation that unnecessarily burdens banks, credit unions, and, most  importantly, consumers, and that will even be detrimental in the long run to the retailers poised  to reap short-term benefits. 

Although the statute itself is flawed, the Fed in its proposed rule has gone beyond what the law  requires in an arbitrary and capricious manner that, as noted in comments by the Illinois  Credit Union League, will likely not survive legal scrutiny under the parameters set out by the  Supreme Court in Chevron v. Natural Resources Defense Council, 467 U.S. 837 (1984). Among  other reasons, the rule is arbitrary and capricious because in interpreting the language of the law,  it disregards standard regulatory interpretations of the word “reasonable” in setting prices – which not only encompass cost but a rate of return — and disregards the standard economic  definitions of “incremental cost” — which include a business’ fixed costs.  

As a result, the proposed rule creates an unprecedented price control scheme that not only  outlaws profit, but forces pricing below cost. It sets a firm price cap of 12 cents per transaction,  reducing interchange revenue for banks and credit unions by as much as 90 percent. If the rule  goes through, the results would not only be a substantial reduction in investment and innovation  in payment card technologies that benefit both retailers and consumers, but a massive shifting of  the costs of debit card transaction from some of the nation’s wealthiest retailers to middle- and  lower-income consumers. Media reports already indicate that banks are eliminating free  checking and requiring customers to maintain much higher balances to avoid such a fee. Given  the experience of other nations with interchange caps, such as Australia, the imposition of other  fees and reduction of payment card rewards are likely on the horizon if the rule goes through.  

Furthermore, the rule as applied — if not the law itself as contended in the pending lawsuit from  TCF National Bank — deprives debit card issuers of their property rights to a return on  investment in violation of the Due Process and Takings clauses of the Fifth Amendment of  the U.S. Constitution.  

It is our hope that the Fed will give full consideration to our explanation of why:  

The Fed’s proposed rule on interchange fees is arbitrary and capricious and, as  applied, unconstitutional  

Introduction: Collectively, our organizations have decades of experience educating,  advocating and litigating on behalf consumers, entrepreneurs, investors and seniors.

The Competitive Enterprise Institute is a national non-profit public policy organization  dedicated to advancing the principles of limited government, free enterprise, and individual  liberty. Founded in 1984, CEI has grown into an effective advocate for freedom on a wide range  of critical policy issues, including energy, environment, business and finance, technology,  telecommunications, and food and drug regulation.  

CEI also pursues public-interest litigation on behalf of consumers and small businesses to ensure  that federal agencies follow the requirements of the underlying laws and, when applicable, the  Administrative Procedures Act, and that agencies act within the constraints of the U.S.  Constitution. In 2010, CEI counsel and other attorneys garnered a Supreme Court victory in Free  Enterprise Fund v. Public Company Accounting Oversight Board, in which the court found  organization of the board in violation of the Constitution’s “separation of powers” and made the  board’s members subject to at-will removal by the President’s officers.  

Founded in 1992, the 60 Plus Association is a non-partisan seniors advocacy group with a free  enterprise, less government, less taxes approach as well as a strict adherence to the Constitution.  60 Plus has set ending the federal estate tax and saving Social Security for the young as its top  priorities. 60 Plus has been called, “an increasingly influential senior citizen’s group” which  calls on support from over 7 million activists.  

The Minnesota Free Market Institute is a non-partisan, non-profit educational organization  dedicated to the principles of individual sovereignty, private property and the rule of law. It  advocates for policies that limit government involvement in individual affairs and promote  competition and consumer choice in a free market environment. It conducts research, publishes  studies and reports and conducts public forums to involve Minnesotans in free market reforms  enhancing the quality of life for all citizens of the state.  

The institute is very concerned that about the impact the proposed rule – which would slash  interchange revenue for financial institutions by as much as 90 percent – would have on regional  banks such as TCF as well as on the state’s community banks and credit unions that are  technically subject to the exemptions but would still suffer due to the rule’s effects on payment  card networks.  Americans for Tax Reform (ATR) is a non-profit taxpayer advocacy group that promotes  individual liberty and free-market public policy. In support of these goals, ATR opposes heavy  regulation and taxation of financial services. ATR was founded at the request of President  Ronald Reagan in 1985.

“Legislative intent” means the intent of all members who voted for Dodd-Frank, not just  the sponsor or supporters of the Durbin Amendment.  

In drafting the rules, the Fed seems to have been unduly swayed by beneficiaries of this rule such  as retailer trade associations that argue for “debit at par,” meaning that retailers should have to  pay very little if any of the costs for processing debit card transactions. The Fed has interpreted  ambiguous language, as well as misinterpreting clear language, in the law to preclude  consideration of fixed costs and even many variable costs in setting the interchange fee price  caps.  

If this is being done to fulfill what the Fed believes to be “legislative intent,” this is a mistaken  way to discern such intent. Legislative intent represents the intent of every legislator who voted  for the underlying legislation.  

The language of the Durbin Amendment is ambiguous, but to a great extent this ambiguity  expresses Congress’ will. If the strongest proponents and beneficiaries of this measure had  submitted language making explicit their desire for such wholesale cost-shifting retailers to  

consumers, the Senate would likely not have approved the amendment, or it likely would have  been stripped from the conference report.  

In the case of Dodd-Frank, the U.S. House of Representatives never approved a measure similar  to the Durbin Amendment, and only signed on to the Senate measure after it was included in a  House-Senate conference report. In addition, 131 members of the House signed a letter to the  conferees asking for the removal of the Durbin Amendment, citing the concerns about cost shifting from retailers to consumers that could result. The letter was signed by more than 70  House Democrats, most of whom voted for the final legislation despite their reservations about  this amendment. It is difficult to argue that these members’ “intent” is reflected by a Fed rule that  goes even further than the statute calls for in shifting costs from retailers to consumers.  

Furthermore, as the Fed knows from correspondence it has received, even some Senators who  voted for the Durbin Amendment believe the measure allows and even requires the Fed to  consider an issuer’s fixed costs in setting the standards. In December, then-House Financial  Services Committee Chairman Barney Frank wrote to the Fed with his concerns about  “unintended consequences for consumer choice” if the rule was not “properly crafted.”  

Unfortunately, the rule was far from properly crafted and, if it goes through, the worst fears of  Frank and other for consumers, community banks and credit unions will come true. We urge the  Fed to not go one step beyond what the plain language of the Durbin Amendment, or section  1075, requires.  

“Reasonable” should mean covering costs, plus a rate of return. All cost of a “particular  transaction” should be considered, including fixed costs  

As written, Section 1075 requires the Fed to “establish standards for assessing” whether an  interchange fee “is reasonable and proportional to the cost incurred by the issuer with respect to  the transaction.”  

As the Illinois Credit Union League notes it its comments, “‘Reasonable and proportional’ is  undefined; this is a statutory gap.” Under the Supreme Court’s instructions in Chevron, when  there is a “statutory gap,” it is not an obligation of an administrative agency to hazard a guess as  to what the bill’s sponsor or biggest proponents had in mind. It is, however, the obligation of the  agency under Chevron not to interpret the undefined terms in a manner that is “arbitrary” or  “capricious.” We agree with the League that “as proposed, the regulations are arbitrary [and]  capricious”  

The Fed, for instance, arbitrarily disregards traditional definitions of “reasonable” from financial  literature and even other regulations. Financial observers have remarked that on its face,  “reasonable and proportional” does not seem to require price controls that outlaw profit. Writing  in the Columbia Journalism Review in response to a critique of the Durbin Amendment  published before the Fed issued its proposed rule, columnist Ryan Chittum argued, “‘Reasonable  and proportional’ fees means ‘basically outlawing profit.’ I don’t think so.”  

In its discussion of the proposed rule the Fed notes in Footnote 44 that even in statutes governing  utilities, considered to be “natural monopolies” with the advantage of a lack of competition, a  “reasonable rate” usually means that the public utility be able to “compensate its investors for the  risk assumed.” Yet for competing debit card issuers, the Fed is arbitrarily interpreting  “reasonable” to mean that a firm cannot make a profit, cannot cover its fixed costs, and cannot  even cover many variable costs. 

The Fed also cites language in Section 1075 such as “incremental cost” and cost of a “particular  transaction,” to establish price controls that force issuers to price below cost, without  consideration of fixed costs or even variable costs not specified by the law. But such phrasing  should not lead the Fed to such a draconian result. The Fed notes that a common economic  definition of “incremental cost” includes fixed costs as part of the costs of per transaction. This is  also common sense, because a business – be it a retailer or a bank – would likely not engage in  many “particular transactions” if such transactions could not help defray operational costs such  as that of renting or owning space in a building. But once again, the Fed arbitrarily disregards  this standard definition to produce a result that is more harmful than necessary to banks, credit  unions, and consumers.  

The Fed also should not be bound to disregard an issuer’s costs due to the statute’s mandate to  consider the “functional similarity between electronic debit transactions and checking  transactions.” Such a consideration must also encompass the differences between debit cards and  checks, including the costs for merchants of bounced check that debit cards relieve and the  convenience of debit cards that translate into increased sales.  

In addition to being arbitrary and capricious, the proposed rule likely violates both the Due  Process and Takings Clauses of the 5th Amendment because it deprives banks and credit unions  that issue cards of their property rights to a return on capital invested. The Supreme Court case  Duquesne Light v. Barasch, 488 U.S. 289 (1989), affirmed 8-1 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 Fed cites Duquesne, but asserts that this case is different because “the interchange fee  standard would not limit the ability of an issuer to earn revenue from other sources, such as by  charging fees to its cardholders.” In addition to this rationalization being yet more evidence of  how the proposed rule is arbitrary and capricious in enabling a massive cost-shifting to  consumers, it also likely will not survive constitutional muster by the courts. As Justice Oliver  Wendell Holmes stated in Brooks-Scanlon Co. v. Railroad Commission, 251 U.S. 396 — a  precedent that has been cited in many modern federal court cases involving rate regulation, a  firm “cannot be compelled to carry on even a branch of business at a loss … for the benefit of  others who do not care to pay for it.”  


For sound public policy and constitutional reason, American banks, credit unions, and  particularly consumers should not be forced to pay the full costs of a sophisticated electronic  payment transaction system for retailers who, in Justice Holmes’s phrasing, “do not wish to pay  for it.” American families and seniors face enough rough economic waters without losing their  free checking, and financial institutions should not be forced to lose capital they could be lending  and investing to keep the economy growing. We recognize that retailers, like all businesses, are  faced with excessive levels of taxation and regulation, but that does not give them the right to use  the instrument of the state to victimize their customers and financial suppliers. We urge the Fed  to go back to the drawing board, and craft a rule that does no unnecessary harm.  

John Berlau  
Director, Center for Investors and Entrepreneurs  
Competitive Enterprise Institute  
[email protected]  

Kim Crocket  
President and General Counsel  
The Minnesota Free Market Institute  
[email protected]  

Grover Norquist 
Americans for Tax Reform 
[email protected]  

James Martin  
60 Plus Association  
[email protected]