Legal Commentary

Durbin Threatens Visa and Mastercard on Debit Interchange Fees:

By Todd Zywicki

As everyone knows, the purpose of the financial regulation reform bill is to prevent another financial crisis from occurring.  That must be why Senator Richard Durbin felt it so urgent to attach an amendment to the Senate version of the bill that places new price controls on the interchange fees that can be charged on debit and prepaid cards, requiring that they be ?reasonable and proportional? to the incremental cost of processing those transactions.  The amendment was adopted with no hearings or serious fact-finding (that I am aware of) and minimal debate and discussion.

Yes, you read that right?the amendment regulates the fees on debit and prepaid cards, not credit cards.  What debit and prepaid cards have to do with the financial crisis has not yet been explained.

By pegging the price to only the ?incremental? cost, the price commissars at the Fed who will be required to set these prices are required to ignore the fixed costs of operating the system.  Which guarantees that debit cards will not be a money-losing proposition.

In order to offset the ruinous effect this would have on smaller banks the Durbin amendment carves out an exception that provides that any issuers of debit and prepaid cards with assets of under $10 billion would be exempted from the price control provisions.  This was intended to protect credit unions and community banks from the legislation.

The problem is that Visa and Mastercard have suggested that it simply is not wise for them to set two prices for those with whom they do business?a money-losing price for their biggest card issuers and a profitable price for smaller issuers that would essentially provide a subsidy for smaller issuers to cannibalize the larger, regulated issuers.  So they?ve suggested that if the Durbin amendment is adopted, they will be forced by competitive pressures to reduce the interchange fee for smaller issuers down to the rate that the Federal Reserve?s central planners will set pursuant to the law.

Senator Durbin responded with this amazing letter to Visa and Mastercard, in which he expresses his frustration when the real world won?t do whatever he tells it to do.  As he explains, if Visa and MC reduce interchange fees on small issuers, that of course, won?t be his fault, but theirs.

It certainly does give rise to a handy excuse for future politicians.  ?Sure, we raised the minimum wage, but we specifically didn?t want unskilled workers to be laid off, so if unemployment rises, it is the fault of the businesses, not us.?  ?Sure, we raised taxes on everyone, but we specifically said that we didn?t want people to work less, so it is their fault, not ours.?  Good intentions don?t make for good results.

Senator Durbin?s letter here brings to mind Adam Smith?s famous ?man of the system? quote:

The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.

Unintended consequences virtually always follow from an enterprise in economic planning such as the Durbin amendment.  And this one, by guaranteeing that debit card issuers will now lose money, will have more unintended consequences than most.  The result inevitably will be to transfer some of the costs now borne by merchants onto consumers.  It is one thing to acknowledge the presence of unintended consequences and conclude that the benefits of the action exceed those costs.  But it is still another to stand like King Canute and pretend that you can hold back the tide of unintended consequences just because you are a Senator.

Full post as published by The Volokh Conspiracy on May 28, 2010 (boomark / email).