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Don’t let special interests take advantage of credit card fight

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Russell Kashian
June 25, 2009

In May, President Obama signed a bill limiting banks’ ability to raise credit-card interest rates and fees. While the bill received strong bipartisan support, like most populist initiatives it risked opening a Pandora’s legislative box in the form of follow-up legislation promoted by corporate special interests.


One of these creatures has emerged: a proposed bill regulating the “interchange rate,” the fee retailers pay to banks when a customer makes a credit card purchase.


Wisconsin’s 2nd District congresswoman, Democrat Tammy Baldwin, sits on the House Judiciary Committee that will consider the so-called Credit Card Fair Fee Act.


The proposal would allow retailers to collude when negotiating with banks over the interchange rate, which averages around 1.5 percent. This proposal carries a certain populist ring: supposedly the retailers will pass along cost savings to customers. But upon inspection, the bill seems anything but populist.


First, the bill contains no rule requiring retailers to pass along the savings they enjoy from lower interchange fees. More likely, they will pocket the extra profit.


Second, the predictable effect of lower interchange rates for retailers will be higher fees on cardholders.


If banks witness drop-offs in interchange revenue, they’ll need to raise the money through other channels. This leaves the issuer with two choices. One would be to increase fees on cardholders. In Australia, after the government ordered lower interchange rates in 2003, credit-card annual fees rose 22 percent for standard cards and up to 77 percent for reward cards, according to one study. This type of increase would cost the average American household an estimated $400 a year—a de facto regressive tax on consumers.


A second choice would be to limit access to credit cards for consumers and small businesses. Interchange fees require retailers to share the cost of default risk because they pay for a portion of the cost of credit. Without this cost sharing, the credit card issuer effectively assumes a greater portion of default risk. So the proposed interchange bill could dry up credit available for “riskier” consumers and small businesses—those with lower credit ratings and lower volumes of credit-card use.


Long story short: this bill would limit revenue to banks while Congress is spending billions to “bail out” the banking system. It would raise costs on consumers. And while reducing an expense for some retailers, it probably would result in customers having less money and credit to spend in stores.


Credit card issuers are an easy target for demonization. However, properly managed by consumers and lenders, credit cards provide a valuable lubricant to society. When retailers convert from cash-only to credit cards, their revenue rises 20 percent, on average, because their pool of potential customers increases exponentially. If the 1.5 percent interchange cost didn’t produce equivalent benefits, the lack of economic equilibrium would discourage the process. Yet in our free market, most consumers choose to use credit cards, and the vast majority of retailers accept them.


Congress should avoid special-interest credit-card legislation that hurts those who supposedly would be helped.


Russell Kashian is associate professor of economics at UW-Whitewater. Write to him at at the Department of Economics, UW-Whitewater, 800 W Main St., Whitewater WI 53190; e-mail kashianr@uww.edu.

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