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Distorting the Market

We’ve heard a good deal of chatter the last couple of weeks over the U.S. District Court’s decision to kill the Fed’s new rules on interchange. For the uninitiated, interchange is the fee that a bank charges merchants for authorizing transactions on cards issued by that bank.

 In return for the interchange fee, merchants get assurance that the card is OK, the funds are available and the merchant is reasonably assured of getting paid for the sale. Sounds like a good deal to me.

But merchants have always griped that the interchange fees are too high. For years they’ve heavily lobbied Congress to order banks to reduce their fees. 

Congress dutifully complied by adding §920 of the Electronic Funds Transfer Act. The Act regulates consumer rights in electronic payments. §920 authorized the Federal Reserve Board to set debit interchange rates.

Having done its work, Congress handed the pricing issue off to the Fed to figure out, and went on to less taxing things. Like recess. The Fed, stuck with the task of micromanaging a business that even some payments experts don’t understand, in effect capped the interchange rates at a price drastically lower than market value. But that wasn’t good enough for the merchants. So they sued the Fed.

On July 30 the court ruled in NACS, et al. v. Board of Governors of the Federal Reserve System that the Fed goofed when it set prices for interchange. U.S. District Court Judge Richard Leon ordered a do-over. His ruling instructed the Fed analysts to go back to the drawing board and come up with still lower rates.

Judge Leon relied in his decision on the words of no less a banking authority than Sen. Dick Durbin, who had proposed the amendment to the EFT Act, and had lobbied for it for years.

Now, I like Sen. Durbin. I admire his spunk. His candor. His Chicago-style directness. He’s Anthony Weiner with clothes on. But he’s a politician. A partisan. He’s not exactly an unimpeachable source of information.

As my good friend and payment expert Peter Quadagno says it wasn’t the Fed that erred—it was the Court. In examining the pricing the Court failed to consider the net present valueof the debit routing systems. In other words the value of the pricing should reflect not just what the last transaction cost, but cumulative costs over time that it took to develop the routing systems to their current state.

Pricing, unfortunately, was the easy part. Judge Leon also took the Fed to the woodshed for the way it implemented Congress’ instruction on making sure that merchants had alternative routing paths to get those authorization transactions back to the banks.

Now, it’s worth knowing that there are two types of debit card transactions. “PIN” debit transactions are authorized by the cardholder keying in his secret passcode when he makes a purchase with his debit card. “Signature” debit transactions are authorized when the debit cardholder signs for the transaction.

Somehow Judge Leon divined that the Fed intended that the “alternative routing” meant that for each authorization method there should actually be fouralternatives, not two: two competing methods for signature and two for PIN debit authorization.

Further, the Oracle of DC somehow figured out that what Congress really meant, as opposed to what it wrote, was that merchants should have their choice of network routing after the transaction is authorized by the bank. Huh? How do you authorize the network route after you’re already sent the message on a network? This isn’t like shopping in a catalog. You don’t thumb through the book, find the rate you want and then call a network’s 800 number.

Needless to say, the Fed is appealing Judge Leon’s Opinion.

The reason I bring all this up is that it is a textbook case of what happens when government decides to bigfoot its way into the free market. Here you have the daily double—both Congress and the courts setting prices. All you need is Pres. Obama weighing in and you’ll have the trifecta of government –created market distortion. Somehow I think the president has more important things to worry about.

My word to the plaintiffs in this case: You’re big boys. Time to grow up. If you don’t like your electronic payments deal, negotiate a better one. Or better yet, stop taking credit and debit cards. There are a lot of businesses that still refuse to honor plastic. They’ve made an intellectually honest business decision based on the market.

But big department stores and box retailers know that most of their payments are plastic. And they don’t want to risk alienating their customers. Seeking court protection on fees is intellectually dishonest. It’s dishonest because ultimately the retailers don’t pay those fees. Interchange is a selling expense that is passed on to customers in the form of higher pricing.

But following the implementation of the Fed-mandated lower interchange rates, you’d have better luck finding a light bulb in Aisle 87 at Home Depot than you would a retailer who shared the interchange savings with its customers.

So this isn’t about asking the Court to redress unfairness in the market. It’s about a nasty, cheap way to grow margin without having to do any work for it.

Government price fixing is a slippery slope. If the solons in Congress want to do something useful, they can create fiscal conditions that are conducive to creating a healthy and vibrant economy. Not one distorted by the dead hand of government.