How Dodd-Frank Hurts The Poor
An effort to limit credit card "interchange fees" backfires.
By Megan McArdle
The Bloomberg View
The Bloomberg View
August 3, 2017
Think of any old newspaper. Every day, or every week, it prints up some sheets of paper covered with recent news and advertising, and sells those papers to consumers. Its revenue comes from both the consumers who buy the papers, and the advertisers who pay the papers to display their copy to those readers.
Economists call this “a two-sided market,” and they consider its many variants to be some of the most interesting creatures dotting the economic landscape. That’s because the optimal pricing strategy in a two-sided market is often unclear. Jack up your subscription rates, and fewer subscribers will buy your papers, which means your advertising slots are probably less valuable. But set them too low, and advertisers will start to doubt that subscribers are actually reading the paper, which will also tend to diminish your overall revenue.
That’s just the problem for papers, however; every two-sided market has its own weird and wacky conundrums. Ordinary folks rarely hear about them, because consumers tend to think about only one side of a market, the side closest to them. Regulators, on the other hand, often get very interested in two-sided markets, because their complicated and often opaque pricing leaves ample room for lawmakers and bureaucrats to decide that some price is unfair.
This is just what happened in 2010, when the Dodd-Frank financial reforms were being constructed. Suddenly, the whole public policy world was talking about “interchange fees,” which are charges retailers pay to have credit card transactions processed.
It was a little odd that this debate got as heated as it did, capturing the attention of more than just financial journalists. After all, interchange fees had nothing to do with the bank follies that led to the financial crisis; they were tacked onto the bill at the behest of Dick Durbin, the Democratic senator from Illinois. Moreover, they weren’t a populist consumer issue, either, because the evidence suggested that interchange fees had very little impact on consumers.
Sure, on the one hand higher fees financed “rewards” debit cards that let you earn airline miles on your purchases. On the other hand, they probably slightly increased the prices that cash consumers paid. But the effects on anyone’s household finances were trivial. Fundamentally, this was a battle between two powerful and well-heeled lobbies: the retailers on one side, and the bankers on the other. The nation’s commentariat had no real reason to become passionately attached to either of their causes.
Nonetheless, they did choose sides, and mostly along partisan lines: Left-leaning commentators tended to believe that high interchange fees were a national scandal; right-leaning ones thought an already highly-regulated sector probably didn’t need more legislative fiddling. Democrats were in power, and the left-leaning commentators won. In 2010 Dodd-Frank passed with provisions to regulate interchange fees, and in 2011, my Citibank airline rewards debit card went the way of all flesh.
But there was a silver lining even for those on this battle's losing side. Regulating a two-sided market offers the same sort of complications as pricing in one. Economically interested pundits could now see what unexpected developments popped up as the new regulations took effect.
And it has been complicated. If you’d asked an average reader in 2010 about interchange fees … well, frankly, that average reader probably would have given you a confused look. But if you’d surveyed the average reader who had heard of interchange fees, probably they would have told you that this was about banks and credit card processors making too much money off the backs of consumers. Or, if they were conservative, that the regulation would do nothing but add more red tape, as banks raised fees and lowered interest rates on bank accounts in order to recoup the lost revenue. They might have added that the regulation could cost consumers money on net, as money was transferred from banks to retailers, who didn’t bother passing the savings on to customers.
Who was right? Everyone, a little bit. A 2014 paper from the Federal Reserve indicated that banks had not managed to raise other fees enough to recoup their lost interchange revenue. And retailers probably ended up benefiting somewhat less than I expected. The gains from lower interchange fees were offset by losses elsewhere, like discounts that had previously been offered for small-ticket transactions.
A new Fed paper suggests that one prediction did bear out: Fees on bank accounts increased, and became harder to avoid, as banks made it harder to get free checking. The sums involved are not enormous; many households probably never noticed. But then, they probably never noticed their interchange fees, either.
Think of any old newspaper. Every day, or every week, it prints up some sheets of paper covered with recent news and advertising, and sells those papers to consumers. Its revenue comes from both the consumers who buy the papers, and the advertisers who pay the papers to display their copy to those readers.
Economists call this “a two-sided market,” and they consider its many variants to be some of the most interesting creatures dotting the economic landscape. That’s because the optimal pricing strategy in a two-sided market is often unclear. Jack up your subscription rates, and fewer subscribers will buy your papers, which means your advertising slots are probably less valuable. But set them too low, and advertisers will start to doubt that subscribers are actually reading the paper, which will also tend to diminish your overall revenue.
That’s just the problem for papers, however; every two-sided market has its own weird and wacky conundrums. Ordinary folks rarely hear about them, because consumers tend to think about only one side of a market, the side closest to them. Regulators, on the other hand, often get very interested in two-sided markets, because their complicated and often opaque pricing leaves ample room for lawmakers and bureaucrats to decide that some price is unfair.
This is just what happened in 2010, when the Dodd-Frank financial reforms were being constructed. Suddenly, the whole public policy world was talking about “interchange fees,” which are charges retailers pay to have credit card transactions processed.
It was a little odd that this debate got as heated as it did, capturing the attention of more than just financial journalists. After all, interchange fees had nothing to do with the bank follies that led to the financial crisis; they were tacked onto the bill at the behest of Dick Durbin, the Democratic senator from Illinois. Moreover, they weren’t a populist consumer issue, either, because the evidence suggested that interchange fees had very little impact on consumers.
Sure, on the one hand higher fees financed “rewards” debit cards that let you earn airline miles on your purchases. On the other hand, they probably slightly increased the prices that cash consumers paid. But the effects on anyone’s household finances were trivial. Fundamentally, this was a battle between two powerful and well-heeled lobbies: the retailers on one side, and the bankers on the other. The nation’s commentariat had no real reason to become passionately attached to either of their causes.
Nonetheless, they did choose sides, and mostly along partisan lines: Left-leaning commentators tended to believe that high interchange fees were a national scandal; right-leaning ones thought an already highly-regulated sector probably didn’t need more legislative fiddling. Democrats were in power, and the left-leaning commentators won. In 2010 Dodd-Frank passed with provisions to regulate interchange fees, and in 2011, my Citibank airline rewards debit card went the way of all flesh.
But there was a silver lining even for those on this battle's losing side. Regulating a two-sided market offers the same sort of complications as pricing in one. Economically interested pundits could now see what unexpected developments popped up as the new regulations took effect.
And it has been complicated. If you’d asked an average reader in 2010 about interchange fees … well, frankly, that average reader probably would have given you a confused look. But if you’d surveyed the average reader who had heard of interchange fees, probably they would have told you that this was about banks and credit card processors making too much money off the backs of consumers. Or, if they were conservative, that the regulation would do nothing but add more red tape, as banks raised fees and lowered interest rates on bank accounts in order to recoup the lost revenue. They might have added that the regulation could cost consumers money on net, as money was transferred from banks to retailers, who didn’t bother passing the savings on to customers.
Who was right? Everyone, a little bit. A 2014 paper from the Federal Reserve indicated that banks had not managed to raise other fees enough to recoup their lost interchange revenue. And retailers probably ended up benefiting somewhat less than I expected. The gains from lower interchange fees were offset by losses elsewhere, like discounts that had previously been offered for small-ticket transactions.
A new Fed paper suggests that one prediction did bear out: Fees on bank accounts increased, and became harder to avoid, as banks made it harder to get free checking. The sums involved are not enormous; many households probably never noticed. But then, they probably never noticed their interchange fees, either.
Taken together, the research points to both small costs and small benefits. But it also suggests that maybe we were right to get worked up in 2010, because the distribution of those costs and benefits seems to be uneven. Affluent households probably don’t even know what their bank’s minimum balance for fee-free checking is, because their savings never dip anywhere near it. For low-income households, on the other hand, even small fees, or modest minimum balances, can represent a financial headache. Similarly, people with low incomes are most likely to be inconvenienced when stores set higher minimum purchases for accepting credit cards.
This group is worth worrying about, because they are at the highest risk of becoming “unbanked”: relying on check cashing and the like, which tend to be expensive and inconvenient compared with a bank account. So any regulation that makes their bank accounts more expensive should be scrutinized carefully.
Very few government regulations work exactly as expected; that’s simply the nature of the beast. But the more complex the markets, the harder it is to see exactly what you’re doing -- and the more likely it is that you’ll end up hurting the people you’d most like to help.
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