Answer: banks and payment networks would compete for customers’ business, and they’d largely do this by trying to offer the most efficient, lowest-cost service. After all, if consumers actually saw the interchange fee tacked onto their bill each month, they’d gravitate toward banks and payment networks with the lowest fees.

That’s what should happen in a healthy market. Credit and debit cards aren’t a healthy market. That’s why regulation is necessary.

Debit cards used to pass at par, like checks (which cost far more for banks to process) do, as Bloomberg reported recently.

According to this paper in the NYU Journal of Law and Business by the folks who won one of the multi-billion-dollar cases against Visa and MasterCard, when debit cards were introduced in the 1970s, banks actually paid retailers a negative-interchange fee.

If you really want to see how our “rock-jawed titans of industry don’t really like free markets,” you should read their 2006 paper, which shows how Visa and MasterCard manipulated markets to gain and preserve their monopoly:

Finally, at-par PIN debit threatened credit card revenues because merchants preferred the guaranteed payment and the efficiency of electronic transactions delivered by PIN debit over discounted credit card payments replete with fraud, signature verification, and myriad other rules and penalties.
To counter the economic force of PIN debit’s challenge, the Associations (Visa and MasterCard) engaged in a frontal attack on PIN debit and the Regional Networks that offered the product. While the Associations took a free ride on the debit infrastructure that the Regional Networks had built, they simultaneously attacked these networks and their at-par pricing model with a dizzying array of predatory and anti-consumer tactics. The assault be gan in the 1980s as the Regional debit programs began to register double and triple-digit annual growth rates.

Visa acquired PLUS and MasterCard bought CIRRUS to prevent these two national ATM networks from emulating the Regionals and extending their networks into national POS debit systems. In 1987, Visa and MasterCard merged their nascent PIN debit operations under the ENTREE Network joint venture. The Attorneys General from a group of 14 states, led by New York, sued under the Sherman and Clayton Antitrust Acts, alleging that ENTREE constituted an illegal merger and an attempt to monopolize the debit card market.

There’s much more in there, if you’re interested in learning more on the issue. And you should most definitely be reading Mike Konczal, too. For instance, his response to Yglesias is here.

Further Reading:

Lazarus Gets the Interchange Issue Right
: In a healthy market, margins will decrease as competitors see fat profits being made and seek a share by undercutting others.

The Financial Industry’s Threadbare Astroturf.

Felix Salmon: Interchange and Free Checking.

WSJ: Plastic Fees Under the Microscope

NYT PINs Visa on Transaction Fees.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.