Kevin Drum, in dismissing Matt Ygeslias’s qualms about over-regulating the credit and debit card industry, touches on an excellent point here:
Unfortunately, as economists since Adam Smith have pointed out, most of our rock-jawed titans of industry don’t really like free markets. They much prefer cozy cartels and opaque pricing, which are far more profitable.
Indeed. The ultimate goal for any capitalist worth his pinstripes is not to compete in a free market, it’s to get control over a market. Merge. Acquire. Consolidate. Squeeze. Fewer competitors means less competition. If that seems like an overly obvious statement, it’s all too often lost on politicians and regulators. Sure monopolists can get fat and lazy and eventually be undercut by some scrappy, inventive upstart (hello, Microsoft!). But that can take decades, and in the meantime we’ve all been paying more than we should have. That’s the point of antitrust laws, properly enforced.
Visa and MasterCard between them have cornered 96 percent of the debit- and credit-card market worldwide (79 percent in the U.S.). Visa alone has 68 percent.
That’s not free enterprise. It’s monopoly (or duopoly if you’re picky). Yglesias understands that, but says this:
But maybe what we really need some super-rich charitably inclined businessmen to do is finance some new ventures in these quasi-utility markets like charge cards, cell phones, mortgage origination, etc. based on a “don’t screw the customer over” business model. The striking thing about the credit card universe, after all, is that there’s very little competition and no meaningful difference in business practices between Visa and MasterCard. But I don’t think it’s written in stone anywhere that there can be only two.
If this were possible it would have already been done, but not by “charitably inclined businessmen.” Visa had net profit margins above 36 percent in the first quarter. MasterCard’s were near 35 percent. These are astronomical margins—ones that in a healthy market would lure capital happy to settle for half that rate of return. Even a government-licensed, unregulated monopolist like Moody’s settled for 24 percent margins.
Why are the plastic guys’ margins so high? Little to no competition. Would-be competitors are daunted by network effects and the steep cost of a nationwide capital-intensive startup from scratch.
But the dearth of competition also comes from a long history of anticompetitive behavior. Let’s not forget that Visa and MasterCard “violated antitrust laws when they barred banks that issued their cards from also issuing cards bearing competing brands” and “work(ed) together to fend off competitors.” They paid a huge $2.8 billion settlement to Discover two years ago for their actions and had to pay American Express $2.25 billion. In 2003, they agreed to a $3.4 billion settlement with retailers for colluding against them. That’s $8.5 billion the two had to fork over.
It’s worth remembering that excellent New York Times piece from January on how screwed up the debit-card market is:
Competition, of course, usually forces prices lower. But for payment networks like Visa and MasterCard, competition in the card business is more about winning over banks that actually issue the cards than consumers who use them. Visa and MasterCard set the fees that merchants must pay the cardholder’s bank. And higher fees mean higher profits for banks, even if it means that merchants shift the cost to consumers.
Seizing on this odd twist, Visa enticed banks to embrace signature debit — the higher-priced method of handling debit cards — and turned over the fees to banks as an incentive to issue more Visa cards. At least initially, MasterCard and other rivals promoted PIN debit instead.
As debit cards became the preferred plastic in American wallets, Visa has turned its attention to PIN debit too and increased its market share even more. And it has succeeded — not by lowering the fees that merchants pay, but often by pushing them up, making its bank customers happier.
In an effort to catch up, MasterCard and other rivals eventually raised fees on debit cards too, sometimes higher than Visa, to try to woo bank customers back.
That’s not what you would call a textbook free market of “capitalist acts between consenting adults.”
Here’s how Drum puts it:
So let’s try a thought experiment. What if credit and debit cards lived in a real free market with transparent pricing? Suppose that instead of just two payment networks there were a dozen. And suppose that instead of hiding interchange fees by extracting them from merchants, who pass them along to consumers invisibly, the card companies actually charged consumers directly. What would happen?
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.
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 rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.