John Thacker: Is it just because they can phrase it as a “discount for cash,” even though that’s the same thing.

Yes.

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So, I was informed that I must pay a $39.00 annual fee on BOA’s credit card beginning in December. I contacted customer service and was told that I had only two choices: Pay the annual fee or cancel the card. It was a non-negotiable demand. So, I cheerfully took out my scissors and promptly cut the BOA card into little pieces. I thoroughly enjoyed the experience.

It was easy for me to see through this non-negotiable corporate decision: I paid promptly and I carried only small balances on my card. Therefore, BOA couldn’t rack up “late fees” or large interest charges from me.

I simply cut up BOA’s card and easily obtained another credit card WITHOUT an annual fee. I suggest others do the same.

The existing credit limits of your credit lines and your utilization (or not) of those lines is a major factor in determining your credit score. If your available credit goes from $50,000 to $10,000, that’s bad for you.

Furthermore, the average age of your credit accounts is also a factor. Canceling your oldest credit cards will actually reduce your credit score as well.

http://www.creditkarma.com/article/relationship_score_and_credit_limits

http://www.creditkarma.com/article/UnderstandingCreditScores

guest1: Possibly someone already made this point in your previous post or above, but annual fees are refunded on a pro-rata basis if you cancel the card in the middle of the year.So one of your points (that the fees dampen card switching) isn’t really valid.

Yes, I was going to make this point as well. In the past when I’ve opened credit cards that later were given annual fees, I’ve successfully had the entire fee reversed and closed the card.

I don’t agree that this is “anti-competition” — the setting of prices in response to changing market conditions (i.e., new regulations) is about as competitive as you can get.

The fact that those users were getting the card for free proves that they were not free riding because the bank was making money off of them somehow. Otherwise they would not get the card for free.

any more than people who win money at casinos can be said to not actually have won money. When the bank offers a credit card with certain terms, they expect that there will be a range of behavior related to that card. Thus it may be very easy for some people to free-ride, because the bank may be hoping for profit in the aggregate, not from every single individual.

We need to be very concerned about the negative unintended consequences of congressional actions in the credit card markets.

Agreed.

We also need to be very concerned about negative unintended consequences of congressional inaction.

We need to be very concerned about the negative unintended consequences of congressional actions in the credit card markets.

Credit cards are a substantial source of profit for the banks. Any loss of bank revenue from the credit card market will have to be made up somewhere else.

Given the fiscal health of many of the banks there is a limit to how much revenue loss they can sustain if it can’t be made up from other segments of their operations.

There is in fact a non trivial risk that too big a loss of revenue from the credit card division may be enough to collapse some banks.

David Welker: First, you are going to have to be more clear when you say “not true.” Are you saying it is permissible for businesses to charge higher prices to credit card customers under their contracts with credit card processors?

No, I was saying that credit card paying customers actually subsidize cash customers, for the many reasons I posted above. Everyone sees the percentage that credit card companies take, but it’s a lot harder to see the efficiency gains and targeting that comes from credit cards. The AmEx example I mentioned above is an illustration of this principle as between credit cards, where an increasing number of merchants found that the targeting benefits *alone* are sufficient to pay for the higher interchange fees.

Second, the customer is the consumer. The merchant is the supplier. The credit card networks are simply middle men. Most retailers do not have any market power compared to the credit card networks and are left with a take-it-or-leave-it deal. If they leave it, they lose a lot of customers.

There is no such thing as *simply* middle men. There is a supply chain that provides finances to a supermarket, just as there is a supply chain to make a computer. Using this same kind of logic, a company like ATI, which makes graphic cards, would be middle man. Instead, Dell, HP, and the gang buy from ATI because it’s more efficient than developing the capability on their own. That’s also true for credit cards. Large merchants have gotten into the credit card business so that they can claim some or all of the merchant banking fees, but that still points to the need for scale to have a viable system.

Retailers may not have a lot of market power and that may mean that they lose a lot of customers if they don’t get the credit cards. But they’ve made the decision that it’s worth it for them to accept the payment form that their customers want! Again, the AmEx example very clearly rebuts exactly this point.

Anyway, I understand perfectly what you are trying to say. I simply reject your model. The real value (the real marginal cost of the transaction) is incurred by the merchant, not the credit card processors.

You’re right that the credit card processors do not have much of a marginal cost. It’s like a telephone. They build it with capital expenditures, and, to a first approximation, have very low operating expenditures. Nevertheless, they charge on a per use basis. The reason they do that is to prevent overloading of their pipes, which would require building more pipes, which requires more capital expenditures. Credit card processing works exactly the same way. You need to buy more servers, if you only charge a flat rate per month than if you charge for each usage.

If you are in fact right that there is a valuable and potential business model, there’s a ready solution: create it. I don’t think such a business is viable, but your confidence should suggest a large potential value-creating opportunity. If you’re right, you would be able to snag away many merchants by charging them lower fees. The merchants would happily pay a low, flat-rate, instead of the percentages. Maybe you could even find a way to eliminate fees altogether by advertising on customer receipts? Who knows? It could well be that no one has thought of such a solution, but it seems more likely to me that when people run the numbers, they realize that it’s not viable.

I also am not quite sure where the equation of value and MC comes from. The best business transactions, in terms of both negotiating range and potential outcomes, are those where one party has a low MC and the other party receives high value from the transaction. That leaves a lot of surplus to be split. You seem to be saying that’s not a desirable situation, but I may be reading this incorrectly.

Now, do I think credit card processors should be rewarded for their innovations? Absolutely. But even a patent only lasts 20-years. I object to credit card processors inflicting a permanent deadweight costs upon society.

All said, this is highly inefficient. In the present state of society, we should be able to have electronic transactions without large deadweight costs as unproductive middlemen take a cut that is disproportionate to the marginal costs of whatever value they add to the transaction. Further, you may think it is neat that cash customers are, in effect, subsidizing the transactions of credit card customers. I do not.

First off, cash customers are not subsidizing credit cards, but vice versa. See above.

I think you mean deadweight loss, not deadweight cost? Assuming you do, I’m not quite sure you’re using the term correctly. First off, I don’t believe prices are being driven up by credit cards. Second, there are four alternative systems (Visa, MC, AmEx, Discover) and a fifth that collapsed recently (Diners), suggesting that there is competition in the system, i.e., unlike a patent.

The collapse of Diners suggests something powerful about these so-called “unproductive middlemen” and their contribution to society. Scale is a very important requirement to building a successful payment processing network, which requires extensive capital expenditures. To recover those costs, you need to charge variable rates. I don’t believe any other system would be viable – and I think the collapse of Diner’s is good proof for that.

While you may think that we should be able to have cheap or free electronic transactions, “in the present state of society,” there are costs and economies of scale involved. Again, see Diner’s.

I apologize. The previous comment was posted before the caffeine had kicked in.

I had forgotten I said that the credit card companies made money off of the transaction fees of card users who did not carry a balance.

Your comment was relevant and I have slammed my head in a door twice to remind myself of that.

My first comment was on the regulation that has passed and how it punishes the financially responsible.

Your comments on the transaction fee are not relevant to what I said.

First, you are going to have to be more clear when you say “not true.” Are you saying it is permissible for businesses to charge higher prices to credit card customers under their contracts with credit card processors?

Second, the customer is the consumer. The merchant is the supplier. The credit card networks are simply middle men. Most retailers do not have any market power compared to the credit card networks and are left with a take-it-or-leave-it deal. If they leave it, they lose a lot of customers.

Anyway, I understand perfectly what you are trying to say. I simply reject your model. The real value (the real marginal cost of the transaction) is incurred by the merchant, not the credit card processors.

Now, do I think credit card processors should be rewarded for their innovations? Absolutely. But even a patent only lasts 20-years. I object to credit card processors inflicting a permanent deadweight costs upon society.

All said, this is highly inefficient. In the present state of society, we should be able to have electronic transactions without large deadweight costs as unproductive middlemen take a cut that is disproportionate to the marginal costs of whatever value they add to the transaction. Further, you may think it is neat that cash customers are, in effect, subsidizing the transactions of credit card customers. I do not.

David Welker: In order to accept credit cards, merchants have to increase their prices in order to pay interchange fees.

Not true. See above.

Also, there is minimal consumer pressure to keep these fees down, since credit card users pay the same price as if they used cash.

This is an extremely misleading statement. There is NO consumer pressure to keep these fees down. Instead, the pressure comes from what the market will bear, i.e., the merchants. Part of the problem is a misconception of who is whose customer. You, the end user / customer are the card issuing bank’s customer. The merchant is the merchant bank’s customer. Both the merchant bank and the card issuing bank are the network’s customer. Of course, in a situation like this, there can be no pressure from the consumer. There can only be pressure from the customer, here, the merchant, on the merchant bank. The merchant bank makes its fees primarily based on volume, so they have every incentive to work within the merchant’s constraints.

In order to accept credit cards, merchants have to increase their prices in order to pay interchange fees. These price increases are paid by both credit card users and non-credit card users, because merchants are not allowed to engage in price discrimination under their contracts that allow them to accept credit cards. Also, there is minimal consumer pressure to keep these fees down, since credit card users pay the same price as if they used cash.

I just don’t see the anti-competitive nature of requiring that people who use a service actually, you know, pay for that service themselves, rather than free-ride on payment mostly made by other customers.

What in the world are you talking about???

Credit cards are a private financial arrangement between an individual and a bank.

The fact that those users were getting the card for free proves that they were not free riding because the bank was making money off of them somehow. Otherwise they would not get the card for free

Congress did not like that arrangement so they stepped in and killed it with regulatory changes.

Once again government steps in and those that are financially responsible are punished and those that are financially irresponsible are rewarded.

In days of old, you could transfer the credit limit from one card to another. You can no longer do that. I will miss having all that available credit (not that I ever want to be that far in debt). But I don’t want to pay annual fees to have the potential to borrow that I am not using.

Of course, it makes sense for the banks to find a way to force people like me to close out dormant credit card accounts. But that does not mean I have to like it.

It just depends on your business. Most probably don’t – I probably shouldn’t have said that apart from being agreeable with previous commenters – but they have the higher risk of some/all of the money disappearing due to employee theft or theft from the employee.

Handling cash: As many have noted, you need to have the armored car. There’s also a higher risk of cash “shrinkage” from your employees helping themselves. Shrinkage is generally a function of the amount of cash and goods going through the business, not a flat figure.

Employees: It takes less time to handle a card than cash, including providing change. Supermarket often have lines, and this difference can mean a reduction in the number of employees.

Maintenance: Supermarkets often use self-serve checkout counters. They break down more often when handling cash and particularly coins than when handling cards, especially contactless cards. Besides the cash loss, there is also the reduction in potential throughput caused by not having that counter available.

Errors and Customer Service: You’re less likely to provide incorrect change with a credit card. This improves customer service, and thereby retention.

Security: Robbing banks because that’s where the cash is may not apply to the card using merchant, as much.

Targeting Customers: Customers who spend with credit cards typically have higher average transaction sizes, and quite significantly so. A lot of this is because they are wealthier – in a world of no credit cards, those people would still exist. In a world with credit cards, the merchant who does not accept a high transaction average card is eliminating a favorable demographic. This is probably the single most important factor.

These are several reasons. There are others, too.

In case you don’t believe me, think about the increase in acceptance of AmEx in the last 10 years or so. AmEx charges higher fees than Visa or MC, by quite a bit. Many merchants refused to pay those higher fees for a long time, but in the last 10 years, that has really changed, especially for the last reason above – AmEx customers are usually relatively affluent, big spenders. They’re the guys you want in your store. As a store owner, you’re crazy to reject them, forgetting about the x% in fees.

Many people here would probably similarly argue that marketing dollars are wasted. They’re not – they’re a way to grow your business by explaining your value proposition to your end users. Likewise, no merchant is paying the fees out of charity – they’re doing it b/c it’s what’s best for their business.

Large merchants, e.g., American Airlines, get into the card business to build loyalty as well, but that’s a different story.

I don’t get all this free-ride worry. The merchant pays a fee for me to use a credit card. He chooses to pay this fee because he feels it is in his benefit (more business, less worry about cash, check depositing fees, etc.).

Lets agree to disagree.

First of also, one need not have an absolute monopoly in order to have market power, and market power does not always manifest itself in the form of monopoly.

It is true that some businesses will accept only Visa and Mastercard but not AmEx and Discover. Or they will accept Visa, Mastercard, AmEx but not Discover. So, there is some competitive pressure. But it is very indirect. If you reject Visa, say, you not only reject Visa, but a significant percentage of your customers who happen to have Visa. It really isn’t the electronic services you are paying for, but rather the right to have customers who only has a Visa card available. Even if we were to have more entrants into the market, this problem of a subset of your customers being attached to a particular card would remain. So, when you reject a vendor, you not only reject their electronic services but also their customers. Your point about technology changing this in the future is highly speculative. Retail merchants do not typically accept electronic checks, for example.

The bottom-line is that there are problems in this market, and those problems cause the output of not just one industry, but many industries and endeavors to be lower than they otherwise would be. The transactions that do no happen and the associated deadweight loss because of these policies probably add up to huge amounts, if you consider the ubiquity of credit card transactions.

I need not belabor this point. My point is not primarily that there are problems in this market. That is obvious and you have already conceded as much. My point is that the government action of regulating prices is not unprecedented and has been successful and effective in other contexts. Public utilities are different, but the conceptual idea of having government regulate price in very limited circumstances and contexts is not. Given that, there is no reason to think it could not be successful in this context as well.

What the actual deadweight loss is–and that is ultimately what your points about limited competition amongst credit card networks and points about future technology lowering those costs in the future are relevant to–is a s separate empirical question. I suspect that deadweight loss is fairly large; you have given some conceptual reasons why those losses might be merely really large instead of gigantic. But, ultimately, this disagreement, which is one of not whether there is a problem but how large that problem is, should be resolved by empirical data rather than conceptual argument.

Further, I’m not sympathetic to the argument that interchange imposes a cost on merchants. Again, historically, the view has been that issuers are service providers to merchants to facilitate payment transactions. Interchange is the cost of this service. The fact that an intermediary plays a significant role in the determination of this cost doesn’t change the analysis for me. Moreover, merchants receive benefits from the acceptance of card transactions in the form of reduced cash management expenses, as others have observed, and in the form of increased sales.

Frankly, the solution is that if merchants don’t like paying interchange, they should form their own payment card networks, and they can price payment services however they like.

Ulquiorra, in this particular circumstance, there is an intermediary between the card issuer and the merchant, the credit card network (Visa and MasterCard being the two largest). The network is, at least, a near-monopoly. It would be inefficient for there to be direct agreements between each card issuer and each merchant. The networks allow for universal acceptance. But because the network is itself a profit-seeking company, it can exercise some monopoly powers, once the network has reached the size which Visa and Mastercard have reached today. Visa imposes requirements on both the card issuers and the merchants. As a single entity, Visa has vastly more bargaining power than individual merchants in setting the terms of its agreements. Anti-trust law generally forbids the merchants from coming together and colluding with each other to bargain with Visa for changes. Thus, for example, the restaurants of New York City cannot form a trade association to tell Visa, either give us these terms, or every restaurant in New York City will no longer accept Visa cards. It is appropriate for the law to recognize and attempt to cope with the issues created by monopolies and near-monopolies.

In this situation, I have argued, card issuers use the requirements imposed on merchants by Visa (accept all cards, or else don’t participate) to give their own card customers benefits which are paid for not directly by the card customers but by the merchants, who are not given the ability to decline to pay whatever interchange rate is set by the card issuer within the limits allowed by the Visa network.

Now to turn against government regulation…

David, I just don’t see the credit card market as analogous to public utilities. The competition is not just among card-issuers, but between credit card networks themselves. More broadly, the competition in the end is between methods of payment generally. Merchants are required to accept all Visa cards (credit and debit) in return for the privilege of taking ANY Visa cards. Merchants are not, however, required to accept AmEx cards in order to accept Visa cards, because AmEx is a different card network. There, the merchant has indeed decided to accept the additional costs imposed on him by AmEx cards. As users experience more frustration because fewer merchants accept the card, or because merchants hassle the AmEx card users ford doing so, that applies competitive pressure to AmEx to reduce its merchant fees. Indeed, it would today be very rare to find somebody who relies 100% on AmEx, precisely because its users know that they cannot safely assume that all merchants will accept their card, while Visa or MC users can indeed feel comfortable in that assumption.

More generally, as I noted before, technology is rapidly providing additional mechanisms for payment. The ACH system allows just about any merchant to accept checks electronically, and my understanding is that the fees are noticeably lower than card companies charge. I predict that we’ll see more on-line banking establishments open which agree to provide to their customers many of the same benefits currently provided by credit card companies (fraud protection, no-questions return policies, extended warranties, whatever), in return for a fee. By letting the consumer pay only for the extra services they like (I belong to AAA, I don’t need free roadside service from my card company), they will be able to reduce the overall fees charged to the customer.

We already have the example of PayPal, which is accepted by many small merchants on the internet. As I understand it (it’s been a while since I looked at PayPal’s details), all of the costs of its transactions are imposed on the purchaser, none on the seller, so they are quite transparent.

So you see, my non-fighting friend ( ;-), there is ample competition in that marketplace, and technology is providing for ever more competition, rendering government intervention, beyond perhaps disclosure and collective bargaining authority for small merchants, unnecessary.

If government intervention were limited to requiring disclosure, where technologically feasible at very low cost, of the interbank merchant fees, I would be for that.

This I don’t understand. The issuer is a service provider to the merchant and the agreement between the merchant and the issuer is a private transaction. Given that, to my knowledge, a person providing services to a merchant isn’t generally required to disclose the terms of their transaction with the merchant, why should issuers be treated any different?

David, not sure why you are picking a fight with me on this issue, as I agree with you far more on this particular topic than many of the other commenters, who are defending the status quo on both libertarian and policy grounds.

I am not picking a fight with you. I am just trying to test your logic. The high quality of your response indicates to me that this test of logic was not a wasted effort.

First, I agree with your framework. We should look at the specific case. Sometimes we may see a market failure of some sort or deadweight costs imposed upon society in some context or another, but then realize that all possible solutions may have more costs than benefits. In that case, the best policy is to do nothing.

Furthermore, I agree with your general approach in suggesting multiple policy approaches one might take to address the problem. Different solutions have different costs and benefits, so exploring multiple approaches as you briefly do is beneficial.

That said, I am not convinced your assertion regarding the supposed problem of regulating the rate directly. The government regulates rates directly and with much success in cases of monopoly all the time. For example, in the case of public utilities, where economies of scale lead to natural monopolies. While certainly we would not want government to fix prices in general, in specific cases involving market imperfections or in cases of extreme emergency (i.e. when rationing is employed as a shared sacrifice during war) it makes sense to regulate prices. So, it seems to me that you are taking a justified general skepticism of government price fixing and not fully considering its applicability in this specific context.

So, while I agree with your general framework, I am not sure you that you have applied that framework with perfect consistency. Obviously, that you have the right framework in mind is much more important, but I don’t think it hurts to ask a few questions on particulars and I do not mean to pick a fight with you. =)

Which is kind of funny, as I’ve never had an account of any kind with Bank of America.

I wonder why they figure in so many phishing schemes?

In particular, I have no confidence at all in the government’s ability to separate out “deadweight” costs from other costs. If government intervention were limited to requiring disclosure, where technologically feasible at very low cost, of the interbank merchant fees, I would be for that. Were the government to merely mandate that notwithstanding any agreements to the contrary, merchants could impose fees based on the card used by the customer, I would probably be ok with that. If government merely allowed merchant associations to form to collectively bargain with the card networks over the interchange fee rates, I’d probably be ok with that (given my belief that the Visa and MC networks are functionally at least a near-monopoly, and necessarily so), in order to level the playing field between giant Visa and regular small merchants. But having government regulate the interchange rate itself would be really bad, because government simply is not good at making those kinds of price determinations.

More generally, every government intervention in the market comes at some cost. Sometimes those costs are relatively minor in comparison to the benefits provided. Other times, they are not. But there is always some cost. Thus, it is not at all irrational to determine that while some result may be desirable in a general sense, it is not desirable for government action to be used to achieve that result. In this case, I think the amount of information currently available to consumers to use in selecting credit cards is so tremendous (thanks to existing truth-in-lending laws and the internet) that government intervention is unnecessary. Even regarding my limited complaint of the free-riders, the actual damage caused by them to others is relatively small. Thus far, nobody’s tried (so far as I know) to impose something like a 10% interchange fee in order to give 8% cash back to the card customers. While the merchants have a limited ability to negotiate very detailed points of the contracts, there are ample other options available to allow them to use other payment processing mechanisms should the fees become too high. For example, Amazon.com really pushes the option to pay electronically by check, even providing financial incentives to do so. If merchant fees rise too high, they can simply switch to other methods of payment. Even almighty Visa itself is subject to competitive pressures.

I will attempt to do it as long as possible. And I understand the economic benefits of more transparency — I just won’t unilaterally disarm.

David Nieporent, just to highlight what I said in the middle of my last post, I agree that the government should stay out of this area. I particularly do not want them to try to set rates for the merchant interchange rates. However, Prof. Zywicki has decided to criticize not simply the intervention, but the outcomes of the intervention. While I disapprove of the mechanism, I think (and have been defending) the outcome, which I think is better for most consumers, and certainly likely to result in much more transparency, which should help consumers make better-informed decisions.

You concede that eliminating deadweight costs from limiting these fees would be a good thing, but you don’t think it should be done. What other actions by government do you think are highly beneficial but should not be done? What principle drives this? Your view strikes me as irrational. You have clearly been hanging around with irrational government-adverse libertarians too much. This sounds like a compromise for the sake of a compromise. Don’t get me wrong, there is nothing wrong with compromise when it is necessary, but I don’t see that there is anything at stake here worth any sort of compromise.

If only there were some way, other than government fiat, for deciding what type of commercial offering is preferable!

If only.

Unfortunately, markets do not work very well when prices are not transparent. Suppliers of credit have inadequate incentive to compete on the basis of the price when their customers do not take those prices fully into account anyway. Government action to make prices more clear actually improves markets. Just as government action to establish clear property rights improves markets.

Making sure that markets actually serve their purpose by “government fiat” is not a bad thing. There are laws against stealing by “government fiat” too. It is a good thing, because a society with clear property rights tends to have more efficient and effective markets. It is not as if markets exist in a vacuum.

To make an argument, you actually have to actual look at consequences. Government actions, like private actions, have costs and benefits. That is the framework you should be using.

Alternatively, if you are going to talking about it as a matter of deontological principle, then stop talking about costs without talking about benefits. If there is a overriding principle against government action (and I and the vast majority of people disagree that any such principle can be sustained), then the costs are irrelevant. The argument isn’t about the costs (which always need to be weighed against benefits if they are mentioned at all) it is about the principle itself. But if you are going to shift to a utilitarian framework and talk about the costs of government action, you had better talk about the benefits too.

An argument that includes costs but not benefits fails either way. From the standpoint of deontologic principle, the argument is entirely irrelevant. From a utilitarian standpoint, you have to consider BOTH costs and benefits to make an informed decision.

By contrast, before the recent changes in the law credit card companies could unilaterally impose changes that amount to ten to a hundred times as much cost.

When the new credit card regulations were under consideration by congress, Prof Zywicki claimed that the sky would fall if it passed. This is the best he can come up with?

BTW, I have a B of A card that I almost never use. If they try to charge me an annual fee, I’ll just cancel it and we’ll go our separate ways. Simple problem, simple solution.