I was bowled over by a figure in The Home Depot's presentation at the Chicago Fed’s 2009 Payment Systems Conference this week: The Home Depot paid more in interchange than for employee health care last year. That’s astounding. Interchange is The Home Depot’s third largest operating cost. And this
is from a company that gets comparatively low interchange rates just by
being large. Interchange is costing large, sophisticated merchants more than health care. And the value it gives is questionable: The Home Depot's interchange costs have risen 16% in recent years, while purchase volume has increased 10%. [COMMENTS NOW OPEN.]
Tag: credit cards
-
Home Depot Spends More on Interchange than on Health Care
Posted by
-
Why Card Issuers Engage In Rate-Jacking
Posted by
The media has been abuzz recently with articles (here and here and here and also here) about rate-jacking–the often arbitrary increases in cardholders' interest rates. At first glance rate jacking makes little sense. Why raise rates on a good, paying customer? The cardholder might decide to close the account. Or the customer might not be able to service the higher rate debt and default? Why mess with a paying customer these days?To understand rate-jacking, you have to understand two factors about credit cards: lock-in and the incentive to increase account volatility created by card securitization.
-
Interchange Fee Settlement
Posted by
MasterCard settled a lawsuit brought by the European Commission’s Directorate General for Competition, which alleged that MC (and Visa’s) “Multilateral Interchange Fee” (MIF) an interbank fee for cross-border transactions in Europe (basically good old US interchange) was anticompetitive. While the settlement allows MC to keep charging an MIF, MC agreed to drop the weighted average of the fee from between .8% and 1.9% to .3% for credit cards and .2% for debit cards. As the Commissioner for Competition Policy noted, “MasterCard could not justify their level with any solid methodology, or explain what, if any, efficiency gains were being passed on to merchants and consumers at the end of the day.” Visa has not settled in the litigation.
MasterCard’s MIF was always much lower than US interchange, which is somewhere upwards of 2.0% (and that’s not the full merchant discount fee, just the interchange component). But now we see that MasterCard has decided that it can survive by charging just .3% interchange on credit cards in Europe. So why are American merchants going to pay seven times as much in interchange for credit card transactions? Are American banks or merchants seven times riskier? Or is US antitrust law just seven times weaker?
-
Easterbrook: Banks Free to Gouge Consumers (at least for now)
Posted by
Yesterday the Seventh Circuit upheld a district court decision permitting the retroactive application of penalty credit card interest rates to existing balances. Writing for the court, Judge Frank Easterbrook noted that (1) the plaintiff's state law claims were preempted by the National Bank Act and (2) the plaintiff's Truth-in-Lending Act/Reg Z claim that she did not receive proper notice of the repricing was not tenable.
Most of the opinion addresses the TILA claim. It's very technical, but Judge Easterbrook recognized that the applicable Reg Z language as well as the Federal Reserve Staff's comment on Reg Z are ambiguous. Easterbrook resolves the ambiguity by playing economic equivalence:
"It would be lawful for a bank to impose an over-limit fee (say, $75) in the first month, then increase the periodic rate of interest only for successive months. As the Bank’s actual practice of back-dating the penalty rate has the same economic effect as a fee in the initial month, it is hard to see why one method should be allowed and the other prohibited…. Structuring penalty interest to have the same effect as a penalty fee in the initial month therefore does not undermine the goal of advance-notice requirements. Swanson and others in her position still can shop for better rates for future months."Two problems with this statement.
-
Interchange is No Laughing Matter
Posted by
The Merchants Payments Coalition, a merchant alliance that is pushing for reform of the credit card interchange fee system, has a nifty little cartoon out in Roll Call and the Washington Times.
So a few words of explanation. Interchange is no small change. I've written about it on the blog here, here, here, here, here, here,here, here and here. Interchange is technically a fee paid on every credit card transaction by the merchant's bank to the bank that issues the credit card to the consumer. The fee is set by the card network (MasterCard, Visa, etc.). While interchange fees are generally in the range of a couple of percent of credit card transaction value (say 2%) it adds up to big bucks. $48 billion last year!The fees depend on the type of business the merchant is in, the way the transaction is processed (card present or not, e.g.), the size of the merchant's business, and crucially, the type of card used. Each card network has a couple of flavors of cards depending on the rewards and customer service that go with the card. The more rewards, etc., the higher the interchange fee, as nearly half of interchange is used to fund rewards programs (and card issuers' financials illustrate this–rewards are listed a reduction in interchange revenue).More broadly, though, interchange is used to refer to the "merchant discount fee," the fee that the merchant's bank charges the merchant for every card transaction. The merchant discount fee, of course, includes interchange as its major component. Interchange sets the floor for the merchant discount fee. If interchange is 2%, the merchant discount fee might be 2.5% or 3% or even 15% for high risk merchants (GOB sales, adult Internet sites, etc.).Merchants are likely to pass some or all of that merchant discount fee back to consumers in the form of higher prices. Merchants can't pass it back just to card users because credit card network rules prohibit them from surcharging for credit or from discriminating among cardholders. Federal law allows merchants to offer discount for cash, but that's not the same economically as a credit surcharge, even if it is the same mathematically.What's more, the problem for merchants isn't that they don't want to take credit cards. Instead, merchants want to avoid the higher cost rewards cards for which they receive no clear benefit. The federal right to offer cash discounts doesn't help merchants avoid high cost rewards cards.Interchange is not just a merchant vs. bank issue. It's an issue that affects the entire consumer credit system. As I've written elsewhere, interchange supports and encourages reckless credit card lending and is used to fund rewards programs that encourage overuse of credit cards for payments, which inevitably results in unintentionally and expensively revolved balances and late/overlimit fees.Interchange is transaction-based revenue; the issuer doesn't incur the consumer's credit risk. That means that issuers can risk greater credit losses because they've already made a nice bit of money via interchange with virtually no risk. Not surprisingly, interchange has increased over the last decade from being about 13% of card issuer revenue to being 20%. Just as with mortgages, the shift from a lending to a fee-based business model encourages more reckless lending. Securitization only further encourages this, although it works differently for credit cards than for mortgages, an issue about which I'll post another time.To be sure, issuers can argue that interchange covers the cost of the typically 20 days of float on gets on a credit card. But if that's the case, then it's really a finance charge for a 20 day extension of credit, which would be annualized at 36.5% APR (based on 2% interchange rate). And if we include a merchant discount fee (including interchange) of 3%, then we're talking about a 55% APR. And that's not including the cost of then revolving a balance. In short, credit cards are a lot more expensive then they appear.To be fair, there are costs associated with other payment media. It's expensive to print and distribute cash, and the inefficiencies of the paper check system of legendary. But these are both systems in which the government is heavily involved. And that means that the costs are, in theory, subject to political control. MasterCard, Visa, American Express, and Discover are, at best, subject only to shareholder control. Payments are a lot like a public utility. They are as essential a part of the economic infrastructure as the electric grid or the water pipes. And maybe we should think about regulating them as such. -
Credit Cards in the 2007 Survey of Consumer Finances
Posted by
The Federal Reserve has released its much anticipated triennial summary of the Survey of Consumer Finances. There's a lot to digest in this important report. I fear, though, that the 2007 SCF is already hopelessly dated because of the economic turmoil of the past year.
I'll just offer a brief observation about what the SCF showed for credit card debt. The SCF is notorious for underreporting credit card debt levels–in the past, the total revolving debt reported in the SCF from voluntary interviews is off by a factor of two from what card issuers report to the Fed for its G.19 statistical release. Consumers seem to either lack awareness or be in deep denial of their debt levels. Whether this underreporting has continued in the current report is unknown, but there's not reason to think there'd be a sea change in the nature of voluntary responses.
So, with the caveat that consumer credit card debt is likely underreported in the 2007 SCF, consider this:
"Overall, the median balance for those carrying a balance rose 25.0 percent, to $3,000; the mean rose
30.4 percent, to $7,300." Balances for revolvers grew by somewhere between a quarter and a third in three years. Wow. This bespeaks a rapid leveraging up in credit card debt for a large segement of Americans. And this was at a time when a lot of people were paying down credit card balances by doing cash-out refis on their homes. One can only imagine what credit card debt would look like absent the tapping out of home equity to pay down cards. As Paul Krugman noted today, we have a serious consumer overleverage problem, and it's going to be hard to get things on track without addressing consumer debt. -
Worst Practices: Residual Interest
Posted by
Professor LoPucki’s APR issue might not be two-cycle billing as many of the commentators think. Just as likely, it is residual interest (a/k/a trailing interest), the often ignored, but just as potent cousin of double-cycle billing.
Residual interest has not gotten nearly as much attention as it should (and it is often confused with double-cycle billing). Residual interest is a nasty billing trap that drains away discretionary income (also known as potential savings) from American consumers, and should be at the top of the Congressional hit list for predatory credit card billing practices.
-
Behaviorally Informed Financial Services Regulation
Posted by
A new policy paper issued by the New America Foundation and authored by Michael Barr, Sendhil Mullainathan, and Eldar Shafir argues that we need to move toward “behaviorally informed financial services regulation.” By this the authors mean that financial services regulation should incorporate the insights of behavioral economics and cognitive psychology, regarding things like default rules, framing of information, and hyperbolic discounting.
This paper comes on the heels of Richard Thaler and Cass Sunstein’s book Nudge, the culmination of their work in developing what they call “libertarian paternalism”–a soft-form version of paternalism that instead of mandating outcomes, such as requiring retirements savings, sets default rules and menu choices in a way that encourages them, such as making workers opt-out of retirement savings plans, rather than opt-in.
There’s much to commend about this work (Barr et al., as well as Thaler & Sunstein), and the incorporation of behavioral economics into law has been an important development in the last decade or so of legal scholarship. I do not doubt that behaviorally informed financial services regulation would be an improvement over our current model. But I am dubious about its ultimate efficacy for three reasons.
-
Credit Card Promises
Posted by
During the debates over bankruptcy reform, the credit industry launched a public relations campaign claiming that bankruptcy cost every American family $400 every year. The stat was picked up and repeated as fact by both the politicians and the press (more details here). The promise was clear: pass bankruptcy reform and watch the costs of consumer credit fall. Now the numbers are coming in. Did credit industry losses decline? Did the cost of a credit card go down? A new paper, The Effect of Bankruptcy Reform on Credit Card Prices and Industry Profits, assembles pre- and post-BAPCPA data to answer that question.
First, the answers from the author, Mike Simkovic:
-
Credit Cards and the Mortgage Meltdown
Posted by
The role of subprime lenders in inflating the housing bubble, then bringing down the whole economy has received plenty of headlines. But there has been little attention paid to the role of credit card lending and BAPCPA in the current home foreclosure crisis.
A new academic paper, Bankruptcy Reform and Foreclosure, argues that the 2005 bankruptcy amendments are deepening the mortgage crisis. The article was written by David Bernstein, an economist at the U.S. Treasury who chose to post this analysis as private citizen listing only his home address and home e-mail address. Drawing on data from the Survey of Consumer Finance, he links credit card debt, access to bankruptcy, and mortgage foreclosures. If more families could use bankruptcy to deal with their credit card debts, more could avoid foreclosure on their homes.