Tag: cross-subsidy

  • The Disingenuous Mr. Russell Simmons

    Posted by

    Adam Levitin

    Russell Simmons (yes, the hip-hop entrepreneur and vegan advocate) is blogging away at Huffington Post against the Durbin interchange amendment.  Simmons claims that his card takes "the poor, the voiceless and the
    under-served" out "from the claws of payday lenders and check cashers, from
    humiliating
    lines waiting to cash their paychecks and then more lines to pay their
    bills." 

    Gosh, you'd think that Russell Simmons was operating a
    charity. Somehow Simmons neglects to mention how much money he is pocketing from debit card swipe fees in addition to the $1/transaction "convenience fee" the RushCard charges its low-to-moderate income users.  (See here for more details on the RushCard.)  The RushCard is an alternative to check-cashing outlets, but that's all that it is–another high-cost financial service for the poor.  I'd be curious to know how much revenue the RushCard makes on interchange; I suspect it would still be quite profitable without it.  Maybe Russell will show us the books.

    Russell Simmons is claiming to be the voice of minority communities and the poor on interchange.  He's not, and his personal financial interest in maintaining high interchange rates compromises him as an advocate on interchange, just as the fees on the RushCard compromise him as an advocate for the poor. 

    It's worthwhile looking at what The Hispanic Institute, which has no financial stake in the matter, found in an empirical study it sponsored on interchange fees.  The study finds that there is a regressive cross-subsidy that has a disproportionate negative impact on low income minority communities.  

    Simmons also misunderstands (perhaps deliberately) the Durbin amendment in his post; he complains that it regulates debit interchange while leaving credit interchange untouched, and that this dings the poor, while leaving the rich unscathed.  That's just wrong.   While part of the amendment deals only with debit cards, part covers all payment instruments, including permitting merchants to offer a discount for debit (how does that hurt the poor?).  The impact of reduced debit card interchange will inevitably be reduced credit card interchange rates for smaller ticket transactions where credit competes with debit. 

    The logic of the Durbin amendment is straightforward:  debit transactions are just like checks, but with even lower fraud risk because of real-time authorization.  Checks clear at par throughout the entire banking system.  Therefore, debit should clear at par too (or close to it–the amendment is generous in this regard).  If debit clears at near par, credit interchange rates will drop, and because merchants are, in general, more price competitive than card issuers, the savings will be largely passed through to consumers.  The card industry will have to learn to live with reduced (but still substantial profits), which should incentivize the card industry to innovate to develop new, efficiencies or higher margin products.  Net result:  consumers win.

  • The Interchange Cross-Subsidy: False Analogies

    Posted by

    Adam Levitin

    Zywicki's interchange paper repeats a claim made by other opponents of interchange regulation that cross-subsidies, even regressive ones, exist throughout the economy, so there's no reason to get worked up over the interchange cross-subsidy imposed by credit card network rules. 

    Zywicki provides several examples of cross-subsidies in the consumer economy:  Starbucks charges the same price regardless of whether a consumer takes sugar and cream, so those who take their coffee black subsidize the sugar and cream of the others.  Supermarkets offer free parking, so the walkers subsidize the drivers. 

    Zywicki's examples, however, are false analogies to the credit card
    interchange cross-subsidy from users of low cost payment methods (cash, debit, nonrewards credit) to users of high cost payment methods (rewards credit).  The Starbucks' cross-subsidy is Starbucks' business decision.   The free parking cross-subsidy is the grocery store's business decision.  But the interchange cross-subsidy is not the merchant's business decision.  It is the card network's business decision.  Card networks force merchants to impose a cross-subsidy.  It's an affront to the nose-picking rule of commerce:  you can pick your friends, you can pick your prices, but you can't pick your friends' prices….

    With this in mind, it's worth examining another cross-subsidy caused by interchange.  Interchange fees are paid from acquirers to issuers.  The fees are the same for all banks.  Therefore, the safer banks are subsidizing the riskier banks in a card network.  But there's a catch.  The safer bigger banks often get rebates from the card network in addition to interchange fees. 

    Two interesting points about this.  First, it shows that the card networks won't tolerate cross-subsidies for themselves. Second, it casts some doubt on the efficiency rationale for interchange fees–that one-size-fits-all fees are sensible as a way to avoid the transaction costs of individually negotiating every issuer-acquirer contract.  Truth is that 20 or so banks make up 95% of the credit card market.  The transaction costs for these banks to negotiate with each other is fairly low.  This points to the question of whether small banks should be in the card business at all.  Cards are very much an economy of scale business; smaller issuers tend to see cards as loyalty devices, not profit centers.  Would a 20-bank card market be a more efficient arrangement than the current networks with thousands of institutions? I'm not sure, but I think the efficiency of the interchange system is far from proven.