What happens when you ask the government to "help"

Recently in the US there has been quite a controversy over the issue of debit card transaction fees. These fees are the money that the "system" (Visa/MasterCard, banks, clearinghouses, etc.) charge to process a transaction at the point of sale.

Previously, it involved a rather complex set of rules to apportion the amount that the system would charge to move money from the purchaser's bank account to the business' account. Take a look at this page which describes some of what is involved with a merchant account, then try to figure out what a transaction will cost you if Visa handles the transaction.

On that Visa link, don't you just love the term 'reimbursement'? It sounds like you are getting something back, doesn't it? Actually it is the amount that Visa reimburses the card-holding financial institution for the transaction. Also, it looks like a complicated government tax form, doesn't it? So complicated that you can never actually figure out what it will cost you, as a merchant, to take the card as payment. You just wait until the end of the month and you pay the fees.

There is HUGE money in transaction fees. The dirty little secret is that the customer almost never pays for any of them. (Rarely, you may see a four or five cent per gallon discount for paying cash for fuel at a gas station, but other than that, most credit cards disallow this practice.)

As a merchant, I have had to play this game for decades. When my company was in retail, we would sell a lot of big ticket items (computers, printers and service.) We would cringe if a customer reached into their wallet and pulled out an American Express card. "Oh, no!" we would exclaim. If we wanted that money deposited into our account the next day, that transaction would cost us around 5%. So, if someone bought a $3000 computer system (not atypical back in the 1990's), $150 would go directly to Amex.

The customer would feel great, because they just extended their one year warranty to two years, and they got some protection from a bad purchase from American Express.

What did we get? Well, we saw our profit margin (which averaged 20% at the time) immediately go to 15%. So, now we pocket $450 instead of $600. "Wow", most would say. $450 is a lot of money to keep just for delivering a computer system. How a merchant has to dice up that 15% profit is the subject for another post.

Suffice it to say, merchant fees for credit cards have always been a touchy subject for retailers. The recent dust-up in Washington concerns debit card fees, but these fees are twin sons of different mothers.

There has been an uneasy peace between the banks, the interchange companies (Visa, MasterCard, etc.), the merchants and the cardholders for decades.

What, I believe, has caused the fee system to come to a boil is the fact that many people do not use cash anymore. So what happens is that every one of their purchases goes onto a debit card or a credit card. So, in my previous example of the computer system, if a customer purchases a $1000 computer system, between $25 and $30 goes to credit card clearing house and that gets divvied up between the bank, the card company and the interchange company. I can live with that 'tax' in order not to have to worry about bounced checks, or even worse, extending credit to someone.

The cardholder gets their product, a few airline miles, an extra year's warranty, some peace of mind from buying a lemon and it costs them 12% to 30% interest (assuming they do not pay the card down each month) plus some annual fee which they just close their eyes and pay.

Everyone's happy, right? Well, no one is ever really happy. Everyone wants more for less.

The trouble with the current situation is that each transaction has a transaction fee. In the case of debit cards, it was usually about 44 cents. On big ticket items like my computer systems, that is a rounding error. But, when you pop into 7-11 and buy a Big Gulp for $1.49 and swipe your debit card instead of giving the clerk two ones, the store owner (usually a small businessman, often an immigrant) loses 30% of his sale. Right off the top. If you look at business that live off of small transactions (convenience stores, fast food, street vendors, craftpeople, etc.) these fees become a huge tax on their profit. Talk about regressive. And the purchasers are none the wiser... they just buy more, because it is almost like play money. They never see the cash leaving their wallet.

So what is a merchant to do? The "system" isn't going to give in. They like how it works. It requires a huge infrastructure to support these transactions, but once built, it is like the golden goose, laying them golden eggs.

Like often happens when the little guy has no clout against the behemoth, where else can the little guy turn but to the government for help? And if you want to fight big business, who better to enlist in your battle but the Democrats?

The Dodd–Frank Wall Street Reform and Consumer Protection Act was created and enacted while the Democrats held majorities in the House and Senate, and also held the Presidency under Barack Obama. It was a response to the sins of the 2000-2009 decade and (IMHO) was largely punitive while it tried to dial back the ability of banks and investment firms from going crazy again. During debate, Sen. Dick Durbin (D, IL) inserted an amendment aimed at reforming interchange fees. Originally targeted at an average 12 cents per transaction, they settled on an average 24 cents per transaction, down from a prior 44 cents.

Of course, the banks lobbied hard to keep this out of the final bill, but failed. So, last month, several banks announced monthly fees to make up for the estimated $20 Billion they will lose annually by not collecting the prior amount. Notoriously, Bank of America stated that they would start charging $5 per month if a cardholder used their debit card at least once per month (ATM transactions excepted.) Wells Fargo and SunTrust have also begun to charge $3 to $4 to their customers.

Like squeezing a balloon filled with water, it just starts sliding around, but the amount doesn't change. There has been a big hue and cry over this, with many saying that they will just start using cash again, or start using their credit card instead of their debit card. I doubt much will change in the long run. People like the convenience too much. If you think about it, $60 per year is the average annual fee for credit cards and people have many cards in their wallet. This fee effectively becomes an annual fee to use a debit card.

It has shifted the burden of transaction costs somewhat off of the merchants, back onto the consumer, where I believe that it really belongs. The goal of Sen. Durbin of punishing the banks isn't going to meet its goal, because banks will make it up elsewhere.

Similar to the argument surrounding the Fair Tax, will the consumers see a slight drop in the cost of goods because the merchants will no longer shoulder the full burden of interchange fees? I doubt it. Cumulatively it is a lot of money, but on an item-by-item basis, it is pennies.

The point of this whole blog posting is that the best (or worst) of intentions often usually spawn unintended consequences. The unintended consequences are often usually worse than the problems they were intended to solve.

Am I proposing that nothing be done to cure the ills of society? No, but our economic and social structure is delicately balanced and whenever the heavy hand of government gets involved with its one-size-fits-all approach to problem solving, strange things are bound to happen. Just remember the water balloon.

Life isn't fair. There are going to be winners and losers, but it all eventually comes around. Remember how insanely worked up we were about Japan in the 80's? Remember how Wal-Mart was going to ruin America in the 90's? Remember Global Cooling in the 70's? Remember the Hunt brothers and how they were going to ruin the silver market?

It is funny... I find myself almost feeling sorry for banks and health insurance companies as they battle onerous legislation and regulation coming out of Washingon. I have to pinch myself occasionally to remind myself how much I hate banks and health insurance companies. I have to remain cognizant of the fact that bankers (in relation to loaning ME money) don't take risks. Every penny they loan me is collateralized, so the notion that bankers are supposed to support new businesses by loaning them several hundred thousand dollars is a fantastic myth (unless the business owner has that amount of assets to put up as collateral.)

Similarly, every August when I get the estimate for next year's health insurance costs for my small business and the rates jump by 25%, but the agent can negotiate them down to an 18% rise, am I supposed to feel good about that? Can I raise my prices by 25% every year and get away with it? Why can't I charge huge amounts of money to provide IT support to medical practices (after all, isn't it they who are driving up the cost of health?)

Needs and wants cost money. The more needs and wants, the more it costs. Period. It is an immutable truth. Write it in crayon on your bathroom mirror. You are going to need to remember it.

And also remember what happens if you ask the government to help.


Craig Hollins said…
Are you forgetting about natural market forces? If small businesses or consumers deem the price is too high and stop using cards then the banks would be forced to restructure their fees to meet the price expectations.
In Oz it is common for merchants to add up to 5% on all credit card transactions. Our bank charges us 1.09% on all Visa and MC transactions and 2.8% on Amex. We don't accept Amex - ever. It's technically illegal to profit when adding surcharge fees but many business do it anyway.
Our take is it's pretty easy for us to pay 1% and not have to worry about counting cash, security issues taking the money to the bank (and the time) etc. To us it's a cost of doing business.
Why are fees in Oz lower than the US? Don't know for sure but we do have a very aggressive Trade Practices regulator that loves to look for businesses colluding on price fixing. You can bet that if all banks changed their fees on the same day there would be prosecutions following.
Our banks don't offer extended warranties or guarantees on goods bought with cards. The only protection the consumer gets is a refund if the goods don't arrive.
But for debit cards it is quite common to see a sign saying the minimum purchase is $10 - that makes the transaction charge insignificant and if the customer isn't spending $10 then it's only a few coins which they probably are glad to get rid of anyway.
Recently there have been changes to EFTPOS fees to bring them into line with credit cards. There have been talks about getting the consumers to pay the fees but I think the marketing people have seen that's a really dumb idea.
The banks have a great opportunity to eliminate cash but the cost of doing so to merchants and customers has to be proportional with the benefits of security and convenience.
The Asterisk said…
Maybe I am a tightwad, but I avoid 'random' ATMs like the plague. I have a big problem with getting cash from a machine and paying $3-$5 to my bank PLUS the ATM company. If you think about it, the ATM owner actually deserves the fee, since he/she is putting the machine out there, paying for the space, electricity and network connections and servicing it as well. Whereas the bank pays very little for the transaction and the bank saves $$$ by not having to employ tons of cashiers.

Not using third party ATMs is market force on my part, but there are a huge number of individuals who will grab money from any ATM regardless of fee. These people are the ones that make 'voting with your feet' so difficult.

Retail establishments are between a rock and a hard place, since not accepting debit cards narrows their scope of clientele. They have very little leverage with the banks.

I don't have the answer to this one (maybe there isn't an answer) but my point of "careful what you wish for" applies.
Craig Hollins said…
Again, in Oz the standard ATM fee is $2 if you use one not from your bank. Some smaller banks have banded together and don't charge fees for each other's customers. You should never pay a fee to your bank for using an ATM - you pay a fee to the provider of the ATM.
You guys really are getting screwed by your banks. Maybe the OWS people have a point?

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