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March 26, 2009

Merchants pile on the pressure

The heated rhetoric surrounding US credit card interchange fees escalated even further recently as legal representatives for the National Retail Federation (NRF), one of the largest merchant groups in the country, told a national gathering of state attorneys that hefty interchange fees have changed the credit card industry in much the same way lucrative origination fees changed the home mortgage industry and contributed to the current recession.

By Verdict Staff

A new political climate in the US is encouraging merchants to bare their teeth at the credit card industry, with some even going as far as drawing comparisons to mis-selling in the mortgage industry. But do their claims have any weight behind them? Charles Davis reports.

The heated rhetoric surrounding US credit card interchange fees escalated even further recently as legal representatives for the National Retail Federation (NRF), one of the largest merchant groups in the country, told a national gathering of state attorneys that hefty interchange fees have changed the credit card industry in much the same way lucrative origination fees changed the home mortgage industry and contributed to the current recession.

“We know that one of the causes of our current financial crisis is that the business model with respect to mortgage lending shifted,” NRF senior vice-president and general counsel Mallory Duncan said. “Rising interchange has caused the same thing to happen in the credit card market.”

As a result, “it is just as much in the banks’ interest to get as many cards into consumers’ hands to collect the interchange fees as it was for banks to get mortgages issued to collect the origination fees,” he said.

“The piles of pre-approved credit card offers in your mailboxes attest to that,” Duncan added. “Unless we can bring market forces to bear on that incentive, it will only grow.”

Warnings of ‘economic calamity’

Speaking at the annual spring meeting of the National Association of Attorneys General in Washington during a panel discussion on credit card issues called: ‘The Credit Card Crisis – The Next Shoe to Drop?’, Duncan issued a stinging indictment of interchange fees and warned that the system, if left unchecked, could lead to economic calamity.

Duncan said credit card issuers used to focus primarily on whether a cardholder could afford to repay the amount charged on a card and made most of their money off the interest. But with interchange bringing $48 billion a year to Visa and MasterCard banks and other consumer fees providing revenue, “it doesn’t matter whether you carry a balance – the card fees alone generate a huge revenue stream.”

Interchange is a fee averaging close to 2 percent that is collected every time a credit card is used, giving the issuing banks the equivalent of 24 percent annual interest even if card balances are paid in full each month, Duncan said.

Duncan said the shift reminds him of the way banks once held mortgages for their full 30-year terms and depended on interest for a profit. Today, however, mortgages are sold off to other institutions almost as soon as they are issued, and the issuing bank or mortgage broker makes its money from origination fees regardless of whether the borrower ever repays the loan. Many observers blame the current wave of mortgage defaults on this practice, which encouraged banks to make loans with less regard to the borrower’s ability to pay.

Duncan argued that interchange practices violate federal anti-trust law because banks historically have agreed to charge the same rates for each type of Visa or MasterCard card. Several class-action lawsuits seeking damages are pending in the US District Court, but Duncan hinted that state attorneys should seek action, saying “what we really need is an injunctive solution ending the practice brought by plaintiffs not motivated primarily by a monetary return.”

By contrast, Duncan said that when retailers issued credit cards, the goal was not to make money off the extension of credit, but to enable consumers to conveniently purchase larger-value items and pay them off over time.

“Even at those long-ago APRs, for most of their history retail card systems were barely a break-even proposition,” he said. “The credit lines and balances were small: typically less than a few hundred bucks. Most people paid off quickly. The yearly interest earned on an account might be $20. The real purpose of the cards was to cement customer loyalty and provide a shopping convenience.”

Duncan said that all changed when, after the last recession, retailers began to sell off their card portfolios to banks. The credit lines got larger; and some of the terms and conditions began to change.

“Where retailers have been able to retain control over credit programmes, they have been much more consumer friendly,” he said.

Duncan said that the result is a dichotomy between the competitive nature of the issuance side of the business and what he views as the non-competitive nature of the merchant side of the business.

“Historically, Visa and its banks have gotten together and decided how much they are going to charge to process card payments,” he said.

“All issuing banks agree to charge the same fees, regardless of which bank’s name is on the card. These otherwise competing banks, under the Visa and MasterCard banners, the two of whom control 83 percent of the market, insist that merchants accept their cards, fees and rules on a take-it-or-leave-it basis, with no opportunity to negotiate. And even though the fees are outrageous and the rules harsh, no merchant can stand up against that kind of power.”

In other words, Duncan said, “we believe the two card associations each operate as illegal price-fixing cartels in clear violation of anti-trust law.”

Duncan noted that interchange fees are growing at about 16 percent per year, and they hit $48 billion in 2008.

“That’s more than annual fees, cash advance fees, late fees and over-limit fees combined,” he said. “It amounts to $427 in hidden fees per household, each year.”

Duncan concluded by stating unequivocally: “this market is broken.”

“It needs transparency and genuine competition,” he said. “Currently, Visa and MasterCard battle to get more banks to issue cards under their names by offering to collect more interchange from merchants and their customers.

“This is the only market I know of where the parties compete to raise prices rather than to lower them.”

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