Economists often use the word “collusion” when they define price fixing. Price fixing is “inefficient,” they charge and almost never good for the buyers or sellers of a product or service unless they are the ones artificially fixing the prices for their own benefit. That’s why, when it happens, price fixing almost always is considered to be inappropriate, sometimes sinister, and not good for the economy.
But price fixing is exactly what the Dodd-Frank Act ordered the Federal Reserve to do about the fees financial institutions will be allowed to charge merchants when their customers use debit cards. The Durbin amendment to Dodd-Frank, which was adopted with no hearings and little debate, mandated that the Fed propose a rule on debit card fees. That rule, which was announced on December 16, would limit the fee to between 7 and 12 cents per transaction, about 80 percent less than what the fee is today and way below what it costs banks and credit unions to provide the service. In other words, it’s clearly price fixing as any economist defines it.
The Durbin amendment and the Fed’s proposed rule qualify as price fixing in a number of embarrassing and unfortunate ways. For example, the amendment did not allow the Fed to take into account the full costs of providing the service. Instead, it was limited to only considering the marginal cost of each transaction. The costs of the research and development for the debit card fee system, maintenance, full security, training, etc. were required to be ignored.
The amendment also prevented the Fed from taking into account the size of the transaction even though the costs and risks are higher the larger the sale. The Fed was also told not to consider the value of the service even though its convenience and safety, not to mention the fact that it does not require that buyers take on any additional debt by using a credit card, is a major reason debit cards have become so popular recently. In fact, they are now the purchase option of choice for many consumers.
The negative effects of this price fixing, which are already becoming obvious, are exactly what an economist would have predicted had they been asked before the Durbin amendment went into effect. For example, many banks and credit unions are already imposing new fees on other services to pay for the costs that are no longer covered by debit card fees. This means the end of free checking for some customers. For others, it means that the debit cards they already have will be cancelled. New customers may never be offered a debit card at all.
Some banks and credit unions are also starting to limit the size of the transaction that can be made with a debit card because the Fed-proposed rule will not provide them with the ability to insure the losses from large illegitimate transactions.
Try to imagine what would happen if the Durbin amendment had imposed similar price fixing when AT&T began to sell iPhones. Suppose, for example, that AT&T was only allowed to charge for the incremental cost of making each phone call rather than the cost of the iPhone, the R&D required to develop and build the network on which the calls are carried, etc. What would happen? First, the greatly reduced price of the iPhone that consumers are now charged when they sign up for the service would be increased substantially. Second, the number of people who would be allowed to purchase iPhones would be restricted limited because AT&T would want to limit the amount of money it could lose. Some existing customers might have their iPhone accounts canceled or they would be forced to shift to less costly cell phones. Third, the price of other AT&T services and products would likely increase to make up for the lost revenue from the price fixing. Finally, AT&T would limit the length of calls for most customers because the longer the call, the bigger difference from what they could be charged and what it was costing the provide the service.
The debit card equivalent to each of these is exactly what is happening because of the Fed’s price fixing proposal. That can’t be allowed to happen.