The latest dialogue on interchange.

. As a risk manager, I’d advise against using interchange to subsidize the credit risk of a credit card, but that’s a their problem. However, by contract, merchants can’t discriminate between the two.

Now there are additional problems with this outside the generic problems. One is that it functions as an inequality machine. Nobody here seems too moved by this argument, so let’s move on. It’s worth noting that there’s been a debate on whether or not this would really exist, and now we have an additional measurement. Another problem is that it blurs the line between transactional and revolving debt. If you are moved by behavioral arguments about how people function with credit that’s a problem.

I’m more interested in how that blurring destroys the normal supply/demand function. Markets are abstractions over the ability to contract, and once the ability to contract is twisted we can get all kinds of neat distortions later down the road. For instance, competition seems to increase interchange. Since my wallet is filled with plastic cards already, the only way to get me to switch to another card is to promise more rewards. The only way to promise more rewards is to soak the merchants. The merchants would normally charge more for that credit card….except they can’t. By contract. They have to sign these contracts because of the excessive market power. That’s where the problem enters.

Matt mentions “retailers’ monopoly rents” but that’s completely backwards. There’s plenty of reasons to believe that the largest firms pay less in interchange than smaller firms. I tried hard to quantify and confirm this, but nobody releases this data or will go on the record, so I will just say that it is widely assumed places like Walmart’s grocery store pays less in interchange than a local grocer. A grocery runs on razor thin margins and this wipes them out.

And it is small businesses that get hit by these the most, not “retail monopolies.” In fact, it has been a hilarious pleasure of mine to talk about progressive economic reform of finding ways to check monopoly power with owners of small businesses over the past year fighting on this topic. Small business owners! When do they ever get in the fight for regulation!?!? It goes like this:

Small Business Owner: I’m really getting screwed on these rates. I can’t put any pressure on banking system but I also can’t discount or not accept these cards. We’re way past the point where I get “lift” from the new business and I don’t know what to do.
Mike Konczal: It sounds like you think that the government needs to pass a regulation here; that there is a genuine market failure and that only the government can stand in to check the power of finance and monopolists.
Small Business Owner: I can’t even believe I’m talking to you about this. I’m normally very conservative, I don’t do things like this.
Mike Konczal: It’s ok. This is a safe space to experiment. But you just have to tell me what the government needs to do.
Small Business Owner: Ok….it’s like the government needs to….the government should…..it’s like I’m paying a crappy government tax to the credit card companies!
Mike Konczal: Hmmm. That’ll do, I guess.

And notice how elegant of a solution we got with the Durbin amendment. Instead of some complicated mechanism we simply say “merchants can give a discount if you use your debit card.” Maybe they will, maybe they won’t. This will probably open the door to all kinds of new innovation: a check-out line if you use pin debit is one idea just off the top of my mind.

Like Matt, I’m not particularly interested in regulation. But I’m not sure what we’d “tax” here in order to rectify this. Probably the tax-free benefits that cardholders get, which sounds like a nightmare. And I do think when it comes to the means which we use for exchange the government should have a simple mechanism to watch the rate, and give merchant the power to engage the payment system on equal footing by giving them a fair contract and means to price discriminate. Not a bad job for Liberalism.