Credit-Card Wars                         

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Even amid a shaky stock market, last week's Visa IPO made a splash, climbing more than 40% from its initial offering price. So why is Congress trying to fix a $2.5 trillion industry that isn't broken? Apparent answer: Because it's there.

At the behest of a coalition of U.S. retailers, House Democrat John Conyers of Michigan and Republican Chris Cannon of Utah have introduced the Credit Card Fair Fee Act that would regulate fees that the credit-card industry charges to retail stores. 

Consumers who actually use credit cards may ask: What's the problem? Some 90% of Americans with an income of more than $30,000 use credit cards. Just eight years ago, only about one-quarter of consumer transactions were done with plastic; today it's above 40% and rising.

A steadily increasing number of retailers – the very folks who are seeking Congressional redress from Visa and MasterCard – accept credit cards for payment. Just don't ask the folks behind the cash register about "interchange fees." Those are fightin' words.

Typically, a retailer gets about 98 cents on the dollar for a credit-card transaction; the bank that issued the card gets most of the remaining 2% in what's called an "interchange" fee. The card industry rakes in about $35 billion in fees a year. Much of the complaint about fees comes from small retailers, who say that because they operate on thin margins, they pay more in fees than they earn in profits.

On the other hand, retailers benefit from credit cards. Studies show definitively that shoppers spend more in stores when they have a credit card than when they pay cash. Total sales volume tends to be higher for stores that accept credit cards.

It's not at all clear why Messrs. Conyers and Cannon need to belly-slam into the middle of whether the benefits of accepting credit cards are worth this 2% fee. Retailers have options to avoid the fees. They can offer customers a discount on cash purchases. Larger retailers can even issue their own cards offering discounts as an alternative to Visa. Some big chains exploit their own market power by negotiating lower fees.

Still, the merchants want government to decide what these fees should be. The Conyers-Cannon bill requires that any credit card company with more than 20% of the credit and debit market -- Visa has about 50% and MasterCard 25% -- negotiate for 90 days with a coalition of retailers on a mutually acceptable fee. (The retailers would gain an antitrust exemption for these deliberations.) If the parties can't agree, a three-person panel of "electronic payment judges" will "determine rates and terms" which shall be binding. That sounds like a price-control regime.

The merchants contend this political muscle is needed because banks collude to set interchange fees and because Visa and MasterCard control so large a share of the market that they can effectively set prices. And it may be true that the credit-card companies are setting prices higher than in a perfectly competitive market. The Visa interchange fee has increased over the past decade to 1.76% from an average of 1.5%. Economies of scale should be driving fees down, as in most other service-fee industries.

But an equally strong case can be made that Visa and MasterCard have attained their market share and profits because they've built an efficient and superior product through a vast network of cardholders and banks. No one should want the precedent of punishing a business for winning huge numbers of voluntary customers by outcompeting rivals.

The Ninth Circuit Court of Appeals dealt with the merchants' complaint on March 7 in an antitrust case, Kendall v. Visa. The ruling stated: "The [bank] consortiums indirectly establish the merchant discount fee, much as the cost of eggs sets a floor price of an omelette on a menu. Just like the restaurateur, the banks charge the merchant a higher price than their cost of business to make a profit. This behavior suggests a rational business decision, not a conspiracy."

Competition is beginning to emerge in this industry. There are four major credit-card companies, and lower-fee cards are growing in popularity. One of the biggest areas of electronic transactions is Internet sales; PayPal is a competitor and customer of the credit-card industry and has 25% of the online market. Google has launched an electronic payment service, and last month the RevolutionCard came on the market – a credit card with no fees.

As consumers we'd like to see interchange fees come down too, but through market innovation and competition, not Congressional fiat.

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