Kevin Drum

Interchange Fee Regulation (Partially) Survives

| Mon Jun. 21, 2010 4:45 PM EDT

Dick Durbin (D–Ill.) has apparently reached a deal that would mostly keep his amendment to regulate debit card interchange fees intact in the final financial reform bill. The original version regulated both the fees charged to merchants and the fees charged to banks:

The House will seek to maintain the Senate’s proposed cap on debit-card interchange, or “swipe” fees, according to Representative Barney Frank, the Massachusetts Democrat leading talks to produce a final regulatory overhaul bill. The plan from Senator Richard Durbin would empower the Federal Reserve to set fees charged to merchants that are “reasonable and proportional” to the cost of processing debit transactions.

....The compromise prevents the Fed from regulating “network fees” that Visa and MasterCard charge to banks on each transaction as long as the fees aren’t used to “circumvent” interchange regulation, according to Durbin, the Illinois Democrat and majority whip. Reloadable prepaid cards, including those used to disburse government benefits, would be exempt.

This isn't too bad as these things go. Merchants and consumers really don't have much bargaining power when it comes to interchange fees, so regulations there make sense. Big banks, however, do, so letting them fight it out with Visa and Mastercard on their own sounds OK to me. (Though the additional language adds complexity that banks will almost certainly find some way to exploit. That's unfortunate.)

I wouldn't mind seeing some regulation of credit card interchange fees as well, but that wasn't in Durbin's amendment to begin with and it's a secondary issue. Debit card interchange fees are the bigger abuse since banks are literally doing nothing there except moving money from one account to another. Add this to the recent rules reining in overdraft fees and we've made some real progress on the consumer finance front. We only got about half of what we should have, but that's better than nothing.

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Afghanistan Update

| Mon Jun. 21, 2010 1:19 PM EDT

I don't really know what to make of this, but here's the latest from Afghanistan:

Britain's special envoy to Afghanistan, known for his scepticism about the western war effort and his support for peace talks with the Taliban, has stepped down just a month before a critical international conference in Kabul. Sir Sherard Cowper-Coles has taken "extended leave", a spokesman for the British high commission in Islamabad said today. He has been replaced on a temporary basis by Karen Pierce, the Foreign Office director for South Asia and Afghanistan.

....Cowper-Coles, who also had Pakistan in his remit as special envoy, clashed in recent months with senior NATO and US officials over his insistence that the military-driven counter-insurgency effort was headed for failure, and that talks with the Taliban should be prioritised.

Presumably the U.S. approach can now proceed without any kibitzing from doubters. In related news, the Washington Post's Rajiv Chandrasekaran reports that some Afghan villagers are starting to revolt against the Taliban, and on Sunday Rahm Emanuel confirmed that Obama still plans to begin the U.S. military drawdown in July 2011, as planned.

Watching Commercials: Your Civic Duty

| Mon Jun. 21, 2010 11:52 AM EDT

Check this out. Apparently the White House has set up a site called, and among other tips for high quality male parenting it suggests watching a ball game on TV with your kids and then chatting with them about their lives during commercials. To encourage high quality chatting, however, the site suggests muting the commercials, and Ira Stoll is outraged:

Suppose I work at an advertising agency and earn my living making commercials, or own a company that has just invested millions of dollars in those commercials in the hope of winning customers and making a profit? Suppose I own a television network that makes its money by selling those commercials? Suppose I am a taxpayer who has just shelled out major bucks for the Army or the Census or some other branch of the government to buy these commercials, only to have another branch of the government instruct Americans not to listen to the same commercials my tax money was just spent to purchase. If I had any advice for fathers, it would be to mute the ballgame and turn up the volume for the commercials, or turn off the tube altogether and go play a game with your child. But now the government wants us to mute commercials? Really.

Wow. I understand that Stoll is probably still cranky over the failure of the New York Sun — and so am I, since I liked their crossword puzzle — but seriously. Muting commercials is your beef against Barack Obama and his socialist minions? And conservatives wonder why the rest of us think their entire movement has gone stone crazy?

(Via Jonathan Chait.)

Is New York Bigger Than Ever?

| Mon Jun. 21, 2010 11:06 AM EDT

Gregory Rodriguez writes about the reascension of New York City in the cultural and intellectual world:

New York, long the intellectual capital of the U.S., has seen its stature strengthened by the decline of regional newspapers and media outlets. While critics had hoped (or feared) that the digital age would decentralize information media, the opposite has happened. Manhattan's so-called Media Corridor between 8th Avenue and Avenue of the Americas, and roughly from Columbus Circle south to 40th Street, is both more concentrated and farther reaching than ever. Over the past two decades, The New York Times has joined the Wall Street Journal as a truly national newspaper.

Oh yeah, and all that hype about the blogosphere democratizing information? Well, it was just that: hype. Now that the reading public is realizing that most blogs are self-serving claptrap, the value of the well-considered written word is rising again, but it is rising at the same time that regional periodicals are suffering. In other words, while the digital revolution walloped mid-level publications nationally, it has left elite New York publishing — newspapers, books, magazines — with more power (if not more revenues) than they have ever had.

OK, two questions. First, is it really true that New York is more influential than ever in the media world? It's an intriguing assertion, and quite possibly true, but I haven't really heard anyone else making that case recently. Second, putting aside the question of whether most blogs are self-serving claptrap, is there any evidence that the value of the well-considered written word is rising again? I mean, I think it would be great if that were the case, but I don't feel like I'm exactly drowning in testimonials that this is happening. Comments?

Should Derivative Reform Include End Users?

| Mon Jun. 21, 2010 10:34 AM EDT

One of the key pieces of financial reform is Blanche Lincoln's proposal to force derivatives to be cleared on an exchange instead of being traded over the counter in private deals. However, end users like airlines or agribusiness companies, which generally use derivatives to hedge price fluctuations, hate the idea that this would apply to them as well as to banks that use derivatives for speculation. The Wall Street Journal reports:

In a clearinghouse, akin to a cooperative, all parties to derivatives deals chip in to cover losses if any one goes under. To make that work, companies that use derivatives, either to hedge or speculate, post collateral, in case the bets go against them. End users hate this idea. It "will have a significant drain on working capital at a time when capital is highly constrained and credit is in short supply," David Dines, head of risk management at commodities giant Cargill, told a Senate committee in 2009.

Maybe so. But as Wallace Turbeville has pointed out, the collateral problem could be taken care of easily: the bank selling the derivative could simply extend a conventional loan at the same time they sell the derivative (which the customer would then post as collateral) instead of taking on the collateral risk themselves (which essentially rolls a loan and a derivative into a single package). What's more, customers would almost certainly get a better price than they do now with packaged products. The problem, Turbeville says, isn't so much that corporations couldn't get the loans as the fact that a conventional loan is carried on a corporation's balance sheet as debt, while the embedded loan in a packaged derivative isn't.

If Turbeville is correct, the current method of selling OTC derivatives is basically designed to take advantage of an accounting loophole: by packaging a loan together with a derivative, corporations get to pretend that they're carrying less debt than they really are. That's probably not something that federal rules should encourage, which means that maybe everyone should just get over their phobia of including end users in the new rules. The derivative market would get more stability and transparency, end users would get lower prices, and investors would get a better picture of corporations' true short-term debt exposure. And as Tim Fernholz points out, there's another bonus: if we just go ahead and include end users in the rules, we don't have to worry about writing complex exemption language that banks will almost certainly eventually figure a way to work around. What's not to like?

Down to the Wire on Financial Reform

| Sun Jun. 20, 2010 11:49 PM EDT

The New York Times reports on 11th-hour industry efforts to gut financial reform:

Industry lobbyists — and sympathetic members of Congress — are pushing for provisions to undercut a central pillar of the legislation, known as the Volcker Rule, which would forbid banks from using their own money to make risky wagers on the market and would force them to sell off hedge funds and private equity units.

....The three main changes under consideration would be a carve-out to exclude asset management and insurance companies outright, an exemption that would allow banks to continue to invest in hedge funds and private equity firms, and a long delay that would give banks up to seven years to enact the changes.

Italics mine. That certainly makes sense. I mean, an insurance company mucking around in highly leveraged investments certainly could never cause any problems, could it?

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Quote of the Day: We Agree, Dammit!

| Sun Jun. 20, 2010 12:42 PM EDT

From Tyler Cowen, discussing fiscal and monetary policy with Brad DeLong:

In my view of this exchange, Brad and I largely agree, but he does not (yet?) agree that we largely agree.

It would be lovely for Brad and Tyler to conduct a high-quality, meatspace discussion of this stuff that the rest of us could all watch on YouTube or something. Perhaps moderated by David Leonhardt. I'll volunteer my living room if that would help.

Do Politicians Need the Media Anymore?

| Sun Jun. 20, 2010 11:42 AM EDT

Steve Benen writes that the "traditional" press model, in which reporters interview candidates for office and then write stories about them, is withering away:

The traditional model is quickly being replaced, and for the first time, we're finding multiple statewide candidates — Kentucky's Rand Paul and Nevada's Sharron Angle, for the example — who simply ignore reporters' questions and blow off interview opportunities. The fear, of course, is that reporters might ask them to explain their extreme policy positions.

Eric Boehlert adds Sarah Palin to this mix. Are they right? Can politicians get away with not talking to the press these days? A few miscellaneous comments both pro and con:

  • At the presidential level, anyway, this trend has been ongoing for decades. It started with Nixon, took off under Reagan, and by the 1990s was in full swing. Presidents learned that they could get away with talking to the press less (or blowing them off with media-training-honed nonresponses) and talking directly to the public more, and they've been increasingly taking advantage of this ever since.
  • Rand Paul and Sharron Angle may be avoiding the press right now, but keep in mind that it's early days for both of them and it's not all that uncommon for candidates to lie low for a month or so after they've won a primary anyway. And Palin is a special case: at the moment she's not running for office. She isn't obligated to talk to anyone she doesn't want to.
  • A better example than either Paul or Angle (or Palin) is California's Meg Whitman. She's not an extremist and she's not just taking a break to regroup after a tough primary. In her case, she actually spent an entire primary largely declining to talk to the press. It was a pretty amazing performance. How did she get away with it? Easy. She just did it. And then spent $80 million of her Silicon Valley wealth to blanket the airwaves with attack ads.
  • Another aspect of this is that avoiding reporters is just a lot easier than it used to be. As Walter Shapiro pointed out a week ago, local news coverage of statewide candidates for office has shriveled almost to nothing in a lot of places thanks to newsroom cutbacks. During the final weeks of Senate campaigns in Kentucky, South Carolina, and earlier, Massachusetts, local reporters were almost invisible at campaign events.

If I had to guess, I'd say that Paul and Angle are unusual cases and probably don't signify any kind of sharp turn. (And Palin is sui generis.) Still, as local reporting continues to decline and candidates realize they can get away with talking to potentially hostile reporters less, they probably will. I wouldn't be surprised to see a slow but steady rise in bubble candidates like Meg Whitman, especially if they have reliable funding sources that don't rely on broad media exposure.

Government Debt and Financial Markets

| Sat Jun. 19, 2010 5:59 PM EDT

Edmund Andrews isn't impressed by Alan Greenspan's remarkably strained efforts to find a reason, any reason, that government spending needs to come down now now now. However, he also isn't impressed by Paul Krugman's counter-insistence that German leaders are nuts to be worried about a (so far) nonexistent market reaction to increasing debt levels:

But the German fiscal hawks aren't crazy. The markets can panic, without much warning in advance, just as they did about Greece and to some extent the euro-zone itself. No one knows where the tipping point between acceptance stops and panic kicks in. But there's also no dispute that deficit and debt levels are in uncharted territory in the U.S. and in Europe. Nobody knows whether they will get back to sustainable levels or how long it will take them. Nobody knows what the bond markets' tolerance will be like, or how all the moving parts will interact with each other.

....We need insurance. We need to plan for the possibility of getting our next move wrong. I agree with Calculated Risk that Greenspan is flat wrong about the need to slam the brakes on spending right now. But we need to recognize that there's a non-trival risk of a bond-market rebellion.

For the record, I pretty much agree with Andrews's ultimate judgment: "If I were king, the plan would allow for another round of stimulus spending but call for real belt-tightening around 2015." And he's right when he says that sometimes markets can go nuts very suddenly and without warning.

Still, anyone taking the position that this is a genuine risk for the U.S. needs to answer a question: where are panicked markets going to go? If investors suddenly decide that Germany and the United States are poor risks, what's their alternative? Developing countries? Not if you're worred about risk. China? Not a convertible currency. Japan? Interest rates are close to zero. Switzerland? Too small. Etc. It's one thing for rates to gap out against a country like Greece as investors flee to quality, but they won't gap out against the United States unless there's someplace better for money to go. And there really isn't unless our fiscal position deteriorates substantially and everyone else's fiscal position improves. On a global basis, what matters isn't a country's absolute fiscal position, it's a country's fiscal position compared to everyone else.

So a sudden panic directed at the United States or Germany is pretty unlikely in the short to medium term, and that means, for now, that we have a fair amount of leeway for fiscal stimulus if we're smart enough to take advantage of it. As Brad DeLong says, "The obvious policy is the long-term debt neutral stimulus: spending increases and tax cuts for the next three years, standby tax increases with triggers and spending caps with triggers thereafter, all calculated to guarantee that the debt is no larger ten years from now than in the baseline."

The Credit and Debit Card Industry, Take 2

| Sat Jun. 19, 2010 12:31 PM EDT

After reading my post on Thursday about the depredations of the credit and debit card industry, Matt Yglesias objects to my plan to "micro-manage" their business:

Regulate business to prevent negative environmental externalities, sure. Basic safety, okay. But the idea that what we need is for a bunch of people to get together and say that it would be better to ban this and that and the other capitalist act between consenting adults just strikes me as the wrong way of going about things. Purely economic regulation of this sort doesn’t have a compelling track record, runs into all kinds of Hayek-esque knowledge problems, and is basically an open invitation down the road for regulatory capture and the use of rules to prevent the emergence of competition. Count me out.

This is a very good point, and it's one that normally I'd find persuasive. So much so, in fact, that I originally planned to address it in my initial post. But that post ended up running too long as it was, so I decided to leave it for another time. Which this is. So let me take a crack at persuading Matt and other doubters that although there are indeed some important issues here related to consenting adults, competition, and Hayek-esque knowledge, they mostly point in a non-intuitive direction. There's a lot less micromanagement here than meets the eye.

Here's the thing: in my initial post I actually proposed only two pieces of government action: one to regulate interchange fees (the 1-2% fees that merchants are required to pay card issuers on every debit or credit transaction) and another to regulate overdraft fees. Let's take a look at those

First, interchange fees. The problem here is twofold: (a) the fees themselves are non-transparent to consumers and (b) they're administered by an effective monopoly. There are lots of banks and credit unions that issue credit and debit cards, but two companies — Visa and MasterCard — control the vast bulk of the payment network and set the interchange fees. Even the most ardent free marketers usually concede that a combination of monopoly power and opaque pricing is a problem, and that's what we have here.

So let's try a thought experiment. What if credit and debit cards lived in a real free market with transparent pricing? Suppose that instead of just two payment networks there were a dozen. And suppose that instead of hiding interchange fees by extracting them from merchants, who pass them along to consumers invisibly, the card companies actually charged consumers directly. What would happen?

Answer: banks and payment networks would compete for customers' business, and they'd largely do this by trying to offer the most efficient, lowest-cost service. After all, if consumers actually saw the interchange fee tacked onto their bill each month, they'd gravitate toward banks and payment networks with the lowest fees. Those fees would very quickly converge on an amount just slightly over the actual cost of running the network, and given what we know about that from the early days of debit card networks before Visa and MasterCard took over (you can read the astonishing story here), that means fees would be about a quarter of what they are now.

Now, would some card issuers try to compete on other factors? Maybe. American Express charges an annual fee and lots of customers consider it a good value anyway. So maybe some banks and one or two of the payment networks would charge a higher interchange fee and then offer rewards cards to customers to make it worth their while. This sounds like a pretty improbable business model to me — would you knowingly pay a higher monthly fee in order to get a fraction of it back in rewards? — but you never know. And if it works, I'm fine with it. That's the free market at work. A real free market with competition and transparent price signals.

Unfortunately, as economists since Adam Smith have pointed out, most of our rock-jawed titans of industry don't really like free markets. They much prefer cozy cartels and opaque pricing, which are far more profitable. So although I'd be fine with regulations that forced a genuine free market onto the card industry, I'm not sure it's feasible. As a next-best alternative, then, I favor federal regulations that push down interchange fees to something within shouting distance of what they'd be in a free market.

Second, overdraft fees. The problem here is simpler: overdraft protection is, by any common sense definition, a short-term loan. And it should be regulated as a short-term loan. Unfortunately, back in 2004 the banking industry strong-armed the Greenspan-era Fed into declaring that up is down and black is white. The Fed conceded, in its final report on the matter, that banks promote overdraft protection "in a manner that leads consumers to believe that it is a line of credit." And the Fed politely encouraged them to be a little more honest about this. But that was it. Officially, overdraft charges still weren't loan payments, they were fees, and banks could charge whatever they wanted.

There are a couple of problems here. The first is that regardless of the Fed's Alice-in-Wonderland opinion, overdrafts really are loans and ought to be regulated as loans. This is, obviously, an intrusion on a pure free market, but it's not much of one: regulating consumer loans is a long-accepted role for the federal government, and regulating overdraft fees fits right into this role. All we need are rules for overdraft fees that are roughly the same as for any other consumer loans. That includes limits on interest rates, transparency about what's being charged, and restrictions on the fees and charges that surround the origination of the loan.

Beyond that, though, there's also a pure free market distortion in the way overdraft protection works today. In a proper free market, consumers have a choice. If they don't want your good or your service, they can choose not to buy it. But until recently, that wasn't the case: consumers weren't notified that they were about to overdraw their account. They weren't given the option of choosing to accept or decline the purchase anyway. Hell, they weren't even given the option of not having overdraft protection in the first place. On the contrary, overdraft protection was deliberately set up to rope low-income consumers into paying wildly abusive fees for small mistakes. What kind of free market is that?

So that's my case. In the case of interchange fees, the free market has been so badly distorted that it simply doesn't work in any recognizable way. There are two options to fix this: either force transparency and competition on the industry or else regulate fees down to levels that aren't too flagrantly abusive. I suspect that the latter is, at this point, the only feasible option. [Update: And the latter is, at least partly, going to get done. Three cheers for Sen. Dick Durbin.]

In the case of overdraft fees, simply regulate them as short-term loans with a maximum interest rate of, say, 100%. It's an intrusion on the free market, but it's a small and long-accepted one. As a rich member of a rich society, I have a hard time accepting that we aren't willing to impose this kind of modest regulation in order to rein in a genuinely contemptible practice that's cynically set up to prey on the weakest, poorest, and most unsophisticated consumers as a way of subsidizing finance for the best off among us.

And one final thing. You can, as some pious conservatives say, avoid both interchange fees and overdraft fees simply by not using credit or debit cards. If you don't like the way the industry works, exercise your right in a free market not to participate. And 20 years ago that was a perfectly good option. But in practical terms, it just isn't anymore: it's close to impossible to live an ordinary working class or middle class lifestyle without credit and debit cards, and it's only going to get even more impossible as time goes on. For better or worse, credit and debit cards are now required parts of our existence, and that means consumers need to have real choices and real competition within the e-payment network we all live in. And that's what I want: choice and transparency, with modest regulation to prevent abuse of the most vulnerable among us. Fifty years ago that wouldn't have been controversial. It still shouldn't be.

POSTSCRIPT: Just to address a couple of likely questions before they come up:

First: So how will banks make money on credit and debit cards? Answer: interchange fees would still offset the cost of actually running the payment network. Beyond that they'll charge annual fees and make money on interest from outstanding balances. You say you don't like annual fees? Well, you're already paying one, and it's a lot bigger than you think. The only difference between interchange fees and an old-fashioned annual fee and is that an annual fee is usually smaller and is always transparent.

Second: what does this have to with financial reform? Answer: nothing much. These fees weren't directly responsible for the credit bubble or the collapse of 2008, and fixing them won't do much to prevent future disasters. It's just the right thing to do for other reasons.

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