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Credit Slips (5)

• Interchange and the Price of Gas

  Posted: July 1st, 2008, 9:22pm PDT by Adam Levitin

  With all the attention being paid to the soaring cost of gasoline, there's one price component that could easily be lowered that hasn't gotten a lot of attention: interchange. Americans pay about 10 cents/gallon or $2/tank (20 gallon) in interchange fees. Compare this with the estimated benefit of drilling in ANWAR--3.5 cents per gallon by 2027. Tremendous political energy that has been spent over drilling in ANWAR. If we're really interested in reducing gasoline prices, then reforming the interchange fee system presents an option of immediate savings that would far outstrip ANWAR. Of course, the maximum savings would be less than from a federal gas tax (18.4 cents/gallon), but a gas tax holiday isn't permanent. (I'm putting aside the question of whether we should want pricing that encourages fossil fuel consumption.)

  Fortunately, the good folks at Visa are looking out for the American consumer. And out of concern for American drivers, Visa has adjusted its interchange rate schedule. Unfortunately, there's more than meets the eye to Visa's apparent benevolence and desire to "Help Ease Pain at the Pump." The devil, of course, like so many things in the card industry, is in the details.

  When you go to the gas station and you use a Visa card, the gas station will pay its acquirer bank a merchant discount fee that consists of the interchange fee plus some thin profit margin for the acquirer. For simplicity's sake, let's just say that the merchant pays interchange and ignore the acquirer's margin.

  So currently, if you fill up your tank and pay at either a service station or an automatic fuel dispenser with a Visa card, the interchange fee will be is a five or ten cent flat fee plus between 1.43% and 2.10% of the purchase price (depending on rewards level). So on a $50 tank of gas, you're paying your credit card issuer that's between $.80 and $1.15. I'm going to use the $1.15 for illustrative purposes.

  Let's say you can buy 12 gallons of gas for $50, so gas is $4.17/gallon (close to the national average). If you weren't paying the interchange fee, you'd be getting 12 gallons for $48.85. That means gas would be $4.07/gallon. In other words, you're paying 10 cents a gallon to your credit card issuer. And that's before any interest or late fees, etc. For smaller purchases, the credit card tax on gasoline gets higher because of the flat fee. And if the price of gas/gallon is higher, then interchange represents an even greater cost per gallon.

  [For debit, Visa's interchange fee is .70% plus 17 cent flat fee, but debit card transactions at service stations often result in debit card holds--much large notional charges--that can limit the cardholder's available funds for a few days. I'm going to leave the debit card hold issue aside for now.]

  So what has Visa done in response to the "Pain at the Pump"?

  Visa instituted a new interchange fee for all gas stations of 1.5% 1.15% of transaction price plus 25 cents, regardless of the level of rewards on the card. Because of the increased flat fee, consumers making high dollar amount transactions will pay less, but consumers with small transactions will pay more. Where is the dividing line? It depends on whether you were using an exclusive Visa Signature Preferred Card (2.10% + 10 cents) or a mass market rewards card like Visa Signature or Traditional Rewards (both 1.65% + 10 cents) or a non-rewards card (1.50% + 5 cents). If you are wealthy enough to land a Visa Signature Preferred Card, this means the cost of interchange to the gas station (and thus ultimately to you) will be less on transactions over $15.79. If you have a regular rewards card, then the savings kick in at $30. And if you don't have a rewards card at all, then the new rates are actually more expensive for the station for all transactions under $57. [Correction 7.2.08]

  Does this new structure actually represent a lowering of interchange costs for gas stations? It depends on the card mix and the purchase prices. If everyone in town drives a Hummer and has a Visa Signature Preferred Card (Greenwich?), then this is a great program. But if most people have plain vanilla cards and aren't letting their tanks get bone dry, then that $57 threshold is pretty high; I rarely exceed $57 for a single gas purchase with my thirsty minivan. That'd mean that gas stations would be paying even more in interchange and the price to consumers would go up even more.

  Surely Visa looked at card usage data and concluded that it would actually be more profitable to lower percentage fees while increasing the flat fee. Visa is a for-profit company, after all, and there's no tax write-off to helping consumers. So it is easy to see a scenario in which Visa gets the PR boost for trying to help consumers, while actually sticking it to them.

  Curiously, the Visa move also undercuts Visa's litigation and lobbying position, that interchange is just an interbank fee. By announcing its "lowering" of interchange rates as a move to help consumers, Visa implicitly acknowledged that interchange contributes to consumer costs. (The best empirical evidence that interchange is passed on to consumers also comes from the gas station industry.) Interchange is not just a Main Street vs. Wall Street issue. It is also a consumer issue.

  All of this points at the need to think about ways of reforming the interchange system. One possibility is that it will be done through the courts. Another possibility is that it will be done legislatively. Interchange week will continue with a post about the Credit Card Fair Fee Act.

• Interchange Week on the Slips

  Posted: July 1st, 2008, 8:01pm PDT by Adam Levitin

  Let's call this interchange week. With efforts to bring the Credit Card Fair Fee Act to vote in Congress picking up steam, I'm going to do a few postings on different aspects of the interchange debate this week. Coinciding with this, the printer proof of my recent article on the economics and origins of interchange is available on SSRN (spoiler: interchange and merchant restraints are less about network effects than about evading TILA, usury laws, and branch banking restrictions).

  So as a primer for the rest of my posts, who's up for some good ol' fashion credit card network economics?

  Here's the deal. You purchase $100.00 of goods at a merchant on a credit card. The merchant receives $100 minus the "merchant discount fee," of say $3.00 which is taken out by the merchant's bank (the "acquirer bank"). The acquirer bank keeps perhaps $.40 and remits $.10 to the credit card network (MC or Visa--Amex and Discover are a little different so I'll leave them out of this) as an authorization, clearing, and settlement fee, and $2.50 to your card issuer (the "issuer bank"), which is the interchange fee. The interchange fee is thus technically a fee paid by the acquirer to the issuer, not by the merchant or the consumer. But leaving this formalism aside, it is a fee on merchants and consumers. The interchange fee sets a floor for the merchant discount fee (often it is explicitly priced to merchants as "interchange plus"), and merchants pass along at least part of the interchange fee to consumers.

  The interchange fee is set by the card network. Fees are typically a flat fee of a 5-15 cents and a percentage fee of 1-3 percent. The precise fee depends on (1) the merchant's industry, (2) the size of the merchant, and (3) the level of rewards on the consumer's credit card (more rewards-->higher interchange fees). In other words, the interchange fee, which is technically not a fee paid by merchants, but an interbank fee, as the card networks emphasize in their literature, is set based on merchant and consumer characteristics. How often does an interbank fee depend on the characteristics of third parties?

  Credit card network rules restrict merchants' ability to pass on interchange fees to cardholders. (For shorthand, let's call these rules "merchant restraints".) Merchants are required to accept all (credit or debit) cards bearing a card association's label, to take them at all of their locations (web, brick and mortar), to treat all cards the same, and are forbidden from surcharging for credit. Federal law gives merchants the right to offer cash discounts, but merchants are forbidden from doing the mathematical equivalent of surcharging for credit. Of course, the right to discount for cash largely misses the point--such a right would be valuable if merchants didn't want to take credit cards. Merchants generally do want to accept credit cards (and in certain businesses, like Internet retailers, they must). What merchants don't like is having to accept high cost rewards cards on which they see no benefit. And merchants also don't like that interchange rates have been marching steadily upwards without any increase in benefits of card acceptance (and arguably an increase in liability because of PCI data security standard rules).

  So that set's the stage for my next post--interchange and the price of gas.

• Credit Check

  Posted: July 1st, 2008, 2:11pm PDT by Elizabeth Warren

  Late yesterday I recorded an interview with Terry Gross on Fresh Air.  She is one of my favorite interviewers (smart, and what a voice!).  She had called me to ask about credit reporting agencies. What made the interview stand out was her introduction. She told a story about her husband's trip through Credit Reporting Hell. 

  Her husband's experience is no real surprise.  After all, a 2004 PIRG study found that 87% of credit reports had errors, and one in four had an error big enough to change a credit score. Consumer Federation of America reported  that 31% of credit reports had an error that would change a credit score by 50 points or more.  If a serious error hasn't happened to you, then it has happened to someone you know. Because Terry Gross's husband could hire a lawyer, the problem was eventually fixed, but not until he had spent a lot of time and a lot of worry. 

  Starting the interview with a personal story about the impact of an error raised an important question:  Why should consumers be saddled with the responsibility to monitor the errors of credit reporting agencies? It is MY information about ME.  Someone else is collecting it, creating errors, and passing those errors along to other people. Those errors can cost me a job, denial of homeowners' insurance, a higher premium on my car loan, a higher price to buy a car even for cash, and, of course, a higher price for a mortgage, a credit card, a car loan, or any other loan. And the system says, in effect, it is my problem to monitor the information. It isn't enough that I don't impair my own credit. It is also my problem to find errors that the company has put in, to document the correct those errors, to fight with the company if they won't believe me, to check to make sure the errors were removed and to make sure those errors never reappear. I can even pay for insurance to help me if a credit reporting company makes a mistake.   

  Since I already have a full-time job and a life outside that job, I resent this capture of my time. I also believe that a law that puts the burden on consumers to correct errors and puts no penalty on the credit reporting companies for passing along bad information is designed to encourage a high error rate.  There are simply not enough incentives for the credit issuers to spend their money to reduce errors in the credit reporting system or to make correction cheap and quick. 

  In some states, it is possible to lock a credit report to stop all activity.  That helps prevent future errors, but it still puts the burden on the customer.   

  A lot of people end up paying for bad credit reports. Many never know it because they don't know that the price quoted for insurance or a car was based on their credit score. They will just be poorer than they would have been if the credit reporting companies had more incentive to get it right.

• Will BoA Claim Preemption?

  Posted: July 1st, 2008, 9:40am PDT by Bob Lawless

  Today (July 1) is supposed to be the closing date for the Bank of America/Countrywide merger. In recent weeks, the states of Illinois, New York, and Florida have sued Countrywide for various wrongs committed to the citizens of their states. People are lining up to sue Countrywide. As the deal has been going through the approval processes, numerous commentators have wondered about why Bank of America is willing to expose itself to such liability.

  Once the merger goes through, I wonder whether Bank of America is going to claim these lawsuits are preempted by the regulations of the Office of the Comptroller of the Currency (OCC). This obscure federal agency has regulatory authority over national banks and has issued regulations exempting national banks like Bank of America from state laws and regulations governing lending. To legal types, this concept is known as "preemption," and the OCC regulations were upheld by the United States Supreme Court as we discussed here and here.

  Countrywide did some but not all of its lending through a bank, called Countrywide Bank, that was a national bank and then converted to a federal savings bank (FSB). FSBs are regulated by the Office of Thrift Supervision, which does not have broad preemptive regulations like the OCC.  Thus, the protection that the preemption doctrine would provide Countrywide is full of holes. BoA would have a stronger hand with the OCC, a regulatory agency that has a lender-friendly track record.

  Yes, the lawsuits all allege abusive lending practices by Countrywide that predate Bank of America's acquisition, but BoA might point out that the purpose of the OCC preemptive regulation is to prevent national banks from being subject to diverse state regulators. It does not matter, BoA might say, when the violations occurred. Under this reasoning, the OCC is the only regulator that can touch the BoA empire which would now include Countrywide. Any state lawsuits would have to be dismissed. (For the bankruptcy mavens out there who might be wondering about the power of the U.S. Trustee versus the OCC, think about which agency might win a fight over the primary jurisdiction doctrine.)

  Is this scenario farfetched? The timing of the state lawsuits, just before the deal closed, suggests to me that perhaps the state attorneys general were similarly concerned about a preemption claim.

• Debt Stress and Other Credit Card Gems

  Posted: July 1st, 2008, 9:11am PDT by Bob Lawless

  On June 9, the Associated Press and AOL released a poll describing an increase in self-reported stress by Americans struggling with debt. According to a Debt Stress Index that compiled the poll results, 43% of respondents scored in the moderate to high range as compared to 32% from a comparable survey at the end of 2004. Blog posts and news stories summarizing the results can be found in many places including here (WebMD), here (AOL), and here (MSNBC, a good summary).

  The link between high consumer debt and physical problems has been well known, albeit not as well publicized as it should be. For example, this most recent poll finds 44% of persons reporting high debt stress also reported migraines or other headaches as compared to 15% of the other respondents. Also, persons reporting high debt stress reported heart attacks at double the rate of persons reporting low debt stress.

  Beyond these very important health issues, Credit Slips readers will want to take a look at the answers to the general financial questions in the survey. These questions focus principally on credit card usage and payment patterns. Despite a reported increase in the levels of debt-induced stress since 2004, there are smaller differences in how persons are reporting they are using their credit cards. In 2008, 63% of respondents reporting using a credit card in the past month as compared to 57% in 2004. (That figure seems very low--can it possibly be right?) As far as carrying a monthly balance, 37% report doing so as compared to 34% in 2004. The biggest change seems to be in the amount of persons carrying high amounts credit card debt with 32% now reporting carrying a balance of $3,000 or more as compared to 25% in 2004. Even accounting for inflation, that represents a real increase.

  How to reconcile the higher levels of debt-induced stress with only small changes in payment patterns? I think there probably are two factors. First, we would expect the persons with high credit card balances to be most likely to report increased levels of stress, and we do see a substantial increase in persons reporting carrying high card balances. Second, the AP/AOL survey ask about debt-induced stress generally but mainly focused on credit-card debt in its questions about payment patterns and debt levels. The mortgage foreclosure crisis undoubtedly has contributed substantially to the increase in debt stress levels.

  Like Elizabeth Warren's recent post on how foreclosure is affecting families, the AP/AOL survey is another reminder to the credit regulatory community that consumer credit issues go beyond our nation's economic health and affect many parts of our lives.