Interch-ch-ch-changes

[Timothy B. Lee]

Mike Konczal has a sharp response to my post on interchange fees. He's been following this issue more closely than me, so there's a lot of good information there. But one part of his argument that doesn't seem quite right is this:

Is there inequality within the credit market for those who have access to it? From Adam Levitin's Priceless? The Social Costs of Credit Card Merchant Restraints (19), which gives a history of the "merchant restraints" on distinguishing between debit and credit, we know that: "Visa Signature cards, which carry a high level of rewards and are marketed specifically to affluent consumers, comprise only 3.5% of all Visa cards but have accounted in recent quarters for 22.2% of all Visa purchases." That's a high volume of purchases with high rewards going to just a few people. Many people have rewards cards, but the very best ones are reserved for the high end, and those at the high end spend more than those not at the high-end. And everybody pays the same price.

We also know that around 45% of interchange goes to fund rewards. These high interchange rates drive up prices. Tim's 1% back requires a merchant to pay an estimated 2.22% interchange for that feature alone. People who get less back, or who use debit, or who pay with cash, are paying higher prices to transfer money to Tim.

I'm not sure I follow Mike's math here. The fact that 44 percent of interchange fees get passed through as rewards doesn't mean that a dollar of rewards "requires" a fee of $2.22. Offering a credit card at all costs money; you have to do things like printing statements, processing checks, staffing help lines, and the like. For less affluent customers, the revenue from interchange fees may barely cover these fixed costs, leaving little revenue for benefits. For more affluent customers, in contrast, the fixed costs will be a small fraction of interchange fee revenues, and so the company can afford generous benefits. This isn't a transfer of wealth from poor to rich, it's just a reflection of the fact that wealthier customers are more lucrative.

If regulatory measures push down interchange fees, it will likely mean that affluent customers get less generous benefits. But it may also mean that the least affluent credit card holders have to start paying annual fees again (or won't get cards at all) because interchange revenues no longer cover the cost of providing the card. This isn't an outcome we should cheer if we're concerned about those at the margins of the banking system.