Crying wolf over credit card fees

AS WE gird for the holiday shopping season, the convenience provided by credit cards is one of the last things on our minds. Credit cards work so well that consumers largely take them for granted, but merchants are increasingly angry about paying the fees associated with credit card transactions.

Because the retail sector is intensely competitive, it's not surprising that merchants are seeking to cut costs at every possible turn. To the extent that they do so through international trade, informational technology, and other efficiency-boosting measures, everyone benefits. When they resort to frivolous litigation and pleas for unnecessary regulation, however, consumers are made worse off. This is precisely what's happening with credit card fees, which have been widely demonized by merchants recently.

Merchants are chafing about paying so-called interchange fees, which are fees used by MasterCard and Visa in their four-party payment systems. When you use a Visa (MasterCard works the same way) to make a purchase, the merchant submits the transaction to an acquiring bank, which in turn submits it to Visa. Visa sends the transaction to the bank that issued the card, which subtracts its interchange fee and pays Visa. Visa pays the acquiring bank, which pays the merchant. Cardholders are later billed by their issuing banks.

In three-party systems, like American Express and Discover, there are no interchange fees because the acquirer and issuer are one and the same. The discount fees they charge, however, are consistently higher than the total fees, including interchange, in the four-party systems. The verdict of the market, given the success of Visa and MasterCard, seems to be that it's more efficient for the acquiring and issuing sides to be separate.

Tucked away in one of the bills passed in the aftermath of Katrina was a provision directing the Federal Trade Commission to investigate interchange fees. At the same time, several recent lawsuits have challenged these same fees on antitrust grounds. In several countries, including Australia and Britain, merchants have succeeded in having these fees regulated, to the detriment of consumers.

In Australia, where regulators slashed interchange fees well below their market level, the result has been a dramatic decline in cardholder benefits -- reward programs and the like -- and an increase in annual fees. This has driven a double-digit increase in the use of more expensive charge cards from companies like American Express and Diners Club. As a result, merchants are paying more on many transactions, and there is a push for regulation of the three-party payment systems.

In a free economy, prices are determined by the interaction of buyers and sellers. The claims that Visa and MasterCard are monopolistic are laughable given the broad array of payment options available to merchants and consumers. Along with cash and checks, merchants can now accept a bewildering array of credit cards, debit cards, and charge cards. Moreover, within the credit card segment there is robust competition between Visa, MasterCard, American Express, Discover, and small players. The fee structures of Visa and MasterCard are plainly designed to maximize the use of these cards, not to extract monopoly prices.

The trial lawyers are locked in on Visa and MasterCard because they see dollar signs. The merchants who are buying into these suits are, in their understandable desire to cut costs and maximize profits, being shortsighted. Crippling Visa and MasterCard through regulation or litigation would decrease consumer choice and buying power and ultimately hurt the merchants who are calling for it. The trial lawyers may be their friends on this fight, but seeking legal and regulatory intervention for market advantage is a precedent that large merchants will likely regret in the future.

No merchant is forced to accept Visa or MasterCard. Their near-ubiquity is not the result of any market abuse, but rather follows from the terrific value proposition they offer both consumers and merchants. The merchants know that accepting credit cards allows them to retain customers and make far more sales than they could otherwise make, and they are willing to pay transaction fees, including interchange, for those benefits.

That's how a free market works -- willing buyer meets willing seller. There is no coercion here, and Congress should make that clear by terminating the FTC investigation and barring the frivolous lawsuits against Visa and MasterCard.

Phil Kerpen is policy director for the Free Enterprise Fund.