Behavioral economics has taken the academy by storm over the past two decades. The Obama administration has even looked to the discipline—which posits that psychological biases frequently lead consumers to make bad economic decisions—to shape government policy. But is behavioral economics relevant to interpreting the Constitution? That’s the novel claim raised by Expressions Hair Design v. Schneiderman, which the Supreme Court will hear Tuesday.

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The Obama administration has promised that the Federal Reserve’s new Consumer Financial Protection Bureau will be independent from politics, a model of regulatory expertise grounded in sound data and economics. Naming Harvard Law Prof. Elizabeth Warren as de facto agency head undermines both goals.

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Late in the Senate’s proceedings on the financial regulatory reform bill, the Senate adopted – with no hearings and minimal debate – a controversial provision proposed by Sen. Richard Durbin, Illinois Democrat, that imposes price controls on interchange fees for debit and prepaid cards. The amendment also allows merchants to override several rules of payment card networks that currently protect consumers from abusive practices by merchants. While big-box merchants and convenience stores are declaring this a victory against the financial services industry, if the amendment survives in conference committee, consumers and small banks will be the real losers.

Summary

Fresh off of the most substantial national liquidity crisis of the last generation and the enactment of sweeping credit card regulation in the form of the Credit CARD Act, Congress continues to deliberate, with a continuing drumbeat of support from lobbyists, a set of new regulations for credit card companies. These proposals, offered in the name of consumer protection, seek to constrain the setting of “interchange fees”— transaction charges integral to payment card systems—through a range of proposed political interventions. This article identifies both the theoretical and actual failings of such regulation. Payment cards are a secure, inexpensive, welfare-increasing payment mechanism largely unlike any other in history. Rather than increasing consumer welfare in any meaningful sense, interchange fee legislation represents an attempt by some merchants to shift costs away from their businesses and onto card issuing banks and cardholders. In particular, bank-issued credit cards offer a dramatic improvement in the efficiency and availability of consumer credit by shifting credit risk from merchants onto banks in exchange for the cost of the interchange fee—currently averaging less than 2% of purchase value. Merchants’ efforts to cabin these fees would harm not only consumers but also the merchants themselves as commerce would depend more heavily on less-efficient paperbased payment systems. The consequence of interchange fee legislation, as Australia’s experiment with such regulation demonstrates, would be reduced access to credit, higher interest rates for consumers, and the return of the much-loathed annual fee for credit cards. Interchange fee regulation threatens to constrain credit for consumers and small businesses as the American economy begins to convalesce from a serious “credit crunch,” and should be accordingly rejected.

Fresh off of its enactment this summer of new regulations on consumer credit card terms, some in Congress want to go further—to impose a national usury ceiling on credit card interest rates and limits on interchange fees (the price that credit card issuers charge to merchants that accept their cards). That caps on interest rates harm consumers is well understood. But price controls on interchange fees would also result in consumers paying more and getting less.

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In my first post I argued that consumers as a group would likely be made worse off as a result of artificially imposed reductions in interchange fees.  This post considers a second line of attack—that even if consumers overall would be made no better off (or even worse off) as a result of regulating interchange fees, Congress should intervene in the name of “fairness” to regulate interchange fees.  This “fairness” argument, however, is a red herring, especially when advanced by merchants purporting to speak for consumers.  Indeed, the sincerity of the merchants’ concern is belied by their own behavior.

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Although the mechanisms vary, legislation pending before Congress on interchange has a basic central purpose—to reduce interchange fees, either indirectly or directly.  If adopted, these efforts will likely succeed in their intended goal of reducing interchange fees.  But they will also likely have substantial unintended consequences that will prove harmful to consumers and competition and will roll-back the innovation in the credit card market over the past two decades.

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