Those Wall Street boys are loads of fun. Their irresponsible lending practices fueled the housing bubble, the collapse of which has given us the worst economic disaster in 70 years. The collapse also would have sunk the banks themselves, had they not used their political power to hustle enough taxpayer dollars to see them through the bad times.
As soon as they got back on their feet they shifted their focus from securing bailout bucks to stifling financial reform. They sent an army of lobbyists to Congress to remove or weaken any measures that could limit their profits. This army was largely successful. For example, the Brown-Kaufman amendment, which would have broken up too-big-to-fail banks that rely on implicit guarantees of taxpayer bailouts, was laughed out off town.
Nonetheless, there were some aspects of the final bill that will curtail abuses and reduce bank profits. One of these provisions was a restriction on debit card fees.
The banks currently make huge profits on debit cards. The profit comes through two routes. First, it is common for the banks to charge fees that can be as high as 2.0 percent on debit card transactions. These fees are far above the actual cost of a transaction, which is typically in the range of 0.1 percent.
Retailers pay these fees because few stores want to risk the loss of business that would result from not accepting Visa or MasterCard, the two dominant issuers of credit and debit cards. They pass these fees on in the price of their products, effectively making their cash customers subsidize the use of credit and debit cards.
The other channel through which banks make excessive profits on debit cards is with overdraft charges. They typically charge overdraft fees that can be several times as large as a transaction. If customers are in the habit of using a debit card for purchases, and don't realize that they are overdrawn, they can run up fees of $30 or $40 by buying a few cups of coffee or similarly small purchases.
The financial reform bill will limit the banks' ability to profit through these channels. It authorizes the Federal Reserve Board to limit debit card fees to a reasonable mark-up above their costs and it requires banks to notify customers of overdraft fees when they are making a purchase. Now customers can decide if they want to pay a $12 overdraft fee to buy a $2 cup of coffee.
This would seem to be a victory for consumers over the banks, but J.P. Morgan CEO Jamie Dimon was quick to say that it ain't so, telling us that the banks will just raise their fees for other services:
ìIf you're a restaurant and you can't charge for the soda, you're going to charge more for the burger. ... Over time, it will all be repriced into the business.î
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Actually, this is not typically true. If a particular restaurant charged high prices for its drinks in order to subsidize its burgers, then we would expect many customers to just buy the burgers and order water. The restaurant would only be able to get away with its burger subsidy strategy if it either did not offer the customer the choice of just getting the burger or if it had substantial monopoly pricing power.
Given the dominance of Visa and MasterCard in the credit and debit card industry, it is not surprising that they have monopoly pricing power. Still, it is nice to hear Mr. Dimon confirm this fact for any remaining doubters. This means that they should have been subject to antitrust action in the absence of the restrictions in the new law.
The ending of excessive fees for banks that are exploiting this monopoly power will mean some changes in the way they do business, but these are changes that are long overdue. It does not make sense to have people who are overdrawn in their accounts -- typically people with lower incomes -- subsidize the free checking of others.
If it is not profitable for the banks to offer free checking without being able to gouge people who make overdrafts, then they should charge for their checking. It is not good policy to have lower income people subsidize those who are better off. It was very nice of Jamie Dimon to acknowledge that this had been J.P. Morgan's policy.
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