The Customer


The Fed enters the skirmish over debit card fees.

The Federal Reserve’s proposed regulation governing transaction fees for debit cards is best understood as the latest skirmish between bankers, merchants, and consumers over the future of money.

In the beginning—well, maybe not the very beginning, but, say, prior to 1950—there were two ways to buy most items. You could pay cash, or you could write a check. After 1950 you could pay with a charge card like Diners Club, Carte Blanche, or American Express. These were all cards where you could run up a tab, but only for one month. Then, in 1958, there appeared, like the tree of knowledge in the Garden of Eden, the credit card. With BankAmericard (later Visa) and MasterCard, you could run up a tab for as long as you liked, up to some dollar limit established by the issuer. Monthly payments were required but they didn’t have to cover what you owed; indeed, the bank preferred that you didn’t cover what you owed, because then it could charge you interest on that. It’s probably fair to say that from the dawn of man until Sept. 1969, when Chemical Bank put up America’s first automatic teller machine in Rockville Center, N.Y., every step in the evolution of money encouraged people to spend more and more.

In some ways, the advent of ATMs encouraged people to spend more and more, too, since now it was possible to put your hands on your cash at any time of day or night. And certainly people continued to use credit cards to spend like drunken sailors. But to access your bank account at an ATM you needed a debit card, a little piece of plastic that looked like a credit card but lacked its awesome capacity for destruction. A credit card let you buy stuff with money you didn’t have, but to use a debit card you had to have the cash in your bank account. Credit cards were Scott and Zelda Fitzgerald splashing in the Plaza Hotel fountain. Debit cards were the Rev. Jonathan Edwards declaiming that we’re all sinners in the hands of an angry God. And they could be used not just to get money out of a cash machine, but also to buy stuff in stores. A debit card became the equivalent of a little plastic checkbook, one that tucked neatly into your wallet and cost your bank much, much less to process than a paper check.

Debit cards did not catch on in the U.S. as quickly as they did in other industrialized nations. In a 1998 law review article, David Balto (then a staff aide at the Federal Trade Commission, now a senior fellow at the Center for American Progress) suggested this was partly because U.S. banks didn’t want to “cannibalize their lucrative credit card programs.” Visa and Master Card finessed the problem by promoting use of a different kind of debit card that had some characteristics of credit cards: the “offline” debit card.

An “offline” debit card didn’t suck money directly out of your bank account; it waited a few days, then sucked the money out. You couldn’t use an offline debit card at an ATM; an offline card was good only for buying stuff. Transactions with offline debit cards used the same flimsy method of verification as credit cards (a signature rather than the PIN number used for ATM cards). This made offline debit cards comparably susceptible to fraud. But it also enabled offline debit cards to travel through the same high-speed point-of-sale connections that by the mid-1990s were becoming widely available in stores for credit card purchases. Retail point-of-sale connections for ATM cards were much harder to find. Even today, only about one-quarter of the point-of-sale terminals that take debit cards will take the ATM kind. Banks preferred offline debit cards to ATM debit cards because their similarity to credit cards facilitated the introduction of swipe fees comparable to those for credit cards. Initially ATM cards incurred no swipe fees at all; as of not quite one year ago the New York Times estimated ATM swipe fees (23 cents on average) were about half those for offline debit cards (56 cents). The beauty of these swipe fees was that the purchaser never had to know they existed. They were paid by the merchant, who raised prices incrementally for all customers to cover the cost. Today Visa and MasterCard’s point-of-sale networks compete on price not to lower debit fees they charge consumers but to raise debit fees they share with banks, their true customers.

The debit card was tamed.

Its popularity, meanwhile, increased to the point where last year, for the first time, the volume of debit-card payments exceeded that of credit-card payments. Half of all “third-party debits” to deposit accounts were made with debit cards, compared to less than one-third made with paper checks.

This year’s  Dodd-Frank financial-reform law contained an amendment sponsored by Sen. Dick Durbin (D., Ill.) that pushed back against debit fees in two ways. First, it prevented Visa and MasterCard from penalizing retailers who offered customer discounts according to payment method. Such discounts make swipe fees for credit cards, offline debit cards, and ATM cards transparent to customers. Second, it directed the Fed to limit swipe fees charged for debit cards to a level that’s “reasonable and proportional to the cost” incurred by the bank. The proposed Fed rule (text here) proposes a couple of different ways to do that, but in essence it says a debit swipe fee can’t exceed 12 cents per transaction. That, apparently, is a tougher limit than was expected, and Rep. Barney Frank (D.-Mass.) thinks it’s too low. Frank didn’t favor Durbin’s amendment when it passed because he thought it would hurt small banks, though small banks appear to be exempt. Senate Democrats, on the other hand, were emboldened to initiate a push to limit fees for prepaid cards in the same way the Fed is doing for debit cards.

Credit card use is down, though probably not permanently; the decline likely reflects current hard economic times. Debit card use was rising before the 2008 crash and is continuing to rise. Merchants would like to see debit fees down not because they favor thrift—far from it—but because they want to lower their costs. And consumers? Clearly they like debit cards. Consumer advocates, however, appear to be divided. Balto argues, persuasively, that ATM cards are an excellent financial innovation and offline debit cards are their corruption. But the distinction is rapidly disappearing; today about 87 percent of all debit cards are hybrids that can be used at ATMs with PINs or at stores with a signature. That’s largely because it’s banks who send you your ATM card. Might as well send you a dual-use card, they figure, because you just may use the offline function at the supermarket and put some extra cash into their pockets. Never mind that the hybrid cards are easier for thieves to use.

Debit cards have been so debased over the past 15 years that Reuters personal-finance columnist Linda Stern  claims “you won’t find them in the wallets of top consumer advocates.” Better to tie yourself to the mast and pay your credit card in full every month, they say. Easier said than done. The Fed has a different idea: Rehabilitate the debit card. Eliminate its obnoxious bank fees and make consumer thrift practical again. Score one for the merchants, and one for consumers, too.

But the war over money’s future never ends. Let’s see what the banks’ next move is.