Of late, a spotlight has fallen on the wide range of fees charged annually to consumers who use debit cards. News stories and congressional inquiries have brought to light the extent to which lucrative overdraft charges, for example, are being collected. "Prepaid" debit cards with maintenance and inactivity fees, among many others, have also attracted attention. And to avoid spurring legislation that would control the fees they set, certain large banks, such as JPMorgan Chase (JPM), Wells Fargo (WFC), and Bank of America (BAC), have voluntarily altered some of these practices.
But these disclosures and countermoves are a sideshow. Now that the dominance of debit-card transactions is inevitable—today they far surpass transactions with credit cards—the $20 billion question has to do with their oversight, or lack thereof. It's a job that clearly should fall to the Federal Reserve, which was established on Christmas Eve in 1913 to supervise America's payment system (then primarily cash and checks). That system had a serious problem then, and it's cropping up again.
Nearly a century ago banks routinely discounted checks from rivals. If a New Yorker paid a store in San Francisco with a $100 check drawn on her Chase account, the store might only get $95 because its bank—Bank of America, say—would discount that "foreign" check. This became a huge problem for stores, shoppers, and banks, and these fees, called "exchange charges," were a major stumbling block to the growth of interstate commerce. The Fed was in large part designed to stop this madness.
It did its job, and exchange charges vanished. Banks were forced to honor each other's checks "at par." A $100 check was again worth $100.
This rule and Fed oversight worked splendidly for the next 70 years, until the 1980s, when debit-card transactions started to replace cash and checks. By and large, this shift was a good thing. Consumers could conveniently tap their bank accounts using plastic. Stores were relieved of the hassle of handling cash and checks. Banks certainly preferred the higher security of electronic transfers to the expensive processing and clearing of checks.
The Fed noticed this shift and debated extending the at-par clearance rule for checks to electronic debit transactions. That made sense since debit-card transactions were nothing more than electronic checks. But the Reagan-era Fed never acted. In the regulatory vacuum, two debit systems developed. Cards branded with NYCE (FIS), STAR, MAC, PULSE, Shazam, and other network names were used with a PIN, and, like checks, cleared at par. But Visa (V) or MasterCard (MA) debit cards required a signature. When that happened, the transactions were tagged with a so-called interchange fee, effectively restoring pre-Fed exchange charges.
Stores couldn't avoid these fees because they were forced to accept the Visa/MasterCard debit transactions if they wanted to take Visa or MasterCard credit cards—which were, and remain, the primary line of credit in the U.S. The Visa and MasterCard debit cards, designed to look like credit cards, also fooled a great many consumers, resulting in overdrafts and bounced checks.
This ended in 2005 after a long but successful lawsuit brought by Wal-Mart Stores (WMT) and the Limited (LTD) on behalf of 5 million stores—disclosure: I was lead counsel for the retailers—that forced Visa, MasterCard, and the banks to "untie" the acceptance of debit from credit and print "Debit" on every one of the hundreds of millions of Visa and MasterCard debit cards. But that left, to this day, the unresolved issue of regulating interchange fees.
Last year banks collected more than $20 billion in interchange fees on debit transactions, and that number is rising fast. You might ask, why? After all, debit cards enable banks to sidestep the expense of processing checks or cash. Interchange fees can be accurately called many unpleasant names. I'll use a euphemism economists prefer: They're a "transfer of wealth" from U.S. stores and shoppers to banks.
The Fed's original mandate gives it power to end this practice. Now that the country recognizes that everything government does is not necessarily bad and all that business does is not necessarily good, it's time the Fed did the job it was given and still has the authority to perform: supervising America's payment system.
Jack and Suzy Welch are off while Jack recovers from a back infection.