What financially significant news was in the Fed's final Durbin regulations release on June 29? An objective measure is the impact of the release on stock prices.
The stock prices of the banks that had complained most vehemently about Durbin, such as JP Morgan Chase, were scarcely affected at all.
Maybe that's because word of the new interchange level of "around 20 cents" had been leaked earlier. Still, even if we go back a couple of weeks to the time of the apparent leak — there was no material impact on bank stocks.
If a drop in interchange from 44 cents to 23 cents made little difference to bank earnings expectations, then going to 12 cents — the level the Fed had proposed in December — also wouldn't have mattered much. Banks set prices for checking accounts. Tempest in a teapot.
But the Fed's announcement was an important price driver for a few other stock prices. Visa rose by 15%, MasterCard and E-Bay's by around 10%.
Visa and MasterCard are not directly affected by interchange rates. (They set these rates, subject now to the Durbin limitations!) But their income would have been dramatically reduced by elimination of anti-competitive restrictions and incentives by which they obtain transaction routing from merchants. In effect, Visa and MasterCard pay or require card issuers to provide them with exclusive routing. The Fed's proposed regulation envisioned prohibiting this, but the final regulation dropped this provision. Visa, with the larger share of debit volume, rose more than MasterCard.
The market says the regulation will not promote effective routing competition — competition that could reduce Visa and MasterCard market share and/or pricing. Thus, the Fed has made this component of Durbin a dead letter. The regulator achieved this by deciding not to require competition in signature transactions — which are the majority of purchase transactions.
E-Bay benefited in a different way from the regulation. Its subsidiary, PayPal, was exempted from the Durbin interchange restriction.
The Fed reached this result — which the market clearly didn't expect — by bringing to bear a formidable intellectual weapon: the dictionary, which evidently had been lost or out of reach when the Fed formulated the proposed regulation, in December.
According to the Fed, PayPal has a "three-party" network, to be contrasted with the Visa and MC "four-party" networks. Namely, PayPal's network serves only one "issuer" — PayPal itself, which also processes the transaction flow. Visa and MasterCard serve multiple issuers, according a vestigial role to "fourth party" acquiring banks.
The dictionary definition of "routing" is now interpreted by the Fed to mean that PayPal's network consequently does not engage in "routing" because it takes all transactions to one destination. Hence it's exempt from the Durbin interchange ceiling. (The air traffic controllers who do nothing but direct airplanes traversing diverse approach paths into Kennedy Airport would be surprised to learn that their work does not involve "routing.")
This semantic gymnastics spared the Fed from determining how much of what PayPal gets is "interchange" — which is what is limited by Durbin. By analogy with the other networks, interchange constitutes at least 85% of the net revenue going from the merchants to PayPal. And if the Fed was prepared to juggle cost numbers to arrive at its 23-cent ceiling for four-party networks, then it could have gone the extra mile to make a comparable calculation for three-party networks — even if the answer turned out to be a bit different.
In a backhanded way, this exemption for PayPal is slightly pro-competitive. It permits higher revenues for issuers with three-party networks: brands of cards that run transactions from the merchants to a single issuer. Maybe Discover, if it supports no other debit or prepaid card issuers, can benefit from that. Amex is a less likely beneficiary, since it has enrolled a larger number of issuers. It's obviously illogical, however, to rule that Discover or Amex is exempt from Durbin if it carries none of any other issuer's debit traffic — but, on the contrary, is subject to Durbin if its network carries even a tiny amount of such traffic.
Given their uncertain status as three-party networks, Discover and Amex had only small stock price moves. But PayPal's and Discover's creation of new networks were fairly recent, so perhaps others will now be drawn to the Fed's magnet of higher debit interchange, creating additional three-party networks. This is scarcely the kind of routing competition that Congress sought to foment: the idea was that if merchants were not impeded by Visa's and MasterCard's anti-competitive impact on issuers, the merchants would save money by choosing lower-cost four-party networks.
Hard cases make bad law. In this case, complex and ambiguous legislation leaving too much to regulators has engendered arbitrary and inconsistent regulation, roughly 50% nullification of Durbin. Sen. Tester's Senate majority, a small one, got half of what it wanted.
Andrew Kahr is a principal in Credit Builders LLC, a financial product development company, and was the founding chief executive of Providian Financial Corp. He can be reached at akahr@creditbuilders.us.com.
