Card Industry 'Model of Competition,' Prof Says

August 22, 2000, 1:00 a.m. EDT 5 Min Read

A prominent economist from the Massachusetts Institute of Technology testified Monday that the credit card industry is a "textbook model of competition," in which "many firms compete, and none of them is large relative to the market."

Richard L. Schmalensee, who is dean of MIT's Sloan School of Management and a professor of economics and management there, took the stand in U.S. District Court in Manhattan as an expert witness for Visa. He has done a good deal of consulting work for Visa over the last decade - leading prosecutors to suggest he is biased - and recently served as an expert witness in another antitrust case, the Justice Department's lawsuit against Microsoft Corp.

Describing the Justice Department's current action against Visa and MasterCard International, Mr. Schmalensee said: "Ironically, we confront in this case an industry that has, from the consumers' perspective, all the features economists expect from a robustly competitive industry. The payment card industry is one of the most competitive industries in the economy."

The Justice Department is seeking a remedy that would force banks that sit on the Visa or MasterCard board to issue new cards only under the brand of the association they govern. Under the government's proposed legal remedy, banks that do not sit on either board would be free to issue any card brand they chose, including American Express and Discover.

Mr. Schmalensee testified that neither the government nor its expert witness, Michael L. Katz of the University of California at Berkeley, has been able to point to another industry that operates "in this fashion." Given the choice to either govern one association, or have access to all card brands, most banks would probably choose the latter, Mr. Schmalensee said.

"The payment card industry is certainly not functioning so poorly that it invites drastic restructuring by the government followed by ongoing judicial regulation," he said. "It would be a mistake to adopt a remedy that could substantially weaken the very joint ventures that have been most responsible for the intense competition that has served consumers so well."

As with the other expert witnesses in the credit card antitrust case, Mr. Schmalensee was deposed in private before the trial started, and cross-examined on the stand. Transcripts of part of his direct testimony were released Monday, the day he was questioned by government lawyers.

According to the transcript, Mr. Schmalensee - who has published a book and several articles about the credit card industry and antitrust - spent much of his direct testimony lambasting Mr. Katz, the economics professor who took the stand for the Justice Department earlier in the trial. Of the 142 pages in his report, Mr. Schmalensee dedicated the first 44 to poking holes in Prof. Katz's testimony, which he called "fatally flawed."

Mr. Katz had argued in favor of limiting dual governance, the system that lets banks that sit on the board of one association maintain a strong economic interest in the other association. This system has been in place for years, and Mr. Katz said it has stifled competition between Visa and MasterCard, and thus brought harm to consumers.

Mr. Katz also said he thinks banks should be allowed to issue American Express and Discover cards.

"Professor Katz assumes that large issuers will chose to be governors in his but-for world, but he offers no support for this assumption," Mr. Schmalensee said. "Since governors must give up competitive weapons that are available to non-governors, some, or all, large issuers may in fact elect to be non-governing members."

Mr. Schmalensee said Mr. Katz did not back up his theories with specific examples.

"Prof. Katz has presented no evidence that would enable an economist to determine whether consumer welfare would be significantly improved if the associations moved from the actual world to his 'but-for' world," Mr. Schmalensee said. "His testimony contains no estimates of the extent to which output, quality, product variety, innovation, or advertising would be greater, or the extent to which prices would be lower in his but-for world."

Among a multitude of other flaws he said he found in Mr. Katz's arguments, Mr. Schmalensee testified that Mr. Katz had failed to show that Visa's bylaw 2.10e and MasterCard's competitive programs policy - both of which restrict member banks from issuing card brands outside the associations - have harmed competition or consumers.

"Bylaw 2.10e and CPP do not prevent American Express or any other firm from being in the market or getting its product to market," Mr. Schmalensee said. They are "ordinary business loyalty rules and therefore presumptively pro-competitive."

Mr. Schmalensee argued there is no basis for prohibiting the bank cooperatives from having the same rules that a "for-profit integrated firm" could have.

In cross-examination Monday, lead prosecutor Melvin A. Schwarz questioned Mr. Schmalensee's strong ties to Visa, which date to an antitrust lawsuit filed against the association in 1991 by Sears Roebuck & Co., the Discover card's owner at the time. (Discover is now owned by Morgan Stanley Dean Witter & Co.)

Sears filed the suit because Visa refused to let it issue a Visa card. Mr. Schmalensee testified with limited success as Visa's expert witness in defending a rule preventing competitors Discover and American Express from issuing Visa cards. A jury in 1992 sided with Discover. Visa appealed, and in 1994 a judge overturned the decision.

More recently, Mr. Schmalensee co-wrote a book on the history of the credit card industry, "Paying With Plastic," published in December by MIT Press. His co-author was David S. Evans, a senior vice president of National Economics Research Associates Inc. Mr. Schmalensee said the book was meant to address the misperceptions of the credit card industry.

As expected, Mr. Schwarz made much of the fact that Visa provided the funding for the book, as well as much of the data. The book was distributed to journalists by a public relations firm hired by Visa.

Mr. Schwarz also pointed to Mr. Schmalensee's role as an expert witness in the Microsoft trial - for which he was paid $800 per hour - in an attempt to portray Mr. Schmalensee as a witness who can be bought.

Mr. Schmalensee said he would never risk his reputation for issues he did not strongly believe in or agree with.

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