For all the faults of Dodd-Frank-era regulations, some of which I outlined in my last post, the consumer protection elements may create the worst distortions. Reforms aimed to cut consumer expenses but ended, no doubt unintentionally, closing off access to credit and otherwise either disguising costs or transferring them. The resulting opacity and confusion imposed by these reforms now demand additional reforms so that financial firms will reliably offer services and consumers can make informed choices according to which cost the most to deliver.
First on this list of unintended consequences emerges from Dodd-Frank’s efforts to reduce the fees banks charge merchants for the use debit cards. The reforms concerned banks above a certain size. That stipulation no doubt aimed to protect smaller banks, but in reality was pointless, since smaller institutions seldom issue such cards, and when they do, they constitute a tiny fraction of overall debit card services. Before Dodd-Frank, Federal Reserve (Fed) research estimated, merchant fees came to about 44¢ on the average transaction, which the Fed’s researchers estimated at about $38.00. The law capped fees at 24¢, a flat fee of between 21 and 22¢ plus 0.05% of the transaction’s value. This measure, again according to Fed research, cut back bank revenue from this service by almost three quarters from $14.6 billion to $4.1 billion.
The rule, in other words, made this service a losing proposition for most banks. They had a simple choice. They could discontinue the debit card service, hardly a benefit to the millions of users that the legislation aimed to protect. Or they could make up the difference somewhere else where the regulators had not yet turned their gimlet eye. Most firms chose the second path. Fed research estimates that they made up almost all the lost revenue by raising account fees to all customers some 15%. It was either that or end the service.
The distortions and inequities of these moves should be obvious. The banks were made whole. Merchants paid less than the costs of the service from which they benefited. Bank account customers foot the bill for the difference. Effectively, retail bank customers subsidized the merchants and the banks — hardly an equitable outcome. The whole picture also brought to light a more general inadequacy of Dodd-Frank. The ease with which banks raised account fees reveals how little competition exists among larger banks in this country. Dodd-Frank, for all its complexity, has done little to correct the consumer abuse implicit in this situation. On the contrary, by enshrining notions like too-big-to-fail, the legislation has created a privileged place for these large institutions.
A different piece of Dodd-Frank-like legislation, the CARD Act, created other distortions. It aimed to protect credit card borrowers by mandating lower rates. The effect was to bring the banks back to where they first introduced credit cards in the 1970s. Then, bank credit cards aimed at low risk, high-income customers. Banks had little choice, since most cards faced state-mandated interest rate ceilings, making it a losing proposition for any financial institution to offer cards to customers where there was a greater risk of default. As those state interest rate regulations eased in the 1980s and 1990s and banks could charge a rate commensurate with risk, they began to expand their card business to include less credit-worthy holders. By forbidding rates commensurate with risk, the CARD Act left financial firms with two choices. They could lose money on a large portion of their credit card business, or they could reverse the historical process by pulling back from less-credit-worthy customers. They chose the latter course. From 2010, when the act, along with Dodd-Frank, went into effect, the number of low-credit-worthy people holding cards dropped from 70% of the total to 50%.
In response, non-prime borrowers also had two options. They could lose their access to credit, which the law seemed determined to do, or they could turn to less-regulated sources. Some states blocked this second avenue by forbidding non-bank lenders access to the market. Retail borrowers in these states simply had to do without. But in those states that lacked such regulation, non-prime borrowers flocked to less-regulated corners of finance. In these states, Fed research concluded, high-risk consumers substituted “consumer finance credit for reduced access to bank credit cards,” often at higher cost. In other words, the people who the CARD Act aimed to protect either lost out completely or paid more.
Conspiracy theorists might see in these distortions and inequities collusion between Wall Street and Washington. One could forgive them for reaching such a conclusion. Matters certainly look suspicious. A more charitable interpretation would simply point to unintended consequences, or in more folksy language the old saw that the road to hell is paved with good intentions.
Those problems stem from two chronic failings of Washington regulation. Its legalistic nature focuses on institutions and particular legal structures leaving markets and the broader financial industry to swing around the regulations, as has clearly happened with consumer protections as well as elsewhere with Dodd-Frank. The other problem is Washington’s habit of using regulation to impose on vendors and industry to help favored or needy groups in society. Because these impositions reduce profitability, it should come as no surprise that business avoids them in one way or another. In most cases, the people that Washington intended to help lose out on services or if they can get them elsewhere, pay more than they did before the regulations went into effect. If Washington wants to help certain groups that badly, it might do well to resist the temptation to impose the expenses obliquely on others through regulation and instead forthrightly tax to give certain groups the help. Then the authorities could see clearly at the polls how much the public likes the idea.
Originally published on Forbes.com.