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THE FED IS BEHIND THE CREDIT CARD MERGER  
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Matt Stoller
March 1, 2024
The Lever
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_ If Capital One is allowed to acquire Discover, it’ll gain access
to a government loophole allowing it to raise prices and reduce
competition. _

A Discover credit card and the logo for Capital One Financial. , AP
Photo/Charles Krupa and Richard Drew

 

It’s an obvious point, but credit cards in America generate a lot of
cash for banks. In 2022, I wrote up
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how the business works, with the observation that the industry
generates close to a quarter trillion dollars a year in revenue. This
revenue comes from fees for connecting merchants and banks, as well as
fees charged to consumers for access to credit.

Every credit card network is also a data sieve, connected to
advertising data brokers, anti-fraud features, and analytics firms. In
addition, being able to reject someone from the payments system is a
core sovereign power, and the stated reason the right is so afraid of
a central bank digital currency.

There are many barriers to entry in the credit card business, and
significant pricing power among incumbents. As the Consumer Financial
Protection Bureau found, margins for credit cards are persistent,
increasing, high, and tilted towards the larger firms in the industry
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(And this is true even when you take higher interest rates into
account.)

Capital One’s recently announced attempt to buy
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the credit card company Discover hits at all of these elements of the
business. While the merger looks like a credit card bank buying
another credit card bank — and it’s certainly that — it is more
like a Big Tech merger, where a bank is trying to turn itself into a
platform with an app store-like power over a class of customers, in
this case merchants. The key quote from Capital One co-founder and CEO
Richard Fairbank on the call announcing the deal was this: “The holy
grail is to be an issuer with our own network.”

Here’s what Fairbank meant. An issuer, aka a bank, is regulated like
a bank, while a credit card network is regulated like a network, which
includes price caps on debit cards. But thanks to the Fed, a bank that
owns a network isn’t regulated at all on its own network. And
because of that, Capital One, if allowed to buy Discover, can set
prices in ways its rivals can’t. Fairbank also made clear that’s a
key rationale for the deal, as I’ll discuss after I’ve explained
the industry and the regulatory framework.

Let’s start with the basics of credit/debit cards. Banks make money
in two ways. They issue cards to consumers, and charge those consumers
credit card interest charges and various fees when they buy things
with merchants and don’t pay the money back immediately. 

But banks also make money from the merchants themselves. In between
the bank and merchants sits a network utility, usually Visa or
Mastercard. The network operator takes a swipe fee, known as an
‘interchange fee,’ from the merchant, roughly 1.5 to 3.5 percent
of every transaction, and then splits that fee with the banks. Banks
send some of that money back to the consumer in the form of rewards to
keep consumers locked into using that card. 

Here’s an illustration of how credit card networks function.

There’s a difference between American Express and Visa or
Mastercard. The latter two don’t issue their own cards, banks issue
them. Conversely, banks don’t issue American Express cards, only
American Express does that. So American Express isn’t a standard
credit card network. It is technically a ‘three-party system,’
between consumers, merchants, and American Express itself. This
distinction matters for legal reasons. (Though American Express’
status as a three-party network isn’t strictly accurate, U.S. Bank
does issue
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credit cards that operate on AMEX.)

So what is Discover? Well, it’s both a normal network and a
three-party system. Like Visa and Mastercard, Discover allows banks to
issue Discover cards. But like American Express, it also issues its
own credit cards.

So why does any of this matter? Well, America’s credit card system
is a massive extraction machine for middlemen, and this merger is part
of a knife-fight over who can get the biggest piece. Nowhere else in
the world
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is there a payments system in which 1.5 to 3.5 percent of trillions of
dollars of transactions goes to a set of middlemen, but that’s how
credit cards work in America, much to the chagrin of merchants, both
small ones and the giants like Walmart. 

Network fees are excessive because Visa, Mastercard, American Express,
and Discover have market power over merchants, who must accept the
cards their customers would like to use, even if the fee those
merchants have to pay is excessive.

In 2010, Congress actually noticed this was a problem, Senator Dick
Durbin attached an amendment to the Dodd-Frank Act which regulated
these networks. Specifically, the Durbin Amendment did two things. It
had the Fed impose a price cap on swipe fees for debit cards, and it
allowed merchants to choose among debit networks for processing debit
payments. 

While the Fed tilted the rules as far as it could towards banks, the
Durbin amendment has delivered
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somewhat for merchants. (The Durbin Amendment only addressed debit
cards, not credit cards, and so it left out large chunks of the
market. There’s now Senate legislation, called the Credit Card
Competition Act, which would allow
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merchants to choose among multiple payment networks for credit cards.)

But the Fed also punched a hole in the Durbin Amendment. When writing
the rule, the Fed went along
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from American Express
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and in its 2010 rules exempted
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three-party networks from regulation, only applying it to Visa and
Mastercard. And this brings me back to Capital One, whose CEO made
this point explicitly on the investor call announcing its attempt to
buy Discover. Here’s Fairbank:

_The Durbin debit rules, intentionally and by design only applied in
networks like Visa and MasterCard who negotiate with merchants on
behalf of thousands of banks, including negotiating terms and pricing.
Discover like American Express deals directly with merchants without
an intermediary. They are both the issuer and the network, so there is
nobody in between. The Durbin debit rules were written to explicitly
exclude networks like Discover and American Express._

Fairbank also noted that their intention is to move Capital One’s
debit portfolio immediately into Discover, though it will only move
part of its credit business. As _Digital Transactions Magazine_ put it
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“Fairbank called out a pricing advantage of the planned move into
debit.” After this merger, Capital One will have millions of
merchants at its mercy, merchants who will have the choice to either
lose customers who want to use Discover, or accept higher fees and
more intrusive rules from Capital One.

Of course, there are other reasons for the deal. Capital One will gain
a funding advantage as a bank and become Too Big to Fail if it
acquires Discover. Additionally, Discover is a large issuer of credit
cards, and the bigger the credit card issuer, the higher the prices
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banks tend to charge. If Capital One buys Discover, it’ll jump to
the number-one largest credit card issuer. But the pricing power it
will acquire as the owner of Discover is a core stated reason for the
merger.

And to underscore the point about barriers to entry, Fairbank also
made that clear when he told investors about his lust for Discover’s
network, saying that “we all kind of revel in the fact that a
network is a very, very rare asset. There are very few of them. And
it’s just, you know, I don’t think people are going to be building
any of these anytime soon.” 

That’s not stating outright that the goal is monopolization, but
it’s pretty close.

So will the merger go through? The deal has already drawn high-profile
opposition from both sides of the aisle, as the _American Prospect_
reports
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_Several advocacy groups have come out against the merger proposal,
including the __National Community Reinvestment Coalition_
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has fought Capital One in particular for several years. Sen. Josh
Hawley (R-Mo.) __said on Wednesday_
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deal should be blocked, joining Sen. Elizabeth Warren, who __opposed
the merger_
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earlier._

Under the current administration, it’s hard to see a clear path for
approval. The Federal Reserve and Office of Comptroller of the
Currency would have to allow the deal, and then the Antitrust Division
would have to give a green light. The Fed and the OCC are weak, but
they are also embarrassed.

And given the CEO stated on the acquisition call that the ability to
raise prices and reduce competition through a regulatory loophole is
one of the key reasons for the deal, the Antitrust Division strikes me
as an unlikely ally of the deal. As Steptoe lawyer Stephen Aschettino
put it, “I think antitrust is probably first and foremost on the
list of hurdles that Capital One is going to have to get past, and
that could take a while.”

That said, in many ways this deal is contingent upon the election. If
there’s a change in administration, then there will be a different
set of bank regulators and antitrust enforcers. It’s not clear what
happens then. In his first term, Donald Trump was lax about banking
consolidation, though his Antitrust Division did sue
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to stop the Visa merger with Plaid.

So one could see this deal as a bet on Biden losing. But I think
that’s overthinking it a bit, since there’s no reason Capital One
couldn’t just wait until after the election to announce the deal.
Capital One CEO Fairbank is known as a super aggressive operator; he
has already been fined
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for violating antitrust laws multiple times.

If I had to guess, I’d say this one’s about ego, as many of these
mergers are. Fairbank is a billionaire, and so he won’t be dislodged
from his position as CEO regardless of whether he has to walk away
from the deal. He’s probably thinking, swing for the fences, the
worst that happens is you strike out. 

But what this deal really shows is that the U.S. payments system is
ripe for genuine reform, whether that’s through the Fed making its
public payments system, called FedNow, workable, or Congress enacting
more rules mandating competition in payments. Regardless, you
shouldn’t become a billionaire by grifting on payment fees that no
other country in the world tolerates. And a merger to enable further
bloat and consolidation isn’t the way out.

_Editor’s note: This story was originally printed on_ _Matt
Stoller’s newsletter_ BIG_,_ [[link removed]]_
where he explores the politics of monopoly power. _
_The Lever_ is a nonpartisan, reader-supported investigative news
outlet that holds accountable the people and corporations manipulating
the levers of power. The organization was founded in 2020 by David
Sirota, an award-winning journalist and Oscar-nominated writer who
served as the presidential campaign speechwriter for Bernie Sanders.

* credit cards
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* capitalism
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* The Fed
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* Wall Street
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