CFPB

Why Regulators’ War On Fees Will Kill Consumers

Free. What can be better than free?

“Free” is so alluring that songwriters have created a boatload of songs about the concept.

Prince, who sadly passed away last week, has a song called “Free.”Be glad that U r free,” the lyrics go, and I hope he is.

Then there’s Pink, who also has a song called “Free.” “I just wanna be free,” she sings. I guess you can’t copyright “free.”

And who can forget the ’70s ballad “Free Bird” by Lynyrd Skynyrd (I’m a bit partial to those guys since, like PYMNTS, they obviously have a thing against vowels) “Cause I’m as free as a bird now and this bird you cannot change.”

Janis Joplin probably sang it best, though with, “Nothin’, don’t mean nothin’ hon’ if it ain’t free.”

“Free” has become the siren song of Silicon Valley now, too.

Wired magazine blazed “Free! Why $0.00 Is the Future of Business” on the cover of its February 25, 2008 issue. WhatsApp finally sang the “free” song earlier this year too. Those crazy guys … what were they thinking when they decided to charge users a whole $1 a year for the service? But no more – it’s free – as a bird – now.

Of course, everyone who has actually lived life, and been in business to actually build a business, knows “nothin’, and ooooh nothin’ and I mean nothin’ is really free.” (Now you know why my dreams of being a rock star were crushed.)

There’s always a “quid” for every “quo” that every Mom warned their daughters about. It’s also words to live by for consumers too.

For instance, consumers sign on to Facebook for “free” but Facebook sucks up oodles of data about whatever they do and sells it to advertisers who now barrage them with ads in their newsfeed. The quid is free access to Facebook – the quo is ads consumers now see in their newsfeed. That quid pro quo is also why Facebook has a massive audience of 1.5 billion people and raked in more than $6 billion of profits in 2015.

But is Facebook really “free?” Not a chance.

As for WhatsApp?

Well they’re going to figure out some other way to make money too, just like free “Messenger” is now with Chatbots and free “WeChat” has already done.

In fact, every smart entrepreneur and investor now understands the multisided platform model that my colleague David Evans has been writing up since around 2000 and the power of “free.”

Give stuff away to one side (like consumers) to get them on board the platform and then charge another side (like advertisers) to get access to them. But, you better have a paid “quid” for that free “quo.” And for those “free: businesses to sustain themselves and exist – the “quid” revenue side better be a whole lot bigger than the “quo” cost side that is being given away for free.

And that is the very tricky, very nuanced, but very important – part of making these very complicated multisided platform models actually work as real businesses rather than a venture funded experiment that is destined to fail.

The dirty little secret of “free” is that it only works if someone else is willing to pay – and that exchange of value between the free side and the paying side makes it worthwhile to both parties.

Unfortunately, judging from the news over the last few weeks, there are still a lot of folks, many of them who work in government, who – I swear – must have a whole playlist of “free” songs and listen to them constantly for inspiration about how to make decisions.

Take the European Commission.

Last week the folks in Brussels came down hard on Google for pushing handset makers to include its ad-supported services, like Google Search and YouTube, on the phones they sell.

Now, respectfully, what the Commission is doing is seriously nuts.

Google makes one of the leading mobile operating systems in the world — Android — and licenses it for free to companies like, say, Samsung that make it the software foundation of smartphones they sell for hundreds of dollars. Android may be open source, but virtually all of the people who work on it are on the Google payroll and their salaries are coming out of Google’s pocket book.

Google has a simple quid for their quo. “Hey handset maker, you get Android for free, and a bunch of other cool software, but you have to include our stuff on the phone.” That’s really the only way Google makes serious money on its Android investment.

But that’s a no-no according to the Commission. Instead, they’d rather see Google continue to invest billions in Android and give it away for free, so that everyone else can make money off it.

I can’t imagine why Google wouldn’t jump at that business proposition, she says sarcastically.

See what I mean though? The Commission staff probably has a whole playlist of “free” songs on their Commission-issued “free” iPhones. And speaking of free, they surely have a great “free” thing going themselves — they get paid really good salaries and other perks that are – let’s sing this together now – “tax FREE!”

Free – a good gig if you can get it.

Here’s another variation on “I just want the world to be free.”

Back across the pond, the CFPB seems to like that song a lot too. Last week they took their latest whack at payday lenders. Payday lenders, of course, make highly risky loans to people who need to borrow money and don’t have any collateral except for their weekly paychecks. And who can’t get any other people to lend them money on a short-term basis.

These people are in unfortunate situations. We can argue whether or not the government should be doing more to create better paying jobs, more employment opportunities, or a social-welfare net. But the government isn’t doing any of that and so some people really, really need to borrow against their future earnings to make ends meet today.

A recent Fed study says that 47 percent of all respondents couldn’t come up with $400 to pay for an unexpected bill – a car repair, an emergency doctor’s visit, a busted washing machine that needed repair – without borrowing or selling something. And, payday borrowers aren’t just the stereotypical indigent, migrant worker either – they are the typical middle class citizen with good jobs who just happen to live paycheck to paycheck.

Payday lenders have figured out a way to extend short-term credit to these folks. And there are lots of safety checks in place at the state level in many states to make sure that these lenders do the right thing – like vet the borrower and remain in compliance with state usury laws. But, like Google, and every other business that wants to stay in business, they need to make money and enough to cover their costs – which in this case is the risk that they won’t be paid back. Otherwise they’ll find something else to do with their capital.

The Bloomberg headline from April 20 on the topic though says it all: CFPB Study Finds Payday Loan Borrowers Hit with Fees, inferring that we should be living in a world where people can borrow money without paying any. The report says that, “borrowers face steep, hidden costs to their online loans in the form of unanticipated bank penalty fees.”

But let’s dig into this a bit more.

The payday lenders rely on banks to collect payment for them. When the consumer doesn’t have enough funds to cover that payment, the bank imposes overdraft fees. Now this can lead, in some cases, to the unfortunate situation in which the payday lender makes multiple attempts to get the money and the consumer may end being hit with multiple overdraft fees.

But in the immortal words of Janis Joplin, when it comes to “nothin’ don’t mean nothin’ if it ain’t free,” it doesn’t get any better than this.

The CFPB gets to attack two of the worst fee villains on its hit list — payday lenders who charge high interest rates and fees for small short-term loans and banks that charge overdraft fees for people that spend more than what they have in their accounts.

A two-for fee-free for all!

But let’s see just how horrible these fees are according to the CFPB itself and its recently released study.

Half of the people holding the accounts the CFPB looked at over 18 months didn’t have any overdraft fees at all. They got their loans, and paid them back from their bank accounts.

More than two-thirds have no more than one overdraft over 18 months.

To me, given the financial stress that people who take out payday loans face, that seems like a pretty good track record.

In a lot of cases where there aren’t good funds in the account, the bank is fronting the money for the account holder. For the first time a payment request is made, 88% are paid with no overdraft, 6% are paid with an overdraft, and 6% fail with an overdraft.

So half of the payments that fail end up being funded by the bank. Collecting the money from that 6% though is where the trouble comes. They keep getting hit with overdraft fees.

But those overdraft fees serve several good purposes.

For one, they give people incentives not to overdraw their accounts. The CFPB says that they are “unanticipated bank penalty fees,” which I think is about as plausible as “free dinner with a date” doesn’t come with any expectations.

But listening to the CFPB you’d think banks in America were trying to sucker in low-income people just so they could whack them with fees — in fact the reason we have millions of unbanked people is at least partly because banks can’t make money serving them and so don’t.

Finally, the overdraft fees help the payday lenders and the people who are getting loans — they help cover the occasional situation where people don’t have good funds and they take some of the risk off of the payday lender, which means the lender can afford to charge a lower interest rate overall.

And, speaking of “free” the CFPB has the biggest “free” credit card in the whole wide world.

Under the Dodd Frank Act, they get up to 10 percent of the Federal Reserve Board’s operating expenses. Interest free! So, whenever Congress gives the Fed more money for such trivial things like worrying about inflation and unemployment, the CFPB gets a bigger credit line.

I used to wish for a Neiman Marcus card with an unlimited credit line but now when the genie gives me three wishes I’m going for a CFPB-like deal.

And I’d be fine with just 2 percent, by the way.

Of course, it isn’t just that regulators have their playlist tuned into the one of Prince, Pink, Lynyrd Skynyrd or Janis’s odes to “free.” Lots of other players have been serenading the regulators, courts, and whoever else will listen with those same tunes.

In fact, from mountain to ocean, across the great seas, from Paris to Minneapolis, from giants to dwarfs, merchants from around the world have adopted “Nothin’ don’t mean nothin’ unless it’s free” as their theme song when it comes to payment cards.

Consumer walks into the store, whips out a payment card, pays in seconds, a sale is made, good funds flow to the merchant, and their margins grow. What could be better than that?

I’ll tell you: Make it free, please, they say. And why not?

So far merchants haven’t gotten their wish, but they’ve gotten close in many places around the world.

Here in the U.S. they got Congress, which got the Fed to force a permanent half-price sale on debit cards in the U.S. But the place to go to really get things for free is, yet again, Brussels. The European Union forced debit card interchange fees down to 15 basis points, and credit to 30.

Of course, if you are regulator, with a steady paycheck, and you don’t have to actually manage a P&L, indulge pesky investors in quarterly earnings calls, meet a payroll, and come up with the funds to innovate the next great thing, the free song sounds pretty intoxicating.

Back in the real world there’s no such thing as a free lunch, as economist Milton Friedman helped everyone understand.

Everything costs something and someone has to pay for it — and what the regulators miss, time and again, is that every time that they squeeze fees down for businesses it has consequences.

If the European Commission made it harder for Google to make money from advertising on Android phones, does it really think that Google would continue happily investing in the only mobile operating system that keeps Apple on its toes?

Then what would the world look like?

Clever issuers in Europe are now looking at alternatives to extending credit via installment loans which don’t qualify under the interchange rules, too. To make up for the revenue they don’t have anymore, banks are looking at new ways to make money since they have to make margins in order to keep the doors open, serve customers and comply with the slew of other regulations bearing down on them. There is only one other party who is left to pay – and that, of course, is the consumer.

Here in the U.S. if the CFPB keeps squeezing fees and raising costs for payday lenders, it may get its wish — these lenders who are operating legitimate and compliant businesses today may just decide to do something else.

But where does it think people who really need the cash are going to get it? Some might turn to crime if they get desperate enough. But most will turn to the unsavory lenders that the CFPB won’t be able to find or fine.

Again, the consumers pay – and in this case with some potentially dire consequences.

And who do regulators and lawmakers think are going to fund the payment card systems if merchants won’t contribute? Obviously consumers since there isn’t anyone else – and then the world may look a lot different for everyone.

Remember, free only works if someone else pays.

That brings me back to Prince.

The artist who traded in his name for a symbol, was a lover of purple, and wrote songs about free was anything but a card-carrying member of the “I want everything to be free” crowd. He and Pink, and even Janis were talking about an entirely different notion of free.

The last thing they wanted was for everyone to use their music for free.

After Prince’s death you might have gone to Pandora or Spotify or Apple Music to listen to “Let’s Go Crazy,” “Purple Rain,” “U Got The Look” or some of his other popular tunes.

You would have been out of luck.

Prince, in fact, ripped all of his music out of the leading streaming services because he didn’t like the fact that they weren’t paying the artists much. Through his career he tried to protect the business model that allowed artists like him to create great music but get paid for it.

A statement announcing his lawsuit against YouTube and eBay back in 2007, said “They are clearly able to filter porn and pedophile material, but appear to choose not to filter out the unauthorized music and film content to their business success.”

When it comes to business, “free” is sort of a scam but it’s a “wink-wink” sort of one where everyone really knows the rules and generally no one is harmed.

The regulators have a “free” scam going too, but it’s a more serious one. They seem like heroes whacking fees and making it hard for businesses to make money so that they can make it look like they are giving consumers a “fair deal” – giving them everything they want for free or close to it.

But they aren’t the only ones who can carry a tune. These business might, in the words of the Rolling Stones, sing right back to the regulators – “I’m free to do that I want, any old time,” and reallocate their investments or simply exit the business.

Unfortunately, the song that ought to be the one on regulators’ playlists should be the one that sounds something like this: “ain’t nothin’, for free, including feel-good regulations against businesses trying to make money.”

OK, I admit that needs some work, but I think I’m feeling my inner rock chick starting to emerge.

Lady Gaga, watch out.

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