Transcript: Can TCF Stop Durbin?

DAVID S. EVANS: Hey, everyone. This is David Evans. TCF, which is a mid-sized bank, about $18 billion of assets headquartered in Minnesota, sued the Fed – the Federal Reserve Board over Durbin last week. They claimed that the legislation amounted to an unconstitutional seizure of property, and they asked the federal courts – the federal district court, actually, in South Dakota, to issue a stop-work order, so to speak.

I’m going to talk to two people who know this subject very well. To my left is Ron Mann, who is a law professor at Columbia University. Ron has written a lot on the payments industry, including his book that came out in 2006 called “Charging Ahead.” He’s also done a very important casebook on the industry as well. And then right below me on the screen is Mallory Duncan, who has been leading the merchant charge against him to change these – for the National Retail Federation. He’s their General Counsel and Senior Vice Pesident. Thanks, guys, for joining me today.

MALLORY DUNCAN: Good to be here.

EVANS: Let me start with you, Ron. Ron, I’m sure my introductory remarks, coming from an economist, mangled the law here. So what’s this case really about?

RON MANN: Well, I wouldn’t say you mangled it that badly. I mean the lawsuit asks to have the Durbin-Frank statute held uncon – the Dodd-Frank statute – the Durbin Amendment part of it – held unconstitutional. And the basic claim is that the statute has defects that are so serious that it either takes the property of the banks that are subject to it without compensation, which would violate the Fifth Amendment, or it doesn’t provide banks due process.

And the basic claim is directed at some of the most salient features of the statute. And the most important one is this idea that the very large institutions are treated differently from the small institutions, and so there’s a very small number of these large institutions – they have a large market share, but they’re small – and then there’s a very large number of the smaller banks that participate by issuing debit cards. And the argument is that there’s no reason that would satisfy the Constitution for drawing a line between those two groups.

And the second claim is the idea that the pricing for debit cards is supposed to be based on the marginal cost of processing transactions – is so far below the cost of those transactions that this is just not a rate that the Constitution can accept.

EVANS: Do they have a shot?

MANN: A shot, maybe, but I think it’s very unlikely. Since the 1930s, the Supreme Court has been very reluctant to invalidate legislation at the state or the federal level that’s really wholly economic regulation and particularly reluctant to invalidate federal statutes. And this is a statute that affects only people that are in a heavily regulated industry. It doesn’t take any of their property for the government to have or take their property and give it to somebody else. It simply regulates the way that they do business.

Now I’ll agree – I think the statute is poorly done. I don’t think the statute is sensible. I don’t think it addresses even the concerns that should be important about interchange regulation from the merchants’ perspective. I think it’s typical of what you would get from Congress if you asked them to deal with a complex regulatory matter, but that’s not enough – or even close enough – to have it held unconstitutional.

EVANS: Let me turn to Mallory. Before I do, let me note that everyone probably knows that I have strongly held views and have written a lot on interchange fees. I’m not going to make any editorial comments today, so no one should think the fact that I don’t say anything about this means that I necessarily agree with anyone. I’m going to try to just do a straight conversation with these guys and let them get their views out.

Mallory, putting aside the merits of the lawsuit, which I want to turn to in a second, doesn’t TCF have a point? They’re kind of caught between a rock and a hard place. Their smaller rivals are exempt and their bigger rivals have more ways to recover the lost interchange fees. Are they wrong about this or is this just acceptable collateral damage that you get in any kind of legislation?

DUNCAN: Well David, I wouldn’t refer to it as collateral damage. Congress has always had to draw lines. As Ron suggested, for example, Congress makes distinctions between some businesses that will have to take more activist steps with respect to things like the Americans with Disabilities Act, as opposed to others who may have a little more leeway. Those are reasonable decisions that Congress gets to make.

In this case, TCF, although they may claim otherwise, they’re an $18 billion bank. And they have a lot of options available to them in terms of how they manage the business. The fundamental question – and again, I realize this is not necessarily a debate about interchange – is whether there should be any fees associated with interchange on debit transactions in the first instance. So anything they’re receiving we see as essentially as a bonus.

EVANS: Thanks, Mallory. Well let’s talk a little bit about the lawsuit. Ron, you gave a quick summary to it. Let’s suppose you were playing partial devil’s advocate here and had to make kind of the best case for the lawsuit. What would you say in terms of where these guys have the best shot and sort of the scenario under which it’s conceivable that a federal court – and I guess, more importantly, a court of appeals and the Supreme Court – could actually decide in their favor? – if you’re comfortable answering that.

MANN: Yeah, I am. And I mean obviously they have – I mean Richard Epstein’s working on this case, and he’s an extremely capable. He’s a very capable, experienced and well-informed advocate. So that’s one thing they have going for them that counts for a lot.

I think that the thing that they have that sounds the best in the complaint is the part of the statute that says, the fees they’re supposed to – the Federal Reserve is supposed to set are not supposed to be enough for them to recover the cost of the transactions. The legislation tells the Federal Reserve to set the fees below the actual cost of the transactions.

And I think that, if you can manage to put a box around that and not look at the context and just look at that specific part of the statute, that’s difficult to defend because reasonable rate regulation is supposed to provide a reasonable return on investment. And so if he can get someone to evaluate that as a statute that requires them to set a price that’s below their actual costs, then I think he has a good chance.

EVANS: As a legal matter, does it bother you that – and I haven’t personally read through the Congressional Record myself, but at least my impression – is the $10 billion cutoff was sort of pulled out of thin air. Does that bother you at all, assuming that I’m right about that?

MANN: Well, I think the whole Durbin memo was pulled out of thin air. I mean I think that’s – I think Richard does a very good job of weaving that into the complaint. It’s not relevant doctrinally to any of the particular claims that he makes, but I think it’s true. And I think the court will know that it’s true – that this is not a piece of legislation that went through the process for – a lot of the things in Dodd-Frank – this was not drafted six months ago and gone through lots of hearings and revisions. There’s not a 350-page House report that nobody read. There’s no legislative history.

This is – Durbin wrote this. It’s very sloppily done. And a lot of the decisions that are made, I think, can’t really be defended as sensible. They’re defended as, well, Congress can do whatever they want. And if the law is Congress can do whatever they want, well then it’s perfectly OK. And that’s what it has in its advantage. The rule generally is Congress can do whatever they want.

EVANS: Mallory, any reaction to that?

DUNCAN: Well, Congress has been looking at the issue of interchange for probably five years now. And they’ve done that both in the Senate as well as in the House. I’ve testified myself a number of times and specifically testified about debit interchange. This is a serious issue. And Congress can take that record and take that information, and one member drafts legislation, which, frankly, close to two-thirds of Congress said, makes sense to us. And that passed both bodies as part of the Dodd-Frank bill. So this legislation was certainly – has a longer history than many other things that Congress has done.

And in terms of whether it makes sense – if you’re trying to achieve a greater degree of transparency and competition, which is important for any market to function, this legislation is very clearly aimed towards that.

EVANS: Guys, it took three months after the passage of Dodd-Frank to get this lawsuit concerning the so-called Durbin Amendment. What’s your prediction? Both of you are lawyers. Are there going to be more lawsuits? And what do you think the issues are going to be? Ron?

MANN: I think there’s surely going to be a lawsuit whenever the Federal Reserve announces what the rates are. And it wouldn’t surprise me if there’s pairs of lawsuits – one by the National Retail Federation saying that the rates that they announce are too low and one by the banks – by the National Retail Federation saying the rates are too high and one by the banks saying they’re too low. I think everybody will be unhappy whenever they set the rates.

DUNCAN: Well I don’t envision us bringing a lawsuit, certainly not as long as the Federal Reserve Board is following the statute. In practice, they’ve – the Fed has addressed a similar issue just last year with the Card Act, where they were asked to come up with reasonable, proportional late fees for credit cards. And the Fed came up with a formulation and the – for developing that. And then really this statute says the same thing. It doesn’t say the Fed is supposed to set a rate. It says the Fed is supposed to come up with rules or guidance as to how that rate is to be set. And we expect that’s what will happen.

EVANS: I guess the only push back I have against both – with respect to both of the answers – is it seems like this legislation, more so than many, has a bunch of different stakeholder interests where, I guess, I at least could imagine conflict. No?

MANN: The Card Act, I just think, is different. I think if the Federal Reserve takes a statute at its – it takes a statute literally and sets rates that are below the demonstrated costs of processing – of having – the demonstrated average cost of processing the transactions, the banks are going to sue them. And I think if they set it at five times the marginal cost or 10 times the marginal cost, I think there’ll be a group of merchants that will sue them.

EVANS: Now let’s talk about the implementation of the debit card regulations. Do you have an estimate of or any thoughts on how much the Fed is going to take down debit card interchange fees?

DUNCAN: Well I think they’re going to be guided by a couple of things. They are certainly going to be guided by what is a reasonable and proportional recovery of the ACS – that’s authorization, clearance and settlement – of a debit card transaction. But they’re also going to be guided by language in the statute that points them to a comparable transaction, which is a check transaction.

As I’ve said before, a debit transaction is nothing more than a plastic check, or a debit card is like a plastic check. And when Congress looked at check transactions, they made a determination, and the Federal Reserve has developed rules that require paper checks to pass at face value. There’s not a whole lot of discussion about how much the banks are going to recover for issuing paper checks. They pass at face value. All of parties to the transaction absorb their own costs associated with that.

And there’s something very close to that going on here. So looking at that and looking at what’s going on overseas, and in our neighbors in Canada, you see debit transactions – a very vibrant debit transaction business going on – where the transactions are about 3 cents. I wouldn’t be surprised if the ultimate rules create a formula that comes up something similar to what Canada has, possibly less because we’re a larger and more efficient operation.

EVANS: Could you remind us what the rates are in Canada?

DUNCAN: They’re about 3 cents flat per transaction.

EVANS: OK. The bill also says that merchants can do a variety of things to encourage consumers to use particular kinds of payment instruments, whether it’s cash or check or signature debit or PIN or whatever. In talking to your members, what kinds of changes do you think consumers will see at merchants, and when do you think they’re going to see them, if they are going to see them? Do you have any kind of feedback from your membership on that?

DUNCAN: Sure. A number of my members have called me already to sort of brainstorm and to delve into some of the issues surrounding the Durbin Amendment. Realistically, I believe they are going to wait until they see what the Federal Reserve does. Even though some of the tools in the Dodd-Frank bill could be implemented instantly, it’s easier if you have the full suite of alternatives in front of you before you decide what you’re going to do so that you’re not confusing the public, so that you’re giving them a single look at what the options are going to be.

In terms of those options, we operate on an extremely narrow profit margin. And merchants are successful to the extent they can grow market share. So they’re going to try to find things that they can do that will incentivize customers to shop at their store as opposed to the one down the block. So that means returning either a lower price, possibly through a discounting store, or providing some other incentive or benefit. I’ve talked to restaurants who are looking at – are there menu options that we could make a preference or available to those who use cheaper forms of payment – basically so they’re sharing the savings with their customers.

EVANS: This is like I get free dessert if I pull out my PIN debit card?

DUNCAN: Might be. Or it could be a free dessert or you might get free delivery if you’re buying a washer and dryer and you’re paying for it with your debit card rather than a credit card.

EVANS: That’s a nice segue to my next question on this subject, Mallory. The card industry says that merchants are just going to pocket the savings and not pass them along to consumers. What do you say?

DUNCAN: Well, we are a far, far more competitive industry than the financial services industry. As I said, the average profit margin – that profit margin in retail – is just about 2%. The luxury retailers make a little bit more. The grocery stores make about half that much. So the competition is fierce. And that competition is what forces merchants to pass on savings to their customers to grow market share. So we think most of this money is going to get passed back and shared with our customers.

EVANS: Ron, you’ve heard Mallory’s comments on this. Do you have any reactions to them, anything you want to add to them?

MANN: Well I think a lot of things he says are valid. I think I’d respond to two things. I mean, one, I do think there’s a substantial difference to merchants and to customers as well between debit cards and check transactions. They’re really very different. From the merchants’ perspective, when they take a check, if they just take the check and send it through the system and don’t pay anything to anybody, they have no contemporaneous verification that the transaction is going to be paid. And if they take a debit card, they have a more-or-less ironclad real-time commitment from a bank to pay them. And that’s valuable, and they don’t get that with a check.

And the second thing is, yeah, it’s true that checks clear par because of the statutes that set up the Federal Reserve about 100 years ago. But it’s also true in reality that the only reason they can clear par is because the government has the Federal Reserve in there, which is basically subsidizing the check processing system, and that’s where the money comes to make them clear par from small banks. And the motivation for that was so the small banks could compete, because they would have been driven out of a system where there wasn’t a requirement they clear par. So I don’t think that analogy carries a lot of weight with me, myself.

EVANS: Mallory, unless you want to respond to Ron, maybe one last question, which is we’ve talked a lot about debit card interchange fees. Obviously, the other thing that the National Retail Federation has gone after, as have other merchant groups in the United States and around the world, are credit card interchange fees. Any predictions on when, if ever, that’s going to get resolved?

DUNCAN: Well let me start by saying just a couple of words about what Ron said.

EVANS: Sure.

DUNCAN: Certainly, the Durbin Amendment does recognize that smaller institutions might be a special case. And that’s why we had the discussion at the beginning of this interview about a line being drawn, and the smaller institutions are treated somewhat differently.

But even going beyond that, if you look at why debit was introduced in the first place, it was introduced because it saved the banks buckets of money on transactions – all compared to checks. So even when checks were passing at par, banks found they could save a lot more money if they introduced debit cards into the equation. And so it seems somewhat backwards to then say, the process that saves them all of this money – they can then turn around and charge other people, merchants and customers, for their savings.

As to where we’re going with credit cards, clearly, out of that $48 billion that merchants and consumers pay every year, credit cards is the largest bucket. And clearly, if you look at us and the rest of the world, we’re paying much, much, much too much in terms of credit card interchange. And so I firmly believe, once this system is worked out in terms of debit and Congress sees how well it works, the next attention will be to bringing us into relation with the rest of the world in terms of credit card interchange.

EVANS: Ron, do you have anything else to add?

MANN: I think that’s a reasonable prediction.

EVANS: Guys, I really appreciate the time today – very insightful discussion. As I mentioned before, I don’t necessarily endorse or agree with any of it. But still, very fascinating, really interesting to hear your views, so thanks again. And hope to see you again on PYMNTS.com.

Executive Bios

Ron Mann is one of the leading global authorities on the law and economics of payments. He has authored numerous authoritative books and articles on the law of payments including Payments Systems and Other Financial Transactions.  He is a Professor of Law at Columbia University.

Mallory Duncan serves as Senior Vice President, General Counsel for NRF. He is responsible for coordinating strategic legislative and regulatory initiatives involving customer data privacy, bankruptcy, fair credit reporting and truth-in-lending.

Prior to joining NRF, Duncan served as corporate counsel in the Washington office of J. C. Penney Company, Inc., where he advised stores and headquarters on federal and state legislative and regulatory issues. Duncan was an attorney advisor in the Office of Policy Planning at the Federal Trade Commission and was previously associated with the law firm of Sutherland, Asbill & Brennan.

He has served on the boards of several non-profit organizations throughout his legal career, including the National Hospice Foundation. His publications include the Federal Trade Commission’s Policy Guidance on Civil Penalties and co-authorship with Anne P. Fortney of “Fair Credit Reporting Act Creates New Duties for Employers,” Credit World, May/June 1998.

Duncan is a graduate of Pomona College and Yale Law School.