Sunday, June 26, 2011

Law of unintended consequences strikes again

The U.S. Senate in June refused to repeal a rule capping debit card fees, primarily due to the efforts of Richard Durbin (D-IL). There were numerous, though regrettably not enough, opponents worried about the consequences of this action. An article from the Los Angeles Times discussed the skepticism of an opponent of the cap, liberal Democrat Jon Tester (Montana):

Tester proposed delaying the regulations to study the effect on smaller financial institutions and credit unions, particularly those in Montana, where he is up for reelection next year. Smaller institutions fear they will be unable to recoup the costs of handling transactions or that their cards will be shunned by retailers.

Tester was right. As any economist could have predicted, the law of unintended consequences (I will refer to it as the LOUC) will soon cause debit cards to become much more expensive, as this Los Angeles Times article correctly points out here. I'll quote parts of two paragraphs:

Starting next month, merchants will pay just 12 cents for debit processing, unless bank lobbyists persuade the Federal Reserve to tack on a surcharge for fraud prevention.

The bottom line is that banks stand to lose more than $10 billion a year in merchant fees and more than $6 billion in overdraft fees. They'll be looking to make it up somewhere — and it's likely to be from the mainstream debit card users, not just the sloppy ones.

What exactly is the law of unintended consequences? The excellent website Econolog explains it well in this article. This historical anecdote was my favorite example:

In 1692 the English philosopher John Locke, a forerunner of modern economists, urged the defeat of a parliamentary bill designed to cut the maximum permissible rate of interest from 6 percent to 4 percent. Locke argued that instead of benefiting borrowers, as intended, it would hurt them. (Emphasis added). People would find ways to circumvent the law, with the costs of circumvention borne by borrowers. To the extent the law was obeyed, Locke concluded, the chief results would be less available credit and a redistribution of income away from “widows, orphans and all those who have their estates in money.”

To sum it up: Good intentions in legislation often lead to bad results. Price caps, as much as anything, almost always cause more problems than they solve. I wish more legislators would understand how the LOUC works. Are you listening, Richard Durbin?

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