This provides an
excellent explanation of the credit card business model and it is certainly a
way to tax commerce rather than anything that approaches an at risk
business. Read it carefully to fully
understand just how effective it is and also how excessive it actually is.
It is also a natural
monopoly. There is room for one more
effective competitor at most and no one wishes to compete on price because they
simply do not have to. Ellen is right that
the best way to properly compete with this particular pig is to introduce a
state bank that naturally services the bulk of local business clients and then
establishes its own local credit card system.
This provides a local
lobby that establishes fair pricing.
Better have this system operated and owned by the merchants as a credit
card cooperative which rebates surpluses back to the merchants at the end of
the year. Done properly, the consumers,
the bank and the merchants will be well served.
There never was a need to incorporate a for profit model here when no
one is at actual risk except in terms of established credit risk and that falls
on the consumer generally.
Rip Off Alert! How the
Credit Card Gravy Train is Running Over You
The credit card biz is
now the banking industry’s biggest cash cow, mostly due to fat hidden fees.
Ellen brown
February 14, 2014
You pay off your credit card balance every
month, thinking you are taking advantage of the “interest-free grace period”
and getting free credit. You may even use your credit card when you could have
used cash, just to get the free frequent flier or cash-back rewards. But those
popular features are misleading. Even when the balance is paid on time every
month, credit card use imposes a huge hidden cost on users—hidden because the
cost is deducted from what the merchant receives, then passed on to you in the
form of higher prices.
Visa and MasterCard charge merchants about
2% of the value of every credit card transaction, and American Express charges
even more. That may not sound like much. But consider that for balances that
are paid off monthly (meaning most of them), the banks make 2% or more on a
loan averaging only about 25 days (depending on when in the month the charge
was made and when in the grace period it was paid). Two percent interest for 25
days works out to a 33.5% return annually (1.02^(365/25) – 1), and that figure
may be conservative.
Merchant fees were originally designed as a
way to avoid usury and Truth-in-Lending
laws. Visa and MasterCard are independent entities,
but they were set up by big Wall Street banks, and the card-issuing banks get
about 80% of the fees. The annual returns not only fall in the usurious
category, but they are returns on
other people’s money – usually the borrower’s own money! Here
is how it works . . . .
The Ultimate Shell Game
Economist Hyman Minsky observed that anyone can
create money; the trick is to get it accepted. The function of the credit card
company is to turn your IOU, or promise to pay, into a “negotiable instrument”
acceptable in the payment of debt. A negotiable instrument is anything that is
signed and convertible into money or that can be used as money.
Under Article 9 of
the Uniform Commercial Code, when you sign the merchant’s credit card charge
receipt, you are creating a “negotiable instrument or other writing which evidences
a right to the payment of money.” This negotiable instrument is deposited
electronically into the merchant’s checking account, a special account required
of all businesses that accept credit. The account goes up by the amount
on the receipt, indicating that the merchant has been paid. The charge
receipt is forwarded to an “acquiring settlement bank,” which bundles your
charges and sends them to your own bank. Your bank then sends you a statement
and you pay the balance with a check, causing your transaction account to be
debited at your bank.
The net effect is that your charge receipt (a
negotiable instrument) has become an “asset” against which credit has been
advanced. The bank has simply monetized your
IOU, turning it into money. The credit cycle is so short that this
process can occur without the bank’s own money even being involved. Debits and
credits are just shuffled back and forth between accounts.
Timothy Madden is a Canadian financial analyst
who built software models of credit card accounts in the early 1990s. In
personal correspondence, he estimates that payouts from the bank’s own reserves
are necessary only about 2% of the time; and the 2% merchant’s fee is
sufficient to cover these occasions. The “reserves” necessary to back the short-term
advances are thus built into the payments themselves, without drawing from
anywhere else.
As for the interest, Madden maintains:
The interest is all gravy because the transactions are funded in fact by the
signed payment voucher issued by the card-user at the point of purchase. Assume
that the monthly gross sales that are run through credit/charge-cards globally
double, from the normal $300 billion to $600 billion for the year-end holiday
period. The card companies do not have to worry about where the extra $300
billion will come from because it is provided by the additional $300 billion of
signed vouchers themselves. . . .
That is also why virtually
all banks everywhere have to write-off 100% of credit/charge-card accounts in arrears
for 180 days. The basic design of the system recognizes that, once set in
motion, the system is entirely self-financing requiring zero equity investment
by the operator . . . . The losses cannot be charged off against the operator's
equity because they don't have any. In the early 1990's when I was building
computer/software models of the credit/charge-card system, my spreadsheets kept
"blowing up" because of "divide by zero" errors in my
return-on-equity display.
A Private Sales Tax
All this sheds light on why the credit card
business has become the most lucrative pursuit of the banking industry. At one
time, banking was all about taking deposits and making commercial and
residential loans. But in recent years, according to the Federal Reserve,
“credit card earnings have been almost always higher than returns on all
commercial bank activities.”
Partly, this is because the interest charged on
credit card debt is higher than on other commercial loans. But it is on the
fees that the banks really make their money. There are late payment fees, fees
for exceeding the credit limit, balance transfer fees, cash withdrawal fees,
and annual fees, in addition to the very lucrative merchant fees that accrue at
the point of sale whether the customer pays his bill or not. The merchant
absorbs the fees, and the customers cover the cost with higher prices.
A 2% merchants’ fee is the financial equivalent
of a 2% sales tax – one that now adds up to over $30 billion annually in
the US. The effect on trade is worse than either a public sales tax or a
financial transaction tax (or Tobin tax), since these taxes are designed to be
spent back into the economy on services and infrastructure. A private
merchant’s tax simply removes purchasing power from the economy.
[W]hen anyone brings up Tobin taxes (small
charges on every [financial] trade) as a way to pay for the bailout and
discourage speculation, the financial services industry becomes utterly
apoplectic. . . . Yet here in our very midst, we have a Tobin tax equivalent on
a very high proportion of retail trade. . . . [Y]ou can think of the rapacious
Visa and Mastercharge charges for debit transactions . . . as having two
components: the fee they’d be able to charge if they faced some competition,
and the premium they extract by controlling the market and refusing to compete
on price. In terms of its effect on commerce, this premium is worse than a
Tobin tax.
A Tobin tax is intended to have the positive
effect of dampening speculation. A private tax on retail sales has the negative
effect of dampening consumer trade. It is a self-destruct mechanism that
consumes capital and credit at every turn of the credit cycle.
The lucrative credit card business is a major
factor in the increasing “financialization” of
the economy. Companies like General Electric are largely
abandoning product innovation and becoming credit card companies, because
that’s where the money is. Financialization is killing the economy,
productivity, innovation, and consumer demand.
Busting the Monopoly
Exorbitant merchant fees are made possible
because the market is monopolized by a tiny number of credit card companies,
and entry into the market is difficult. To participate, you need to be part of
a network, and the network requires that all participating banks charge a
pre-set fee.
The rules vary, however, by country. An option
available in some countries is to provide cheaper credit card services through
publicly-owned banks. In Costa Rica, 80% of deposits are held in four
publicly-owned banks; and all offer Visa/MC debit cards and will take Visa/MC
credit cards. Businesses that choose to affiliate with the two largest public
banks pay no transaction fees for that bank’s cards, and for the cards of other
banks they pay only a tiny fee, sufficient to cover the bank’s costs.
That works in Costa Rica; but in the US, Visa/MC
fees are pre-set, and public banks would have to charge that fee to participate
in the system. There is another way, however, that they could recapture the
merchant fees and use them for the benefit of the people: by returning them in
the form of lower taxes or increased public services.
Local governments pay hefty fees for credit card
use themselves. According to the treasurer’s office, the City and County of San
Francisco pay $4 million annually just for bank fees, and more than half this
sum goes to merchant fees. If the government could recapture these charges
through its own bank, it could use the proceeds to expand public services
without raising taxes.
If we allowed government to actually make some
money, it could be self-funding without taxing the citizens. When an
alternative public system is in place, the private mega-bank dinosaurs will no
longer be “too big to fail.” They can be allowed to fade into extinction, in a
natural process of evolution toward a more efficient and sustainable system of
exchange.
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