Paul Krugman on Financial Reform

Paul Krugman has had an epiphany about why banks don’t like Barack Obama:

But Konczal points out that there’s a more mundane financial reason Wall Street is mad at Obama: financial reform, even if it’s weaker than we might like (and it is, much), will undermine several highly profitable rackets. More transparent markets for derivatives hurt the profits of firms that were selling things nobody understood; interchange reform hurts the profits of the companies that were earning big monopoly rents on credit cards; consumer protection undermines the business of making money by duping financial customers. All this adds up to a surprisingly large amount of money — and that’s even before we get to things like increased capital requirements for systemically important institutions.

So hurt feelings go along with a keen appreciation of the fact that fairer, more transparent markets are not good for the Masters of the Universe. In a way the miracle is that Wall Street isn’t even further in the tank for Romney.

Wellllll–no.  I can’t speak to derivatives but I can speak to Mr. Krugman’s reflections on some of the consumer protection issues he discusses.

Let’s start with this one: “ interchange reform hurts the profits of the companies that were earning big monopoly rents on credit cards.”

First, apparently unbeknownst to Mr. Krugman, interchange fee price controls applied to debit cards, not credit cards (which is what the Konczal article discusses too).  As President Obama might put it, “Today we have these things called debit cards that enable consumers to withdraw money directly from their bank accounts without having to pay at the end of the month.”  To be sure, there are provisions of the Durbin Amendment that apply to credit cards (and prepaid cards too) that deal with routing of transactions and the like.  But those provisions are not what Konczal discusses in his post to which Krugman links, so I’m assuming that he is talking about the same thing as Konczal.

I assume Mr. Krugman knows the difference between debit cards and credit cards, of course.  So why pick on this?  Because it shows how superficial his understanding of these issues is.

So, first he confuses debit and credit cards.

But second, he blithely assumes that interchange reform “hurts the profits” of the “companies that were earning big monopoly rents on credit cards.”  Let’s assume he means debit cards, not credit cards.  He is making an assertion here that to a non-economist might not seem that significant but which to an economist (such as Krugman) actually is quite a bold statement: that debit card companies are making “big monopoly rents” on [debit] card interchange fees and by implication that imposing price controls on debit card interchange fees simply reduces the profits of card issuers.

If it is true that interchange fees generate “big monopoly rents” then the only impact of interchange fee price controls would be a wealth effect of shifting “profits” from institutions subject to the price controls to those accept debit cards, such as retailers.  First there was no evidence in the first place that banks were earning “economic rents” off of debit card interchange fees.  What Krugman could say (and Konczal does) is that the Durbin Amendment reduced revenues, which of course it did.  But, of course, bit revenues is not the same thing as big economic profits.  And there is no evidence that there were sustainable profits in an economic sense from interchange fees.

Why does the distinction between revenues and “profits” (or economic “rents”) matter so much?  Because–to say it again–there is no evidence that issuers were earning economic rents prior to Durbin (Krugman provides no evidence that thre were–he seems to have simply made up that conclusion with no supporting evidence whatsoever.  Konczal properly speaks of revenues, not profits.).  But also because the market response to interchange fee price controls is consistent with what would happen when you impose price controls in a competitive market rather than a monopolistic market.  The key to understanding payment cards is that they are a two-sided market (which I won’t repeat the arguments again, if you want to read it see this).  The basic idea is that in a two-sided market it is perfectly plausible and efficient for one side of the market to pay a price higher than the other side of the market.  So, for example, newspaper advertisers “subsidize” newspaper readers.  Adobe Reader is given away for free while all of the cost of the product is borne by those who buy Adobe writer and thus “supply” Adobe documents.  The list could go on.  Although considering that Krugman writes for a newspaper–the protypical example of a two-sided market–you’d think he’d understand this.  Does he really think that falling advertising revenue at newspapers simply comes out of the “profits” of the New York Times and has no implications for subscriber prices or the quality of the paper?

Anyway, the effect on the market post-Durbin belies Krugman’s unsupported assertion that all price controls did was reallocate economic rents without an efficiency effect.  First, as I have noted repeatedly here, those institutions that are subject to the Durbin Amendment’s price controls (those with over $10 billion in assets) have responded to the Durbin Amendment’s price controls by raising prices and reducing services to consumers.  Second, those institutions exempted from the Durbin Amendment (banks and credit unions with under $10 billion in assets) have not raised prices to consumers in the same fashion.  (Is also bears to note, of course, that if interchange fees were nothing more than economic rents, then Krugman should oppose the exemption for smaller banks from the Durbin Amendment because the same basic interchange fee system applies to them in relevant respects and so redistributing their rents should have no effect on their viability).

As I stress in my paper on this topic, there are theoretical arguments that the interchange fees produced in a competitive market might be too high–there are also theoretical arguments that they might be too low or just right.  There similarly are a lot of different empirical conclusions.  What there most certainly is not is a consensus that there are sustainable economic rents generated by interchange fees or that those rents are not competed away on the consumer side of the two-sided market.  If Krugman has evidence that there are sustainable economic rents then I’m sure I’m not the only one who would like to see it.  And surely Krugman knows that when he is talking about “monopoly rents” he is using an economic term of art.  He might want to make sure whether he is talking about debit cards or credit cards while he is at it.

Update: Oops, I forgot the link to Krugman.  Now fixed.