- Key insight: The 8th Circuit’s ruling in Corner Post v. Federal Reserve Board ignores congressional intent, leaving banks unable to charge fees for reasonable expenses related to debt card transactions.
- Supporting data: A unanimous decision from the 8th Circuit panel affirmed a ruling for Corner Post, a North Dakota truck stop. The decision vacates Regulation II’s debit interchange price ceiling.
Neither of us should ever be mistaken for fans of the Durbin Amendment, the red-headed stepchild of the Dodd-Frank Act. The delicate card payment ecosystem has never been the same since its implementation. Yet some readers may be surprised that we both filed amicus briefs in two critical card payment and interchange cases in the last 12 months: Linney’s Pizza v. Federal Reserve Board and Corner Post v. Federal Reserve Board. In both cases, our briefs supported the position of the Fed. Last week, we were both disappointed to see the Fed lost against Corner Post.
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A unanimous decision from the 8th Circuit panel affirmed a ruling for Corner Post, a North Dakota truck stop. The decision vacates Regulation II’s debit interchange price ceiling. Originating with the Durbin debacle in 2011, that restriction has held the interchange fees charged by large card issuers to a 21 cent maximum plus 0.05% of each purchase, with an allowance for one additional penny for meeting fraud prevention standards. Writing the opinion for the court, Judge David Stras read the statute to consider an issuer’s “incremental cost” as an unambiguous congressional command to set that price cap at marginal cost: the cost of one additional swipe.
It’s not really Corner Post v. Fed; it’s marginal cost v. incremental cost. Marginal cost is the change in total cost for each additional unit of output, whereas incremental cost is the total additional cost incurred over multiple units. And a tiny truck stop just put the nation’s payment card network, and bank customers, on trial over the difference.
The statute’s language explicitly says that interchange fees must be “reasonable and proportional to the cost incurred by the issuer with respect to the transaction.” The Fed was compelled to “establish standards” for assessing that, but in doing so, was also required to distinguish between two kinds of costs. Statute required the Fed to consider the “incremental cost” of authorizing and settling “a particular electronic debit transaction.” However, the central bank was not to consider “other costs … not specific to a particular … transaction,” such as the overhead costs of bank branches, advertising, and mailing monthly bank statements, even though those debit card systems can’t exist without them.
But Congress realized there are transaction-specific costs that are not included in authorization, clearance and settlement, or ACS, such as fraud monitoring, fraud losses, and the networking costs of servers and software that are necessary to process individual transactions. Judge Stras says that fraud losses are not recoverable, so next time your card is stolen, blame the 8th Circuit, not Congress. Had Congress meant these as mirror images, it would have barred all transaction-specific costs not specifically related to ACS processing. For an economist, “incremental costs” includes the proportional costs of these otherwise fixed cost transactions as part of the costs of transactions. And so, Congress delegated responsibility to the experts at the Fed to figure out what those costs are, how much they are and how they might change over time.
Nevertheless, in its ruling last month, the court insisted that the Fed “sort the costs” rather than “pick a number.” But the Fed had already sorted them, back in 2011. It counted costs a bank must incur for any transaction to happen. That includes hardware, software and labor. It also excludes costs like card production, which the famed Judge Stephen Williams of the D.C. Circuit identified as being incurred “without regard to whether, how often, or in what way” a transaction occurs. That includes overhead, marketing, and debit rewards programs (which not coincidentally disappeared from banks’ debit card programs following the Fed’s rule).
That court largely upheld the framework in 2014 but under the Chevron doctrine, which has since been abandoned. A federal judge in Kentucky reached the same conclusion last year with no Chevron to lean on: The statute lets the Fed consider costs it isn’t required to consider so long as they aren’t forbidden.
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Long story short, the 8th Circuit’s reading erases that middle ground, taking the arguably carefully chosen congressional language with it. The court’s own words are that interchange fees need not “exactly match marginal cost.” The Fed can use a proxy, sure. Average variable cost bears a reasonable relationship to the real thing. Neither is “incremental costs.”
The line it drew produces strange results. For example, assume one computer server can process 1 million debit card transactions, after which the bank needs to buy a new one. Under the 8th Circuit’s reading, the marginal cost of the first 1 million transactions is about a nickel but we’d hate to be the guys who get charged $5,000,000.05 for the 1 million and first swipe that occurs on the new server. Some expenses can be fixed for one bank and incremental for another. Under that test, a bank that purchases anti-fraud software outright can’t count it, but if it outsources that service to a third party that charges a per-transaction screening fee, they can charge for it, even if that is more expensive and less effective than in-house fraud prevention. In-house customer provision of customer service to deal with fraud is out, out-sourcing to overseas agents is in. The Durbin Amendment was ill-advised, but it wasn’t stupid.
Durbin has been relitigated so many times that we’ll spare you the pain of doing so again. But it did show us that after the 2011 cap, the Fed’s own economists found that free checking accounts from covered banks were in free fall. Simultaneously, monthly maintenance fees and minimum balances both increased. This new cap built on marginal cost would teach that same lesson again. Like last time, account holders are going to pay for it.
The 6th Circuit heard oral argument in Linney’s Pizza on Oct. 22. Meanwhile, the ruling in Corner Post doesn’t take effect until the court issues its mandate. After that, the Fed has 45 days to seek rehearing. If the circuits split, with the D.C. Circuit on the Fed’s side, the Fed and the solicitor general have a path to seek Supreme Court review, along with a stay of the pending mandate. This would prevent the rule from being rebuilt on one circuit’s reading before the question is settled.
Fidelity to Congress means reading every word it writes. But as Justice Samuel Alito recently noted in an analogous context, fidelity to statutory text does not require judges to pretend that ambiguous terms aren’t or abandon a sensible reading in favor of a strained and absurd one. The 8th Circuit only read half of the Durbin Amendment. The full court or the Supreme Court should read the rest.
