While Americans rely on debit transactions for the necessities of life, most are unaware of the networks that drive those transactions, nor are they aware that one company, Visa, has monopolized debit transactions, penalized industry participants that seek to use alternative debit networks, and co-opted innovators, technology companies, and financial institutions to forestall or snuff out threats to Visa's debit network dominance.” So begins the monopolization lawsuit filed on September 24 by the United States Department of Justice (DOJ) against the country’s largest card company, Visa Inc. On one level, the case is simple: The DOJ alleges a clear violation of laws protecting markets against monopolies. But the case gets more complicated when looking at the details, in part because payment systems are mostly invisible part of the financial ecosystem. In effect, the DOJ alleges that Visa is pulling the levers of a really opaque and complex system to preclude competition and squeeze fees out of banks and vendors for itself.To understand the complexities and implications of the case, Bethany and Luigi are joined by Kathryn Judge, Harvey J. Goldschmid Professor of Law at Columbia University. Judge is an expert on banking, financial crises, regulatory architecture, and intermediation design beyond finance. Her book, Direct: The Rise of the Middleman Economy and the Power of Going to the Source (HarperBusiness, 2022), was on the long list for the Financial Times Business Book of the Year Award. Together, the three of them discuss both the surface-level and structural issues of an economy where consumers and small businesses are shortchanged on what is essentially a private sales tax on all debit-card purchases—and how to look for collective solutions when opt-outs aren’t possible.
While Americans rely on debit transactions for the necessities of life, most are unaware of the networks that drive those transactions, nor are they aware that one company, Visa, has monopolized debit transactions, penalized industry participants that seek to use alternative debit networks, and co-opted innovators, technology companies, and financial institutions to forestall or snuff out threats to Visa's debit network dominance.” So begins the monopolization lawsuit filed on September 24 by the United States Department of Justice (DOJ) against the country’s largest card company, Visa Inc.
On one level, the case is simple: The DOJ alleges a clear violation of laws protecting markets against monopolies. But the case gets more complicated when looking at the details, in part because payment systems are mostly invisible part of the financial ecosystem. In effect, the DOJ alleges that Visa is pulling the levers of a really opaque and complex system to preclude competition and squeeze fees out of banks and vendors for itself.To understand the complexities and implications of the case, Bethany and Luigi are joined by Kathryn Judge, Harvey J. Goldschmid Professor of Law at Columbia University. Judge is an expert on banking, financial crises, regulatory architecture, and intermediation design beyond finance. Her book, Direct: The Rise of the Middleman Economy and the Power of Going to the Source (HarperBusiness, 2022), was on the long list for the Financial Times Business Book of the Year Award. Together, the three of them discuss both the surface-level and structural issues of an economy where consumers and small businesses are shortchanged on what is essentially a private sales tax on all debit-card purchases—and how to look for collective solutions when opt-outs aren’t possible.
Episode Notes: Also check out the ProMarket article “A DOJ Victory Against Visa May Not Help Merchants or Consumers” by Lulu Wang, Assistant Professor of Finance at Northwestern University’s Kellogg School of Management.
Kathryn Judge: One of the indicia that I would look at for whether this is an area where I want to dig a little deeper, for a problem with the middleman economy, is it’s an area where it seems like technological change should have really disrupted the rule of the middleman, and it hasn’t, and that’s a sign that there’s something wrong.
Bethany: I’m Bethany McLean.
Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?
Luigi: And I’m Luigi Zingales.
Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.
Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.
Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?
Luigi: And, most importantly, what isn’t.
Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.
Bethany: “While Americans rely on debit transactions for the necessities of life, most are unaware of the networks that drive those transactions. Nor are they aware that one company, Visa, has monopolized debit transactions, penalized industry participants that seek to use alternative debit networks, and co-opted innovators, technology companies, and financial institutions to forestall or snuff out threats to Visa’s debit-network dominance.”
So begins the lawsuit the Justice Department filed against Visa on September 24, which alleges that Visa illegally maintains a monopoly over debit-network markets.
Merrick B. Garland: Earlier today, the Department of Justice sued Visa for violating Sections 1 and 2 of the Sherman Antitrust Act. We allege Visa is a monopolist in the debit-transaction markets that is violating federal antitrust law and inflicting often hidden, but significant, harm on American consumers and businesses.
Bethany: According to the complaint, more than 60 percent of debit transactions in the United States run on Visa’s debit network—
Merrick B. Garland: Visa operates the largest debit network in the United States. A debit network facilitates the electronic transfer of funds directly from a consumer’s bank account to the merchant’s bank account in a retail transaction.
Bethany: —allowing it to charge over $7 billion in fees each year for processing those transactions. Merchants and banks pass along those costs to consumers, either by raising prices or reducing quality or service, said Attorney General Merrick B. Garland. As a result, Visa’s unlawful conduct affects not just the price of one thing but the price of nearly everything.
Luigi: On one level, the case is simple. The Justice Department alleges that Visa is violating Sections 1 and 2 of the Sherman Act. Now, for those who are not that familiar with those sections, let me try to explain.
Section 1 makes illegal any contract, combination, or conspiracy that unreasonably restrains trade. In this particular case, what is alleged is that Visa is paying participants like Apple not to compete against Visa. Section 2 is the so-called monopolizing behavior—if you’re trying to perform a behavior that uses your monopoly power in a relevant market to willfully acquire or maintain that power.
In this particular case, what Visa does is that it offers volume discounts to some of the participants who are particularly big. Now clearly, if you are big, you have a bigger incentive to get out of the monopoly by Visa, and so, if you’re subsidized to stay in or you pay a lower cost, then you stay in, making it more difficult for rivals to compete.
Bethany: But on another level, the case is really complicated—although I think, Luigi, even Section 1 and Section 2 of the Sherman Act might be complicated, too—but it gets more complicated when you look at the details of the case. That’s in part because payment systems, which are effectively the ways in which a lot of money moves in a modern economy, are a subterranean and mostly invisible part of the financial ecosystem.
Visa, for instance, makes its money by taking a set of fees that amount to just a fraction of each debit transaction. Consumers don’t see it, but merchants and financial institutions do.
In effect, the Justice Department alleges that Visa is maneuvering in the dark, pulling the levers of a really complex system in order to make more money for itself. And, wow, does Visa make a lot of money. The Justice Department’s case notes that Visa has a global operating income of $18.8 billion, which equates to an operating margin of 64 percent, and North America is even more profitable with a 2022 operating margin of 83 percent. Oh, my goodness, that’s just semi-incredible.
Luigi, you were explaining how there are two components to the case, but maybe filter that through the lens of the Justice Department’s case, if you can.
Luigi: I will, but let me add that an 83 percent margin, I don’t think even selling drugs gives you that margin.
Bethany: No.
Luigi: Real drugs, not the pharmaceuticals. Even the pharmaceuticals are pretty high, but the real drugs, I don’t think they sell at that margin. Anyway.
One part of the case involves the old ecosystem. The Justice Department alleges that Visa has used its market clout to extract promises from customers that they will use Visa’s system.
As the case put it, “Most merchants face staggering financial penalties each year unless they route all or nearly all eligible debit transactions to Visa.” The government knows that Visa itself calculated by the end of 2022, at least 75 percent of transactions by volume were insulated from competition by its rivals through its contracts.
But the other part is the new ecosystem or what should have been the new ecosystem. The case also alleges that Visa uses monopoly power to stifle emerging fintech competitors like Apple Pay and PayPal. As Visa’s then-CFO put it, “Everybody’s a friend and partner; nobody’s a competitor.” That CFO then added, “The only issue is to figure out how to make it worth their while to partner with us.”
Bethany: In response to the government’s case, Visa’s general counsel has said this: “Anyone who has bought something online or checked out at a store knows there is an ever-expanding universe of companies offering new ways to pay for goods and services. Today’s lawsuit ignores the reality that Visa is just one of many competitors in a debit space that is growing with entrants who are thriving.”
I found the evidence in the case about how, in actuality, Visa has stifled or co-opted these competitors to be a really compelling part of the case. For instance, according to the lawsuit, Visa worried that Apple, which could have developed its own proprietary payment network, was an existential threat. Instead, Visa pays Apple to make Apple Pay an on-ramp for Visa’s system.
Or take PayPal. In 2016, according to the case, Visa signed a massive deal with PayPal to squash the threat of consumers paying directly with their bank accounts, instead requiring them to use Visa’s systems. If PayPal didn’t do this, they risked losing customers who used Visa on its platform if it told them they could no longer use their Visa-branded cards. The government said it had little choice but to take the deal.
Luigi: The funny thing is that while Visa’s operations are invisible to most of us, the Justice Department’s case is just the latest salvo against the company, which has been controversial. They’re not invisible to merchant users like Home Depot and Starbucks, who have waged an antitrust battle against Visa for almost two decades.
The government has also tried to cut fees and encourage competition. Even as we record, two senators are trying to get traction for something called the Credit Card Competition Act, which they say would reduce Visa’s fee. This particular investigation actually came from a 2021 DOJ investigation following the merger between, or the acquisition, of Plaid by Visa. The DOJ stopped that acquisition and after that started an investigation of Visa itself.
Bethany: But of course, it’s a whole different thing when the federal government gets involved. Should the government prevail in this case, it has the ability to force remedies that aren’t available to civil plaintiffs. In addition, it’s a sign, I think, of the increased activism of the government under President Biden.
Luigi, what stood out to you about the case? How convincing do you think it is?
Luigi: There are enormous natural externalities. We all want to use the mean of payment that other people use because carrying a lot of different means of payment is costly, and it makes perfect sense that we all coordinate. Increasing competition in the credit-card market, paradoxically, is not necessarily welfare-improving because you have more fragmentation.
The better way to approach this, in my view, is in a regulatory manner by forcing interoperability or by creating a common standard and having everybody operate under the common standard. In my view, there is no doubt that Visa is a monopoly or oligopoly, that Visa has market power, and that DOJ can prove the alleged case that Visa has abused its market power.
The question is more, what is the remedy? Because there could be a solution in which the remedy is worse than the disease.
Bethany: That’s really interesting. Part of what interests me is that, so far, the reaction has been relatively muted. Visa’s stock has regained most of the losses that it suffered when the lawsuit was announced, and the market simply doesn’t really seem to care. One investor told me that they’ve long regarded the money Visa has to pay for settlements and civil litigation as simply part of its cost of doing business, and maybe that’s partly why no one is really focused on this lawsuit as some kind of existential threat to Visa.
Luigi: But this is the reason why I think should be a big deal, especially for us at Capitalisn’t, because we’re focused on issues just like this. What defines fair competition? What does the government need to do in this particular case? Should it get involved, should it improve competition, should it regulate, and who is really paying the cost of this monopoly? At the end of the day, it’s almost like an invisible tax that we all pay, but for each one of us, it’s sufficiently small that we don’t complain.
Bethany: We thought we would discuss all of this with Kathryn Judge. She’s a professor of law at Columbia University and an expert on banking, financial crises, regulatory architecture, and intermediation design. She’s also the author of the book Direct: The Rise of the Middleman Economy and the Power of Going Direct to the Source.
Kate, let’s start with your work on the middleman economy. How do you define a middleman economy, and what makes a middleman good or bad?
Kathryn Judge: What’s interesting about middlemen is they are both good and bad in so many different settings. We have intermediaries or middlemen who start off doing really helpful things. They help overcome all the challenges that we have with transacting. They help overcome information asymmetries; they help overcome challenges with trust, overcome the challenges that two people might be very disconnected.
In the process, they become experts; they develop relationships. They oftentimes develop really critical infrastructure that also gives them outsized power. And what we oftentimes see, then, is them using this power in their private settings but also in the subsequent shaping of regulation in ways that tend to entrench their position and oftentimes disadvantaging the people on both sides.
Luigi: I would like to start with one that most of us are familiar with and you also discuss in your book, the real-estate brokers. What is unique about American real-estate brokers? Outside of the United States, things are very, very different.
Kathryn Judge: Real estate is a great setting for precisely the reason that you point out. Whenever you can see the same type of transaction happens the world over, and yet it costs consumers a lot less almost everywhere other than the United States, it’s a sign that the system we have in the United States probably doesn’t work all that well.
You can look at the history of how the system evolved. Again, we traditionally had a system where you had brokers representing both buyers and sellers. The seller paid the fee that actually covered the cost of both brokers.
When you went to a full-service brokerage, they would have all this information about your house. They would put it into the multiple listing service, the MLS, and then the brokers who are representing buyers would be able to go to the MLS and say, “Well, for your budget, for the neighborhood you want to be in, here’s a bunch of different houses.”
It’s a lot more efficient than classified ads or what the alternatives might have been. At first, it really helped sellers who wanted to find the buyer that was willing to pay the highest price, and it helped sellers have access to a much more robust set of information.
What we saw happen over time is real-estate agents collectively use their control over the MLS to effectively prevent lower-cost alternatives from coming into the market, by making it so the buyer’s agent wanted to make sure that they were going to get their full commission, and so, they would steer people away from options that actually were not going to offer the full commission to the buyer’s agent. Going back to the international comparison, that’s where a lot of the inefficiency comes in, but it was exacerbated by the political influence they had.
One of the best ways to opt out of the system was to get a broker who said: “All right, I will represent you, and I’ll take the 3 percent. Let’s say in real estate, the commission is 6 percent. It’s going to be split three, three. I’ll take the 3 percent, and I’ll give 2 percent back to you.”
This was actually made unlawful in 15 states at one point. The number has gone down. Real-estate agents managed to convince legislators that this was really, really bad for consumers, when really, the only people who were harmed were the real-estate agents.
Luigi: Being probably the only one old enough to have bought property before the introduction of the internet, I can testify that the multiple listing service was a fantastic thing. However, even before the political side, I think that the two-sided nature of this business really entrenched them in a way that is remarkable.
What I want to stress for our listeners is the trick was the following. If you are a buyer—and buyers tend to be more finicky than sellers. Sellers want to sell. Buyers would say, “Maybe I’m going to buy, maybe I’m going to rent,” whatever. If you are a buyer, it would cost nothing out of pocket to hire a real-estate agent. As a result, basically every buyer on the face of the earth would have a real-estate agent.
Given this, what was kind of coercive, in my view, was the type of contract that the real-estate agents were having with the sellers. With a seller, they would say, “You have to pay us 6 percent,” but of this 6 percent, 3 percent is given to the real-estate agent of the buyer. And so, if you get a real-estate agent, the real-estate agent would never show you a property where he didn’t get the 3 percent. The ability to counter on one side really locked the market in a way that, even with the internet, was not easy to undo.
Kathryn Judge: That’s a great summary, and that’s exactly the challenge and part of the reason that when you’re dealing with a middleman economy, it is very hard, oftentimes, for individual opt-outs to be the mechanism through which we actually bring about structural change. If you’re the seller, it’s rational for you to effectively bribe the buyer’s agent with a 3 percent commission because you don’t want a lot of potential buyers not to come to your house. This is why we need a collective solution.
Bethany: Moving on from real estate, at least sort of, you wrote this, which resonated with me as I read the Justice Department’s case against Visa. You wrote: “The very attributes that make middlemen good connectors also give them outsized power. In time, this enables them to expand their domains, entrench the need for their services, contort consumer decision-making, and otherwise promote their interests at the expense of those they are meant to serve.”
In the Justice Department lawsuit against Visa, they wrote, “Visa, one of the most profitable companies in the United States, has succeeded so thoroughly in insulating itself from competition that it is now earning outsized profit margins from its role as a dominant intermediary, a digital middleman at the center of the debit-transaction market.”
Do you think of Visa as a classic middleman? Are there ways in which it is and ways in which it isn’t?
Kathryn Judge: In many ways, it is classic in the sense it first arose to influence because it is providing a really useful service, and it is a situation where there are clear network effects. The more people on both sides that you have signed up to your network, the easier it’s going to be for buyers and sellers to connect. It works really well for everybody.
And then the challenge arises after you’re Visa and you have 60 percent of the volume. There’s a whole variety of transactions where you’re going to be the only network where both a buyer and seller are able to connect using your network. Well, then, the merchants have no choice but to use you in those settings.
For that subset, buyers and sellers have no choice whatsoever to say, “We’re going to give you a better price for those narrow transactions when we’re the only ones that are an option if you also use us in these other circumstances where you do have a choice.” You’re effectively precluding the ability of networks to come in, offer lower prices, and really compete away at the monopoly that Visa has built up.
Bethany: It seems that at the core of the Justice Department’s case against Visa is this issue of noncontestable transactions, these transactions where Visa automatically controls it. That is what gives them the leverage to demand pricing power and demand merchant loyalty on other transactions. What are the noncontestable transactions? I read the case a whole bunch of times and I couldn’t grasp it. I’m embarrassed to admit that, but I need somebody to explain it to me.
Kathryn Judge: It is actually really difficult, and it’s because the payment system and the way it operates is really difficult. The key idea is that one of the ways the Durbin Amendment, which is part of the Dodd-Frank Act, tried to bring additional competition to the space was to make a requirement that for every debit card, it has the ability to opt in to two different networks. That way, as a consumer, when I’m coming to the table, I have two different networks.
Merchants have the ability to be, in theory, affiliated with as many different networks as they want. But as a practical matter, once you have a dominant actor like Visa, for almost all of those consumers, there’s going to be a subset where Visa is one of the networks that their card has opted into, but they’re opting into another which might or might not be a network that the merchant is a party to. And so, the noncontestable transactions are the ones where the only network that both is an option given the consumer’s card, and that is an option given the networks that this particular merchant has chosen to opt into, Visa is the only one that they’ve both managed to match on. You could think about it as a matching challenge.
Bethany: Got it. That makes sense.
Luigi: There are two reasons why I wanted to start with a real-estate broker. One is, recently, the DOJ won a big case against real-estate brokers. The second is, I think there is a very strong parallel with the payment process because what made the real-estate broker system so stable was precisely the fact that one side was heavily subsidized in a way that was difficult to resist. The same is true with Visa.
Why don’t you explain to our listeners what the subsidization is that makes it rational for all of us not to deviate?
Kathryn Judge: You don’t actually see the cost, just like when you’re the person buying real estate, and you don’t directly experience the cost. This is a consistent challenge. Again, it makes sense for the structure of transacting to only have one of the two parties bear the cost, but it does make one party cost-insensitive, and then, that creates structural challenges. The dominant player needs to only exercise leverage over the party that actually would otherwise be cost-sensitive.
Here, it’s the merchants. Merchants are very, very, very attuned to the amount of money that they’re paying to Visa to process these transactions. But for the individual buyers and sellers, you’re not experiencing any of that cost.
Again, it’s a circumstance where those costs to you would be really modest, even if we think that maybe they’re passed on through alternative mechanisms. It’s not worth it to you to invest any effort to really understand how the system works or to open up different alternatives or options for the sellers from whom you’re buying things.
Luigi: The moment when I understood the problem with Visa was when I was in a cab in Rome. The Italian cab drivers are notoriously against any form of credit cards, and there was an advertisement for Alipay. The Chinese had arrived in Rome. And why had they arrived in Rome? Because Alipay is so much cheaper than Visa, it’s not even funny.
All of a sudden, you realize that it doesn’t make any sense, and you need to fight, in some way, the system. Not only does it damage consumers in the United States, but at the end of the day, it also damages the competitiveness of the US economy. You’re going to have fewer and fewer people use the American system of payments and more and more using other method of payments, particularly Alipay.
Kathryn Judge: It’s a key point, and that’s one of the challenges with the middleman economy. One of the indicia that I would look at for whether this is an area where I want to dig a little deeper, for a problem with the middleman economy, is it’s an area where it seems like technological change should have really disrupted the rule of a middleman, and it hasn’t, and that’s a sign that there’s something wrong.
Luigi: Going back to the real-estate broker example, because I think it’s easy for people to grasp, it’s very inefficient to have two multiple listing services. You do want to have one because you have all the properties there, and it is much easier to search. If you were to try to enter by creating an alternative market, at the beginning, you are creating enormous inefficiencies. Even at the end, unless you replace it completely, if you have two segmented markets, I’m not so sure that consumers are necessarily better off.
My question is, maybe we’re going the wrong way because rather than trying to go the antitrust way, we need to go the regulatory way by forcing interoperability. I don’t know if you’re familiar with what’s happening in India, but in India, they created a uniform payment interface that is basically public domain. Anybody can use it and benefit from the network externalities, but nobody owns that structure. That makes it a much more competitive system. Why is it so difficult in the United States to go in that direction?
Kathryn Judge: It’s precisely the right question to ask. For a lot of these challenges, antitrust is an important tool to be brought to bear, but it’s going to be incredibly incomplete. Are there alternative mechanisms, whether it’s through interoperability or other bottom-up mechanisms of making it less costly for people to opt out of the dominant system?
The payment space is a great example of this, and you’ve mentioned that both China and India have done a great job moving ahead. We’ve actually seen Brazil move ahead with Pix, with a distinct central-bank digital currency.
Luigi: You mentioned the Brazilian Pix. I imagine a lot of our listeners don’t know what this is. This is a system of payment designed by the Brazilian central bank and provided basically for free to all the banks and all the intermediaries that is free to operate. You go to the beaches in Rio de Janeiro, and you see people selling stuff, like coconuts, with a QR code and Pix. This is really a very effective alternative as a means of payment. And you wonder, where is the United States?
First of all, the United States is late to the game. It introduced FedNow only a year ago, and FedNow has been introduced very gingerly, not pushing it too much, by the very words of the Federal Reserve, not to disrupt the deposits of the banks, so to protect the monopolies of the banks. The next step in this big debate is the so-called Central Bank Digital Currency or the so-called CBDC.
Can you tell us why this is such a contentious issue, and where do you fall on this spectrum?
Kathryn Judge: One of the reasons it’s such a contentious issue is what we actually mean by a CBDC is a whole bunch of different things. The Fed has at times considered whether or not it might issue a CBDC at some point in the future. It has been very clear it would not do so without direct instruction to do so from Congress.
But when they contemplate doing this, they are contemplating doing it in a way where banks would still be the key players to which you actually have the account. That makes a big difference, as opposed to the idea some have had of, we’re going to have a bunch of retail and consumers, so folks like all of us, with an account directly at the Fed. We’re going to earn the same rate of interest on our accounts that the Fed earns.
One of the reasons it’s gotten to be so controversial is one of the things that we ask banks to do is to effectively play a role in monitoring—one could even say spying—on the entire citizenry and noncitizenry, anybody who’s really engaging in any way with a US bank or a correspondent bank. There’s a bunch of affirmative obligations we have in terms of retaining information about those transactions and reporting on those transactions.
One of the reasons this has become very controversial is there are a lot of questions over whether we want all of that information, which is very personal at this point. Every time I go on the subway, I effectively swipe a credit card or perhaps a debit card.
Now, all that information could be directly in the hands of a central bank, and what might they do with it? I think one of the reasons the central bank doesn’t want this to be done directly is they don’t want to have any responsibility whatsoever for trying to assess or analyze the suspiciousness of transactions, and they don’t want to actually have this type of data about our behavior.
Luigi: I want to pause a second on what you said because I think it’s very meaningful. If I understood correctly, you said that the Fed does not want the responsibility to actually implement the rules imposed by the Fed. All the anti-money-laundering things, et cetera, are created by Treasury, by the Fed, in order to play a perfectly legitimate, important role, which is to screen against money laundering, but the Fed does not want to be responsible to actually follow up on its own directives.
Kathryn Judge: Yeah, I’m happy to say that, but I think it’s important to know what we’re actually talking about with respect to directives and what the Fed thinks it’s good at and the Fed thinks it’s not good at. The Fed right now is structured to be a bank to banks, and in asking it to instead provide perhaps direct accounts to people all over the country, you’re changing dramatically the nature not only of AML but providing all of the other services that we typically want from our banks.
Luigi: Sorry, there are two different functions. One is to provide some services, and the other is to hold and invest those deposits, and the two can be separated. What I want to stress, because I’m very frustrated by this, is that today, when I deposit my money at Citigroup, I receive five basis points. Citigroup turns around and deposits at the Fed and gets 4.9 percent. They gain 485 basis points for just the privilege of being a bank. If this is not subsidization, I don’t know what it is.
Kathryn Judge: Well, you should go out and find yourself another bank. What you were pointing out, which is really important, is one of the ways banking has long worked is that it’s relied on a certain amount of . . . You can put it in more and less critical ways. One is ignorance on the part of depositors. Another is a willingness to accept a lower rate of return on deposits in exchange for a whole variety of services, including the ability to go to an ATM, the ability to wire money, a bunch of fraud-protection services, which potentially can be quite significant.
One of the interesting challenges that has arisen more recently in Brazil is that faster payments have been really great, and once people realize there are fast payments that were irreversible, kidnappings, actually—with the requirement that you’re then kind of passing money on along really quickly—became more of a challenge.
There are reasons that we actually have frictions in the payment system, and there are reasons that we have some of these safety mechanisms built in, but you’re certainly right. The structure of the banking system does mean that during periods of relatively high interest, in particular, what you’re going to get on those accounts is not going to match what Citibank is getting in terms of interest on reserves that it has sitting at the Fed, which is the reason I would expect you to have very little in your bank account and a lot more in your money-market mutual-fund account, which is getting something much closer to the current interest rate.
Bethany: If you were to craft an ideal payment system, if we could start from scratch, rip Visa out and craft a payment system that worked really well for merchants and consumers, what would it look like? How would it look different than what we have today?
Kathryn Judge: That’s a wonderful question. I think you would have to start with the core question of, do we want the payment system to be embedded in the banking system or not? Today, most credit is extended outside of the banking system, but banks continue to be a cornerstone that actually play an important role stabilizing the provision of credit during good times and bad times.
Part of the reason they’re able to do this is because folks like Luigi leave their money on deposit and don’t earn that much. There’s a trade that’s being made, in some ways, with a banking system where we’re allowing them to earn a little bit more on deposits, but in exchange, we’re asking them to play these various roles both providing credit and, as we’ve discussed, monitoring activity in ways that actually might be suspicious.
There’s the possibility of revisiting that core agreement that we’ve reached and, more importantly, if we’re going to allow banks to do it, do we have affirmative service obligations to make sure that everybody has access to a bank account? We’ve seen a significant decline in the unbanked and the underbanked, but it’s not at zero. One might be to just create a whole new payment system. The other would be to leave the banking system in place but put more affirmative obligations on banks to actually provide bank accounts to all comers.
Luigi: You stated it beautifully. I think you’re a candidate to become the next Fed chairman or governor because the trade-off is not between my laziness and the bank’s stability. If that was the case, I would be very happy to trade my laziness for the bank’s stability. The trade-off is between unsophisticated people who get screwed, to use a technical term, and the stability of the banking sector.
We have a system where the Fed, by design, defends the stability of the banking sector, de facto screwing the unsophisticated depositors. From a social point of view, I find this unacceptable, but it seems that everybody at the Fed seems to be very comfortable in doing that, which I find very strange.
Kathryn Judge: First of all, I don’t think it’s specific to the Fed or specific to the United States, which is part of what’s striking. It is a core challenge, but I wouldn’t say it’s just about sophisticated versus unsophisticated. It is really a question of, what are the values that people think that they’re getting from a bank account? That’s changing over time.
For a long time, we had community banks everywhere, and those banks played a really important role with depositors but also supporting growth in their communities. They did more small-business lending. We know that they still do more small-business lending. More of that small-business lending is relationship lending, which really promotes a certain type of economic development. We’re shifting to a very different banking system that’s becoming much more transactional and is more dominated by the biggest players.
There, I think we do have to scrutinize far more closely whether this is a trade-off we want to continue making, or are there ways to revive a banking structure where it is more relationship-based, where there’s actually community building and credit provisioning in ways that we particularly value, that we’re getting out of the structural trade-off that we’re making?
Bethany: Luigi, I thought one of the things you were trying to get at in the conversation with Kathryn is something we talked about in our introduction, which is, for lack of a better way of putting it, the difference between a result and a result that actually accomplishes something.
How do you think about that, in this case? Did anything Kathryn said make you think about this any differently? Is this a case that’s worth doing, even if the result is not actually beneficial to consumers or merchants or financial institutions? Is it worth doing on the merits of Visa’s monopoly alone, assuming the government’s facts are right, or is it a case that should only be brought if the remedies can actually fix something?
Luigi: As you know, as I get older, I become more cynical, and I think that the biggest benefit of most antitrust cases is not remedy but the process. If they get to discovery, we find out a lot of juicy emails that really nail the case. This is also very important for us economists because we always look in the dark, et cetera.
But when you have the emails that say, “This is an existential threat, they’re becoming our friend,” these are fantastic. Warning to everybody, never write anything in an email because everything that you have in an email is discoverable. At this point, you must not pass the IQ test if you write something like this. At the very minimum, they should be convicted for sheer stupidity for writing this in an email.
The second thing, which is more important, is that once a company is actually under scrutiny by the DOJ or the FTC, they start to behave much better.
It’s a bit like the elementary-school teacher saying, “I’m watching you,” and then, all of a sudden, the boy that is always misbehaving starts to behave a little bit better because he knows that the teacher is looking at him all the time.
Basically, an antitrust case is like this. They are very instrumental in allowing competition per se. In the Microsoft antitrust case, the remedy was a nothing burger. Basically, nothing was done. Very little was done, and nothing effective was done. However, because they were under this enormous pressure, Microsoft found it more difficult to monopolize the internet as they wanted, including creating Google. If Google exists, it’s thanks to the antitrust suit.
Bethany: What happened with Microsoft is an interesting lens to see this through because I’m actually unresolved on that aspect of the Microsoft case. It clearly changed Microsoft’s behavior, and clearly, because it changed Microsoft’s behavior, it probably did open the door for companies like Google to exist.
But because it changed Microsoft’s behavior, it also resulted in the growth of an enormous legal bureaucracy at Microsoft and the loss of a certain degree of confidence and, really, a lost decade or almost a lost decade and a half for Microsoft as a company, where it struggled to find its footing again after that. Is it necessarily a good thing that it changes the company’s behavior?
Luigi: The bureaucratization of Microsoft, I’m not so sure you can attribute to the antitrust case. I think that it—
Bethany: Maybe.
Luigi: —is easier to look perfect if you don’t face competition. The moment you face competition, then you see all the problems. If you are saying that the antitrust case generated an enormous amount of return to lobbying and increased lobbying in Washington, et cetera, as our previous episode demonstrates, I think that you’re absolutely right. I would see as a societal cost more the increased lobbying as a result.
One of the things that Google learned is you have to start lobbying from day one. Now, even startups have a lobbying department, which is kind of ironic because in the old days, it was not the case. I think I see that as a major cost. The other one, much less so.
Bethany: I thought the broader aspects of our conversation with her were really, really interesting, too. I liked her idea that antitrust . . . I think it’s easy to become the person with a hammer who sees everything as a nail. Isn’t that the old saying? I think it’s easy, if you see things through the lens of antitrust, to think that the remedy for everything is an antitrust lawsuit. I liked her idea that that was just one part of the panoply of options or just one aspect of how to think about this. Did you agree with that?
Luigi: I agree with that a hundred percent. Where I happen to disagree with her is the solution. I think she’s much more reluctant in going for a Fed-led solution to payment than I would have expected.
Bethany: Her explanation, her privacy explanation, didn’t do it for you?
Luigi: No, to be honest. Again, maybe because I’m cynical, maybe because I’m Italian, or maybe because of both, but I assume that anything that a company has, the government can get tomorrow. If Visa has some compromising details of something that I’ve done wrong, and President Trump wants to extract them from Visa, he’s going to find a lot of ways to extract them from Visa in a way that I’m not even aware.
I feel better protected in terms of privacy if there is a government agency with a particular mandate and some particular rules, and maybe you give the chairmanship of that agency to the opposition party or something like this.
I think that some government-based solution to protect my identity is much safer, in my view, than one that relies on profit motives. The profit motive is to sell me at the highest bidder.
Bethany: I like that idea in a much broader way that perhaps the leadership of every regulatory agency should be put in the hands of somebody who is in the opposite party of the one in power. I think that would be a really nice addition to the Constitution, actually.
Back to that note, it’s funny, I have a little more skepticism of the Fed than you do or of a Fed-led payment system. I think part of that is, at times, hypocritical resistance to the idea of the government as part of our business life and this sort of antiquated idea or idea that was never true, that the two should be separate, when in reality, they are not separate.
I remember dealing with this when I wrote about Fannie Mae years and years ago, back in 2004. It struck me as insane that the government was as involved in the housing market as it was through its effective sponsorship of Fannie Mae and Freddie Mac, in this unofficial guarantee that existed, which was the strangest concept in the world to me at the time.
I’ve subsequently realized that much of our system, the financial system in particular, does work in exactly the same way, whether it’s the government backstop of the banking system or the Fed’s involvement now in financial markets. But I still can’t help this resistance to the idea of the Fed taking over the payment system. Does that make sense to you? Am I articulating this well?
Luigi: Actually, yes and no, because on the one hand, I’m a hundred percent with you on Fannie and Freddie. I think that probably we are the two people in America who hate Fannie and Freddie the most. You cannot find a bigger supporter of this idea than myself.
However, remember, this is a function that can be handled by the private sector. In the case of payments, you have to realize that the government has been in the business of payments at least since 1913, probably even earlier than that, through so-called cash, right? The Fed is providing cash.
The only business that even Milton Friedman wanted to be controlled by the government was the Fed. There was a debate between him and Hayek. Hayek believed in private money, and Milton Friedman said, “No, money should belong to the government.”
Why? Number one, there is a gigantic natural externality. Number two, there is a seigniorage involved, so that you get money out of providing the service for doing nothing. This is the closest thing to a free lunch, and that belongs to the government, not to the private sector. That’s the reason why I see a threat in all these stablecoins, because all these stablecoins are really eating up part of the seigniorage of the Fed and part of the seigniorage of the banks.
I’m coming to the seigniorage of the banks, but the idea that payment should be done by the government is not a new idea. I am a big supporter of that, even if I think the government should be out of everything else except defense. I’m exaggerating a bit, but just to make the point.
Bethany: Go back to your first point. You said there were two things. There was a giant externality and then there was the seigniorage. I understand the concept of the seigniorage, but I don’t understand what you meant by the externality.
Luigi: Oh, there’s a natural externality that you want to use the same method of payment as I do, and so we naturally converge to the same platform.
In this situation, if there is only one, that one tends to be a monopoly and with the problems that come with monopoly. That’s another reason to have the government involved. If you cannot have a private competitive solution, I think that the lesser evil is a government monopoly rather than the private monopoly, because the private monopoly tries to extract all the surplus from the customers and gives all the profits to a few people. From a redistributional point of view, it has very negative aspects. We didn’t have time with Kathryn to go into that.
There is an aspect which is less important with debit cards, but much more important with credit cards. There is a pretty adverse redistributional effect, which is exactly like the real-estate brokers—sorry for my obsession.
They basically rebate or give a gift to the buyer by not charging anything out of pocket. With Visa, you get a rebate in the form of miles. Part of the cost of those miles is paid by the merchant through the discount, but part of the cost of those miles is paid by the people who use cash.
I saw some estimates that basically every cash user subsidizes credit-card users to the extent of $700 a year, under the assumption that prices are the same. When I go and buy my Starbucks coffee, I can pay cash, or I can pay with a credit card. I can also pay with a Starbucks app, but that’s a different story.
Let’s say that I pay with Visa, so I pay the same cost. To the extent that they make up for part of the difference by charging higher prices to everybody . . . If the price charge is the same, and imagine that they need to reach a profit target or need to survive, so there is some constraint, then they need to increase all the prices.
Suppose that I pay with a credit card, and you pay with cash. We both get the same price, but I get the miles as a rebate. Because the miles don’t come from heaven, they have a cost, you end up paying for that. You, cash buyer, are subsidizing me, credit-card owner, and the people who own credit cards tend to be richer, and the people who own cash tend to be poorer. So, this is the opposite of Robin Hood. You should call it the Sheriff of Nottingham, because it’s really charging the poor to give to the rich.