Credit Card Wars: Context of a Consumer Victory

Albert A. Foer

While most rumination about antitrust in 2002 focused on settlement of the U.S. government's case against Microsoft Corporation, two important antitrust cases involving Visa and MasterCard were quietly wending their way toward a conclusion that will have sweeping consequences for consumers, retailers, bankers, and the payments industry.

In the first case, the Department of Justice won its suit against Visa and MasterCard and now awaits an appellate review. Twenty-five consumer groups (including the American Antitrust Institute) signed an amicus brief supporting affirmance. The second case is a class action brought by much of the retail community against Visa and MasterCard, seeking damages that are reported to exceed $50 billion. The class certification was approved and withstood appeal in 2002 and the trial was about to begin when, in the past two days, first MasterCard and then Visa folded their hands. While information about the settlements is still sketchy, it was reported that the companies will pay a total of $3 billion to retailers, lower the fees they charge for most debit card use, and end the card associations' practice of requiring their credit card retailers to accept their debit cards.

There were over 500 million general purpose charge and credit cards outstanding in the United States in 2001, involving an estimated $1.124 trillion in purchases. There is a myth that this market is very competitive, because there are thousands of card issuers. But at the critical network level, the market structure is far less competitive. Visa and MasterCard are national associations that together account for 85% of credit cards issued. The two associations have virtually the same members (approximately 8,000 banks), the same owners, and the same rules of operation. Must they relinquish certain of their internal rules that keep other companies from competing against them? Two issues, exclusionary rules and "honor all cards" tying, have been in play.

DOJ attacked the so-called Exclusionary Rules adopted by both Visa and MasterCard. These rules prohibit any bank that issues a Visa or MasterCard card from also issuing the cards of American Express, Discover, or certain other competitors-but banks are allowed to issue Visa and MasterCard cards, as well as Diners Club. (Back in 1996, the European Commission forced Visa and MasterCard to give up these rules in Europe, and consumers apparently benefited.) After a three-month trial in 1999, U.S. District Court Judge Barbara Jones found this to be an unreasonable restraint of trade, in violation of the Sherman Act. Because of the market power held by Visa and MasterCard, the Exclusionary Rules foreclosed smaller, competing networks from having the banks also issue their cards, which would make them better able to compete against the two dominant firms. This raised the costs of American Express and Discover and also delayed innovation, particularly the introduction of the "smart card" and multi-function cards. It also prevented banks from competing with one another by issuing American Express or Discover in addition to Visa and MasterCard.

Debit cards are an increasingly vital part of the payment card industry and are growing at a much faster rate than credit cards. Judge Jones also found, over Visa/MasterCard's objections for irrelevancy, that the exclusionary rules foreclosed the debit card market to significant entrance. This holding came as a surprise in that it was not sought by the DOJ.

The retailers' class action (representing more than four million merchants and three merchant trade associations, possibly the largest class action in American history) also focuses on the debit card market and no doubt benefited from many of the official findings in the DOJ case. In their merchant contracts, Visa and MasterCard impose an "honor all cards" duty on retailers, which forces them to accept their debit cards, if they want to be able to accept their credit cards. Retailers alleged that this is a tying arrangement aimed at monopolizing the debit card market. They objected because the off-line debit technology utilized by Visa/MasterCard is slower, more prone to fraud, and much more expensive than the on-line ATM technology offered by various regional debit networks with whom they would prefer to deal. That extra cost, by the way, pushes up prices for consumers. In countries such as Canada where there is no "honor all cards" rule, debit card usage is more significant, safer and less expensive.

The purpose of antitrust enforcement is to eliminate artificial barriers on competition so that the competitive process can provide the optimum in lower prices, innovation, and consumer choice. Visa and MasterCard maintain their domination by using their market power to substantially disadvantage their rivals and they extend that power into debit cards by requiring retailers to accept their more expensive, less desirable cards. If the principles of antitrust assure that competing networks, such as American Express and Discover, are permitted access to the banks, consumers will be the ultimate winners.

Contact: Albert A. Foer, 202-276-6002