This is the second in a two-part series looking at airline credit card deals. See this post for part one which explains how the ecosystem works.
The biggest US airlines are making billions of dollars every year thanks to their cobranded credit card deals with banks. Without those deals, the airlines are actually losing money which seems… bad. But could this whole setup possibly go away? If so, it’s going to have to come from Congress… which means it’ll never happen. There have actually been some efforts to kill this golden goose, though I remain highly skeptical of them.
On the surface, it is not hard to see what some of the arguments might be against continuing this arrangement, but only one makes any sense under scrutiny, and that seems like a longshot.
Let’s start with the primary argument that’s been used against these deals. In essence, if we lower fees charged when someone uses a credit card, that’s money that will go back to the consumer. Of course, if we lower fees, then the economics of the current cobrand arrangements won’t work, so the whole thing will fall apart. This is what happens in Europe where interchange fees are capped at 0.3 percent. That’s why we don’t see lucrative card deals across the Pond.
In a perfect world, the idea here is that when interchange fees drop, that’s money that gets returned to the consumer in the form of lower prices on goods. After all, the businesses will keep a higher percentage, so they can lower their prices and everyone is happy. Right? No, not right.
We actually have some real-world examples to show this. After the Great Recession, the Durbin Amendment to the Dodd-Frank bill limited fees on debit cards. One study of the impact was summed up this way:
Banks recouped a significant portion of their losses by charging consumers for products that they previously provided for free on the subsidized side of the two-sided market. The accelerated adoption of credit cards with higher interchange fees likely diminished—if not eliminated—merchants’ savings. These effects impede the regulation’s stated objective of enhancing consumers’ welfare through lower retail prices.
In other words, it became a lot harder to get a free checking account, because previously that was being subsidized by higher transaction fees on debit cards for those checking accounts. With the fees down, banks started charging fees directly to consumers to open the account. And in the case of debit cards, when the rewards that did exist started to disappear, people began shifting over to rewards credit cards instead. Those carried even higher fees than the debit cards. But even more damning is this from the University of Chicago:
The cost to merchants of taking payment on debit cards declined by more than $7 billion annually… while the effective cost to issuers of providing debit card services to consumers increased by a corresponding amount…. Did consumers gain more from cost savings passed on by merchants, in the form of lower prices and better services, than they lost from cost increases passed on by banks, in the form of higher prices or less service? We find that consumers lost more on the bank side than they gained on the merchant side. Our estimate is that, based on the expectations of investors, the present discounted value of the losses for consumers as a result of the implementation of the Durbin Amendment is between $22 and $25 billion.
Something is always subsidizing something else, and the market finds a way to equalize when new regulation comes into play. In this case, banks ended up finding ways to charge more for their services outside of the regulated fees. Then merchants didn’t give back nearly as much as hoped to consumers, so the consumers actually ended up losing money overall.
The last big attempt by Congress to address this issue on the credit card side of the house was the Credit Card Competition Act of 2023. This says that the real problem is the credit card networks like Visa and Mastercard. Credit cards are connected to only one network, and that gives them control over their fees more than would be the case if cards has a choice of networks. This would require the credit cards issued by the big banks to use at least two networks and one of them can’t be Visa or Mastercard.
Though the mechanism is different, the goal is again to reduce credit card transaction fees. And if that happens, it seems to put us right back in the same place as it did with debit cards.
I have to admit that I hate that this is the case. I’d like nothing more than to stick it to the banks. But banks are full of industrious people who find ways to make their profit margins one way or another. The real loser would end up being the consumer, not just in higher fees, but also in higher airfares. And that is a problem for Congress. The optics are not good.
This would have to lead to higher airfare. Remember, these big airlines are all losing money flying airplanes. If you take out the card revenues, they are going to have to figure out how to make money flying airplanes. That is going to mean higher fares are required, so they’ll cut capacity in order to make money. Right now, credit cards are subsidizing your airfare.
We can argue whether this model is right or not, but if you have to tell your constituents that what you support is going to raise fares and reduce airline capacity, it’s not going to go over very well.
There is, however, one argument that I think has legs to it. That’s the anticompetitive argument. Big airlines have big credit card deals that new entrants can never hope to ever match. So any new entrant is already playing with one hand tied behind its back. While eliminating the credit card deals would increase fares, it would make for a more competitive playing field for new entrants and potentially spur successful competition. (Yes, it’s a longshot, but it’s… something.) Perhaps there is some compromise in between that could require some sort of cross-subsidy. I don’t know.
I haven’t really heard people making this argument, but it’s the one that I think should be made. The big airlines have created a very significant barrier to entry into the industry through these deals, because they can keep fares lower. Someone should look into this, but there are no easy solutions. This whole construct has been built over decades, and it would be problematic to just have it disappear overnight.
Updated European interchange cap from 0.03% to 0.3%
