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March 1999
Volume 17, Number 3

Credit-Card Conspiracy
by Gregory Bresiger

Duality is the Visa and MasterCard management policy that allows banks doing business with one to issue both credit cards. It is a contractual arrangement the merits of which must be tested by the market. There is no way to know ahead of time which contracts will (and should) survive and which will (and should) go by the wayside.

But in these times of hyper antitrust enforcement, when even the right to develop software is questioned in court, the Justice Department has announced that duality is "anti-competitive." It has staked the success of a huge lawsuit against Visa and MasterCard on proving that duality is strangling the card marketplace, hurting consumers, and killing innovation. It was not always thus. The potential absence of duality was the basis of an antitrust lawsuit lodged against the big card associations by the Justice Department in the 1970s. Back then, government attorneys insisted on duality. So the credit-card associations, under the threat of lawsuits from the federal government, each adopted the policy. The attorneys at the Justice Department's Antitrust Division, the same people who virtually invented duality, now want it scrapped.

What is it the Justice Department wants out of the biggest credit- card associations? Is duality in credit- card membership, the freedom for a bank to be a member of both major credit-card associations in the United States, good or bad? Is it legal or illegal? Is it a system that promotes cartels or a system that results in vigorous price cutting much to the consumer's benefit?

Back in the early 1970s, MasterCharge, the predecessor of MasterCard, and AmeriCard were rival bank associations. AmeriCard was a collection of banks that regarded their charter members as belonging to an exclusive club. No one was allowed to go outside the club. Then one bank member of the association, Worthen Bank of Arkansas, tried to issue MasterCharge cards.

Worthen, the Visa member, took the position that Visa membership rules would be anti- competitive--a violation of the Sherman Antitrust Act--if it was not also able to issue MasterCharge cards. Worthen went to the federal district courts to gain support in its battle with AmeriCard.

AmeriCard wanted to change its bylaws to ensure that type of battle wouldn't happen again. Then AmeriCard officials used the type of language that U.S. Attorney General Janet Reno uses today. In a letter to the Justice Department on November 11, 1974, AmeriCard counsel Francis Kirkham explained to government attorneys why the company was changing its bylaws to prohibit duality.

"AmeriCard submits that competition between the two competing bank-card systems must not be lessened and that it is the duty of each system to resist any action which will lessen the competition," Kirkham said. He complained that "dual membership causes misuse of confidential and proprietary information; dual membership erodes and eliminates competition; dual membership lessens the incentive to promote each system competitively."

Compare those words to the ones now used by the Justice Department in its recent complaint: "Each of the associations is a fishbowl and officers and board members are aware of what the other is doing, much more so than in a normal corporate environment."

But going back to the 1970s, the Justice Department of that day warned AmeriCard that, if it tried to stop members from pursuing duality, it would trigger legal problems. That Justice Department then seemed to be endorsing the duality that Worthen Bank was seeking. On November 6, 1975, the Justice Department wrote in a press release commenting on AmeriCard's proposed bylaw prohibiting duality that "it had antitrust objections" to the proposed bylaw.

The card associations backed down. Duality had won the day in 1975. After 1975, the card industry in the United States developed with two major associations allowing issuers to use each other's products. The card associations, which faced a few lawsuits from competitors over the issue of duality, apparently felt safe. They easily won in court. The cards business exploded with tons of new products in the 1980s and1990s.

MasterCard and Visa could be chummy, with directors serving on each other's board, but competition survived nonetheless. Issuers, the ones who make card offers, sold their own kinds of MasterCard and Visa products. They ferociously competed on price--the interest rates they offered prospective customers--and on frills such as free airplane tickets and other customer inducements.

Many issuers waived annual fees, fearful that they couldn't keep up with the competition unless they came up with perks. Issuers are the ones who actually sell the credit-card services to cardholders. Visa and MasterCard, which are card associations, process the transactions and enforce rules and regulations for the members of their associations.

Today's credit-card business generally doesn't look like a cartel. Consumers are paying less in fees and other charges for the various services. Profits generally are achieved by issuers through huge economies of scale. A few big issuers have become much stronger--Citigroup, MBNA, Chase Manhattan--and a large number of inefficient players have been pushed out or merged over the past two years. However, consumers receive more offers than ever.

Today annual fees are rare in the card business, a byproduct of competition. Issuers continue to steal each others customers using "teaser rates," rates that are unusually low for a short period of time. Later the rate often rises. But then the sage consumer just transfers his or her balance to another issuer's card product offering teaser rates.

Cardholders with good payment records can keep the bargain rates going indefinitely. Others stick to the same card, but pay off their balances in full each month, meaning that the issuer has extended a 25 to 30 day interest-free loan to a smart consumer. More cardholders have been taking advantage of the grace period and paying off charges without interest--these people are known as transactors--a development that is good for cardholders, but not so good for some issuers. No wonder credit-card profit margins have been on the decline since the early part of this decade.

But some twenty years after the Justice Department forced duality on the card associations, government lawyers decided that duality was destroying competition. American Express, which had been falling behind in the competition with Visa and MasterCard, urged the government to sue the associations. Amex, which tended to have higher fees and charges than its competitors, has been losing market share in the United States over the past few years. Amex officials were angry that the associations had a bylaw prohibiting their members from issuing Amex cards. Said Amex Chairman Harvey Golub: "[The associations] betrayed millions of American consumers. They abused the trust of thousands of banks that relied on them." Amex was serious. It hired Robert Bork (who is also on the frontlines attacking Microsoft) to lobby the Justice Department.

Discover, another card company shut out of Visa/MasterCard networks, joined Amex in complaining to the government. In its lawsuit, the government devoted about a third of the complaint to arguing that Discover and Amex would have grown faster and been more competitive if duality and restrictive bylaws were not in place. Justice wants rescinded the Visa/MasterCard bylaws that prevent members from issuing Amex and Discover cards. Whatever the merits of duality, the lawsuit against Visa/MasterCard is sheer folly. There is feral competition between the members of the associations, the banks that issue various kinds of products. Visa, for example, has some 6,000 member banks. They offer some 20,000 different Visa cards with different interest rates as well as bonus features such as free groceries, airline miles, and gas.

That's because sage consumers have used the competition between issuers to find good card buys. Teaser deals have ranged from zero percent to three-percent interest. Today, individuals can borrow money at better rates than huge corporations. These hardly seem the characteristics of a monopolistic market, a market in which competition has been "restrained." The government's Visa/Master-Card lawsuit will serve a useful purpose if it triggers a debate about the nature and usefulness of antitrust laws. These laws are a danger to the rights of business owners who want to use peacefully their property under law. Agreements reached by consenting individuals that do not involve the use of fraud or coercion should be beyond the authority of government.

And just because a market has fewer competitors, fat profit margins, and higher prices--the latter two are the opposite of what has been happening in the credit-card market--is no proof that a market has been rigged. The government, in enforcing what seem to be at times nebulous rules, once again, is setting out to accomplish an impossible task, a task beyond the knowledge and capacities of even the most brilliant bureaucrats.

The nature of business is a dynamic process of innovation. Businesses, and different categories of business, spring up with amazing speed, while outdated technologies die quickly. Given the government's conflicting antitrust policies on credit cards over the past quarter century, and given the obvious buoyant nature of a credit-card market with fierce competition and consumers enjoying a plethora of different products and services, the government should drop this case and not hurt issuers who are doing a good job serving the needs of the American consumer.

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Gregory Bresiger is a journalist living in Kew Gardens, New York.



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