The Federal Reserve’s mission creep: Picking market winners and losers

Originally published at Washington Examiner.​

Government intervention in markets is back in vogue after Vice President Kamala Harris proposed price controls on groceries and food. But this isn’t the only price control the government is eyeing. The Federal Reserve is picking sides in a fight between banks and big-box retailers concerning who pays what when a customer makes a purchase using a debit card.

The proposed regulation, known as Regulation II, limits the amount that large banks can legally charge merchants to process a debit transaction. It was first enacted in 2011 as required under the Dodd-Frank Act. At the time, retail lobbyists tried to justify this price cap by arguing that lower debit card interchange rates would translate to savings for consumers at the register.

​Surprise, surprise: Those savings never transpired. Only about 2% of large retailers reduced consumer costs after the initial implementation of Regulation II, per research from the Federal Reserve Bank of Richmond. Instead of passing on savings, these large merchants often pocketed the difference, undermining the very premise of the regulation.

Letting large companies such as Walmart fight their own battles seems like a no-brainer in a free market economy. Companies come together, negotiate a contract, and, if they don’t like what they’re paying, find an alternative provider.

Yet, retail lobbyists have somehow convinced the Federal Reserve to tip the scale in their favor by further lowering the legal limit that large retail stores have to pay to process debit transactions. Meanwhile, banks and card networks such as Visa and Mastercard will be forced to cover the cost.

​This change could have serious consequences for consumers and small financial institutions, but it also sets a bad precedent for the government’s role in the marketplace. Should the Federal Reserve’s mission be to pick winners and losers when it comes to the activities between private companies? The answer is no.

The Federal Reserve isn’t oblivious to the politics here. It knew it would be controversial, therefore, it only applied Regulation II to institutions with over $10 billion in assets. That way, it wouldn’t also have to justify the changes to frustrated community banks and credit unions. Yet, the regulation had unintended consequences hitting even these exempt institutions. Between 2011 and 2021, debit card interchange revenue for exempt issuers fell by 13% for single-message network transactions, a clear sign that the ripple effects of price controls extend far beyond their intended targets.

Moreover, the proposed regulation’s stricter routing requirements could further strain smaller banks by limiting their flexibility in negotiating better terms with networks. This could reduce their ability to offer competitive pricing and services to consumers, stifling innovation and increasing operational costs. In 2014, a survey found that 73.3% of exempt banks reported that the policy hurt their earnings, indicating that even institutions not directly subjected to the cap suffer from these market distortions.

Given these harms, it’s unsurprising that groups representing community banks, credit unions, and minority depository institutions oppose the Federal Reserve’s proposed changes. By imposing these price caps, the Fed is not leveling the playing field but rather tilting it in favor of bigger firms, leaving financial institutions, especially smaller ones, at a disadvantage.

Government intervention in pricing inevitably leads to market distortions. Whether it’s rent control, wage control, or debit card fees, price fixing creates artificial shortages, misallocates resources, and stifles innovation. When the government dictates prices, it disrupts the natural balance of supply and demand, leading to unintended consequences that ripple through the economy.

The Fed’s willingness to cave to retail lobbyist demands ignores the lessons of the past decade. Instead of fostering competition or benefiting consumers, these price controls have distorted the market, harmed smaller institutions, and failed to deliver on their promise of consumer savings. It’s a textbook case of the government picking winners and losers, propping up large retailers while putting additional strain on institutions that are the backbone of many communities.

The reduced debit card transaction fee revenue for smaller, exempt banks directly affects their ability to offer competitive services and maintain profitability. As these institutions struggle, the services they provide, often vital to underbanked or rural communities, could diminish, leading to fewer options for consumers. This contradicts the goal of financial inclusivity and broad access to banking services.

The reality is that government price setting rarely benefits the average consumer. While lower costs are appealing, the savings seldom materialize where they’re needed most. Instead, the benefits accrue to large retailers while smaller banks, credit unions, minority depository institutions, and their customers bear the brunt of the costs.

As the Fed considers its next steps with Regulation II, it should be wary of further entrenching these market distortions. The path forward should focus on enhancing competition and innovation in the payments ecosystem, not embracing failed price controls and doing the bidding of corporate lobbyists. If the goal is to create a more equitable financial system that benefits all consumers, the Fed should reconsider its involvement and allow market forces, not government mandates, to determine prices.