ard Association representatives were on the hot seat July 19, 2006, when called to testify on possible antitrust issues related to interchange. Yet they were adamant the card system gives merchants good value.

Senators pushed for straight answers, particularly to the question of whether card Association rules are posted publicly. Anticipating the question, Visa U.S.A. announced just days before the Senate Judiciary Committee hearing that it will make its operating regulations available to merchants and third-party agents as of Sept. 1.

Senators expressed puzzlement at the complexity of rates, but revealed a grasp of issues merchants find objectionable. Sen. Jon Kyl, R-Ariz., said constituents had reported their interchange rates have gone up more rapidly than other costs, creating the suspicion of collusion between the two Associations.

"I am astonished by the number of constituents ... who have complained about the increase in interchange on credit cards," said Sen. Chuck Grassley, R-Iowa.

"I was impressed with the power of Visa and MasterCard to stop banks from issuing Discover and American Express cards" before courts disallowed the practice, said Committee Chairman Sen. Arlen Specter, R-Pa.

Sen. Richard Durbin, D-Ill., said, "[Interchange] is a tax everybody pays."

Monopoly rules: Pass go, collect $

Joshua Floum, General Counsel for Visa, said the industry is not dominated by a few firms, but many, and interchange rates would be expected to rise if the Associations were engaged in monopolistic behavior.

Yet, he pointed out, the average merchant discount rate has dropped to 2.2%, from 7% "half a century ago" when general-purpose credit cards were introduced.

He also said the merchant lobby seeks caps on fee rates, but caps imposed by Australia's Reserve Bank have backfired. "[Australian consumers] are paying more from higher annual fees. Merchants have seen the cost of card acceptance decline, but there's no evidence that retail prices have declined," he said.

A Reserve Bank bulletin indicated Australian banks' income from merchant service fees dropped by 19.6% from 2003 to 2005, the first full year after implementation of the interchange rules. From 2002 to 2005, credit card fees to households rose 112%, late fees rose 38%, and the annual fee on rewards cards rose 39%.

"The true objective of these efforts is government-mandated price caps on interchange fees that would be lower than the default rates" established by the Associations, said Joshua L. Peirez, Associate General Counsel for MasterCard Worldwide.

Testifying on behalf of the Merchants Payments Coalition, W. Stephen Cannon said merchants haven't asked for price controls. Congress, he said, has many other options in the gulf between a "cartel" and government-mandated rate controls. He called the interchange system a simple case of price fixing conducted in the open, "where two players control 80% of the market."

Australia's interchange fees are now one-third of what U.S. merchants pay, Cannon said. "The card Associations have not told you that fierce competition has erupted, [with Australian banks] offering lower and lower rates."

He also said card issuance and use have risen. Card use, in terms of the value of credit-card purchases, has risen, the Reserve Bank bulletin confirmed.

Merchants are mistaken when they compare interchange rate-setting to a cartel fixing prices, said Visa legal adviser Timothy J. Muris. "The end of a cartel lowers prices. But the end of interchange will lead to chaos. Merchants understand this," he said.

Instead of breaking up the system, merchants want lower interchange rates. But the reasonableness of their argument "is never a defense for price fixing," he said.

Peirez denied that the Associations have ever colluded. "MasterCard and Visa are fierce competitors." He said his company doesn't have market power to control competitive rates. Peirez also said all legal challenges to interchange on antitrust grounds have failed in the courts.

But upon close questioning by Specter, Muris acknowledged that merchant court challenges to interchange are still pending.

Specter asked for Muris' legal opinion on the merits of the pending class action suit, which alleges price fixing due to the overlap of Visa's and MasterCard's member banks. Muris characterized these arrangements as joint ventures, which are legally free to set prices.

Looking for Mr. Fixit

Comparing the two major card Associations' dominance to Ma Bell before the breakup of AT&T, Bill Douglass, representing the National Association of Convenience Stores (NACS), said recent changes in the governance structures of Visa and MasterCard have not addressed the interchange rate situation. "This market is broken and something must be done to fix it," he said.

MasterCard is considering allowing U.S. merchants to surcharge for card use, a practice the company already permits in Europe and Australia, Peirez said.

But Douglass said surcharging "would drive people off."

To Specter's question of whether the Associations' adoption of independent board structures will remedy merchant complaints [See "Card Association transparency bodes well for industry," The Green Sheet, May 22, 2006, issue 06:05:02], Cannon said the transition was "form over substance."

MasterCard's Securities and Exchange Commission registration states that member banks still own 44% of MasterCard, and its success or failure will depend on its customers - the banks, Cannon said.

Mom and pop hanging on

Sen. Patrick Leahy, D-Vt., invited the owner of a small family business in Elmore, Vt., to testify. He said he did not want interchange fees to drive such small enterprises out of business.

Kathy Miller, owner of The Elmore Store, said her margins are thin, and she and her husband struggle to keep the doors open in a community of 850. She recently allowed a customer to run a $108 tab to avoid taking plastic. The customer returned with cash the following day. "Nine times out of 10, [we] don't have that option," Miller said.

"I hope something good comes from this," Durbin said of the session. Specter answered, "It's not likely that nothing will come from this hearing."

As to the posting of rules on Web sites, little distinction was made during the grilling between rules merchants must follow and Association operating rules. "We were told - with a lot of parsing of language - that all the rules are up there," NACS Communications Director Jeff Lenard said in an interview. "All the rules are not up there."