Assessing the Impact of Proposed Federal Reserve Debit Interchange Policy

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Mar 302011

By William A. Longbrake and Clifford Rossi, Executives-in-Residence at the Center for Financial Policy

The authors would like to thank the Trustees of the Anthony T. Cluff Fund for their support on this project. The views and conclusions expressed in this study and any errors and omissions are solely those of the authors.

On May 13, 2010, the Senate passed the Durbin amendment with little debate and no vote in the House of Representatives. The amendment became the new Section 920 of the Electronic Fund Transfer Act (EFTA Section 920), added by Section 1075 of the Dodd Frank Act, which President Obama signed into law on July 21, 2010. The Durbin amendment directs the Board of Governors of the Federal Reserve System (Board) to issue rules relating to debit card interchange fees, network exclusivity, and transaction routing. The Board adopted a notice of proposed rulemaking on December 16, 2010; comments on the proposed rule were due on February 22, 2011; and the Dodd Frank Act directs the Board to issue final rules for interchange fee standards by April 21, 2011, which are to be implemented on July 21, 2011, and final rules on network exclusivity and routing by July 21, 2011.

This study demonstrates that restricting debit card interchange fees is based on an incorrect understanding of debit card market economics, and if interchange fee restrictions are implemented as proposed, consumers, small businesses and the economy will be harmed. It is a cardinal tenet of public policy that market and price regulation should be imposed only when a market failure has occurred or in limited circumstances, such as regulation of monopoly utilities, where a market failure could occur. In the absence of clear proof that a market failure exists, government intervention will interfere with the efficient allocation of goods and services and will have unintended impacts on competition which will favor some, who can guide regulatory intervention to serve their individual interests, to the detriment of others. Neither the framers of EFTA Section 920 nor the Board has offered convincing proof that a market failure exists for debit cards. Rather, proponents of price regulation have asserted that a market failure has occurred because issuers are charging excessive interchange fees to acquirers, which are unjustified by issuer costs, and also because issuers are incenting consumers to overuse debit cards. This study examines the economic theory of how a debit card market functions. Theory indicates that it is likely that government intervention will result in a less efficient debit card market with adverse consequences for the payments systems. Based on a rigorous simulation model of two-sided markets, introduction of a cap on debit interchange fees will also harm consumers and could lessen the combined benefits, net of costs, for consumers and merchants (or aggregate consumer and merchant economic welfare, as economists refer to it in economic theory).

You can find the full report at the Financial Services Roundtable website.

CFP to host Frank Medina, Senior Counsel at the House Financial Services Committee

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Mar 182011

On Monday, April 11, the Center for Financial Policy will host Frank Medina, Senior Counsel at the House Financial Services Committee.  He will be a discussion leader on reform issues pertaining to the Dodd-Frank Act.

This talk is part of the Center for Financial Policy’s “Congressional Briefings” series that regularly host Capitol Hill staffers to the Smith School to speak about legislative issues related to financial policy.

The talk will take place at the University of Maryland’s campus in Van Munching Hall on April 11 at 2 p.m.

There is no registration fee for this event.

To register for this event, please visit

Economic Recovery Progressing But the Emergent Global Oil Price Shock Amplifies Risks

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Mar 172011

An Excerpt from the March 2011 Longbrake Letter

by Bill Longbrake
Executive-in-Residence at the Center for Financial Policy

Global Oil Price Shock

During the last month we have been reminded why economic forecasting is so difficult. That is because it is nearly impossible to anticipate consequential events that can shock the global economy and force a fundamental change in direction. The revolution in Tunisia, regime change in Egypt, civil war in Libya, unrest in Bahrain and chaos in Yemen were surprises that few, if any, anticipated. And the repercussions these events have unleashed are far from spent. Like a nuclear chain reaction, each event has emboldened people in other Arab countries to challenge long-entrenched, unpopular regimes.

Broadly-based political crises of the sort that are current underway in the Middle East are not unlike global financial crises. Both often times seemingly erupt without warning and their virulence takes most by surprise. However, upon closer examination, it becomes clear that unsustainable imbalances had built up over time and what had passed as stability was an increasingly fragile and unstable situation vulnerable to abrupt correction. Once the spark is lit, conflagration quickly ensues because the rot of persistent and large imbalances provides ample fuel. Tunisia was the spark and now the conflagration rages.

Political imbalances, like economic imbalances, correct but the process usually is a messy one and can take a long time to unfold. Furthermore, political intervention, as is also true with economic policy intervention, can prevent complete correction of an imbalance and can set in motion nascent imbalances.

There are several things that make the current Middle East political crisis especially worrisome and will bedevil economic forecasters. First and foremost among them is the global oil price shock that the crisis has spawned. It is a simple fact that energy hungry emerging economies have been driving up demand for oil faster than new sources of supply can be found. While this fact has been well understood and has been behind forecasts of rising oil prices, what is new is that civil war in Libya has reduced supply by 1.5 million barrels per day, which equals about 30% of OPEC’s spare capacity of 5.2 million barrels per day, and perceived threats to interruption of supply in other Middle Eastern countries have combined to lift oil prices by more than 20% in a few weeks time. Algeria is a prime candidate for interruption of 1.8 million barrels per day in exports. While not much in the news, protests have been underway in Algeria since late December and foreign policy experts consider the Algerian situation to be very fragile.

It is impossible to foresee precisely whether the oil price shock is temporary and will fade away as civil war in Libya is resolved and a semblance of political calm returns to the rest or the Middle East or whether political upheavals will continue and spread and result in persistently higher oil prices and perhaps at much higher levels than those that prevail currently.

By and large most Middle Eastern countries have not participated in accelerating economic growth that has engulfed most of the world’s emerging economies. This naturally leads to the question of whether the new political order that eventually emerges in the Middle East out of the current crisis will provide the kind of leadership which fosters more rapid economic growth or whether religious theocracies of the sort that currently rules Iran will emerge. And, there is also the question of the longer-term Middle Eastern balance of power between the political ambitions of Iran and the rest of the Arab nations. Oil, for better or worse, is the key to economic power and thus is the prize for which those who are seeking political dominance aspire.

All of these forces are in play. We cannot with any certainty know where they will lead as they interact with each other. What we do know, as we have learned from the recent global financial crisis, is that once the process has begun there will be new events and further disruptions. All we can be certain of is that volatility has increased and will continue unabated for a period of time.

Risks to the U.S. and Other Economies Posed by Global Oil Price Shock

Europe appears likely to be affected adversely to a much greater degree than the U.S. for several reasons. First, the lost Libyan oil is predominantly low-sulfur “sweet” crude, which goes mostly to Europe. While Saudi Arabia has the capacity to increase oil production to close the shortfall created by the loss of Libyan oil, it is “sour”, high-sulfur content crude. Unlike the U.S., Europe has little capacity to refine high sulfur content crude, so the replacement of lost supply is far from perfect. That is one of the reasons that a large price gap has opened up between the Brent and West Texas Intermediate (WTI) oil prices. As of March 12, 2011 WTI was about $101 per barrel while Brent was $114 per barrel. Prior to the crisis Brent averaged about $1 more per barrel than WTI. Another reason that the price of WTI has not escalated to the same extent is that the current ample supply of natural gas in the U.S. is an effective energy substitute and it is currently cheap and abundant. Europe does not have access to cheap U.S. natural gas. The impact of the Libyan situation will be the greatest for Italy, which is not a happy prospect because Italy is not totally immune from possible sovereign debt issues.

Second, commodity prices have a greater impact on measured inflation in Europe. For a variety of reasons unrelated to oil prices, inflation had already been rising in Europe, so the run up in oil prices simply exacerbates matters. Unlike in the U.S. where the Federal Reserve has a dual policy mandate covering both inflation and employment, the European Central Bank (ECB) is only responsible for limiting inflation. That mandate lead to the untimely increase in European interest rates in June 2008 just prior to the worst phase of the global financial panic. The ECB is once again telegraphing the likelihood that it will have to raise interest rates to contain inflationary pressures.

Third, if the ECB raises interest rates, this most certainly will have two consequences, both negative, for the peripheral European members of the European Union (EU) that are struggling with sovereign debt problems. First, higher oil prices and interest rates will depress economic growth and second, higher interest rates will increase the cost of sovereign debt. The first will depress tax revenues, the second will increase expenditures. Already, in anticipation of the next round in the on-going sovereign debt crisis, interest rates have risen on sovereign debt to levels that are simply not sustainable without intervention of some sort. In other words, it is not a matter of whether but when financial crisis will engulf Greece, Portugal, Spain and perhaps other European countries.

While the consequences in the U.S. are likely to be lesser in scope, they are not trivial. Already, consumer optimism has plummeted, although this has yet to show up in reduced consumer spending.

There will also be consequences for emerging economies because most are net importers of oil. The increase in oil prices that has already occurred is expected to have a modest negative effect on global growth over the next two years. But, further escalation in oil prices would result in much greater damage to global growth.

What to watch for is that when shocks occur, if they persist for any length of time, consequences will emerge and those consequences will set in motion responses that could have further adverse impacts on the global economy.

Read the Full March 2011 Longbrake Letter.

Center for Financial Policy Hosts Systemic Risk Data Issues Forum

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Mar 122011

On Wednesday March 9th, the Center for Financial Policy at the University of Maryland’s Robert H. Smith School of Business, in partnership with NYU’s Salomon Center, UC-Berkeley’s Fisher Center and Carnegie Mellon’s Center for Financial Markets, hosted a one day forum on systemic risk and data issues.  A working group of academic, regulatory, and industry representatives discussed a wide range of issues to lay the groundwork for the larger conference that will be sponsored by the four partner university centers.

Topics discussed included: Systemic Risk Conceptualization and Measurement Issues, Shadow Banking, Executive Compensation, Identifying the Currently Available Data Sources and Determining Data Gaps, and Access to Confidential Data and Dissemination of Findings.

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act. The act created an Office of Financial Research (OFR) and a Data Center (OFR/DC) with the mandate to establish a sound data management infrastructure for systemic-risk monitoring.

“Our working group was created to bring together a small group of leaders from academia, regulatory circles, and industry on the subject of systemic risk and data issues,” said Lemma Senbet, Director of the Center for Financial Policy and William E. Mayer Chair Professor of Finance.  “I’m very pleased with what has happened today and confident that we will have valuable recommendations to offer OFR as it develops its capacity.”

Members of the working group include representatives from the Office of Financial Research (OFR) at the Treasury, Federal Reserve Board, Commodity Futures Trading Commission (CFTC), Securities and Exchange Commission (SEC), Federal Deposit Insurance Corporation (FDIC), Financial Stability Oversight Council (FSOC), NASDAQ OMX, and Depository Trust & Clearing Corporation (DTCC).  Academics from Maryland, NYU, Berkeley, Carnegie Mellon, University of Pennsylvania and University of Michigan, as well as private sector representatives and Nobel Laureate Robert Engle rounded out the working group.

The highlights of the forum discussion will be presented as a “white” paper, identifying the salient issues of focus for the conference later this year.

The Center for Financial Policy was launched in November 2009 and develops thought leadership in financial policy that impacts corporate performance, capital allocation and the stability of the global financial system. Located in both College Park, MD and in Washington, D.C. at the Smith’s School’s campus in the Ronald Reagan Building and International Trade Center, the center is well-situated to take a leadership role with its globally recognized faculty and its extensive relationships with key policymakers, practitioners and academics.

By Eric Miller
Graduate Assistant, Center for Financial Policy
MBA/MPP 2012

Rossi conducted analysis for the NABE March 2011 Economic Policy Survey

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Mar 102011

NABE Panel Concerned About Rising Fiscal Budget Deficits and Eager to See Federal Spending Curbed

CFP Executive-in-Residence Cliff Rossi was one of six experts that analyzed the March 2011 Economic Policy Survey results.   This survey was sent to the National Association for Business Economics (NABE) membership during January 28th to February 14th, 2011.

A few highlights from the NABE survey:

“71 percent of those surveyed think that meaningful deficit reduction measures would not pass through Congress this year.”

“Despite such desires for austerity, these panelists were overwhelmingly in favor of the compromise legislation in December to extend the Bush-era tax cuts, although a sizable number of individuals would have preferred that these tax cuts not be extended for those earning $200,000 ($250,000 for those who are married) or more.”

“Six out of ten survey respondents feel that the Federal Reserve’s program to purchase up to $600 billion in Treasury securities has had a positive impact.”

“Seventy percent of the survey panelists believe that Fannie Mae and Freddie Mac should ultimately be privatized, with most suggesting that this should be a gradual process over several years.”

Please visit NABE’s website at for more information.

To read the full PDF version of the report, visit