A "Reasonable Profit'

http://www.futureofcapitalism.com/2010/04/albert-foer-new-york-times-credit-card-fees

The president of the American Antitrust Institute, Albert Foer, has an op-ed in today's New York Times exposing the fees that credit card companies charge businesses that accept the cards. Here's the crux of it: "Congress should authorize the Federal Reserve to limit credit card interchange fees to their actual cost, fairly determined, plus a reasonable profit. The annual savings to merchants would be in the tens of billions of dollars. Since retailing is highly competitive, most of these savings would be passed on to consumers in lower prices or in the form of improved services by retailers that could afford to hire more people."

This concept of a "reasonable profit" is also seen in the International Monetary Fund's proposal of a FAT, or Financial Activities Tax, that might apply to "profits only above some threshold rate of return," so that "the FAT would become a tax on 'excess' returns in the financial sector."

One problem with this line of thinking is that is difficult to agree on what constitutes a "reasonable" profit or an "excess" profit. If a firm makes a 50% profit one year but loses 40% the next year, is the 50% profit unreasonable or excess? It may look that way after year one, but not after year two. What if the firm goes out of business in year three? If a firm with 1 billion shareholders makes a $1 billion profit, is that unreasonable or excess? What if the same firm makes the same profits, but it has only one shareholder? If one firm makes a $1 billion profit on $100 billion in sales, and another makes a $1 billion profit on $1 billion in sales, they both have a $1 billion profit. Is one of the profits more reasonable, and less excessive, than the other? What if you pay out your "profits" as employee compensation expenses so that the profits look lower?

An alternative approach to the idea of U.S. government bureaucrats or IMF bureaucrats or Congressmen defining what is a reasonable profit or an excess one would be to allow market competition to work. If the profits that can be made by charging businesses a 2% transaction fee on credit cards are so excess or unreasonable, you'd think they'd eventually attract competition, or new entrants, who might say to businesses, "Hey, if you accept NewCard in addition to Visa, Mastercard, and American Express, we will charge you a transaction fee of just 1% instead of 2%, because we are just out to make reasonable, non-excess profits, rather than unreasonable, excess ones."

The concept of unreasonably high or excess profits is often applied not only to financial institutions but to health insurance companies and oil companies and whatever other company happens to be either unpopular or profitable at a given moment. It's worth keeping an eye on.

by Ira Stoll  |  Apr 21, 2010 at 9:52 am Related Topics:  Banking, Capital Markets Regulation, Energy, Federal Reserve, Health Care, Press receive the latest by email: subscribe to the free futureofcapitalism.com mailing list