Your reward cards may become worth-less

It's not such a bad thing to live with less debt.

Economics isn’t really that hard when you look at it from the bottom up. Raw material producers sell to manufacturers, who sell to distributors, who sell to merchants and service providers, who sell to you and me. Along the way, there’s this living organism of other enablers who move either goods in one direction, or money in the other. And there’s the government, which can put up barriers, gates, taxes, and grand incentives to try to funnel either goods or money in the ways public policy-makers want. It’s not hard, for instance, to see that tariffs, which are taxes on moving goods, get added to the price of the items we buy.

It’s also not hard to see that certain costs associated with accepting money are so universal as to become a fixed cost of doing business.

For example, some restaurants or service providers, or a rural gas station, might add a surcharge for using a credit card, in order to discourage their use, or in reality to make things fair to people who pay cash. Most people these days don’t pay cash, so it ends up just being another way to pass along fees. However, the nature of credit cards has morphed over the years from a way to conveniently pay a bill to the main way many people live paycheck to paycheck, financing their lives in an ever ballooning cycle of debt.

The banks and card issuers are glad to give people who really shouldn’t be charging their lives away, giant credit lines, as in 50 percent of their annual income or more. This results, as you might think, because economics isn’t hard, in a whole lot of default risk. The banks do it because when the economy is flying high, the rewards for them are great—lots of interest and fees, with not much operating cost compared to the profits they rake in. As long as the default risk is manageable, things are rosy, and therefore, the bankers and card issuers spend a lot of time managing that particular risk.

Take a bunch of folks, let’s say air traffic controllers, who aren’t particularly high earners given the importance and stress of the job, and don’t pay them for a month or two, and some number of them are going to have problems paying the card bill. In microcosm, meaning a small group, that can be dealt with, but when the whole economy tanks like it did in 2008, or really anytime there’s a recession, banks get clobbered with defaults. This is the nightmare scenario for big card issuers, and the thing they seek to hedge against.

One of the hedges is to attract people with some wealth and liquidity. That’s how the whole card rewards thing got started, but it morphed into this giant marketing suck hole that pulls everyone in. So now, you can easily get a bunch of airline, hotel, online retailer, luxury brand, or whatever other rewards cards they can dream up, with high limits, and lots of benefits (that few people really use). The card sponsors know that relatively few people really use all the benefits and rewards associated with the card, and therefore it’s the ones who pay their bills on time and in full who get the benefit, and that mitigates the risk of the folks who get sucked into the debt hole and can’t pay.

There’s a whole bunch of economics for you. But there’s a cost of managing the rewards programs, and there’s a cost to the sponsors for giving the rewards, which accrue to those who pay their bills on time and in full, and therefore the banks get no interest or fees from them. That cost is passed along to everyone in the form of merchant fees that retailers pay for processing the transaction.

If you’ve ever had the misfortune of reading a credit card merchant statement, I commiserate with you. These documents are dense and difficult to analyze, and that’s on purpose. There’s all kinds of card types and fee levels and each of them has its own merchant rate, per transaction fee, and other tricks to get money. I used to analyze these as part of a business I ran, and the only thing I can guarantee is that merchant fees never go down. The part of the fees that go to the card processor, like Mastercard and Visa, is called the interchange fee. It’s a percentage that the processors take; it’s their cut, and that’s always been a fixed cost of doing business.

Until, perhaps, now.

The merchants have had a beef, by which I mean a lawsuit, with the card processors Visa and Mastercard, for 20 years. It just got settled, for $38 billion. The merchants won some concessions from the processing giants, and one of them is that interchange fees, which hover generally between 2%-2.5%, will be reduced by around 0.1% in the next five years.

The bigger concession is that the card processors will no longer force all merchants to take all branded cards. There was always an agreement that if your card had the Mastercard or Visa logo, it would pretty much always work at any merchant that accepts those cards, because the processors required all merchants to take all cards. (There are exceptions like gift cards and other special cases.)

With the settlement, merchants will now be able to choose which rewards cards they accept, and which ones they don’t. The ones with higher fees can be refused, which means rewards cards. It also gives merchants more flexibility with adding surcharges. Mastercard and Visa were always very restrictive on this practice, which is why most large retailers don’t do it. That will change, and it might be the first thing to change.

It will take time, possibly years, for the infrastructure supporting card types and refusals to filter down to the cash register, although maybe not as long as I think, because so many EMV (think Apple Pay or touchless transactions) payments are handled through completely commercial off-the-shelf hardware these days. Simple software changes could push the filter forward and operational in mere months.

What does this mean?

It means people with liquidity and cash who use rewards cards strictly for the rewards won’t get to use them as often, or at retailers they prefer. It means the regular folks who use a hotel or airline rewards card may not be able to use them everywhere they want, limiting their ability to leverage credit for their purchases. It means the number and quality of rewards cards will inevitably decline.

It also means that some cottage industries, like social media influencers who can train you to travel on the cheap using lots of rewards cards (such as Daily Drop), will face some peril. I’m not saying it will be the end of cheap travel, but it might put a good dent into that particular model for achieving it.

The good news is that some merchants, retailers or service providers, like medical offices for instance, will benefit. Having the ability to keep their merchant fees low, and to hedge against the inevitable rise, will hopefully make those goods and services more affordable to us. The bad news is that as rewards cards get pickier, some people who depend on having a big credit line, and maxing it out, will face cuts to their creditworthiness, because the banks won’t be able to attract as many folks with money to mitigate the risk.

How much will it affect regular folks? I don’t know. I don’t think anyone can fully predict it yet, and much of that has to do with how the economy as a whole looks. A big shock to the economy, like a recession or bubble pop (the AI and crypto markets are stupid big bubbles), could bring a wave of credit restrictions and leave many faced with default and no way to increase their own credit lines.

The airlines and hotels will be fine. They’ll just reward their top clients in other ways than credit cards, as they always have.

From the top-down, that’s not such a bad thing. Our nation swims in debt. I am guilty of it myself. Years ago we used to live as debt free as possible, but no longer. Having easy access to giant credit lines and rewards cards is an attractive but risky temptation. It’s better to live without it.

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