By Simon Johnson

As a lobby group, the largest U.S. banks have been dominant throughout the latest boom-bust-bailout cycle – capturing the hearts and minds of the Bush and Obama administrations, as well as the support of most elected representatives on Capitol Hill. Their reign, however, is finally being seriously challenged by another potentially powerful group – an alliance of retailers, big and small – now running TV ads (http://youtu.be/9IUt-lY-XgM, by Americans for Job Security), web content (http://www.youtube.com/watch?v=DiKoFzS_lXs, by American Family Voices), and this very effective powerful radio spot directly attacking “too big to fail” banks: http://www.savejobs.org/audio18.html.

The immediate issue is the so-called Durbin Amendment – a requirement in the Dodd-Frank financial reform legislation that would lower the interchange fees that banks collect when anyone buys anything with a debit card. Retailers pay the fees but these are then reflected in the prices faced by consumers.

The US has very high debit card “swipe” fees – 44 cents on average but up to 98 cents for some kinds of cards. These fees are per transaction – representing a significant percent of many purchases but posing a particular problem for smaller merchants. This is estimated to be around $16-17 billion in annual revenue.

Other countries, such as Australia and members of the European Union, have already taken action to reduce interchange fees – because the cost of such transactions is actually quite low (think about it: the “interchange fee” for checks, which also draw directly on bank deposits, is exactly zero). The United States severely lags behind comparable countries in terms of how consumers are treated by banks in this regard.

The legislative intent behind Senator Dick Durbin’s Amendment was quite clear: Fees should be lowered – to a level commensurate with the costs of that particular transaction – and it attracted bipartisan support on this basis (the vote was 64-33 in the Senate, of whom 17 were Republican.) The Federal Reserve was mandated with determining the reasonable fees through a regulatory rule-making process. There has been some foot-dragging by the Fed but ultimately the proposal is that interchange fees be capped at 12 cents.

The big banks’ formidable lobbying machinery naturally sprang into action, arguing the fee cap would hurt small banks and credit unions. Senators Jon Tester (D., Montana) and Bob Corker (R., TN) are offering legislation – as is Representative Capita – that would postpone implementation of the fee reduction for two years pending “further study”. The best way to kill something in Washington is to study it further.

This is an issue that cuts across party line – witness the eclectic Dick Morris weighing in for Durbin – but there are unfortunately supporters of the big banks on both sides of the aisle. Tea party-inclined congressional conservatives are arguing that the Fed should not get involved with the Market. But this is already a badly broken market, as argued by Jim Miller, budget director under Ronald Reagan. “Too big to fail” banks are not a market – they are a government subsidy scheme because they are backed by implicit government bailout support (to be provided at below market cost whenever needed). These subsidies enable megabanks to borrow more cheaply and grab market share relative to smaller banks (e.g., those with less than $10 billion of assets.) On top of this, and working closely with the biggest banks, Visa and MasterCard have around 90 percent market share for debit cards – hardly conducive to reasonable competitive outcomes.

At the same time, some on the political left are confused (or captured) by the claim that lower interchange fees will hurt small banks and credit unions. This is pure smokescreen – banks with less than $10 billion in total assets are specifically exempt from the provisions of the Durbin Amendment. This exemption was a smart political move but it also makes economic sense given the disproportionate size and power of our largest banks. Adam Levitin, writing on the Credit Slips blog, makes a strong case that small banks will actually win under the proposed cap, as this can level the playing field with larger banks to some degree:

“if they [small banks] end up with higher interchange revenue than big banks as a result of Durbin, that is a step toward undoing the troubling consolidation of financial services around too-big-to-fail institutions.”

See also Levitin’s paper on credit unions, showing that they may also benefit – again as most have less than $10 billion in total assets.

Of course the big banks are threatening to punish customers in other ways if debit fees are capped, for example by ending free checking. But this makes no sense given that these banks have to compete with smaller institutions for retail business that will not be impacted by caps on debit fees.

The big bank vs. nonfinancial sector dispute has just started to get interesting.

An edited version of this post appeared this morning on the NYT.com’s Economix blog; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.