were talking about the introduction of bank credit cards in Britain and it cited the American experience where you cannot really break even by granting credit cards to upper middle-income families where you must have-must concentrate on the lower middle-income families who will run up debt and where you can make money by assessing the rate of interest on the debt.

Senator PROXMIRE. Have you been able to conclude whether the merchant discount is passed on to the cash customer on a credit card? Mr. MANDELL. I think-I have not been able to conclude either way, Mr. Chairman. I know that in instances merchants have offered me a discount to not use my credit card. Other people have related the same experience.

I think it would be-I really do not have the evidence to be able to tell you whether the cash price is increased.

Senator PROXMIRE. Isn't there an element of subsidy where the cash customer is subsidizing the credit card user?

Mr. MANDELL. I think it is likely that there is such a factor. I don't know the magnitude of the factor.

Senator PROXMIRE. Do you know the economic characteristics of cash buyers as opposed to the card users?

Mr. MANDELL. No, I have characteristics of credit card users as compared with noncard users. It is likely that credit card users do not use their cards in all circumstances. I don't know. I would have to do a sample of purchases rather than a sample of purchasers.

Senator PROXMIRE. Do you have any estimate of the national cost of the free ride?

The fact that people can charge and then not incur any interest and pay it within 30 or 60 days?

Mr. MANDELL. No, I couldn't estimate that.

I would imagine if I spent time on it, I could come up with a gross estimate but I would be forced to rely upon publications of the creditors.

Senator PROXMIRE. I don't mean to impose a long study on you, but if you could do that from available figures, it would be very helpful. Mr. MANDELL. Fine.

Senator PROXMIRE. What would you think of legislation to abolish the free ride, to eliminate the subsidy implicit in credit card plans?

Mr. MANDELL. I don't think that that is fair. I think that the socalled free ride is a legitimate selling device for example, for stores. I know I prefer not to carry large amounts of cash and I prefer not to go through the difficulty of having to get a check approved when shopping outside of my own particular bank market area, and I think it is a legitimate device offered by stores to make it perhaps more convenient for persons to shop.

Senator PROXMIRE. There isn't any question though, that you have a free rider involved, he is able to keep his money working for him for a longer period than he would if he paid for what he gets.

The cash buyer is subsidizing the free ride then, right?

Mr. MANDELL. I suppose that is right.

Supposing we went to a two-card system, one card is for chargers who paid on time, and a second card was for people who are going to incur credit.

In my mind, there would be a distinction there. Of course, stores, to stay competitive, would probably offer the free ride, but I think

that the net results would probably be the same. Right now the stores that offer credit cards on their accounting system are lumping together the free riders, essentially, with the payers of interest.

They find that their system does not break even. If they separated out the so-called free riders, they would find that they would make a profit on those who paid interest.

Senator PROXMIRE. I have great trouble eradicating from my mind the experience I had in the thirties when I worked at Macy's and they had that slogan, "We undersell everybody by 6 percent," and the reason is because they had no charge, no free ride. You paid cash. That was it. You came in with a bargain and you got somewhere else, and they would sell you the same thing for 6 percent less, and they did it. Mr. MANDELL. It is possible, but

Senator PROXMIRE. I understand J. C. Penney built up their empire with no credit at all until 1957.

Mr. MANDELL. I think if we realize that it is impossible to ever educate the consumer to understand his transactions, to understand that if he does pay on time, that he also can get a free ride, that anyone can get a free ride, I think if we give up on that and say that we do not really have a free enterprise economy where people are capable of competing in the marketplace, I think I would be willing to accept your proposition.

But right now, I think you would be depriving persons of a convenience which perhaps they are willing to pay for in terms of higher prices.

Senator PROXMIRE. Of course, not everybody can get a credit card. There are standards, and if you can't get a card and have to buy on cash, you have to subsidize the people who can.

Mr. MANDELL. That then becomes a matter of competition. Senator PROXMIRE. You are critical of lowering the standards, too. Mr. MANDELL. Of lowering the standards for credit cards. I think it could become catastrophic with current knowledge.

Senator PROXMIRE. I agree.

You say banks have an economic incentive to sign up lower income customers.

Would this extend to signing up marginal merchants who do a high percentage of credit business?

Mr. MANDELL. I would-well, I think it is in the bank's interests to sign up as many merchants as possible. I don't think they can lose by signing up merchants.

Senator PROXMIRE. Especially marginal merchants who do high credit. That would maximize profits.

Mr. MANDELL. I think it would be in their interest to get as much of that credit business as they could, provided that they could pick and choose among the creditors to screen out any whose risk would exceed the revenues they could be expected to generate.

Senator PROXMIRE. The holder in due course probably could then be more serious in the future without legislation, is that correct? Mr. MANDELL. I think so.

Senator PROXMIRE. All right.

Thank you very, very much, doctor. You have been most helpful. It is unusual that a scholar makes this kind of pragmatic and very revealing and helpful study, and we are indebted to you.

Thank you very much.

Senator PROXMIRE. Our final witness is John Weistart, professor of law, Duke University.

STATEMENT OF JOHN WEISTART, PROFESSOR OF LAW, DUKE UNIVERSITY

Professor WEISTART. Good morning.

Senator PROXMIRE. We have your complete statement; and if you would like to summarize, that would be fine. It will be printed in the record in full (see p. 83).

Professor WEISTART. Thank you. I will not go into the details of my prepared statement.

I am pleased to have the opportunity to appear before you. As I indicated in my prepared remarks, I am limiting my testimony to only one provision of S. 914, and that is section 172. That section provides that the issuer of a credit card will be subject to claims and defenses arising from transactions between the cardholder and a merchant who accepts the card. I believe the general approach taken in the proposed bill is a desirable one. As I indicate in my written statement, I have some reservations about some details of the provision. However, those reservations are not intended to suggest a diminished support for the basic thrust of your efforts in section 172.

It is appropriate for Congress to counter attempts by credit card issuers to immunize themselves from transactions in which they provide the financing mechanism. Section 172 must, I think, be viewed in the context of what is presently happening to the holder-in-due-course doctrine. It must be accepted that recognition of the holder-in-duecourse doctrine by legal institutions is being modified and withdrawn on a large scale. Whether the ultimate result of these developments will be universal abolition of the doctrine remains to be seen, but the inroads into the doctrine leave little question that judges and other policymakers have serious doubts about the continuing need for and validity of the holder-in-due-course concept.

The present legislation can be seen as giving credence to those doubts. In effect, section 172 prevents the growth of the doctrine beyond the areas of retail financing in which it has been traditionally applied. Credit card relationships-at least as they involve the vast majority of the bank-card holders-are a relatively new phenomenon. I think it is appropriate for Congress to play an active role in shaping development of those relationships. As a part of that process, Congress can reasonably choose to reject attempts by issuers to introduce the suspect holder in due course notion into the credit card sphere.

I should make clear my belief that the exemption for small transactions is a critical part of the legislative scheme. There are a number of considerations supporting this conclusion. First, such transactions do not present a severe liquidity problem for consumers. In addition, consumer expectations in small transactions are likely to be similar to those manifested in cash transactions. Finally, there must be recognition that the profit margin on small transactions is typically quite small. Thus, the cost of providing for a system of adjustment at the financing level will likely exceed the benefit which results to cardholders.

Where these cash-substitute purchases are involved, it is better to avoid imposing additional burdens on the system which might discourage merchants from accepting cards from consumers in small transactions. Affording protection for larger transactions gives appropriate recognition to the proportionately greater impact which these purchase have upon the consumer's budget.

In terms of specific language of 172, I would like to mention one of the points which I raise in my statement.

I would like to reemphasize my concern for the mechanism chosen to express a geographical limitation on the application of the section. As I understand the reasoning of those who demand such a geographical limitation, the concern is that a bank or other issuer has little control over merchants located in distant cities. Hence, it would be quite inconvenient for the issuer to secure adjustments from the distant merchant in the event of a cardholder's complaint.

This objection is recognized in the proposed statute which provides that section 172 applies only to transactions arising in the State in which the issuer maintains a place of business. I believe this approach to the problem introduces an unnecessary level of complexity. First, for some firms, a credit card operation is only one of a variety of merchandising and servicing activities. In some of the cases involving these firms, there will be no relationship between the business activities of the issuer and the credit card transaction that gives rise to the complaint. In other cases, there will be interpretative problems in defining whether a particular business operation is "attributable" to the issuer. Finally, the proposed statute standard shares the arbitrariness of any exemption relying on a State designation. It in effect says that a Gary, Ind., bank-card issuer need not be concerned about its cardholders' transactions which occur next door in Chicago, but that the issuer is accountable for transactions which occur a couple hundred miles away in southern Indiana. A preferable approach, it seems to me, is to attempt to isolate those transactions which give rise to the problem for which a remedy is sought. Upon empirical investigation, it likely would be established that cardholders enter into few transactions beyond their home area other than for travel and entertainment services. Those involving the purchase of goods costing more than $50 are probably statistically insignificant. Hence, I would suggest that consideration be given to the desirability of amending the exemption to exclude transactions involving food, lodging, and transportation, and to remove the presently proposed exemption. I appreciate that this suggestion would remove a number of transactions from the ambit of the statute. It is my conclusion, however, that the primary area in which consumers need the protection of the statute is that involving the purchase of goods and services for personal and household use.

Let me say in conclusion that I fully appreciate the difficulty of drafting a measure which will accommodate the competing policy considerations that arise, particularly insofar as the geographical limitation is concerned. We must, I think, accept some imprecision in the statutory language, but debate about the details should not overshadow the important point and that is that section 172 identifies a problem area for consumers and puts forth a solution which in the main produces the correct result. In this time of heightened concern for the position of the consumer, the holder-in-due-course doctrine should not

be allowed to expand unabated into new commercial relationships. The present statute provides a logical limitation on that growth and merits full and active consideration. Thank you.

Senator PROXMIRE. Those opposed to restricting the holder-in-duecourse doctrine in respect to credit card transactions argue that this would give commercial banks too much power over retail merchants and the products they sell. What are your views on that?

Professor WEISTART. It is unlikely, I feel, that card issuers would actually get involved in mediating disputes about the quality of a merchant's goods. If issuers were subjected to cardholder defenses, there could emerge a "chargeback" system which was much the same as that which operates with respect to checks written for insufficient funds. The chargeback would occur within the issuers' clearinghouse mechanism. As with the check written on insufficient funds, the bank would never make an inquiry into the facts underlying the defective transaction.

If there is a chargeback to the merchant, there could occur a very rapid conversion of the transaction from a credit transaction involving the issuer to a credit transaction in which the merchant is the creditor. With that result, the bargaining position of the cardholder is substantially enhanced.

Senator PROXMIRE. Would you agree with the objection of Ms. Furness that if you limit or abolish the holder-in-due-course doctrine, you would get back to the relationship between the buyer and the store?

Professor WEISTART. Yes. The bargaining position of the consumer would be greatly enhanced. And it is my feeling that a chargeback system can accomplish that fairly efficiently.

Senator PROXMIRE. The one simple understandable-and there is so much complexity in this-but the simple understandable reaction that a buyer has when he gets something that doesn't work or something that is bad, is not to pay for it. It is that simple.

Under the holder-in-due-course doctrine, he loses that. The pressure on the merchant to be sure that he sells goods that are adequate and appropriate and workable, is removed as the holder-in-due-course doctrine becomes effective. Under my bill, the merchant has the incentive to make sure that he sells goods that are in order.

Let me ask you this: We also hear an opposite argument against restricting the doctrine on credit card transactions. Some banking spokesmen say that banks have no way of policing the practices of retail merchants, and it is unfair to subject banks to cardholder defenses or claims against merchants. What do you think of this argument?

Professor WEISTART. Again, I really do not expect the banks or other issuers will play a particularly direct role in policing merchants. Even today, a particular bank issuer has a direct relationship with only a relatively few merchants in this area.

But the charge back system will provide an incentive to merchants, without direct control by the issuer. If charge backs are directed to the merchants, those that engage in fraudulent transactions or transactions involving shoddy merchandise will find their profit margins reduced as their costs increase. There will thus be an economic incentive to avoid fraud and shoddy goods. It is true some merchants will