Credit card fraud

There's a lot of credit card fraud. Estimates that I've seen recently estimate the total amount if it to be several billion dollars per year. Despite this, credit cards are wildly popular with banks, merchants and consumers. This means that it's probably the case that we're better off with them than without them. It also means that there's probably more than several billion dollars of value from credit cards, or more than enough to outweigh the massive amounts of fraud that they allow. To understand this, it might be useful to look at the history of credit cards.

Roughly 100 years ago, most consumer transactions were in cash. To make things easier for consumers, many businesses introduced proprietary charge cards in the early 1900s. These were only valid at one particular merchant. Each oil company had its own card that was only valid at its gas stations, and each department store had its own card that was only valid at its stores. In addition, these cards required users to pay their bills in full each month.

These cards were much more convenient than using cash. They reduced the need to get cash from a bank and allowed for one convenient payment per month. On the other hand, they also had a serious limitation: they required a separate card for each merchant. This meant that they weren't very useful to travelers.

The ability to pay in installments was added to charge cards in the 1930s, and in the 1950s, Diners Club became the first card that was accepted in a large area. By 1958, American Express was also issuing similar cards. These cards were still aimed at travelers, so you could expect to be able to charge meals and hotel rooms with them, but you couldn't expect to use them at most stores. In the case of charge cards, the card issuer also processed all transactions, both with consumers and merchants. This required a merchant to have a relationship with each bank that issued a card if he wanted to accept the card for payment.

The first general-purpose credit cards were the BankAmericards that were issued in 1966 by the Bank of America. Shortly thereafter, four other banks (United California Bank, Wells Fargo, Crocker National Bank and the Bank of California) formed the Interbank Card Association to issue the MasterCharge card and compete with the BankAmericard. These cards added an additional level of complexity to the card processing. They allowed the card-issuing bank to be different from the merchant's bank, and created a centralized system to settle transactions between the two. This finally provided the infrastructure that allowed the widespread use of credit cards that we see today. Along the way, the BankAmericard evolved into Visa and MasterCharge evolved into MasterCard.

At each step in this evolution, there were more opportunities for fraud. These opportunities were the fewest when each merchant had its own charge card and are the greatest in the current four-party model that's used by credit card companies today. But even though there is billions of dollars of credit card fraud today, it's only a small percentage of the trillions of dollars of purchases that credit cards are used for.

It's almost certain that the additional fraud that each step has allowed has been outweighed by the benefits that the additional convenience allowed. How much would it cost merchants to each operate their own charge card? The overhead of tens of thousands of such cards is probably much greater that the fees that merchants currently pay on credit card transactions and you'll probably find few merchants who want to return to the older system. The additional convenience, both to consumers and merchants is much greater that the billions of dollars of fraud that the system allows, and we're much better with credit cards that without them.