Most people hate getting nickeled and dimed to death. I am no exception, so when Bank of America, which now holds the mortgage on our house, sent us a letter listing all sorts of fees we would be liable for if we paid off our mortgage, my reaction was uncharitable.
Given the thousands of dollars in interest paid over the years, why should we have to pay a “reconveyance fee” of $100 or pay up to $125 to have the payoff of the mortgage registered with the county recorder?
However, as an economist, I was taught that efficient use of resources is maximized when everyone pays the “marginal cost” to society of everything they buy. So, conventional econ theory goes, society gets more satisfaction of human needs relative to resources used up if one pays the exact additional cost of a “payoff statement via facsimile” or of transporting one additional suitcase or of one more bag of peanuts or can of soda. If that is true, why do I and others feel we are being mistreated when we encounter this in daily life?
That underlines the prior question of why such niggling fees used to be rare, but now are increasingly common.
The answer varies by business sector but usually involves at least two factors. First, there are not many businesses that operate in the idealized perfect competition so esteemed by economic theorists. Second, many business sectors are in a process of structural transformation that is changing the rules of the game.
Take airlines. Before the Carter Administration government regulation of routes and fares meant that the industry was a comfortable oligopoly. Carriers could not compete on price; that was banned by the government. And they had no desire to see fares driven down to the levels that would prevail under perfect competition; that would have curtailed profits considerably. So, they competed on service. Food, inflight movies and generous baggage allowances were all ways to attract customers from competitors that charged exactly the same ticket prices.
Those practices had a momentum that kept them being offered even as the industry became more competitive over the past three decades. But, over time, the competitive pressures of a price-deregulated industry shrank – along with the number and quality of “free” perks like baggage services and in-flight food.
Moreover, price discrimination – charging different prices to people varying on “elasticities of demand,” or sensitivities to price, came to dominate fare setting. A variety of methods were developed to charge higher prices to travelers who react less to price and give lower fares to those who react the most. New technology, including online fare-search web sites, facilitated this, so that now it is not uncommon to find that a dozen people paid a dozen different prices for the same coach seats on the same flight.
While it may seem counterintuitive, this maximizes the revenue per flight, just as giving senior citizens or children lower-priced meals at chain restaurants maximizes profits for the owners.
Going beyond differences in willingness to book in advance or to stay over Saturday nights and to pricing differently for people with and without baggage or with differing desire for food was only a logical step.
There also is an element of exploitation of asymmetric information in this. Frequent fliers now know they are going to have to pay extra fees for all sorts of things. But those who only fly at intervals of years don’t necessarily understand the change. They may be beguiled by the lowest price they find on the Internet, and won’t have any choice when they get to the airport and are asked to pony up more money for services once free.
In this situation, however, once some airlines start to offer lower overt fares by imposing separate charges for food or baggage, and thus draw more people searching for low fares, it becomes increasingly hard for other companies to continue to offer traditional full-service packages. They are caught in a “prisoners’ dilemma” where it is optimal for them to take an action simply because they know they will be at a disadvantage if they do not and their competitors do. For the airlines, the action is charging extra fees; for the prisoner, it’s agreeing to testify in return for a reduced sentence. The logic is the same.
Our mortgage situation is a little different, but also involves structural change in a business sector. It is part of the general phenomenon of banks trying to earn more from specific fees and less from the difference in interest rates paid to depositors and charged of borrowers. Bank of America did not originate our mortgage, and it is not clear that they even own it now. They may merely be handling the administrative servicing of payments for the owners of a package of securitized mortgages. So charging all the fees they can is a way of increasing revenues.
Of course, it leaves a bad taste in the consumer’s mouth. But people don’t get mortgages all that often, and when they do, the right of the services to charge miscellaneous fees is not usually something that will change their minds. And so borrowers end up in situations where they will be nicked a few hundred additional dollars when they pay off the mortgage.
We consumers may be angered by myriad fees, but we are also more price-conscious than we were a few decades ago in buying products like air travel or mortgages. More importantly, the internet gives us the ability to compare “sticker prices” more thoroughly. The natural, profit-maximizing responses of businesses is to compete with lower sticker prices and try to make up the difference in hidden fees.