Multinational Monitor  [Printer-friendly version]
December 1, 2008

THE CENTRALIZATION OF FINANCIAL POWER

[Rachel's introduction: Now, with the mergers of Merrill Lynch and
Countrywide Financial into Bank of America, Bear Stearns and
Washington Mutual into JPMorgan Chase, Wachovia into Wells Fargo we
are moving toward a highly centralized system of capital
allocation.... Bank of America, for example, is going to be an even
more massive employer, with huge leverage over the political and
economic system because of the money it has discretion to give out or
withhold....]

An Interview with Bert Foer

Bert Foer is president of the American Antitrust Institute, a non-
profit organization committed to assuring that competition is present
in industry and challenging concentrated economic power. Previously,
he was assistant director and acting deputy director of the Federal
Trade Commission's Bureau of Competition.

Multinational Monitor: Previous to the onset of the financial crisis,
can you offer an overview of the trends in banking and financial
consolidation over the last 10 to 20 years?

Bert Foer: There's been a huge amount of consolidation in the
financial services sector, but it must be said that a lot of it has
actually been beneficial to consumers.

In the mid-1970s, I was a commissioner representing the FTC [Federal
Trade Commission] on the National Commission on Electronic Fund
Transfers, which was a multi-year study commission established by
Congress to make recommendations for dealing with the emerging ability
to transfer money electronically. At that time, the U.S. had thousands
of small banks, which were restricted in many states to having only
one location, and banks were permitted to operate only in one state.
We looked at this remarkably decentralized situation, and we looked at
the prospects for using computers and electronic systems to transfer
money. One of our conclusions was that it really wasn't in the
consumers' interest to limit competition with unit banking laws and no
branch banking. Although we clearly recognized that removing those
restrictions would lead to the growth of large national banks, we
recommended certain deregulatory changes (as well as various consumer
protections) which Congress endorsed in the late 1970s.

The industry then went into a large-scale consolidation phase. Many of
the consolidations involved banks operating in one part of the country
merging with banks in another part of the country, creating a national
network. These "geographic extension" mergers worked well, bringing
competition to many localities that previously had had only one or two
small banks serving them. To that extent, the consolidation was quite
beneficial to consumers and small businesses. It gave the average
citizen more choices, more options (and thus greater leverage) for
borrowing, more convenient places to deposit, and also helped to
facilitate the growth of electronic transfers. Now you can go to an
ATM any time of the day or night, virtually anywhere, and make
deposits, receive cash or pay bills.

As the consolidation progressed, however, the very large banks merged
with other very large banks, creating megabanks. People legitimately
began to voice worry about creating financial institutions that were
going to be too big or too embedded in the economy to be allowed to
fail.

Meanwhile, other types of deregulation were also having an impact. By
the end of the 1990s, we had relinquished the separation between
commercial banks, investment banks and insurance companies, and had
erased other kinds of distinctions that used to keep different types
of financial services in narrowly defined categories, each with what
was considered to be an appropriate type of regulation. For example,
we allowed Travelers Insurance and Citicorp to merge -- a marriage of
insurance and commercial banking. We permitted brokerage firms to sell
cash management programs and thereby function as banks. As this new
structure of a conglomerate financial services industry came into
existence, the regulatory structure failed to keep pace.

Commercial banking and other functions had been kept separate for what
seemed very good reasons at the time. Capital allocation authority,
which is the essence of a bank or near-bank's function, was seen to be
very dangerous when it becomes too centralized and there are not
enough alternative sources for companies to turn to for capital.
Separation was also relevant because the failure of a megabank in
multiple financial areas would have huge ripple effects throughout the
economy. We also wanted to limit the riskiness of investments that
certain kinds of financial institutions would make with their
depositors' funds. As conglomeration grew and regulations were
removed, sufficient protections no longer remained. And when laissez-
faire ideology came to dominate government, even where regulations
were in place, regulators were often lax.

MM: And now consolidation is escalating to a new level, at lightning
speed.

Foer: Now, with the mergers of Merrill Lynch and Countrywide Financial
into Bank of America, Bear Stearns and Washington Mutual into JPMorgan
Chase, Wachovia into Wells Fargo -- and who knows what's next? -- we are
moving toward a highly centralized system of capital allocation.

I have three main concerns as a student of antitrust and competition
policy. The first is whether there will be sufficient numbers of
separate institutions to keep the financial sector truly competitive.
This is a standard antitrust question, susceptible to normal antitrust
analysis, when there is not a crisis atmosphere that requires
immediate action.

Second, going beyond the narrow antitrust question, I am concerned
whether we will have too much centralized political power in these
great financial institutions. Bank of America, for example, is going
to be an even more massive employer, with huge leverage over the
political and economic system because of the money it has discretion
to give out or withhold.

My third concern is that this political power only exacerbates the
too-big-to-fail problem. These mega financial services companies that
we're in the process of creating, are always going to be able to
persuasively demand from Congress whatever they think they need, lest
they fail. This is not necessarily a question of absolute size.
Rather, it is one of embeddedness, of how deeply their tentacles reach
into everything, everywhere. Everything is now not only linked but
linked instantly through the miracles of modern computerized
communications. We can no longer permit institutions of this magnitude
and complexity to fail because the economic ramifications would be too
drastic -- not only domestically but globally.

I wonder whether governments will be able to deal with their political
power. It is heartening to see many large governments take an
ownership role in the companies they bail out, not for the official
reason that this will give the governments a hope for being paid back
and maybe one day making a return on investment, but for the leverage
it could give to governments when we get to the day after tomorrow.

When I consider these current megamergers, I am reminded of Scarlett
O'Hara's refrain during the challenging days of Reconstruction: "I'll
think about that tomorrow." We have to do the mergers today. We can't
very well bring antitrust into the middle of these bailout situations
and expect the bailouts to work. Antitrust is just too time-consuming
and uncertain, when what is needed is quick action and psychological
therapy. Going forward, however, we need to learn from the fact that a
very weak set of merger controls permitted too much consolidation to
occur prior to the current crisis.

The consolidation problem is not restricted to banking by any means.
When you allow other parts of the economy to become highly
consolidated, you're creating companies that need very large banks.
Part of this is a reality of globalization, which allows corporations
to expand to fill the entire planet's demand. Talk about geographic
extension mergers: we've been creating firms and systems that are
global in their size, and sometimes there are only a handful of such
firms.

Take a look at an industry which plays a central role in providing
certified information that is at the core of a well-functioning
capitalist system: the audit industry. With the scandal-caused
disappearance of Arthur Andersen, we are down to the Big Four. Only
four accounting firms handle all of the public corporation audits in
the world, not just in the United States. It is the same Big Four
worldwide. And there is a lot of concern voiced, even finding its way
into legislation which puts caps on these firms' exposure to
litigation, that we can't allow any more accounting firms that audit
public companies to fail, any more than we can allow the massive
companies they audit to fail.

Huge size in one industry often leads to huge size in complementary
industries. The enormity of the banks, which are now engaged in global
financing, is partly attributable not just to economies of scale
(since banks surpass what economists call the "minimum efficient
scale" at a relatively small asset size), but to the size and
international requirements of their corporate clients, not to mention
to their own drive for power and wealth.

MM: When the state of economic emergency is over, what antitrust and
competition principles should guide evaluations of the financial
sector concentration?

Foer: From an antitrust perspective, several questions must be asked
going forward. The first relates to market definition. Is it accurate
to think that we only have a few really large and important financial
institutions, e.g., Bank of America, Citibank, JPMorgan Chase, Wells
Fargo, Goldman Sachs and Morgan Stanley? Or do the foreign financial
institutions that are more or less of the same size and which
participate in the United States, constitute adequate competition in
the way that foreign auto manufacturers keep the automobile market
very competitive for consumers? Is their presence something we can
count on in the future? If the relevant product market is capital and
the relevant geographic market is truly global, then antitrust will
have very little to say about mergers involving the biggest financial
institutions because there are still quite a few really large
financial institutions in the global market.

At the same time, we probably still have an ample supply of smaller
national, regional and local banks to serve many of our financial
needs. Antitrust analysis focuses on concentration and its effects in
specific product and geographic markets that are narrowly defined,
such as the residential mortgage market in a particular metropolis;
whereas many of our concerns about consolidation relate to aggregate
concentration. That's one thing to keep an eye on: the difference
between market concentration and aggregate concentration.
Traditionally, we have dealt with aggregate concentration issues
through sectoral regulation as a matter of competition policy, not
through antitrust litigation.

A second antitrust issue is whether the law needs to be modified in
light of what we are experiencing. It is arguable that the current
Clayton Act, which sets the rules for merger controls, would allow the
FTC or Department of Justice to take into account whether a merger
will weaken a company financially, such that it might be more
susceptible to failing and thereby render the transaction ultimately
anticompetitive. This is not the current interpretation of the law,
but it is a possible interpretation that the next administration might
attempt.

Beyond that, there is the industrial policy question of whether a
merger should be stopped on the theory that the resulting company will
be too big or too embedded to be allowed to fail. This would probably
require a statutory change, and Congress might want to include a role
for the Treasury Department in any such change.

Among the other things that we should be thinking about is how we are
going to deal with the centralization of financial power. Politically,
how do you deal with the new facts on the ground? Do we even know what
we would want to do, assuming the political will can be found? What do
we want to accomplish? Do we want to break up the largest financial
conglomerates and force them to operate separately in separately
defined product markets, as they did before Glass-Steagall was
repealed? (I believe this is called "putting the toothpaste back into
the tube.") Do we want to make the institutions smaller by giving them
incentives or even mandating that they divest themselves of assets and
create more companies out of those assets, while allowing them to
function in whatever markets they think best? Or do we want to admit
that they will always be too big to fail, in this new global world,
and the solution is a permanently larger role for government
regulation? Do we want all of these institutions to fall under the
aegis of a single federal regulator, a bureaucratic sibling of the
Homeland Security Agency? And don't we now recognize that hot money
travels around the world at warp speed, so that we need to create
appropriate new forms of global governance or at least some new
institutional mechanisms for rapid coordination?

These questions are of a mind-blowing complexity and importance that
is comparable to those which the country faced during the Great
Depression. In addition to experimenting with a variety of programs,
many of which failed, President Roosevelt and the Congress set up the
Temporary National Economic Commission (TNEC), to bring together key
Members of Congress, relevant government agencies and civilian experts
to undertake a large-scale baseline study of the American economy and
to make recommendations as to what should be done. It sounds a little
like what Candidate McCain initially proposed in the face of the
current meltdown. But he proposed a blue ribbon committee as an
immediate solution, which it is not.

The TNEC model is a way to bring together a variety of viewpoints and
develop a consensus over a sustained period of time and to come up
with recommendations based on evidence, diverse ideas and directed
debate. The actual contribution of the TNEC in terms of legislation
was not great, but the TNEC led to acceptance of the idea that high
levels of concentration could be dangerous and deserved to be the
focus of national attention. And that realization eventually led to
modifications of the Clayton Act, intended to stop monopolies, or near
monopolies, from being formed through mergers. I don't believe that
the Clayton Act has been implemented in accordance with the desires of
the Congress at that time, but the TNEC actually was a relatively
productive force in helping the country move into its next stage of
capitalism, a stage that emphasized free markets and intervention to
keep markets operating in the public interest.

We are now moving into a new stage here, there's no question about it.
But is this next stage of capitalism just going to happen, or are we
going to think about it carefully and attempt to shape the future? Can
we control the transformative process in an intelligent way? I'd like
to see the next president take the initiative in appointing a new
version of TNEC with a three-year mission to study the capital
allocation system, domestically and internationally, and to make
recommendations as to its structure and governance.

MM: We really are seeing shotgun marriages. Do you have the sense that
there are alternatives, given the urgency of these situations?

Foer: No. I think that these situations need to be dealt with rapidly
and we need to do it with an understanding that it is only a temporary
resolution to a problem that needs immediate action. But make no
mistake: These mergers will create their own problems and they will
need to be dealt with.

Shotgun marriages are rarely happy marriages. Mergers rarely work out
well in the best of circumstances. The more diverse the parties, in
products and culture, and the less planning that goes into the merger
decision, the greater the likelihood that there will be an eventual
desire within the company to divest substantial assets, after the
management that made the merger decision is no longer in place.
Today's shotgun wedding could be tomorrow's divestiture program, and
governments may need to employ their new equity positions to
facilitate this process of ultimately achieving an efficient,
manageable and politically acceptable outcome.

MM: Over time, will it make sense for the government, even if it
brokered the deal in the first place, to go back and review these
mergers and in some cases undo them or force some divestitures?

Foer: I think something of that nature is going to have to happen. But
I'm not sure if that should or even could happen primarily through
antitrust litigation, as opposed to some form of sectoral regulation.
You'll recall that the government was able to create a more
competitive aluminum industry after World War II by selling off plants
that had been operated by the war-time monopolist Alcoa to establish
new rivals, Kaiser and Reynolds. One of the problems is that when we
create these amorphous conglomerate financial companies, they are
subject to different regulatory forces, and it's not at all clear
who's going to end up regulating what. Of course, the regulators and
their oversight committees on Capitol Hill will themselves have vested
interests that will become important in the process. But a new
regulatory structure is going to be needed. Once we know what our
common goals are and we have an appropriate structure, then we can
design a more permanent structure for financial services. Needless to
say, there's a long unpaved highway between here and there.

MM: Is it too early to articulate principles, say, by which one might
want to undertake a review?

Foer: We don't know who's going to be left standing a month from now,
or two years from now. Remember, the Great Depression didn't all
happen when the stock market fell in 1929. Unemployment grew over a
period of years. We don't know today whether we are facing a recession
from which we'll recover in a year or two, or whether we're on our way
into a deeper hole. Until we establish firmer footing, I don't think
we're going to have the time or calm to deal with the problems of
consolidation that are being created. Right now, we must commit
ourselves to dealing with the problems that we are creating in an
appropriate and timely way and not merely accept that whatever happens
in the crisis is going to be permanent.