The Centralization of Financial Power: Unintended Consequences of Government-Assisted Bank Mergers

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.