The great corporations which we have grown to speak of rather loosely as trusts are the creatures of the State, and the State not only has the right to control them, but it is duty bound to control them wherever the need of such control is shown.
Theodore Roosevelt, “Address at Providence,” 1902 (emphasis added)
By “creatures of the State,” Roosevelt meant not that corporations were created by the state, but that their existence and power existed because of and in concert with the state. A few years ago, someone reading this quotation would have probably thought first of Halliburton; today, it evokes the large banks that are too big to fail.
That quotation was pointed out to us by Zephyr Teachout, a law professor at Duke, who has been proposing new antitrust laws aimed at reducing the political power of large firms.
U.S. antitrust law was rooted in late-nineteenth-century hostility toward large corporations, but in practice became focused less on size than on specific anti-competitive practices. The Sherman Act of 1890 was aimed at collusion among companies to constrain freedom of trade, while the Clayton Act of 1914 went further in specifying anti-competitive practices, such as bundling or mergers that create excessive concentration in an industry. Over the past few decades, in part under the increasing influence of free-market economic theory, antitrust enforcement by the Department of Justice has become more tolerant of size and concentration in themselves, and has focused instead on whether mergers will benefit or harm consumers. On the one hand, increased concentration increases the ability of large firms to raise prices, hurting consumers; on the other hand, or so the argument goes, larger firms gain economies of scale that enable them to reduce costs and therefore reduce prices to consumers. (If you believe that, take a look at the price of text messaging on your mobile phone bill.)
So it seems likely that existing antitrust laws, as currently enforced, would be unlikely to do the trick of breaking up large banks. Even though the four largest banks hold about 60% of assets in the U.S. banking system, that’s not nearly concentrated enough to attract the attention of the DOJ. And while there may very well be illegal collusion among large banks, there is no smoking gun that I’m aware of, and you certainly wouldn’t need collusion to explain the events of the last decade, or the uniformly high prices charged for services such as equity underwriting. (One of the major implications of game theory, which was standard fare in first-year graduate micro by the 1990s, if not earlier, is that what looks like collusive behavior could also result from individual rational action.)
Teachout’s response is clear: write new laws. In particular, she argues, existing antitrust law does not address the problem of political influence.
There are many reasons a “too big to exist” conception of antitrust law makes good sense for a democracy. Perhaps most importantly, large companies have proven to have disproportionate power over the political process. Concentrated financial power often leads to concentrated political power; if you have a lot of cash, one of the most efficient uses of it to maximize profits is to petition the government to change the rules in your favor. Economies of scale might work all too well when it comes to influencing government.
This argument would barely have gotten a hearing in the 1990s and earlier this decade, when companies were scrambling over each other trying to merge, and the business media were constantly congratulating the “winners” in the battle to become big (even though, in most mergers, any actual gains go to the shareholders of the acquired company, since the acquirer invariably overpays). Now that we have official endorsement from a Republican administration that even the third-largest investment bank (Merrill) was too big to fail (and widespread regrets over letting the fourth-largest investment bank fail), and we have increasing recognition of the linkages between Wall Street and the federal government, the need for new laws may receive serious consideration. In addition, there is evidence (I’ll try to post on this another time) that, at least when it comes to banks, there is a size beyond which any economies of scale are outweighed by coordination problems, most tellingly in risk management. (And, there is the simple fact that large banks tend to charge higher fees, charge higher interest rates on loans, and pay lower interest rates on deposits than small banks.)
There is another, minority view, which is that a new approach to enforcing existing laws could be used against large banks. The general principle is that laws are defined by their interpretation. For an example, look no further than TARP, which gave Treasury the power to purchase “assets” of troubled banks, meaning things on the asset side of their balance sheet – and was prompty interpreted to mean that Treasury could buy preferred stock in those banks, which is only an “asset” from the perspective of the buyer, not the seller. Of course, to get your interpretation to stick, you may have to convince a court, in the antitrust case probably the Supreme Court. But it would not be the first time the Court has changed an interpretation that was once considered settled. For example, when the Court found an individual right to bear arms in the Second Amendment in District of Columbia v. Heller, 128 S.Ct. 2783 (2008), it was reversing a precedent that had not even bothered revisiting since 1939.
What would the argument be? Well, for one thing, having banks that are too big to fail, and then having to bail them out to the tune of hundreds of billions of taxpayer dollars, is clearly bad for “consumer welfare” in general. However, consumers under this argument are only being affected indirectly, so that argument may not stick. But perhaps someone can come up with a better legal theory here.
Originally published at the BaselineScenario and reproduced here with the author’s permission.