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.