Mother Jones posts the following graphic which charts the merger paths of four of today’s largest investment banks:
I think this chart illustrates a rather fundamental proposition about free markets: in every free market, there are winners and losers. When you have a wide field of competing firms, those firms who lose competitive advantages have an incentive to merge with competing firms in order to save what’s left of their business. That’s not bad in of itself: it saves employees the hardship of interim unemployment, and customers don’t suffer a disruption in service. There’s also a small efficiency windfall, because as management and departments get consolidated, there’s less administrative overhead. Yet as you can see, the inevitable result of this pattern is that we end up with a small group of exceptionally large firms that come to dominate the market. How can a smaller firm, just entering the market, compete with the kind of leverage and capital that these firms bring to bear?
It should be kept in mind that oligarchal markets aren’t inevitably detrimental to the consumer. Trey Parker and Matt Stone made the observation in an episode of South Park that large firms aren’t necessarily evil: sometimes the reason they get large is precisely because they have a business model that best serves the needs of their customers. They beat the competition and get bigger precisely because they’re providing the best possible combination of quality and affordability to their customers.
Yet on the other side of the coin, this slow, casual aggregation of assets and marketshare in the hands of a single firm means more risk, liability and leverage are packaged underneath the same tent. This is precisely how firms become “Too Big To Fail:” they get so large that the failure of a single company could create such a large short-term shock to the economy that intangible economic factors, such as consumer confidence and/or risk aversion, create real and lasting barriers to economic prosperity. Under those circumstances, the “bailout” is often the lesser of two evils; which is probably why economists on both the Left and Right believed it was the wise thing to do. Once you have a firm that’s Too Big To Fail, it is, by definition, a bad idea to let it fail. Although ideally, regulators actually do their job in the after-math and use Anti-Trust laws to break them up. If being “Too Big to Fail” doesn’t existentially put you in violation of the Sherman Act, I have no idea what possibly could.
The immediate objection to much of this will be along these lines: it is not the rules of the market that cause these mergers, but excessive regulations which create barriers to entry, thus allowing large firms to dominate the marketplace since small firms won’t have the capital to ensure compliance AND competitive prices. But this leaves out the fact that compliance costs shrink and grow in proportion to a firm’s balance sheets and market share. To wit: JP Morgan has a lot more paper to push than a small regional competitor. And the only way around these increased compliance costs is to commit fraud. So it doesn’t make any sense to say that compliance costs are the problem here. Large institutional banks need to retain a lot more help than a small regional bank does to ensure compliance. This is particularly true when you account for the fact that large firms get sued with much more frequency than small firms do; due in no small part to the fact that most large firms are publicly-held companies in which shareholders can bring suit derivatively, as all four of the big banks on the above chart are. This point is bolstered even further by the fact that it is often the regulators themselves who are doing the suing. And nobody is subject to more regulatory scrutiny than the big banks; particularly not in these times.
So at the end of the day, the answer to all this is that you need regulators to actually do their jobs and break up large firms before they get too big to fail in the first place. Libertarian Public Choice theorists may have a point, of course, that moral hazard and human incentives ensure that regulators will tend not to do so. But Citigroup’s latest $285+ million payout shows that federal regulators are capable of exercising meaningful oversight. This oversight may not be perfect in all cases. But to use an oft-quoted phrase, the perfect should not be the enemy of the good.
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laliberty said: Your “but” of compliance costs negates nothing. This is demonstrably NOT the result of a free market. Finance is THE most regulated/controlled industry in the U.S. This is crony capitalism, a corporatist system that REWARDS & PROTECTS big business.
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