In the aftermath of Tuesday’s Massachusetts special election debacle, the White House today is set to announce a major change of strategy on financial reform, with the president to propose new legislation that will limit the size and complexity of banks.
Such legislation is unlikely to pass the Senate. In fact, the approach to financial reform already in place, crafted by Senator Christopher J. Dodd with the blessing of the White House, was to trade away some parts of the House bill — including perhaps the potential new consumer protection agency for financial products — in return for sufficient Republican support to pass a bill in the next month or two.
But fresh from their success in the Democratic heartland, the Republicans will be less inclined than before to compromise in any meaningful way. They may keep negotiating, but the Senate Democratic choice will quickly become: pass a law with little sensible content, or don’t pass anything and look ineffectual.
Fortunately, there is an alternative — one laid out neatly by Krishna Guha of the Financial Times on Tuesday. Instead of pursuing the issue of those “too big to fail” financial institutions exclusively through legislation, the administration could launch instead one or more serious antitrust investigations into the behavior of our biggest banks.
This is a sensible idea that is long overdue. There are definite elements of oligopoly in wholesale markets, underwriting new issues, and mergers and acquisitions both in the United States and around the world. This is part of the explanation for very high profits in banks — particularly big banks — over the past decade.
The question becomes: Is there evidence that our leading banks have used their pricing power or other aspects of their market muscle to keep out competition or otherwise distort behavior in very profitable arenas, like over-the-counter derivatives?
This is a complex question — and most of our existing antitrust experience and capability is more suited to the nonfinancial sector. But given the importance of finance in our economy — around 7 to 8 percent of gross domestic product — and the way in which concentrated credit markets have shown they can move the world economy, both up and down, in destabilizing ways, we need one or more in-depth Justice Department investigations to determine exactly what big banks have been doing.
We may also need new theories of antitrust.
Most of our existing thinking was developed in response to the behavior of giants like Standard Oil — big industrial trusts at the start of the 20th century. There has obviously been some updating of the relevant conceptual frameworks to take account of “network economies,” most prominently around software, although we can debate how successful this has been.
But finance really is different. It reaches every corner of our economy. And the biggest banks have become even bigger: Assets in our largest six banks now stand around 60 percent of G.D.P., up from around 20 percent in the early 1990s. This degree of concentration has only increased during the crisis and bailout of the past two years.
It looks as if we are heading to a European-type situation, where individual banks can be as big as the entire economy. This is not a good destination. When a single bank becomes deeply troubled, like the Royal Bank of Scotland (which had assets that peaked at over twice the size of the entire British economy), that is a major fiscal issue for its home country.
In the United States, we urgently need regulatory action that would include raising capital requirements steeply, as well as a size cap on our biggest banks in order to rein them in. The administration’s existing proposals, including their latest bank tax, are ineffectual at best; today’s annoucement is a major (and welcome) course correction – but by itself this is unlikely to be enough.
The administration and Congressional Democrats were planning to run for the November midterms on their health care achievements. That now seems high risk and low return.
Claiming to have averted a second Great Depression, even if true, is also not an obvious vote winner — after all, what exactly did this administration do that other administrations (led by John McCain or Hillary Rodham Clinton) would not have done? What “change” can you point to in any aspect of our financial system – other than for the worse?
Increasingly, Congressional Democrats are thinking about how to run against the big banks in November — these banks, after all, brought us a massive financial crisis, need to be reformed completely, and so far have resisted any meaningful change. Launching a high-profile antitrust action would play well in that context.
By Simon Johnson
This is an edited and updated version of a blog post that appeared on the NYT.com’s Economix this morning. If you wish to reproduce the entire piece, please contact the New York Times.