Katherine Mereand-SinhaProfessor BuchmanRegulation of Financial InstitutionsMay 2012

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A Call for Greater Competition Oversight of the Financial Services Industry

In 1863 Ohio Senator John Sherman, younger brother to the famous civil war general, put forth the National Bank Act to resolve the tension over whether America needed and wanted a cen-tral bank. Twenty nine-years later his name would also be applied to the Sherman Antitrust Act which he said did not “announce a new principle of law, but applies old and well recognized principles of common law.”

IntroductionThe financial services industry appears, at first blush, to be thoroughly regulated.

With a constellation of different agencies pouring over a variety of different aspects

of the business, the idea that there may be a regulatory deficit may seem absurd.

Nevertheless, as the conduct of financial services firms were generally not subject

to robust and vigorous marketplace competition conduct oversight, particularly fol-

lowing the decision in Credit Suisse Securities v. Billing,1 there are clear signs of

market failure bespeaking a lack of enforcement. This is especially important given

wave after wave of deregulation that banking and financial services have witnessed

since the 1980s opening up the marketplace to competition and thus anti-

competitive practices. Competition policy (a more complete concept of antitrust)

injected properly into the US financial sector would consist of the enforcement rules

aimed at protecting the market, and not simply the firm or the consumer.2

This paper will not argue that any one decision, the “repeal of Glass-Steagall,”

the decision in Credit Suisse, the essential non-examination of financial mergers

under the Federal Reserve’s (the Fed’s) guidelines,3 the general decision of the Bush

2

1 551 U.S. 264 (2007) (finding a clear repugnancy between the antitrust laws and conduct over-seen by the Securities and Exchange Commission).

2 See Testimony of Albert Foer before the House Subcommittee on Courts and Competition Pol-icy of the House Judiciary Committee, Serial No. 111-33, p11 (March 17, 2009), available at: http://judiciary.house.gov/hearings/printers/111th/111-33_48102.PDF [hereinafter Foer Testimony].

3 The Department of Justice clears hundreds of bank mergers a year. However, the 1995 Bank Merger Competitive Review guide the review per the Fed’s market definition

administration to not enforce anti-monopoly laws which potentially allowed other

antitrust abuses to remain undiscovered,4 is the single problem facing the financial

markets. Rather, this paper argues that the financial markets are suffering from a

general lack of competition principles applied through any mechanism whatsoever

after several waves of deregulation that removed other measures of protective over-

sight, although the Department of Justice’s Antitrust Division is making up for lost

time during the current administration. US policy made a fundamental shift in how it

oversees banking, perhaps due to pressures from political interests or perhaps due

to international pressures of other rising economies. Regardless of why we moved

away from regulatory protection, it is time to offer such protection through other

means.

Competition could be managed through market structures, through the regula-

tory agencies, or through non-sectoral antitrust review. One out of three wouldn’t

be bad, but until we learn to use competition consistently to open up markets in

these industries we are not really taking our own medicine, a failing which only hurts

us in the end.5 At this point, however, it is unclear whether the antitrust savings

3

4 William Kolasky, The Justice Department’s Section 2 Report: A Mixed Review, Antitrust 1 (Octo-ber 2008), available at: http://www.americanbar.org/content/dam/aba/publishing/antitrust_source/Oct08_FullSource10_27f.authcheckdam.pdf.

5 See generally, Ian Bremmer, State Capitalism Comes of Age: The End of the Free Market?, 88 Foreign Aff. 40, 50 (2009) (Suggesting that following the crisis which forced Western government to prop up their financial sectors, it is the state capitalist countries like the BRIICs who will be able to recover more easily. This in turn will drive more economies away from the free-market ideal for both short-term gain and a weakening of the belief in the free markets.)

clause in Dodd-Frank will allow for an application of the antitrust laws; given that, it

may be important that antitrust principles be embedded into financial regulations.6

The discussion of the appropriate relationship between banking law and compe-

tition is not new–in some ways it is one of the oldest questions in American banking

dating back to 1791–but it is perpetually an edge case discussion as the business

of banking and banking regulation focus on safety and soundness. But with a

twenty-first century understanding of competition law, banking theory, and a recent

failure of regulation to truly ensure soundness, it is time for a fresh look at an old

idea.

I. Competition PrinciplesThere may be no sine qua non of antitrust and competitive principles and no

single voice of authority on what makes for sound competitive oversight.7 Some

might point to Adam Smith. Some might point to Joseph Schumpeter and his the-

ory of dynamic competition that leads to creative destruction, finding that competi-

tion is a process that can swing dramatically as innovation destroys old economic

4

6 Todd Fishman, et. al., Antitrust, State Aid, and Financial Regulation: US and EU Enforcement: What Role in a More Heavily Regulated Financial Sector?, 7 Competition Pol’y Int’l 32, (2011) [hereinafter Fishman].

7 The “purpose” of antitrust in the US is subject to regular disagreement and political swings. See John Kirkwood & Robert Lande, The Fundamental Goal of Antitrust: Protecting Consumers, Not Increasing Efficiency, 84 Notre Dame L. Rev. 191 (2008); see also Remarks of Deborah Platt Ma-jors, US FTC Chairman at the International Competition Conference/EU Competition Day (March 26, 2007) available at: http://www.ftc.gov/speeches/majoras/070326munich.pdf.

power structures such as natural monopolies.8 Some tie competition principles

back to Roman law or the English common law. It is difficult to draw a straight line

to a single authority, and doing so may be inappropriate as modern economics is

an ever-changing field. Worse, the US courts certainly do not meet the mark for

vigorously applying antitrust to markets over the last decade.9 For authority, there-

fore, it may be safer to say, instead, there is a distinct difference between competi-

tion oversight and a laissez-faire economy.

A. Simple US Principles

A few simple principles drive competition law and theory. Fairness and transpar-

ency of market realities are necessary for a truly free market, because free markets

are not simply free of “government” interference but also from the non-transparent

and unfair interference of dominant market actors. Another simple principle drives

antitrust law but has been more controversial: the goal of antitrust is to benefit con-

sumers by encouraging innovation through competition on price, quality, and variety

5

8 J Gregory Sidk and Davide Teece, Dynamic Competition in Antitrust Law, Jnl of Competition Law & Economics (2009) 5 (4): 581-631.

9 Antitrust law in the US faces a similar theoretical divide that banking law faces. There are theo-rist and jurists who would favor efficiency and profits for a firm over other values in regulation and oversight, and their theories pervade antitrust case law. It would be a mistake to assume that anti-trust, which deals with big business and big money, were any less political than banking or eco-nomic theory generally. See Maurice E. Stucke, Occupy Wall Street and Antitrust (March 1, 2012). Southern California Law Review Postscript, Forthcoming; University of Tennessee Legal Studies Research Paper No. 179. Available at SSRN: http://ssrn.com/abstract=2002234.

of products available.10 American antitrust basics thus hold the following: (1) collu-

sion to set prices or restrict supply is criminal, (2) merger to monopoly or a high

level of concentration in regional or product markets is generally forbidden without

offsetting divestiture, (3) and practices meant to restrict fair competition are sus-

pect.

B. Simple EU Principles–Importing ‘Foreign’ Antitrust Ideas

Another, perhaps important antitrust principle we might import from the Euro-

pean Union would be the idea that national champions are damaging to the mar-

ketplace and to competition. A national champion is an industry or company that a

country protects or supports–either through direct ownership, financial support, or

through preferential treatment–to ensure that it is not harmed by pure competition in

a global marketplace. Europe has focused on national champions, and what they

refer to as state aid, as they focus on creating the Eurozone marketplace amidst

countries that traditionally had several national champions.11 Looking at the rise of

developing nations like the BRIICS who favor national champions, arguably for bet-

ter or worse state supported capitalism is a step on the path to free market econo-

6

10 See Fishman, surpa; See generally, the 2010 DOJ/FTC Horizontal Merger Guidelines. While the courts use a constrained understanding of antitrust and competition law, the Federal antitrust agencies use the guidelines as their touchstone for antitrust principles. The 2010 revisions saw major updates, some of which were referenced in the DOJ complaint in the recent AT&T/T-Mobile failed merger.

11 See generally, Jonathan Galloway, The Pursuit of National Champions: The Intersection of Competition Law and Industrial Policy (February 23, 2007). European Competition Law Review, 2007. Available at SSRN: http://ssrn.com/abstract=1767865.

mies. For the reasons that Europe fights against state aid is the reason that we

should consider the impacts and the harms: one realization that occurred after the

recent financial crisis in both the US and in Europe is that “banks which are global in

life are national in death.”12 In a global economy, financial firms that are global in

scale nonetheless return to their home countries for support when the the market

turns ugly.

II. The Special Status of Banks and Other Financial Institu-tions

A The Belief That Banks Are Special and Thus NonBank Financial Institutions Are Special

Is there something different about a bank, or a brokerage firm for that matter,

than a manufacturer of goods? Is there a unique quality to this industry that requires

a special approach, or is it much like every other? Banks are special. Banks are in-

volved in every segment of our economy, are a critical component of nearly every

major economic transaction, and are fragile. It is not inappropriate to analogize the

Federal Reserve to the economies heart, and the big financial institutions as major

arteries. What that special status should mean for banks is harder to say. That is in

part because it is hard to discuss banks because right now banks mean commer-

7

12 The Retreat From Everywhere: Led by European Banks, The World’s Lender are Pulling Back to their Home Markets, The Economist print edition (April 21, 2012), available at: http://www.economist.com/node/21553015.

cial banks, insurers, investment banks, and speculative trading. “Banks” is serving

as an omnibus term that is perhaps too big to have any real meaning.

There is a long-standing idea that banks, and particularly retail banks, are spe-

cial. They provide deposits, can access deposit insurance, and are subject to

safety and soundness regulation. Some argue that they are only special, however,

because government has treated them as special,13 a view that led to the deregula-

tion waves that happen depending on who controls Congress.

Because there is another thread to this story, perhaps the most important,

which is that banks serve multiple functions, as depository institutions and as credit

intermediaries. It is the latter category where things became confusing and prob-

lems arose.

As early as the 1980s commercial banks began to lose out to investment banks

in the corporate financing market; instead they moved into ever greater commercial

and residential real estate lending into ever riskier markets.14 The breakdown in the

financial model for commercial banking model can be linked to the deregulation

acts of 1980 which led to the S&L (savings and loan) crisis. The business model for

retail banks broke down, and despite an interest in keeping banks safe, keeping

8

13 Catherine England, Are Banks Special?, CATO REview of Business and Government 25 (Spring 1991), available at: http://www.cato.org/pubs/regulation/regv14n2/v14n2-3.pdf

14 Peter Wallison, Losing Ground: Gramm-Leach-Bliley and the Future of Banking, AEI Financial Services Outlook, November-December 2009, available at: http://67.208.89.102/files/2009/12/18/FSO-Nov-Dec-g.pdf; Timothy Curry & Lynn Shibut, The Cost of the Savings and Loan Crisis: Truth and Consequences, FDIC Banking Review, 26 (1986), available at: http://fcx.fdic.gov/bank/analytical/banking/2000dec/brv13n2_2.pdf.

banks liquid was the first order of business. Thus banks were consolidated to help

shore up failing institutions that had made risky loans.

The S&L crisis was a volatile time, but some of the risky investments paid off

and some interest groups fought for more access to allow banks to be involved in

markets that had higher risk for reward premiums. Acts like the 1994 Riegle-Neal

act15 allowed for every more consolidation and allowed banks to take on riskier but

more rewarding investments while maintaining the public safety net.16

We are now in a confusing space where interests are fighting, yet again, about

whether to keep banks and financial institutions “special” or whether to allow them

greater reign to make higher returns. While this tug-of-war occurs, neither theory is

allowed to take hold and we get the worst of both worlds.

Because interestingly, industry deregulation may have widened the umbrella to

apply to investments banks the same “special” status that retail banks have long

enjoyed sans the safety measures. That was inappropriate, because the special

status relied on regulations for safety and soundness and deregulation moved for-

ward without an attempt to inject safety measures by other means. When those

regulations were removed, we were left with a completely laissez-faire approach to

now very special institutions that were nonetheless tied to the public safety-net, es-

9

15 Section 1 of title I of the Act of September 29, 1994 (Pub. L. No. 103--328; 108 Stat. 2338), effective September 29, 1994; codified at 12 U.S.C. 1811.

16 See Carl Felsenfeld, The Antitrust Aspect of Bank Mergers, 13 Fordham J. Corp. & Fin. L. 507, 507-09 (2008).

sentially undoing the protections that have been in place since 1863 when the Na-

tional Bank Act effectively ended “wildcat” banking.17

There is no doubt that before the crash, and even after the crash, that the un-

leashed power of financial institutions was impressive and helped to grow our

economy.18 But even though much of the stance towards banking allowed for

Schumpterian dynamic competition we then held the brakes on creative destruc-

tion. Schumpterian style competition can function, albeit it is a rough ride, but not if

we do not allow for destruction to remove rentier monopolies. The moment that we

decided that we would not let large financial institutions fail is the moment that we

turned away from laissez-faire economics as a guiding principle. At that point it be-

came clear that we need to approach the overall theory of the financial services

market place differently.

This paper does not advocate for Schumpterian destruction per se, but to high-

light that the current approach took us only half way down that path. If you consider

banking regulation to be a spectrum that runs from high-regulated and centrally

controlled to completely laissez-faire, the middle ground is antitrust style competi-

10

17 See generally, Ian Bremmer, State Capitalism Comes of Age, 88 Foreign Aff. 40, 45 (2009) (“Until very recently, New York City was the world's financial capital. It no longer is even the finan-cial capital of the United States. That distinction now falls to Washington, where members of Congress and the executive branch make decisions with long- term market impact on a scale not seen since the 1930s.”)

18 Randall Krosner & Philip Strahan, Regulation & Deregulation of the U.S. Banking Industry: Causes, Consequences, and Implications for the Future, Chapter 8 in Economic Regulation and Its Reform: What Have We Learned? (NBER August 2007), available at: http://www.nber.org/chapters/c12571.pdf.

tion which replaces the destructive element of competition with a more measured

and predictable approach of slower but not completely stalled growth.

B. The Purpose(s) of Glass-Steagall & Gramm-Leach-Bliley

The “repeal” of Glass-Steagall (G-S), a rule that for sixty-six years kept a lop-

sided firewall between commercial banks and securities, was hailed by some as a

deregulatory victory and was predicted by others as the beginning of the end. While

this paper does not advocate to simply reinstate that which was removed, it is ap-

propriate to question whether there were market controls and measures effectively

enforced by G-S that should have been in place or put in place on the investments

side of the ledger when the walls came down.19 The concern is not whether or not

retail banks were exposed to risk, the concern is whether investment banks were

given too much leeway by allowing access to too much of the banks’ public safety-

net. As Allen Greenspan noted in 1999, Gramm-Leach-Bliley (G-L-B) modernization

was not supposed widen the field of institutions that could benefit from “the gov-

ernment guarantee of deposits and the access to both central bank credit through

the discount window[...].”20 The moral hazard created by the safety net was not

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19 Arguably, through loop holes, G-S was already dead-letter when Gramm-Leach-Bliley was passed. See generally Jonathan Macey, The Business of Banking: Before and After Gramm-Leach-Biliely, 25 J. Corp. L. 691 (1999-2000) (“Before the Gramm-Leach-Bliley Act was passed, regulators had construed the Glass-Steagall Act in such a way that commercial bank holding companies were being allowed to establish and acquire investment banking operations, but in-vestment banking firms were not being allowed to acquire commercial banks.”)

20 Remarks by Chairman Alan Greenspan, Insurance companies and banks under the new regu-latory law, Before the Annual Meeting of the American Council of Life Insurance, Washington, D.C. , November 15, 1999, available at: http://www.federalreserve.gov/boarddocs/speeches/1999/19991115.htm.

supposed to extend to investment banks, but somehow that is precisely what

happened.21 Those who wanted to ride the bubble of laissez-faire expansion did

not have the stomach to whether the storm of the inevitable crash.

There is a middle ground between centrally controlled and completely unregu-

lated markets but the middle ground was the path not traveled. The zeitgeist that

led to G-L-B’s 1999 effective repeal of G-S was based on a belief that retail banks

were fading away into obsolescence as banks and nonbanks competed as credit

intermediaries. The repeal of G-S was not necessarily a problem, but it was prob-

lematic to do so without consideration to how a post G-S world would operate

sans the rose-colored glasses.

Much of the rest of the US economy is governed at least by competition princi-

ples in the market place. But through regulation and de-regulation the financial in-

dustry lumbers back and forth between command/control and oligarchy.

C. The Volcker Rule and Section 23A

Named for former Fed chairman Paul Volcker, the rule sought to reset some of

what the repeal of G-S undid by restricting banks and financial institutions from

12

21 Even foreign banks were given access to the Fed’s discount window at the height of the finan-cial crisis. Bradley Keoun & Craig Torres, Foreign Banks Tapped Fed’s Secret Lifeline Most at Crisis Peak, Bloomberg, April 1, 2011, available at: http://www.bloomberg.com/news/2011-04-01/foreign-banks-tapped-fed-s-lifeline-most-as-bernanke-kept-borrowers-secret.html; see also, Federal Reserve Financial Crisis Discount Window Loan Data, Public Intelligence Blog, April 1, 2011, available at: http://publicintelligence.net/federal-reserve-financial-crisis-discount-window-loan-data/ (making public the details of a Bloomberg FOIA request about loans made from the discount window in 2008).

owning, investing in, or sponsoring hedge funds, private equity funds or proprietary

trading for its own profit. It also strengthened preexisting caps on the market share

of deposits each institution could maintain.22

Rule 23A of the the Federal Reserve Act ostensibly limits the extension of credit

and other transactions between a bank and its affiliates to reduce risk exposure,

except when exempted as institutions were during the financial crisis so that the

Fed could inject liquidity into the capital markets.23 Under G-L-B the Fed was the

umbrella regulator of securities firms, and the Fed gave exemptions to rule 23A

strictures.

D. The General Purpose of Financial Sector Regulations

Financial services firms are subject to a wide variety of special regulations.

These regulations are generally promulgated with two purposes. The first (and most

widespread) is to protecting consumers in their bilateral relationship with a given

firm, ensuring the safety and fairness of the transactions. The second, a broader

mandate, is to ensure consumer confidence in their bank and the industry as a

whole, to prevent runs on banks, and generally to encourage the trust required for

mass participation in the financial sector.

13

22 See http://www.asif.org.au/pub/regulations/Article%20by%20Mr.%20Nunami%20final.pdf.

23 Saule Omarova, From Gramm-Leach-Bliley to Dodd-Frank: The Unfulfilled Promise of Section 23A of the Federal Reserve Act. North Carolina Law Review, Vol. 89, 2011; UNC Legal Studies Research Paper No. 1828445, available at SSRN: http://ssrn.com/abstract=1828445.

These goals often do not take into account the impact of these regulations on

the overall marketplace, the relationships and competition between firms, and the

overall access of the consumer to services from the market. Many of these rules

explicitly raise barriers to entry of new market participants, retard the expansion or

differentiation of services, and generally force harmonization within the industry that

reduces direct competition between the firms.

Further, as a result of Credit Suisse, the presence of these regulations precludes

general competition law enforcement and intervention by regulators familiar with

competition law. Existing regulators, with a narrow focus on implementing the

aforementioned bilateral consumer protection and industry confidence mandates,

are less able and less interested in examining systemic competition issues. Indeed,

they often encourage anticompetitive behavior in the pursuit of reducing institution

risk and increasing the stability of the industry.

III. Deficiencies in the Financial Services MarketsIn examining the financial industry’s competition law regime flaws, the question

must be answered as to whether there is a problem to begin with. Is this a competi-

tive market, or does it show signs of concern?

A. Highly Concentrated Markets

Much of the financial industry’s markets are extremely consolidated and the

trend is toward ever greater consolidation to ensure stability. When in doubt, finan-

14

cial companies merge; when failing the federal government enforces merger (also

known as “assisted mergers”).24 Mergers are not per se negative, often they indi-

cate a healthy marketplace, but given that the core business of financial service is

not likely to become obsolete (as all manufacturing firm and technology firms face)25

it is worth questioning whether there is or should be a mechanism for government-

led de-consolidation and divestiture to reduce market concentration. Natural de-

consolidation could occur if barriers to entry into the marketplace were low, firms

were allowed to fail, or if firms had an incentive to divest portions of their business.

Instead, we have continued a long-standing trend of evermore consolidation

with no end and no mechanism for deconsolidation in sight. Given the size and in-

fluence of ever-growing banks and government-erected bars to whom may be

chartered, barriers to a market entry are steep. Firms are not allowed to fail, and

there is no mechanism for divestiture. As Professors Macey and Holdcroft explained

in their 2011 essay, Failure is an Option: An Esratz-Antitrust Approach to Financial

Regulation, “[Larger banks], which account for only 3% of the banks…represent

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24 Assisted merger theory is now applied to SIFIs through orderly liquidation authority given to the FDIC during Dodd-Frank. While orderly liquidation may be workable and prudent, careful consid-eration about healthy competition should be a key component above and beyond stability of the individual institution.

25 Eric Jackson, Here’s Why Google and Facebook Might Completely Disappear in the Next 5 Years, Forbes, published on April 30, 3012, available at: http://www.forbes.com/sites/ericjackson/2012/04/30/heres-why-google-and-facebook-might-completely-disappear-in-the-next-5-years/.

approximately 83% of total bank assets, 82% of total bank liabilities, 80% of total

deposits, and 84% of total bank equity.”26 The trend points only in one direction.

The IPO market is similarly consolidated. As Professors Xiaoding Liu and Jay

Ritter explain in Non-Price Competition and IPO Underpricing, non-price dimen-

sions of under writing reduce the industry structure to “a series of local

oligopolies.”27 In early April of 2012, Bloomberg reported that Morgan Stanley and

Goldman Sachs have a virtual duopoly for high-profile technology IPOs, including

LinkedIn, Groupon, Zynga, Yelp, and Facebook split between them.28 Oligarchic

competition amongst IPO underwriters harms both firms looking to go public as

well as potential investors.

In each case, both groups are harmed twice over. Growing firms may be dis-

suaded from going public in the first place, instead relying solely on debt-fueled fi-

nancing instead of investment fueled financing. If they choose to go public they

must accept worst terms than they would have in a more competitive market. In-

vestors may find that the pricing of the shares are less advantageous because of

the constrained market where there are fewer IPOs and those released are released

16

26 120 Yale L.J. 1368, 1405 (2011).

27 Warrington College of Business Administration, University of Florida (October 12, 2010), avail-able at: http://bear.warrington.ufl.edu/ritter/Liu%20Ritter_10_12.pdf.

28 Ari Levy, Quattrone Says IPOs Can’t All Go to Morgan Stanely and Goldman, Bloomberg, April 5, 2012, available at: http://www.bloomberg.com/news/2012-04-05/quattrone-says-ipos-can-t-all-go-to-morgan-stanley-and-goldman.html.

with substantially similar premiums that might have been avoidable if issued by ac-

tually competing underwriters. Some will accept the worse rate of return or may

chose to not participate in the market. And these effects on firms and on invest-

ment have an attenuated impact on the overall economy as it slows growth and

removes smaller competitors from other markets, like technology, who cannot make

the tall leap into the particularly constrained IPO market. All of this economic harm

is repackaged as economic benefit for the underwriters, and it removes any incen-

tive for innovation in the IPO process. The IPO process, as a result, has been es-

sentially unchanged in the last thirty years. No market entrants or exits have oc-

curred in that period, demonstrating a static oligopoly that is generating these

harms.

As the California Reinvestment Corporation cited in a 2008 press release:

“Washington Mutual, Wachovia, Fannie Mae and Freddie Mac all disap-peared without public input; the nation's two remaining investment banks have become bank holding companies also without public scrutiny; and Bank of America has been allowed to break the bank monopoly barrier with more than 10 percent of the country's deposits. In the desperation of the economic crisis, Americans have lost a say in the future of their fi-nances, and the few remaining banks have been allowed to grow too big.”29

CRC’s central concern was that the management of the crisis forced mergers

and consolidation were not in the public interest.

17

29 California Reinvestment Coalition, Unregulated Bank Consolidation Will Hurt Underserved Neighborhoods, Oct. 15, 2008, available at http://www.reuters.com/article/2008/10/15/idUS228036+15-Oct-2008+PRN20081015 (last ac-cessed April 15, 2012).

Looking at the lockstep pricing of most consumer financial products (interest

paid on savings accounts, etc), some might think that perfect competition was in

operation, driving firm yields down as far as they might go. Canonically, the most

free market is a stock market; the goods are in large supply and are commoditized,

there are a large number of purchasers and sellers, and information is generally

evenly accessible, and in ample supply. Regardless of arbitrage (and acting as a re-

buke to the Efficient Market Hypothesis), the market swings wildly from day to day.

Free markets are volatile markets unless there is no producer/supplier surplus

(which the profit figures and P/E rations regularly announced by financial services

firms disprove), and the quiescent pricing seen in the financial services industry are

a warning sign that aggressive competition is not occurring.

B. Little to No Price Competition

Further, the financial services market, regulated for safety but not for competi-

tion, has cultivated a situation where there is little transparency in many of their

products. Derivatives are so complex that even forensic financial experts cannot

unwind their sources. Credit default swaps (CDS’s) contain counter-party risk is un-

known and even unknowable. Even the prosaic consumer home mortgage has

been encumbered by peculiar terms buried within literal reams of meaningless ver-

biage. The end result is that unlike the stock market with which it is associated in

the public imagination, the financial services industry operates without transparency

and that lack of customer information further retards efficient market operation with

18

respect to pricing, or even risk evaluation. Much of this is the result of an industry,

that while heavily regulated in some regards, is essentially unregulated with respect

to competition law.

IV. State of Competition Regulation in the Financial IndustryA. Traditional Antitrust and Mergers

The Federal Trade Commission Act does not generally apply to the financial

services industry,30 but some aspects of merger review are applied to the market

participants through the Federal Reserve and other sectoral regulators.31 In addi-

tion, DOJ does have some authority to review bank mergers, though not the tradi-

tional Clayton Act authority used in other industries, and that authority it shares with

the Federal Reserve.

In the realm of merger review, banks are special. They are exempt from the

Hart-Scott-Rodino pre-merger notification process,32 but a similar process built into

the Bank Merger Act of 196033 and the Bank Holding Company Act.34 Specifically,

the DOJ reports on competitive concerns to the Fed, but the agency does not need

to accept DOJ’s recommendation. In fact, the Fed may approve an on-face anti-

19

30 Although some nonbank subsidiaries of bank holding companies may come under FTC review.

31 FTC oversight can be implicated when merging companies have nonbank subsidiaries, but the FTC review is limited to the nonbank aspects of the merger.

32 15 U.S.C. § 18a(c)(7).

33 12 U.S.C. § 1828.

34 12 U.S.C. § 1828(c)(5).

competitive merger if the negative effects are “clearly outweighed in the public inter-

est by the probable effect of the transaction in meeting the convenience and needs

of the community to be served.”35 In practice, their review looks for the impact on

system risk of the merger, rather than the impact of free pricing and consumer wel-

fare.

While DOJ can still challenge the merger in court, it has not done so since

1993.36 Once upon a time, DOJ rushed in to block bank mergers (see, the 1970s).

But then antitrust went through a spell of general under-enforcement under Reagan

in the 1980s. And when Clinton’s DOJ antitrust division reversed the trend on anti-

trust enforcement, somehow banks and the financial industry were no longer on the

agenda.37

In 1995 DOJ developed the Bank Merger Competitive Review Guidelines with

the Federal Reserve, and since then the Federal Reserve has defined the markets

used for merger review.38 The way that merger review operates in the US courts

relies almost entirely upon market definition. Arguably this was a failing of the anti-

20

35 12 U.S.C. § 1828(c)(5)(B).

36 Gregory Werden, Perceptions of the Future of Bank Merger Antitrust: Local Areas Will Remain Relevant Markets, 13 Fordham Journal of Corporate & Financial Law 581 (2008).

37 For a discussion of the decline of antitrust enforcement since the 1960s, see generally Jona-than B. Baker & Carl Shapiro, Reinvigorating Horizontal Merger Enforcement (2007), available at http://faculty.naas.berkeley.edu/SHAPIRO/-mergerpolicy.pdf; see also Robert Zora, The Bank Failure Crisis: Challenges in Enforcing Antitrust Regulation, 55 Wayne L. Rev. 1175 (2009).

38 Bank Merger Competitive Review -- Introduction and Overview, Department of Justice (1995), available at: http://www.justice.gov/atr/public/guidelines/6472.htm.

trust laws to be able to fully understand the various market definitions, but also ar-

guably there was not a lot of room for concern because Glass-Steagall was serving

as a partial backstop.

In 2006 the Antitrust Modernization Commission staff39 considered how merger

review could operate in industries where deregulation was occurring. While the staff

explored different options, their number one recommendation was to allow antitrust

experts to review mergers with a purely advisory role for regulator agencies.40 This

is because while the banking agencies assess a merger for safety and soundness,

the question of competition in the marketplace is often overlooked.

Others, like American Antitrust Institute President Albert Foer, suggest that be-

cause mergers are often seen as irreversible, greater attention should be paid when

merging failing institutions with perhaps a division of the DOJ’s Antitrust Division

dedicated to crisis restructuring of failing firms and a flexible power to delay but not

out and out prohibit mergers likely to “exacerbate” systemic risk through the “too

21

39 The Antitrust Modernization Commission was created pursuant to the Antitrust Modernization Commission Act of 2002, Pub. L. No. 107-273, §§ 11051-60, 116 Stat. 1856. “The Commission was charged by statute: (1) to examine whether the need exists to modernize the antitrust laws and to identify and study related issues; (2) to solicit views of all parties concerned with the op-eration of the antitrust laws; (3) to evaluate the advisability of proposals and current arrange-ments with respect to any issues so identified; and (4) to prepare and submit to Congress and the President a report. See Antitrust Modernization Commission, available at: http://govinfo.library.unt.edu/amc/about_commission.htm (last accessed April 15, 2012).

40 Antitrust Modernizations Commission Staff Memorandum to Commissioners, Supplemental Regulated Industries Discussion Memorandum––Merger Review in Regulated Industries, July 26, 2006, available at: http://govinfo.library.unt.edu/amc/pdf/meetings/RegIndSupplMemo060721circ.pdf.

big to fail” conundrum.41 And perhaps most controversially, Mr. Foer recommends

TNEC-Two, named for the 1930s era Temporary National Economic Committee, to

comprise key members of Congress and government to apply a BRAC like consid-

eration of SIFIs whereby they make choose to break down large financial conglom-

erates into smaller component companies.42

B. New Measures for the Consumer Financial Protection Bureau

Some other basic principles of the various antitrust acts that are applied to the

financial services industry were enforced by the Federal Reserve, some of which are

now a part of the Consumer Financial Protection Bureau’s mandate.43 These provi-

sions bind depository institutions, but critically they may not bind non-bank entities

that are also not involved in consumer lending. Nonetheless, at this time many of

these regulations are seeing new life, being rewritten and newly enforced by the

new cop on the beat.

The ban on interlocking directorates of vertically or horizontally related compa-

nies is contained in the Fed’s Regulation L, which prohibits any individual from serv-

ing on the boards of two depository institutions at the same time.44 A general duty

to deal (and specific provisions as to where and how) provided for by Regulations

22

41 Foer Testimony, supra.

42 Id.

43 Dodd–Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, §§ 941–946, 124 Stat. 1376 (2010) [hereinafter Dodd–Frank Act].

44 12 C.F.R. 212.

E,45 N,46 CC,47 and II48 which govern EFTs, foreign bank interactions, check han-

dling, and debit card routing, respectively.

Generally speaking it is fairly easy to shift money, accounts, and business to and

from one bank to another. By ensuring that all banks regardless of size can transact

with other banks on an even playing field (and thus there is no structural disadvan-

tage in terms of any single transaction for a consumer to be transacting through a

small bank rather than a large one), these regulations help prevent abuse of domi-

nance problems common to network-style markets (like such as Internet Service

Providers), that manifest as uneven access to a central network that is necessary

for any meaningful use of that market’s services.

Transparency in financial service transactions are ensured in part through Regu-

lations C (home mortgage disclosures),49 M (consumer leasing disclosures),50 Z

(truth in lending),51 AA (unfair or deceptive acts or practices),52 and DD (truth in

23

45 Details about the final rule available at: http://www.consumerfinance.gov/regulations/final-remittance-rule-amendment-regulation-e/.

46 Interin rule available at: http://www.gpo.gov/fdsys/pkg/FR-2011-12-16/pdf/2011-31731.pdf.

47 Fed’s proposed rule available at: http://www.gpo.gov/fdsys/pkg/FR-2011-03-25/pdf/2011-5449.pdf.

48 12 C.F.R. 235.

49 12 C.F.R. § 1003.

50 12 C.F.R. § 1013.

51 12 C.F.R. § 1026.

52 12 C.F.R. § 227 (overseen by the Fed).

savings).53 Due in part to lack of institutional consumer protection experience, the

Federal Reserve’s implementation of these regulations had led to obfuscation-

through-overcompliance, hiding terms or explanations in the literal reams of paper

sent to consumers about their transactions. The CFPB is attempting to address this

through standardized reporting and disclosure forms that present relevant informa-

tion in a clear and succinct layout.

C. Missing Competition Oversight

Despite these provisions, however, many restraints of trade prohibited or re-

stricted by general US antitrust law are not effectively addressed with respect to the

financial services sector. No regulatory agency with authority over the financial in-

dustry maintains standing scrutiny over tacit collusion in the industry, a particular

concern for submarkets that are highly consolidated, such as IPO underwriting, and

derivative trading. No regulatory agency considers abuse of dominance cases out-

side of regulation-mandated duty to deal situations. No regulatory agency considers

cases of predatory pricing, or cartel price controls outside of stock price manipula-

tion.

Further, even if the general antitrust laws–the Sherman, Clayton, and FTC Acts–

were applied to financial services, they would have proven insufficient to combat

what became “too big to fail.”54 In his testimony to the House Judiciary hearing in

24

53 12 C.F.R. § 1030.

54 See Foer Testimony, supra.

2009 Mr. Foer highlighted the fact that the antitrust laws do not allow the antitrust

Agencies to stop mergers on the basis of absolute size, and he suggested just

such a mechanism was lacking.55

Meanwhile, many of the regulations promulgated to protect the financial system

or the unwary consumer have the de facto effect of raising barriers to entry to many

of the financial services markets (new bank licensing processes, primary dealer

status for Treasury bills, etc). Further, some interventions into the financial services

markets have represented state aid, whether in terms of underpriced or free as-

sumption of risk, or preferential borrowing facilities.

In Conclusion, the Purpose of Competition Law and Regula-tions

Having taken a look at the state of the financial industry with respect to competi-

tion, consolidation, and current legal regimes, it would be timely to step back and

reexamine the goals and methods of competition law in general. Antitrust is an

American invention, but competition policy has undergone serious refinement in the

European Commission. Regardless of any divergence or convergence of antitrust

theory, some very basic principles exist.

The goal is essentially to ensure a marketplace where “competition,” in the

sense of participants striving against each other to provide or acquire goods and

services at the lowest cost and highest yield, in an environment where there are

25

55 Id.

enough participants that almost any transaction has a potential buyer and seller,

where they cannot subvert or avoid the contest through the application of market

power, and where information about each participant, their wants, wares, and

wherewithal, are all evenly and easily available. It’s a tall order.

The specific problems that competition law regimes attempt to solve are myriad.

They include standard monopolies or monopsonies, (and their oligopolist ana-

logues) where one or a few participants can autonomously change the market’s

clearing price. Cartels attempt to manipulate the price through coördination, either

explicit or tacit, where collectively they act as a single monopoly. Abuse of domi-

nance is where a market participant with a high marketshare uses that power to ex-

clude or disadvantage competitors not through economies of scale, but rather

through aggressive moves to impede those competitors’ ability to conduct busi-

ness.

The methods through which the regulators attempt to prevent or solve these

problems include merger review (to discourage consolidation and market power

concentration), conduct restrictions (applying civil and/or criminal penalties to

banned activities such as collusion, or deceptive marketing), monitoring, and con-

sent orders. The variety of tools reflect the myriad circumstances that present anti-

competitive issues.

26

Competitive harms can occur in any market in which there are non-government

actors, and competitive oversight can be conducted by regulatory bodies that focus

on a sector or on the general marketplace. But the critical factor is that competition

is an element to a free market society that must be managed, essentially

In essence, the support that we have been providing to financial institutions, and

the growth they have seen, is the classic state aid that Europe is trying to route out

of their system. And while the Washington Consensus has already been disfavored,

this support is in direct opposition to the American policy stance on free markets

and competition for the last several decades.

27