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Washington Lawyer

Breaking Up Big Banks

From Washington Lawyer, February 2013

By Don Allen Resnikoff

“Taking the Stand” appears periodically in Washington Lawyer as a forum for D.C. Bar members to address issues of importance to them and that would be of interest to others. The opinions expressed are the author’s own.

transparencyThe issue of breaking up big banks and making them smaller has garnered a lot of attention recently. Sanford “Sandy” Weill, former chair and chief executive officer of Citigroup, drew a lot of publicity in July when he said big banks should be broken up and made smaller: “I am suggesting that [big banks] be broken up so that the taxpayer will never be at risk … the depositors won’t be at risk.”

He also commented on separating commercial banking from more risky investment banking: “What we should probably do is go and split up investment banking from [commercial] banking, have banks be deposit takers, have banks make commercial loans and real estate loans, and have banks do something that’s not going to risk the taxpayer dollars, that’s not going to be too big to fail.”

The idea of breaking up big banks to make them smaller has support from some influential people. U.S. Sen. Sherrod Brown (D–Ohio), who serves on the Senate Committee on Banking, Housing, and Urban Affairs, said that “Sanford Weill is one of many banking industry experts who have observed that too big to fail is often too big to manage.” Sheila Bair, the former chair of the Federal Deposit Insurance Corporation, agrees with Weill. “I think these banks are too big to manage centrally. They’re too big to regulate, and they don’t produce good shareholder value, either. There’s a lot of value to be had if they were broken up,” Bair said.

I believe that new laws must be passed by Congress to carry out the goal of making banks smaller. As a practical matter, the current antitrust laws can’t be stretched to do the job. The new legislation could be simple: The scope of the antitrust laws could be expanded with relatively few added sentences.

Unfortunately, it is more likely that any new legislation will follow the modern style and be complex, involving modifications of the massive Dodd–Frank Wall Street Reform and Consumer Protection Act. The large and complicated Dodd–Frank statute, signed into law on July 21, 2010, in response to the nation’s recent financial crisis, has as its primary goals increasing financial stability of banks and avoiding systemic risks to the national economy. Reducing bank size or serving competition goals is simply not the main point.

Luckily, we have some help on the complexities of the Dodd–Frank Act from Daniel K. Tarullo, a member of the Federal Reserve Board of Governors. In October, he talked about bank size issues as part of a speech to a University of Pennsylvania Law School audience about broader issues of bank regulation.[1] Tarullo’s views are useful for two reasons. First, he provides us with information about the current state of bank regulation, making it clear that bank size and issues involving competition are given secondary importance by the Federal Reserve Board as it applies the Dodd–Frank statute to mergers involving bank holding companies. Second, despite the short shrift given bank size and competition, Tarullo believes that congressional clarification is needed concerning limits on bank size.

In his remarks, Tarullo explains that, unlike an antitrust agency merger review where the “focus is solely on whether the transaction would substantially lessen competition,” Dodd–Frank requires the Federal Reserve Board’s merger reviews to balance benefits, such as increased competition, with enhancing financial stability and reducing systemic risk. Such balancing is what explains the Federal Reserve Board’s approval of acquisitions by J.P. Morgan, Bank of America Corporation, and Wells Fargo that increased concentration in banking as part of an effort to strengthen banks.

Tarullo suggests that Congress should step in to provide clearer guidance on certain bank size issues. A particular legislative proposal Tarullo likes “would limit the non–deposit liabilities of financial firms to a specified percentage of U.S. gross domestic product,” focusing on banks that are large because of internal growth.

I think it is fair to treat Tarullo’s comments as both suggesting a need for at least some congressional action on bank size and power issues, and inviting public dialogue on precisely what that action should be. The dialogue is likely to include suggestions for congressional action significantly more aggressive than Tarullo’s.

One question that needs to be addressed concerning the need for legislation is why antitrust laws don’t already do the job of controlling bank size. Additionally, what are the limitations of the antitrust laws that support the suggestion that Congress needs to clarify bank size issues?

The answer is that while U.S. antitrust law has roots in a late 1800s and early 1900s “big is bad” political perspective on companies, antitrust law has evolved so that a company’s large size does not in itself raise an antitrust problem justifying legal action. Some illegal market power problem in a particular market must be found, perhaps a bank merger that reduces competition in small business loans in a specific metropolitan area. Given that evolution, there is great doubt that antitrust laws as currently applied can be stretched to address bank size and the related too–big–to–fail issue of implied guarantees of government support for big banks.

Questions about the current limited scope of antitrust law relate to large political and ideological concerns. In their book 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, Simon Johnson and James Kwak argue for reading existing antitrust laws as including egalitarian or populist political goals often associated with Teddy Roosevelt and early 1900s trust–busting. The authors’ thesis is that broad egalitarian political goals are important to antitrust laws and have not been properly appreciated by the courts or government enforcers in recent decades. Johnson and Kwak believe in applying old trust–busting thinking to reduce the size of big banks. Their view is that the value of forcing big banks to be small and to face competition trumps arguments that big bank size is efficient and necessary to deal with big foreign–based competitors.

Johnson and Kwak readily acknowledge that their advocacy flies in the face of current antitrust enforcement practice. Current antitrust case law applies the antitrust statutes using entrenched standards that won’t accommodate breaking up banks simply because they are big. Under the cases, being big can sometimes be bad, but only when a prosecutor can demonstrate that a big firm does harm because of an exercise of market power that hurts consumers. To the enforcement agencies, the important question under the U.S. Department of Justice and Federal Trade Commission’s (FTC) Horizontal Merger Guidelines and the relevant case law is whether merging firms will gain sufficient market power to harm consumers (through an increase in price, for example). The guidelines explain that “mergers should not be permitted to create, enhance, or entrench market power or to facilitate its exercise…. A merger enhances market power if it is likely to encourage one or more firms to raise price, reduce output, diminish innovation, or otherwise harm customers as a result of diminished competitive constraints or incentives.”[2]

Because of that enforcement philosophy, big banks have been allowed to grow even after the recent great financial meltdown, including the J.P. Morgan, Bank of America, and Wells Fargo mergers mentioned earlier, and that happened with the acquiescence of government antitrust enforcers. As explained in a recent Wall Street Journal article, the four biggest U.S. banks by assets—J.P. Morgan, Bank of America, Citigroup, and Wells Fargo & Company—have more than $7 trillion in assets, up more than 50 percent since the end of 2007. “Those gains came in large part through such crisis–era acquisitions as J.P. Morgan’s takeover of failed Washington Mutual Inc., Bank of America’s acquisition of mortgage lender Countrywide Financial Corp. and Wells Fargo’s purchase of Wachovia Corp.,” the report said.[3] Government antitrust enforcers did not utilize the antitrust laws to stop any of these acquisitions, presumably because the enforcers concluded that the requirements of the antitrust laws were satisfied. Tarullo, however, views the Federal Reserve Board approvals as based on a balancing exercise that gives competition concerns short shrift.

Economist Lawrence White, who opposes broad political goals for antitrust, has argued that there is a “too big to fail” problem that affects banking, but the problem “is not about competition and market power.” White agrees with those who say that a “too big to fail” bank is, in essence, receiving a government subsidy, which is a bad thing. It is bad that capital markets give extra credit for the largest banks as being failure–proof because of an implied government guarantee. Markets value big banks more than smaller banks.

So, White agrees with the argument that “too big to fail” subsidies should be eliminated. But, he says, “the mantle of antitrust should not be stretched to cover such arguments.” White explains that “although size is clearly an issue with respect to TBTF [too big to fail], antitrust and competition issues really are not. TBTF does not represent an instance in which size involves the exercise of market power.”

White’s view of the appropriate scope of antitrust matches the realities of modern antitrust enforcement, including the recent practice at the Justice Department’s Antitrust Division. Antitrust Division officials have said, in accord with White, that “too big to fail” is not an antitrust enforcement issue.

It is interesting and important that some very capable antitrust experts have suggested that reducing firm size can be achieved within the ambit of existing antitrust laws and that the too–big–to–fail problem of government support for big banks is an antitrust issue. These suggestions are intriguing, but they are unlikely to affect real–world enforcement practices.

At a Columbia University Law School symposium on financial services and competition held in June, Scott Hemphill, a professor at Columbia Law School who also serves as chief of the Antitrust Bureau at the New York State Attorney General’s Office, discussed how existing antitrust laws could be used in aggressive and unconventional ways to address the “too big to fail” issues associated with the largest banks. He pointed out that government backing for banks and unique big bank access to capital can be important anticompetitive factors. If being “too big to fail” is not a standard antitrust consideration, at least not in recent decades, Hemphill nevertheless argued that the existing laws can apply if a dominant player engages in excessive risk taking because of reduced downside consequences related to great size. Great company size and power “can give rise to inefficiencies as well as efficiencies,” and deserve antitrust scrutiny. Hemphill suggested that instead of breaking up existing big banks into many smaller banks, government antitrust enforcement could limit these banks to organic growth so that the banks generally would be refused permission for acquisitions or mergers.

White, a panelist at the symposium, argued against Hemphill’s advocacy of such aggressive antitrust enforcement, consistent with White’s previously stated positions. White, with the agreement of some other panelists, said that contemporary antitrust enforcement does not encompass “too big to fail” issues, and that it should not. He noted that government antitrust enforcers long ago gave up addressing the political consequences of company enormity, focusing instead on antitrust issues of market power and consumer harm as explained in the Horizontal Merger Guidelines.

White made an additional practical point: Regulatory attention to the “too big to fail” problem of banks has recently focused not on antitrust concerns, but on issues of bank survival such as sufficiency of capital and riskiness of investing behavior. I understand him to mean that recent regulatory efforts, including the Federal Reserve Board’s application of the Dodd–Frank reform legislation to bank holding company mergers, put great weight on approaches that are distinct from reducing bank size. As pointed out by the Federal Reserve’s Tarullo, a theme of those regulatory approaches is making banks too strong to fail, whatever their size.

As a practical matter, White is correct in saying that in the United States the regulatory approaches to “too big to fail” tend to be viewed as distinct from antitrust. A non–antitrust regulatory approach for achieving bank strength is to require banks to maintain high capital levels. Banks also may be strengthened by requiring at least some separation of commercial and riskier investment banking, somewhat in the manner of the old Glass–Steagall Act, a statute separating commercial and investment banking. That is the main idea of the so–called Volcker Rule, as used in the Dodd–Frank law. (But if segregation of antitrust from other regulatory approaches accurately describes U.S. practice, it might be better to adopt a different practice and integrate such regulatory approaches with competition policy and bank size concerns. European Union countries appear to have been more successful than the United States in integrating competition policy into post–financial meltdown bank regulation. The positive consequences include more competition, which benefits European consumers.)

Robert Pitofsky, a former FTC chair who now teaches antitrust and trade regulation law at Georgetown University Law Center, is a revered antitrust thinker who has focused on political issues relevant to antitrust enforcement, including “big is bad” concerns. He discussed the relevance of political concerns to antitrust enforcement in his keynote address at an American Antitrust Institute conference held in June. He reviewed the major points of his pioneering article, “The Political Content of Antitrust,” which discusses the political values that motivated the antitrust laws. Some of those values relate to big firm size, particularly a fear of an economy and political system dominated by a few corporate giants. 

Pitofsky’s analysis helpfully identifies egalitarian and anti–big business political values that critics may feel are omitted from the Horizontal Merger Guidelines and recent relevant case law. But he does not offer ways in which egalitarian, anti–big business political values might be incorporated into and reconciled with current merger enforcement policies. Merger enforcement decisions in the 1960s and 1970s may have responded to political concerns by simply ratcheting down the concentration levels in particular markets that triggered merger enforcement action, as Pitofsky suggests, but that will not address current concerns about enormous banks.

In the end, the sophisticated analysis of Hemphill and Pitofsky brings us back to the point that new legislation is needed if bank size issues are to be addressed. Applying current antitrust laws is unlikely to work.

New legislation could follow the style of brief but broad statements we find in the relevant antitrust statutes, including section 7 of the Clayton Antitrust Act[4] and sections 1 and 2 of the Sherman Antitrust Act.[5] Most particularly, section 7 of the Clayton Act prohibits mergers if “in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.”

The existing statutory language might be read as already broad enough to permit big–is–bad antitrust enforcement along the lines advocated by economist and author Simon Johnson and others, and as discussed by Pitofsky, but decades of case law and prosecutorial practice suggest the opposite. Reversing decades of case law and incorporating political big–is–bad thinking into the law could be done by adding a few sentences to the existing statutes to make the political goals of reducing firm size inescapably clear. There is a lot to be said for an old–fashioned use of simple language. But such a revision by Congress is highly unlikely as a practical matter.

More likely, any legislative changes will be on the turf of the Dodd–Frank statute that Tarullo describes, and will involve more or less aggressive modifications of the language of that statute. The Dodd–Frank Act already has significant provisions relevant to bank size. Tarullo mentioned some of them in his talk.

For example, Tarullo points out that section 622 of Dodd–Frank contains a financial sector concentration limit, but complains that it is based on a “somewhat awkward and potentially shifting metric” that he believes should be improved. “There is, then, a case to be made for specifying an upper bound” on size, Tarullo said in his speech. The upper bound would need to be determined by congressional legislation modifying Dodd–Frank.

Tarullo also points out section 165 of Dodd–Frank, “which requires that the Federal Reserve establish a special set of prudential requirements for bank holding companies with more than $50 billion in assets.” Also, he points out that section 121 of the act grants regulators “very broad scope for dealing with a large bank holding company or designated nonbank financial company that ‘poses a grave threat to the financial stability of the United States.’”

The existing Dodd–Frank provisions mentioned by Tarullo might theoretically be the basis of vigorous trust–busting efforts by regulators against big banks, but that hasn’t happened yet. The Federal Reserve Board’s policy of balancing, described by Tarullo, suggests that it won’t happen anytime soon. But for legislators interested in further reform legislation that will reduce the size of very large banks, the current Dodd–Frank provisions relevant to bank size issues may be a good place to start.

The near–term prospects for any new legislation restricting bank size are dim, but not hopeless. Whether big banks will be forced to become smaller is a competition policy problem and, at its root, is a political question. Indeed, bank regulation was a topic in the 2012 presidential debates, with President Obama expressing pride in “tough Wall Street reforms” and Mitt Romney complaining about the potential for unfair protection of big banks that he said were imprudently designated as too big to be allowed to fail.

The notion of an array of right–size banks competing on a level playing field is compelling, and powerful and articulate voices will push the political conversation in the direction of reform legislation. Broad public dialogue also may move in the same direction. But powerful and articulate voices also are raised in opposition, and the political muscle of powerful banks should not be underestimated.

Don Allen Resnikoff is a principal at the Law Offices of Don Resnikoff, which provides counsel on antitrust and consumer issues. He formerly was an attorney with the Antitrust Division of the U.S. Department of Justice, and later the principal antitrust attorney with the District of Columbia Office of the Attorney General.

[1] Text from Daniel K. Tarullo’s speech at the University of Pennsylvania Law School, Oct. 10, 2012. Transcript available at http://1.usa.gov/SMpNsB.
[2] U.S. Department of Justice and Federal Trade Commission’s Horizontal Merger Guidelines, available at www.ftc.gov/os/2010/08/100819hmg.pdf.
[3] E. S. Browning and David Benoit, Big–Bank Pioneer Now Seeks Breakup, July 26, 2012. Available at http://on.wsj.com/LPo13a.
[4] 15 U.S.C. § 18.
[5] 15 U.S.C. §§ 1, 2.