January 18, 2010 9:57 pm

Opening salvo on banks has yet to come

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America’s top bankers ought not to lose too much sleep over the planned levy on US financial institutions. What should keep them up at night is what else could happen if the Obama administration and Democrats in Congress make a strategic decision to take on the big banks in midterm election year.

If this were to be the case, a lot more could follow – potentially including regulatory and anti-trust investigations into the big banks as well as further and more onerous taxation.

The consequences of, for example, a wide-ranging investigation into competitiveness in banking could make the $9bn a year temporary levy – little more than one twentieth of this year’s banking bonus pool – look trivial by comparison.

There is no evidence that the Obama economic team is even considering recommending such a move. It is focused on nurturing a sustainable recovery and views the bank levy as delivering on a specific commitment to recoup taxpayer outlays on the Tarp bail-out fund – not the opening salvo in a war against big banks.

Going after top banks on competition grounds would have costs. Heightened regulatory uncertainty would make it harder for big banks to raise capital and could discourage them from lending, undercutting the recovery. It could distract political attention from the critical task of securing regulatory reform to guard against a repeat of the financial crisis.

However, as a policy the case for examining competition in banking – provided it could be done fairly without obvious political rigging – is not at all outlandish. A far-reaching investigation could enrich our understanding of the financial system in the years running up to the crisis. What share of record financial sector profits before 2008 was attributable to market power as opposed to undercapitalisation and the sale of innovatory financial products, whether those that created value or those that did not?

Moreover, a push on competition would support legislative efforts to tackle the problem of banks that are too big to fail. Given near-universal agreement that it is undesirable to have a system dominated by relatively few, big and highly-interconnected firms, why not investigate why it is so difficult for smaller banks – and boutique investment firms – to take market share from dominant rivals?

The political attractions of running against the big banks in what looks like a tough year for Democrats could meanwhile be considerable. Just look at the Massachusetts Senate race, in which Democrat Martha Coakley’s eleventh-hour efforts to see off a competitive challenge from Republican Scott Brown focused on trying to cast him as a friend of the banks.

Opening up a front in competition policy would position the administration as for the little banks and against the big ones, for the real economy and against Wall Street.

The issue is not just market share in deposits, which attracts public attention. Many corners of the financial services market with a lower profile are highly concentrated and highly profitable.

Concentrated markets can still be competitive and high profits are not in themselves proof of anti-competitive behaviour. Market concentration is high in many industries – including new areas of the economy such as web search.

Anti-trust investigation would focus only on areas where critics allege anti- competitive behaviour, for example, the puzzle of why investment banks charge standard rates to raise equity capital for businesses. But even where there is no suspicion of collusion, regulators could examine market structures and practices that create barriers to entry.

Or, the administration could simply float the idea of a wide-ranging push on competition in banking and use it to gain leverage over big banks on issues such as regulatory reform and whether or not they pass on the cost of the financial levy to their customers.

That would be cynical politics. But bankers – who have shown a stunning lack of any instinct for collective self-preservation in amassing giant bonus pools from windfall profits secured on the back of taxpayer interventions that saved the financial system – would have only themselves to blame.

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