Using Anti-trust to remedy “too big to fail”

Simon Johnson, along with Joseph Stiglitz, and Thomas Hoenig argued yesterday in hearings that we need to break-up “too big to fail” banks. I heartily agree.

But of course our argument, both in the Atlantic and more broadly, is not against finance per se. In fact, we’ve received some strong expressions of support from within the financial sector – just not particularly from firms that are Too Big To Fail – as well as from many in the risk-taking entrepreneurial sector. And here Thomas Hoenig – President of the Kansas City Fed, with long experience regulating, winding down, and generally overseeing banks; and very far from being a sensationalist – absolutely nailed it towards the end of yesterday’s hearing. My recollection of his exact wording is: whenever you have banks that are too big to fail, you will get oligarchs yes, he said oligarchs.

But, we need to realize more than an act of congress is needed.   Ideology, economic theory, and the lure of oligarchs can prevent enforcement of even a recently passed anti-trust law. Remember it was almost 2 decades after the Sherman Act was passed before it was really enforced.

If we start looking at anti-trust as a way to prevent “too big to fail banks” (which I whole-heartedly endorse doing), we will run into another ideological roadblock from our freshwater economic friends. In this crisis we have already encountered the freshwater economic views of New Classical & RBC macro theories. These theories started with the assumption that the macro econ is at a general equilibrium and the (surprise!) draw the conclusion that no generalized glut or similar disequilibrium is possible.

Anti-trust has been neutered since Reagan I. With the exception of the Microsoft case and some explicit price-fixing cases, anti-trust enforcement has stalled. Anything goes. Bigger is better has been the Justice dept philosophy. And the intellectual foundation for the abandonment of anti-trust has been “contestable markets” theory and game theory – the idea that no market power will be exercised for fear of encouraging new entrants. It’s a theory that holds that 2 or 3 firms will engage in the same degree of competition that a plethora of small and medium firms will. In much the same way that macro became infatuated with elegant DGE models regardless of their empirical emptiness or uselessness, oligopoly and monopoly theory in IO has become enamoured of elegant game theory formulations that offer clever expressions of intriguing hypothetical situations, but they offer little empirical content, testability, or practical policy guidance. Just as macro needs to go back and re-learn some of Keynes’ (and Fischer and Wicksell) messy, inelegant insights into real economies, IO will need to re-discover structure, conduct, and performance.

As long as contestable markets and similar “the free market is self-regulating and self-limiting” ideology persists in Anti-trust division, even a new bill from Congress won’t help.