The Cantillon Effect and Bank Behemoths

The Treasury Secretary wants more banking consolidation. The Antitrust Division does not. The Age of Confusion continues...

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Today I’m writing about an internal war in the Biden administration over bank mergers.

First, two pieces of excellent news. I just got word that the New York Assembly, along with the New York Senate, has passed a ban on non-compete agreements, which are contracts that prevent employees from going to work for rival firms. If Governor Kathy Hochul signs the bill, then New York will have joined multiple other states in freeing its citizens of these coercive arrangements. (Hochul is friendly to monopoly power, so there’s no certainty she will sign it. But she might.)

Second, the FTC has finally started to chip away at Amazon’s power with an important investigation about how Amazon makes it almost impossible to cancel Prime membership. This one’s a big deal. I’ve put a bit more detail in the post-script of this newsletter.

And now…

Assistant Attorney General for the Antitrust Division Jonathan Kanter presents on bank mergers at the Brookings Institution, the think tank where Warner Brothers recently shot the Barbie movie.

“If you exempt banks from anti-trust, you might as well also shoot the policeman on the corner.” - Rep. Wright Patman, 1965

“This might be an environment in which we’re going to see more [bank] mergers, and you know, that’s something I think the regulators will be open to, if it occurs.” Treasury Secretary Janet Yellen, 2023

In October of 1965, a Congressman named Thomas “Lud” Ashley made a strange procedural maneuver in the House Banking Committee. With the lights off in the committee room, he called a group of his colleagues to order, and held a hearing over a bill to remove the ability of the Antitrust Division to oversee bank mergers. It was a controversial bill, and it was weird to do this with the lights off. What was even weirder is that Ashley wasn’t the Chair of the Committee and had no jurisdiction or legal authority to do it. No Congressional observer had ever seen anything like it.

In fact, the Chair of the Banking Committee, Wright Patman, was in the hospital attending to his wife. He and Ashley did not get along, because Patman had been opposed to the banking industry’s attempt to get out from under the thumb of merger law. “If you exempt banks from anti-trust,” Patman said, “you might as well also shoot the policeman on the corner.”

The fight had started five years earlier. In 1960, the Philadelphia National Bank and the Girard Trust Corn Exchange Bank, the second and third largest banks in the Philadelphia area, decided to merge. This combination was part of a wave, which included the nation’s fourth and seventh largest banks, Manufacturers Trust and Central Hanover. The Kennedy administration’s bank regulators, from the Federal Reserve to the Office of Comptroller of the Currency, were split on bank mergers, while the Antitrust Division, all the way to Attorney General Robert F. Kennedy, were not.

Two years later, the Supreme Court ruled in its Philadelphia National Bank decision for the Antitrust Division, in a landmark not just for banks but for all corporate mergers. The decision, which is still regularly cited today, set up a structural presumption, a bright line set of rules prohibiting acquisitions that go over a certain market share.

In Congress, the Supreme Court decision, and Antitrust Division attempts to bring more bank challenges, set off a bitter lobbying battle among banks and industry. Bribes were common. Congressmen on the relevant committees often found themselves offered positions on the board of banks. One columnist noted that new members of Congress were “approached within hours of their arrival in Washington and offered quick and immediate loan service,” with banks telling members, “Just write a check, we will honor it.” There was also a cultural dynamic at work. It had been a long time since the Great Depression, and new shiny members like Ashley could be both liberal and friendly to big banks, without political pushback.

But ultimately Patman, a close ally of President Lyndon Johnson, won. A committee staffer walked in during Ashley’s rump session and alerted a Patman ally, who stopped the proceedings. The Bank Merger Act of 1966 passed, and it was written in a way to allow the Antitrust Division to challenge bank mergers.

For antitrust practitioners, the Philadelphia National Bank decision on mergers mattered in industries as varied as book publishing and oil drilling. But the case also had specific impacts on banking itself. On one level, it meant America retained its local banking system, and commercial lending through smaller banks continued to flourish for many more decades. But banking is not just any industry, it is special, with government charters that offer peculiar privileges, like access to a lender of last resort function, and deposit insurance. Indeed, it is through banks that we decide how to expand and contract credit.

And so those fights in the early to mid-1960s kept our monetary system functioning smoothly. A lot of small banks would be spread out in the hinterlands, able to make credit available when necessary to all businesses, not just those close to Wall Street. In a sense, policymakers were ensuring that money would move in a neutral manner.

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That is not how money moves today. When the Fed and Treasury bailed out banks in 2008 and 2020, policymakers assumed that money would start at the banks but get to everyone in the economy. Yet, that isn’t really what happened, with money congealing at the top of the economic strata. The 2020 bailout through the CARES Act at the height of the pandemic fostered a merger wave, because it was easy to get zero percent interest rate money to dealmakers on Wall Street. By contrast, moving that money to the rest of the economy was much harder, because the channels from the government to small business and individuals were weaker than the connection between the Federal Reserve and the big banks it trades with every day.

During the bailouts, I wrote this up as the ‘Cantillon Effect.’

Money has to travel through institutions, and right now, the institutions for the powerful function well, and those for the rest of us are rickety and broken. So money gets to the rich first. Eventually, some money will get to the rest of us, but in the interim period before that money fully circulates, the wealthy can use their access to money to buy up physical or financial assets.

An 18th century French banker and philosopher named Richard Cantillon noticed an early version of this phenomenon in a book he wrote called ‘An Essay on Economic Theory.’ His basic theory was that who benefits when the state prints a bunch of money is based on the institutional setup of that state. In the 18th century, this meant that the closer you were to the king and the wealthy, the more you benefitted, and the further away you were, the more you were harmed. Money, in other words, is not neutral. This general observation, that money printing has distributional consequences that operate through the price system, is known as the “Cantillon Effect.”

In Cantillon’s day, the basis of money was gold, so he wrote about what happened when a nation-state discovered a gold mine in its territory. Increasing the amount of gold in the realm would not just increase price levels, he observed, but would change who had wealth and he didn’t. As he put it, “doubling the quantity of money in a state, the prices of products and merchandise are not always doubled. The river, which runs and winds about in its bed, will not flow with double the speed when the amount of water is doubled.”

Cantillon was making a claim about power, asserting that the institutional channels through which money flows determine whether credit expansions or contractions, aka monetary policy, help or hurt everyone equally. If institutional channels are limited to speculators, then speculators will benefit from credit expansions. If those channels are decentralized, as they were from the 1930s to the 1980s, then money will move in a more fair way. Monetary policy, in other words, is not neutral, unless we build political institutions to ensure that neutrality. Local banks and credit unions are such institutions in America.

And that brings me to today’s fight over banking. The Patman era lasted until the 1980s, when most elites thought banking needed to be consolidated. In 1980, we had around 15,000 banks. Today, with a much larger country, we have less than 4,000. And one reason is that from Reagan onward, bank regulators and antitrust enforcers waved through mergers. For instance, since 2013, according to Senator Elizabeth Warren, bank regulators have denied zero out of 1,124 bank merger applications.

The Biden administration is of two minds about this problem. In July of 2021, the White House explicitly cited the Bank Merger Act in its executive order on competition, and mandated that bank regulators get stricter in stopping bank mergers. And to that end, yesterday at the Brookings Institution, Antitrust Division chief Jonathan Kanter announced changes to bank antitrust enforcement, as well as a redo of the bank merger guidelines, which haven’t been updated since 1995.

“Bank competition affects the interest you earn on your savings account, the monthly payment on your mortgage or car loan, the fees you pay to withdraw cash from an ATM, the variety of financial products you can choose from, and whether your business can get an affordable loan,” he said.

“We want our banks,” he noted, “to invest in local businesses and local communities, because banking is the beating heart of the economy, especially in rural areas.” Kanter sounded like Patman, or Attorney General Robert Kennedy, recognizing that local banking is key to having local competitive businesses.

The reason local banks matter to business is because smaller banks do commercial lending, and big banks mostly don’t. To understand the centrality of the local bank infrastructure, look at what happened in 2020 at the height of the pandemic. The government implemented a plan to get capital to millions of small businesses, named the Paycheck Protection Program. The PPP worked through local banks, because the big ones basically don’t have credit relationships with most businesses. Indeed, community banks did a disproportionate amount lending to local businesses, while the Fed did most of the lending to Wall Street dealmakers. This was the Cantillon effect in action.

In a few years, however, there will be no way to support local businesses through the banking system, because those localized banks will simply be gone. And that’s very bad. As my colleague Shahid Naeem wrote in a policy brief, too many bank mergers simply kill communities. In 2019, after BB&T bought SunTrust in $66 billion deal, for instance, the bank renamed itself Truist. Aside from the horrific renaming choice, the combined bank shuttered 820 branches and cut 14% of its workforce, destroying the ability to actually do the business of banking. As Naeem noted:

Customers complained of service problems on the news, highlighting difficulty accessing accounts and making transactions. One summed it up, saying, “You can’t get through. There’s nobody to answer questions. There’s nobody to take responsibility,” adding, “There’s nobody to talk to.”

The consequences to commerce of a decline in banks are dire: less lending, higher fees, worse deposit rates, the drying up of credit for black and rural areas, and so on and so forth. Ultimately, local banks provide capital. No local banks mean no capital, and it’s not capitalism if there’s no capital. The Cantillon Effect is just a description of how institutions interact with monetary policy, but it explains why some areas see commercial activity and others don’t.

What’s interesting is that a group of important Biden regulators have a very different perspective. Since the collapse of Silicon Valley Bank, Janet Yellen at Treasury, Jay Powell at the Federal Reserve, and Yellen’s subordinate Michael Hsu at the OCC have broken with White House policy on competition policy, and pushed for more bank mergers.

During an interview with Reuters this week, Yellen said a certain degree of consolidation in the regional and mid-size banking sector could occur.

“This might be an environment in which we’re going to see more mergers, and you know, that’s something I think the regulators will be open to, if it occurs,” Yellen told Reuters.

Michael Hsu, acting comptroller of the currency, told lawmakers earlier this week that his agency would be willing to quickly consider bank mergers.

The Office of the Comptroller of the Currency is “committed to being open-mind when considering merger proposals and to acting in a timely manner on applications,” Hsu told the Senate Banking Committee.

We can see this philosophy in action during our most recent banking crisis. Earlier this year, First Republic, a large regional institutions similar to Silicon Valley Bank, was sold to J.P. Morgan, further empowering an already Too Big to Fail bank. Yellen and Powell, who pushed for J.P. Morgan’s acquisition of First Republic, believe that American strength comes from our capital markets, not the industrial and commercial sectors underwritten by local banks.

Because of large banks like J.P. Morgan, they believe, foreigners can easily buy and sell U.S. assets, companies can issue bonds and stocks, and all can use the dollar as a global currency to engage in financial transactions worldwide. The U.S. as a financial hegemon is what matters, not whether some podunk bank in Ohio survives or merges. J.P. Morgan is more akin to a critical branch of the U.S. government than a private commercial entity, and Yellen’s job is to make sure J.P. Morgan CEO Jamie Dimon can do his.

This pro-consolidation philosophy isn’t confined to regulators, but is common among academics and journalists who think about banking. For instance, Steven Kelly, the Senior Research Associate at the Yale Program on Financial Stability, called Kanter’s speech “gross mismanagement of the macroeconomic moment by the Biden admin here.” He argued that “bank mergers are the best tool we have, for better or for worse, when a run starts—and they go better when explored in advance,” so “sending a message to the industry of ‘don’t even think about it’ is not the right play when the banking system is still fragile.” During periods of banking crisis, it’s also common to read articles with headlines like “America Just Has Way, Way Too Many Banks“ on Bloomberg or Reuters. Larry Summers often praises the Canadian financial system because that nation has a few very large banks.

But what these arguments miss is the very point of having a banking system, which is to make sure that all citizens have access to a well-functioning payment and credit system situated within local communities. In America, that has always meant having a lot of local banks. The subtext of what Kanter was saying during his speech is that it’s time to refocus attention on the health of local communities and local businesses, not the distant needs of foreign central bankers and Wall Street. Administrations always have conflicting factions, and the dispute between White House competition policymakers and Treasury is one of them. It just so happens to be an exceptionally stark one.

Thanks for reading! Your tips make this newsletter what it is, so please send me tips on weird monopolies, stories I’ve missed, or other thoughts. And if you liked this issue of BIG, you can sign up here for more issues, a newsletter on how to restore fair commerce, innovation and democracy. And consider becoming a paying subscriber to support this work, or if you are a paying subscriber, giving a gift subscription to a friend, colleague, or family member.

cheers,

Matt Stoller

P.S. The Federal Trade Commission just started to chip away at Amazon’s power with an important consumer protection complaint about how the online giant deceived Prime members. The short story is that Amazon made it almost impossible to cancel Prime. Internally, Amazon called its cancelation process “Iliad,” referring to “Homer’s epic about the long, arduous Trojan War.” Amazon also lied to the FTC and withheld documents from investigators.

Prime brings in $25 billion a year directly in subscription revenues, but the revenue for Prime isn’t the point of the product. Amazon’s goal is to control how consumers buy, and then use that aggregated buying power to charge third party sellers and packaged goods producers huge fees for access to the market. For more context, check out my piece in 2021 titled “Amazon Prime Is an Economy-Distorting Lie.”

Amazon of course disagrees, and put out a statement saying as much.