The problem of „moral hazard“ behavior has long been a firm fixture in economic policy thinking. It refers to the dilemma of policy institutions whether to bail out failing actors or let market forces lead these to possible bankruptcy. If the units are bailed out, they will in the future account for that possibility in their own business plans, thus taking on more risk than they would otherwise do because they know, if and when in dire straits, the taxpayer will come to their rescue.
During the ongoing crisis, this dilemma has teamed up with helping “systemic banks” which are too large and too important to let them fail, because they might drag the whole financial system with them. Every person in the street and at home knows that very large banks, very large firms are too important to be allowed to fail. Economics also knows that very large firms/banks accumulate market power and adopt monopolistic behaviour which leads to less output, less quality and higher prices.
U.S. Anti-Trust Policy as the Mother of Competition Policy
Thus when US-American tycoons at the second half of the 19th century amassed market power by buying up competitors, cajoling weaker competitors into succumbing to their superior strength, the US government “invented” and applied competition policy (mainly through the Sherman Act 1980 and the Clayton Act 1914), eventually leading to curbs on market power and – in the extreme – to forced divestments and splitting up of firms. Well-known examples were the electrical industry, railroads, steel companies and others. Neo-classical economic theory lateron supported these curbs on market power, because vibrant competition was seen as “the” driving force for innovation, productivity gains and – eventually – benefits to the consumers.
Europe’s Competition Policy Attempts
Europe’s history with competition policy has been spotty. The creation of “national champions”, the need to compete with American, Japanese giants, was seen as more important than benefits to consumers. The Austrian Nationalized Industries of the sixties and seventies of the past century were a case in point, as were the politically supported mergers in the German automobile and steel industries, the French telecoms giants, the Italian media industries. The debt-financed takeovers of Russian and Ukrainian oligarchs, the forming of Lakshmi Mittal’s largest global steel conglomerate, and many more examples could be named. Many of them today are “too big to fail” and are asking for taxpayer’s help. European Union competition policy has been put in place to supplement national regulations, but sometimes fights a rearguard battle against national industrial and jobs interests.
The liberalization of cross-border capital flows and the introduction of the high leverage culture enabled the financing of ever larger debt-financed mergers; leveraged buy-outs were the dernier cri during the 80s and 90s up to today. The available empirical evidence on the lack of success of around 2/3 or mergers – to the detriment of the taken-over firms, their workers and their stockholders did nothing to counter the arguments of those who profited from them: takeover acrobats, the financial firms enabling them and reaping high commissions (frequently 1-2% of the combined nominal value of the merged firms), the lawers, the CEOs and CFO’s of the acquiring firms. Ideologically they were aided by the “free cash flow” proponents who claimed that the creation of “takeover markets” exerted discipline on the managers, not to appropriate the cash flow for themselves, or their workers – or to put their cash flow into projects which bore no “value”. Once more, market adolation prevented the sober look into reality.
Does Bank Rescue Create New Giants Too Big To Fail?
So far around 3 trillion dollars of taxpayer money have been put towards the rescue of the global financial sector, in part helping to undo the previous mergers in the financial industry (let us remember RBS’s takeover of ABN Amro, that of HBOS by Lloyds, Unicredit of HVB and BankAustria, and many others).
These days there is much talk about avoiding the mistakes of the recent past. But in the background many clever buy-up artists are lurking, willing to buy cheap assets and once more create firms which in the future will again be “too large to fail”.
Of course, to split large existing banks into several smaller ones, is not easy. Should one think of splitting off individual business units, thus separating “utility banks” from trading banks doing investment banking? Should one prevent and undo the financial conglomerates combining all types of financial business, from mortgage banking to insurance? Should one impose balance sheet caps?
Much water will have to flow down our rivers before clear guidance will emerge. But the message should be clear. Policymakers should not, I repeat: not, encourage, condone or allow the crisis to be used to create more unsinkable ships. The taxpayers have been called in to help: the policymakers must take their interests into priority account. We need a more sustainable, less vulnerable and less morally hazardous business model for the future. A strong competition policy at the European level is part of this, as well as the rejection of yet another merger wave creating too large to fail business units.