Wednesday, February 25, 2015

Barriers To Entry

Why is this man grinning?
 I'm Lloyd Blankfein and I love Dodd-Frank!  Please sir, may I have another?

The Wall Street Journal recently reported on Goldman Sachs CEO Lloyd Blankfein's remarks at an investor conference:
"More intense regulatory and technology requirements have raised the barrier to entry higher than at any other time in modern history", said Mr Blankfein. "This is an expensive business to be in, if you don't have the market share in scale.  Consider the numerous business exists that have been announced by our peers as they reassessed their competitive positioning and relative returns."

While the Goldman boss wasn't endorsing all of the added directives from Washington, he said his bank is "prepared to have this relationship with our regulators" - and the regulators are prepared to have a deep relationship with Goldman - "for a long time".
Blankfein's remarks provide direct confirmation of what THC has said for quite some time (see, Surely, You Must Be Joking)- the Dodd-Frank financial reform legislation may have been sold to the public as ending "too big to fail" but instead it codified "too big to fail" as a government policy and in the course of doing so strengthened the hand of the biggest players in financial services.  Even as THC was writing this he came across a recently released study from Harvard's Kennedy School of Government finding that community banks have been losing market share to the largest financial institutions at an accelerated rate since the passage of Dodd-Frank.

Why did so many legislators vote for a bill with results the opposite of what was rhetorically claimed as its purpose?  THC believes their are two conflicting factors at play here.

The first is ignorance or perhaps to be more charitable, a lack of sophistication.  Ignorance by many lawmakers of what Dodd-Frank actually contained beyond the sloganeering used to pass it.  And ignorance of how financial services really work and the law of unintended consequences.

We have such an example of unintended consequences foisted upon us by Congress in the early 1990s.  At the time there was an outcry over what was seen as exorbitant executive compensation.  The cry from the critics was that executives needed their pay tied more directly to performance.  The bright idea in Congress was to encourage this by limiting the ability of businesses to deduct salaries as a business expense to those salaries of less than $1 million a year.  What was the business response?  The explosion in the increase in options tied directly to performance of company stock.  You may recall how that played out in the runaway stock market of the late 1990s.  Executive compensation soared in comparison to the days when salaries were deductible as business expenses with limitations.  Today, of course the complaint is about bloated executive compensation because of stock options and restricted stock even though Congress got the performance based pay it wanted with its legislation.

The second reason is that progressive political theory leads to their promoting government actions encouraging the consolidation of businesses into bigger operations and less competition. 

Progressives like to frame the issue as one of excessive venal individuality in contrast to virtuous collectivity as expressed by government action but that's wrong.  The greatest example of collectivity is the millions of individual decisions made by the daily decisions of people in a free marketplace. What progressives really dislike is the unpredictability of that collective action.  They are constantly concerned that the collective is making a "wrong" decision because of what they see as the disorder and chaos of the marketplace.  The marketplace is collectivity but uncontrolled and uncoordinated.  Progressivism is centrally controlled and coordinated collective action.  The degree of control can vary; sometimes it can be direct, sometimes it can merely be "nudging" but the decision about the degree of control needs to be the government's.

You can see this process going on right now with the FCC's announced decision, at the behest of the White House, to extend its authority to regulate the Internet as a government utility in the name of "net neutrality".  They've promised it'll be just the right amount of regulation and not too much regulation but the important thing from a progressive prospective is the ability of the government to claim the right to regulate as much as it deems appropriate.  And, if the FCC is successful with its power grab, we all know what that little bit of regulation will ultimately become.  This should also not come as a surprise but if the internet becomes subject to regulation similar to utilities and other telecommunication companies it also becomes subject to a bevy of federal and state excise taxes (for more on the tax angle read this).  What is particularly remarkable about this power grab is that it is not in response to any crisis.  The dangers of not having net neutrality are all hypothetical because problems have not arisen from the current non-regulated environment.  Just to drive home the point, the FCC, dominated by appointees of an Administration pledged to "transparency", is voting tomorrow on the 300+ page proposal without the public having an opportunity to see it.

In the case of business, progressives would find it much easier to reduce disorder and chaos and increase bureaucratic control if there were fewer businesses and if they were larger so they could afford the substantial costs imposed by government requirements.  Having one hundred large businesses control the entire economy would make the government's task much simpler, and the lucky hundred businesses would do just fine economically, at least in the short term.

Larger businesses, particularly in the financial sector, favored by this approach are an easier touch for political fundraising and are also cooperative in providing financing for the careers of aspiring politicians and bureaucrats, see, for instance, the former Connecticut Senator Chris Dodd (D- Countrywide Financial Services) as well as providing lucrative landing spots for those seeking to replenish their bank accounts between stints in "public service".  Our current Secretary of the Treasury, Jack Lew, took a break from government to make millions at Citigroup.  He even had a clause in his contract that guaranteed his bonus if he left Citigroup to take a high-level position in government, the exact opposite of how such arrangements are usually structured which is that a senior employee leaving before the set bonus time period forfeits their payment!  Peter Orszag, the former head of OMB, is currently at Citigroup getting his lucre before he undoubtedly returns to haunt us with another round of public service.

By the way, the constant expansion of legislative and regulatory activity is used by politicians of both parties to raise funds.  After all, it was Orrin Hatch (R-Utah) who in 2000 publicly told Microsoft and other big players in technology that they needed to build up a Washington presence so they could "participate" in government so that Senator Hatch could "wet his beak".
Don fanucci gf2 .jpeg (Sen. Hatch)
And let's not forget Rahm Emanuel.  He took a break from his political career and work in the Clinton Administration to spend two and a half years with a large investment banking company before returning to Congress, serving as President Obama's first Chief of Staff and then becoming Mayor of Chicago.  As Wikipedia notes, Rahm did not have an MBA nor prior banking experience before his stint in investment banking but he did manage to earn $16.2 million during his brief stint.  We'll just note in passing that if you make an average of $100,000 a year over a 40-year period your total earnings will be $4 million.

Now there are elements on the left who have been very vocal about this trade back and forth with the financial services sector.  But what they want is direct government control across the board and all that means is that someone else will end up with a bundle of money.  As the renowned philosopher Peter Townsend wrote "Meet the new boss, same as the old boss".

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