Monday, 4 March 2019

Technology Companies and Competition: Are There Lessons to be Learned from Banking?

In this post, we will examine the calls made today by a US Senator in relation to the leading technology companies. We covered the issue of oligopolies and market dominance in a recent post, and the issues are the same within the technology sector. However, a legislative approach that was taken in the 1930s is being cited as a good approach to take now, which is line with the common mantra in the modern day where everything was better and more effectual ‘in the past’. In this post we will take a step back to examine whether that past approach really was effectual, and discuss whether it really is applicable to the modern marketplace.

David Cicilline, a Democratic Head of the House antitrust subcommittee in the US, said today that imposing a system akin to the Glass-Steagall Act upon the technology industry would potentially serve to restrain the size of the largest technology companies and bring them in line with a more consumer-based purpose. Speaking to the Financial Times, Cicilline said that ‘one of the things that we did in the financial services space is Glass-Steagall, where you separate out functions… it’s an interesting idea whether there would be a way to think about separating what platforms do versus people who are selling products and information – a Glass-Steagall for the international [technology companies]’. The call essentially relates to the proposed separation of social media companies from the elements within them that sell customer data. There is a growing sentiment within the media that companies such as Facebook, Google, Apple, and a few others are growing far too large and, with the development of a new task force within the Federal Trade Commission, there are now developments in place to actively constrain the growth of these all-enveloping tech giants. However, Cicilline, who is regarded as a leading authority on tech-regulation within the legislative/regulatory arena (in terms of his political authority), concludes his interview with a review of the Glass-Steagall Act: ‘what we did in the financial services sector, that seemed to work pretty well for a long time… we then repealed it and had a big problem’. The question is whether this nostalgic view of the legislation is an accurate representation of the application of it.

The Glass-Steagall Act, otherwise known as the Banking Act of 1933 (the ‘Glass-Steagall Act’ actually refers to four specific provisions within the Act), was a piece of legislation enacted in 1933 to combat the size and development of what is often referred to as ‘universal banking’. The Act sought to separate commercial and investment banking arms, and thus prevented the investment banking arms from taking deposits, and the commercial banking arms from dealing in non-governmental securities (including underwriting such securities) amongst other aspects. The literature is awash with a number of reasons for the enactment of the Act, and also differing explanations of the process of the Act coming to be. The ‘official’ story, for want of a better term, suggests that on the back of a number of securities-related scandals in the 1910s and 1920s, there was a political movement to take regulatory and legislative action within the finance sector. One of the scandals was that of the so-called ‘Match King’ Ivar Kreuger (analysed in this brilliant book by Professor Frank Partnoy) which saw the Swedish businessman develop an array of exotic financial products (many of which went on to play a major part in the Financial Crisis) that enthralled and eventually entrapped Wall Street and the public. However, it is widely accepted that it was National City Bank (the ancestor to today’s Citibank) and its charismatic leader Charles E. Mitchell that lay at the heart of the reason for the Act’s enactment. Mitchell was quoted in the mid-1920s as stating that he wanted the bank to sell securities to the public ‘just as United Cigar Stores sold cigars’. The amount of securities on offer to the public duly increased, with it being noted that between 1922 and 1931, securities departments within federally recognised banks went from 62 to 123, and separate securities affiliates increased from 10 to 114. The effect was an inevitable one, with massive losses incurred by those who had invested in the securities despite not knowing the true strength of them – although they were supported and validated by third-parties (a familiar story). So, in light of this, an investigation was set up and led by Ferdinand Pecora – what would come to be known as the ‘Pecora Hearings’ – and the Committee found, after investigation, that a separation of commercial and investment banking would serve to offer protection to the wider system (amongst other things). Bankers were blamed for selling ‘unsound and speculative securities’, commercial banks were accused of converting bad loans into security issues, and security affiliates conducted pool operations with the stocks of parent banks; all of this was the evidence needed to push ahead with the enactment of the legislation.

However, the vast majority of research into this process since has found that there was no such evidence. Kroszner and Rajan suggest that, when one considers the delinquency rate from the period, Universal banks were much stronger as a result of the combination and did not present an excessive risk. In addition, the quality of the bonds that the large banks offered defaulted less frequently than purely investment bank-developed bonds did, according to Puri. One of the major proponents of this view is George J. Benston, and more specifically in his 1990 book The Separation of Commercial and Investment Banking. Benston suggests that as the data from the time does not point towards a flaw in the Universal Banking model, ‘financial stability is more likely under universal banking than specially banking, principally because universal banks are more diversified…’ Benston goes on to make a number of other points regarding the superiority of universal banking as a model, one being that as long as antitrust laws do their job there will be no cartelisation as a result of universal banking, although some of these suggestions are hard to swallow. We will return to that in a moment, but this concept of cartelisation is important. Benston notes that the enactment of the Glass-Steagall Act actually precipitated cartelisation, in that the commercial banks were aided in removing unprofitable securities arms, and then their competition for customers’ deposits was immediately eliminated by the Act. This is interesting, and is potentially supported by the fact that after just two years, Senator Glass recognised that the law ‘was an overreaction to an extreme situation’. Yet, we must take great care with this viewpoint. It is offered by those on the economic right, and comes from a school that was instrumental in deregulating the sector prior to the Financial Crisis (proponents such as Professor Charles Calomiris will argue that Universal Banking was not at fault for the Financial Crisis, with his and many of his supporters arguing that federally-backed mortgage institutions Fannie Mae and Freddie Mac were actually at fault).

Another viewpoint into the reasoning behind the Glass-Steagall Act is in relation to the ‘House of Morgan’. The banking empire established by the legendary J.P. Morgan forms one half of an epic battle that saw the US legislative arena caught in the middle. According to Rothbard, Morgan and the Rockefeller Family, led by John D., would grow within their respective fields but the families would come to blows as the competition heated up within the all-important banking sector. Rothbard suggests that the Rockefellers sought to lobby and secure the loyalty of certain politicians in order to dismantle the House of Morgan once and for all and, with the Morgan’s decision to opt for commercial banking rather than its stalwart investment banking arm, Rothbard suggests that aim was finally achieved. The entire story, which revolves around the development of the Federal Reserve and the sheer dominance of the Morgan empire, is worth studying but it all leads us back to the Glass-Steagall Act. It is apparent, for whatever reason, that the Act was a coerced movement based upon political and environment-altering manoeuvrings. If we accept that to be true, then it calls into question the legislative process of the time and, one may reasonably argue, the legislative process in general. It also casts a shadow on the reverence paid to the Act by Cicilline. It will be best left for another post, but the deregulation of the Act and its provisions in the 1990s is not so straightforward either (we should not be surprised), so the reality is that it is extremely dangerous to use something which has not been analysed properly as the basis for a future legislative or regulatory agenda.

The Glass-Steagall Act did, on the face of it at least, work. However, there are so many elements to consider a. in its construction and b. in its effect, that it becomes very difficult to say whether it can be heralded in the way that Cicilline speaks of the Act. For the technology industry, and the social importance of its leaders, it is vital that some control is exerted over their operations. In that sense, Cicilline is absolutely right. However, the arguable effect of the Glass-Steagall was to cartelise the banking industry which, if we connect history lineally, is a direct cause of the concentrated banking arena we witness today in the US (and this then has a global effect). There needs to be impartial studies undertaken on the potential effect of separation within the technology industry because the penalty for not doing so, if we use the banking industry as the example, would be massive for society. A technology industry that is more cartelised than it is now is not beneficial for society at all – the legislative body must take great care in this particular arena, and now is not the time for romanticising the past.

Keywords – Technology, Legislation, Banking, Finance, U.S., @finregmatters

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