Banking Has Become an Oligopoly

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Some folks have responded to Bank of America’s announcement of a new $5 per month fee on debit cards with a glib, “If you don’t like it, just pick another bank. It’s a free market, baby!” They say that competition will punish BofA for its evil ways.

Sounds easy enough. Except for one small problem.

Banking is not really a competitive industry. In reality, it’s more like an oligopoly — a scenario in which an industry is controlled by a small number of firms. An oligopoly is a lot like a monopoly, where one firm controls the whole show. Only in an oligopoly, you have two or more firms calling the shots, and they love to do things contrary to the notion of a free market, like, say, colluding to raise prices. There are a few common signs that tell you when competition has left the building in a given industry. See if any of these look familiar.

Concentration of Power

The last time big banks blew up the economy, causing the Great Depression, they got broken up. Tight regulation protected small banks, so they could get in on the action. But a massive trend of consolidation in the industry starting in the mid-’80s shrank the total number of banks in the United States as bigger banks gobbled up little ones. Result? The biggest banks control a larger and larger share of deposits.

Concentration of deposits is one measure — perhaps the best measure — of competition in the banking industry. The number of depository organizations in the U.S. fell from 15,416 in 1984 to 8,191 in 2001, a drop of 46.9 percent. The share of deposits held by the biggest five banks swelled to 23 percent in 2001 from just 9 percent in 1984. Sound like a competition-driving trend to you?

If you think 23 percent is a big piece of the pie, consider this: In June 2008, before the Lehman collapse, the share of deposits held by the five biggest banks had soared to 37 percent. And the figure has only risen since then. By 2009, the top five banks (Bank of America, JPMorgan Chase, Citigroup, Wells Fargo and PNC) boasted nearly 40 percent of all deposits. They got all these deposits not because they did a great job and offered amazing service (BofA is notorious for low rates on deposits), but because they ate up smaller banks. That’s how I, once a customer of Marine Midland Bank, became a customer of the megabank HSBC.

This increasing concentration of deposits suggests that banks have been getting steadily less competitive over the last 30 years. Which allows nasty things to happen.

For example, when Bank of America decided to charge customers for using a debit card, an activity that actually saves them money on processing checks, they performed a maneuver common in oligopolies, known as “price leadership.” In this form of tacit collusion, the lead dog in the industry announces a price increase, signaling to the other big dogs that it’s cool for them to do the same. In this case, if the other dogs don’t place fees on debit cards, they’ll find another way to get the dough so that they keep pace with the leader. In the last couple of weeks — as though by an invisible hand — you may have received a letter from your bank noting some “changes.” Maybe there’s a new fee for using your line of credit account. Maybe your checking account is no longer free. Or maybe your bank will charge more for using ATMs. These “changes” mean only one thing: price hikes.

Cost v. Returns

Another telltale feature of oligopolies is a yawning gap between the cost of performing a service or making a product and how much a firm charges for it and gets to profit by it.

Jamie Dimon of JP Morgan Chase warned us that if regulators tried to prevent the banks from charging certain kinds of fees, they would find the money elsewhere, just like a restaurant might charge more for the burger if it can’t charge for the soda. To follow the logic of Dimon’s restaurant analogy, if you don’t like how much a restaurant is charging for the burger, you just cruise down to the diner around the block. Problem solved.

What Mr. Dimon doesn’t want you to realize is that the restaurant industry and the banking industry are quite different. Bank of America is not Joe’s Burger Joint. The diner sets a price for its burger based on the cost of the food and the cost of turning it into a burger, serving it to you, cleaning up, paying the electric bill, advertising, etc. In the restaurant industry, food costs are generally about 35 percent of the price of an item you see on the menu. If Joe’s tasty burger costs $10, then you could expect that the meat, bun and condiments cost $3.50. The rest goes to cover the other costs and a slender margin for profit. According to the National Restaurant Association, a restaurant makes about 4 cents on every dollar you spend.

The industry is highly competitive, and restaurants fail all the time, most within their first year of operation. Survivors need a sound business plan, good management, and products that consumers want to buy and don’t make them barf. The gap between costs and what restaurants charge must be small, or else you’ll head to Bill’s Burger Heaven.

But the banking industry operates in a different universe. Charges for products and services and the costs of those products and services often have very little relation to each other. As commercial litigator Lloyd Constantine helpfully points out, banks were challenged by an antitrust lawsuit back in 1996 for charging dubious fees to stores for debit card transactions. They were forced to drop the fee from 63 cents per transaction to 43 cents — a fee Constantine says the Fed knew was still much too high. When ATM cards were first used at stores as debit cards, at first there was no fee because getting rid of checks was hugely profitable for banks. But, as Constantine puts it, “Bank of America, Chase and their Visa/MasterCard partners wanted to have their burgers and eat them, too.” When Dodd-Frank Act ordered the Fed to find out whether the banks could justify high fees on the basis of the costs of processing debit card transactions, the Fed concluded that banks were grossly overcharging: “After initially deciding that debit interchange fees should be lowered from 44 cents to 7 to 12 cents, the Fed, in yet another huge handout to big banks, revised the fee range to 21 to 24 cents.”

This is what the big banks are screaming about. They can only charge 21- 24 cents for something that should only cost 7-12 cents. Because they aren’t really a competitive industry, they can get away with huge cost v. returns gaps.

Risk of Failure

In a free market, businesses fail; 33 percent of all new businesses fail within the first six months. Fifty percent of new businesses fail within their first two years of operation and 75 percent fail within the first three years. They fail for all kinds of reasons. Maybe they had a stupid business plan. Maybe they were underfunded. Or they weren’t cost competitive. Or their management sucked. Whatever the reason, they fail. One day the business is there, and the next day it’s gonzo.

Again, the banking industry sails right past this free market logic.

We’re all familiar with the term “Too Big To Fail,” which sums up what happens nowadays to the biggest banks even when they commit fraud against consumers, poison them with toxic products, grossly neglect their duties to shareholders, and blow up the economy. They are rescued with public money. Yours and mine! That doesn’t happen to Joe’s Burger Joint. If Joe’s restaurant had a management team that made stupid business decisions, picked customers’ pockets, and sold burgers that made you throw up, then Joe would probably see a padlock on his door before too long.

But bad management at a bank seems to have no repercussions except enormous payouts. Just ask recently booted BofA execs Sallie Krawcheck and Joseph Price. The bank gave Krawcheck a severance package that includes a year’s salary of $850,000 plus a payment of $5,150,000. Price got $850,000 and a payment of $4,150,000. BofA CEO Brian Moynihan took over from Ken Lewis, an exceptionally crappy bank manager who exited the door with $125 million in his pocket. Moynihan has been defending his bank’s debit card decision and making a lot of noise about his loyalty to shareholders and customers and his bank’s “right to make a profit.” Former bank regulator Bill Black isn’t feeling sympathetic, though, crisply observing that “it was Moynihan’s incompetence and moral blindness that allowed BofA to commit tens of thousands of felonies in the course of foreclosing through perjury on those who were often the victims of Countrywide’s underlying fraudulent mortgages.”

Moynihan collects a $2 million annual salary. As a base.

The BofA chief also has the nerve to serve up whoppers about how Dodd-Frank regulation is responsible for his bank’s losses, but Black isn’t buying that burger. He calls Moynihan’s claim “false and pathetic,” noting that “endemic criminal conduct by BofA in the mortgage foreclosure process, combined with the massive accounting fraud inherent in Countrywide’s operations combined to cause a loss of slightly over 60 percent to BofA shareholders.”

Right. So given that the idea of a free market in the banking industry is bunk, what’s a Bank of America customer to do? It’s not like you can live normally without a bank. Unfortunately, as Black wrote me in an email, the choices are not pretty at this time. His advice:

First, anyone with BofA stock should sell it. Second, there is no good route for the depositor. Third, as a customer, i.e., for a mortgage loan or debit card, go elsewhere. Fourth, interest/fees on credit cards are far bigger for most consumers, so their focus should be on their credit cards. Pay off as much as possible of your high interest rate credit card debt as soon as possible and change to a credit card company with lower interest rates/fees (comparison shop on the web).

So there you have it. You do what you can. But with that said, it still seems reasonable to take your money out of the biggest banks that caused the financial crisis and are still harming the economy by not lending, doling out huge bonuses, and screwing customers. The alternative is to find a credit union or small bank, if for no other reason than to give your support to local businesses and to invest in Main Street. You might even end up with fewer fees. The Move Your Money campaign, the brainchild of Arianna Huffington, economist Rob Johnson and filmmaker Eugene Jarecki, offers guidance in picking an institution that’s safe.

How hard is this? Well, I’m about to find out, because I’ll be taking my money out of HSBC and finding a smaller bank. I’ll let you know how it goes.

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