Antitrust's next frontier?

Assistant Attorney General Christine Varney, who heads the merger review operation at the Justice Department, gave notice to corporations May 11 that the government will vigorously use antitrust law to restore balance in "distorted" markets.

It would be hard to find a market more distorted than the financial industry, so a key question Varney wants to explore is whether U.S. antitrust authorities could have done more to prevent the financial institutions that instigated the credit crisis from getting so big, so complex and so dependent on each other's stability.

Varney, however, may be stepping into a minefield if she makes a serious effort to invigorate antitrust oversight of the banking industry. Banking has generally enjoyed a hands-off relationship with antitrust regulators. Although the Department of Justice conducts obligatory merger reviews, the agency typically accedes to federal banking regulators regarding bank mergers.

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But some argue that antitrust laws should apply to the financial sector and want antitrust laws to play a central role in checking concentration in the industry. Simon Johnson, an economics professor at the MIT Sloan School of Management, blames ineffective bank regulators for today's financial problems and wants antitrust lawyers to assume some responsibility, particularly by examining whether some institutions have become so critical to the workings of the financial system that they are "too big to fail."

Johnson envisions a "new theory of antitrust" that should be "fairly bold." He worries that not only did players such as American International Group Inc. and Bear Stearns Cos. become perceived as too big to fail, but the global financial system had really become "too complex to fail." As a result, financial regulators around the world committed trillions propping up troubled financial conglomerates.

Johnson insists that antitrust remains a better option for dealing with troubled institutions than filing for bankruptcy protection under Chapter 11, as some critics have suggested. Bankruptcy, he says, "would come with a lot of unknowable, unforeseen problems."

Antitrust isn't the only answer to problems in the sector, but "it could frame the question," Johnson insists. "Something has changed. The risks for taxpayers have gone up significantly," and he argues that people need to seek not only immediate solutions to the crisis but also ask questions about how to regulate the industry in the future.

"We're trying to argue for a more radical, more comprehensive approach," Johnson says.

But the concept is hitting resistance. Antitrust professor Joshua Wright of George Mason University School of Law says Johnson's approach is misguided. "I don't like it," he says. "We don't have a theory of 'too big to fail' in consumer welfare. We don't have any economic notion of what 'too big to fail' is."

As a result, Wright warns, the economic underpinning that drives antitrust cases could be upended.

Lawyers and economists have worked for decades, especially since the early 1980s, to tailor economic models that allow judges to evaluate consumer welfare. Wright, who also works with economics firm LECG Inc., says those tools are still gaining acceptance. "Consumer welfare is complicated enough, and [economists] are barely good enough at this in analyzing mergers and cartels." Adding another layer to antitrust cases "could be a huge step backward," Wright warns.

But Harvard Law School antitrust professor Einer Elhauge sees some possibility for experimenting with Johnson's ideas.

While there's no test for too big to fail, Elhauge says "we should be able to test some predictions." Indeed, regulators are already experimenting with economic stress tests that in part measure how a financial firm's problems could ripple across the industry.

"If the concern is that firms that are too big to fail will take on excessive risk because they know they will get bailed out, we should be able to find empirical evidence that small banks or investment banks invested a smaller share of their assets into toxic securities than big ones did," Elhauge says.

The use of economic theories and analytical tools to better inform policymakers is an area that Varney plans to emphasize. "Rigorous economic analysis has been and will continue to be at the foundation of the division's antitrust policy," she says.

To that end, Varney appointed University of California, Berkeley, professor Carl Shapiro a leading antitrust economist, as deputy assistant attorney general for economics.

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