Four Arguments that Might Justify “Fair-Access” Laws (Pt. 3)
Even if proponents of fair-access laws are correct there is a problem, why can't the market provide a solution? Unfortunately there are reasons for skepticism.
This is the final post in a series discussing arguments that could justify “fair-access” laws, or at least respond to some critiques of the laws. This post will discuss why simply relying on the market to protect people may not work, or at least not work well enough.
In the first post of the series discussed whether fair-access laws could be a legitimate tool to protect the rights of citizens from efforts to effectively restrict those rights via use of the financial system. The second post discussed whether fair-access laws could be a legitimate tool to prevent the abuse of government granted power and protection enjoyed by some financial firms, including banks. That post also considered whether fair-access laws really impinged on the rights of firms, or if they instead could help address an agent-principal problem where management used the power of a firm for a purpose that the firm’s owners did not support.
We have been discussing “fair-access” laws, which seek to prohibit banks and other financial institutions from refusing to do business with customers because the customer is engaged in legal but controversial behavior, such as fossil fuel extraction, making firearms, or certain types of political advocacy. Theses laws are being passed in response to efforts to exclude disfavored industries and political groups from the financial system to de facto regulate.
The laws themselves are contentious, with criticism coming from both left and right. On the right the primary critique is that such laws interfere with the free market and the freedom of association of financial firms. While this argument is by no means frivolous, there are potential responses to it.
In the first post we introduced the laws, discussed why they are controversial, and introduced the first argument in in support of the laws, that certain rights merit state protection. If access to financial firms is being cut off to prevent citizens from availing themselves of rights they are entitled to, the government may have a legitimate role in preventing that from happening. There is also the related argument that implicit within our system of government is the idea that regulation should be done via the appropriate political process, with its checks, balances, and protections, and so the state can intercede if that dynamic is threatened.
The second post dealt with the second and third arguments. The second argument is that banks in particular, and to a lesser degree some other financial firms, are granted public power and protection by law for the purpose of facilitating, rather than controlling the economy. If banks use that power instead to become de facto regulators that action is inconsistent if not outright contrary to the reason those benefits were provided. As such, that state has a legitimate interest in preventing such abuse.
The third argument is that if we take the idea of corporate rights of association seriously, we then need to answer whose right needs to be protected. In the case of many financial firms there is a real risk that firm managers’ decisions to cut off customers, whether motivated by their own preferences or by those of an influential constituency, represents a misuse of the property of others, namely those who actually put their money at risk.
This leads to the fourth argument, that the market may not provide an adequate solution to the problem of debanking, requiring the state to step in if the problem is to be solved.
Argument 4 – The Market May Not Solve the Problem
Even if one accepts that the arguments detailed in the previous posts have some force, a potential response is that while the use of financial services as tools of de facto regulation may be bad, government intervention would be worse. An intervention would be undesirable because it would entail controlling the acts of private parties, which is inherently objectionable. It would risk distorting the market to the extent laws nominally aimed at protecting “fair-access” crossed the line into protecting favored industries from legitimate economic pressure. And it would risk even further intrusion by the state into the market because it is seen as a renunciation of the free market by those who claim to cherish it.
This critique is particularly powerful if the market itself can provide adequate alternatives. After all, if these customers are economically viable won’t someone else come along to serve them? Won’t firms that turn away valuable business suffer at the hands of those who don’t?
These critiques are not frivolous, but there are reasons for skepticism. The first critique deals with the tension between conflicting non-economic values, namely the rights of customers versus the rights of firms. As discussed above, while the issue of a private firm’s freedom of association is of great weight, there are serious countervailing liberty interests that could support fair-access laws.
The second concern is that fair-access laws might distort the market to the extent that they are industrial policy in disguise. If the laws preserve access to financial services for favored groups beyond what is economically rational that could certainly be a problem.
However, nothing says the laws must function that way. If the laws allow financial firms to make business decisions on the basis of profitability, provided the profitability analysis is not distorted by political pressure, firms will still allocate funds to what they see is their best use. Even if the fair-access law does provide some protection to firms that is not economically rational, the cost might still be worth it if the laws also provide legitimate protections. Managing this type of tension is part of what the political process is for, and nobody said being a self-governing republic would be easy.
It is the final argument that is perhaps the most powerful, because it offers the optimistic and tantalizing possibility that this whole debate may be unnecessary. Why should policy makers intervene in the economy, with all the very real risks that entails, if there is a ready solution provided by the market?
Is this a Problem the Market Can Solve?
One potential response to a call to let the market sort it out is that the market can’t protect from the harm because the harm is not exclusively, or even primarily economic. Rather, the harm is in the attempt to prevent the customer from exercising their rights, or in the firm misusing the power granted to them by public policy, or the agent misusing the property of the principal.
Even if a customer could immediately shift service providers at no cost it would not prevent the harm from occurring. The act is inherently harmful, and so an outright prohibition is potentially justified.
Of course, this brings us back to the need to balance rights, or wrongs, and the force of this justification could vary depending on the circumstances. Trying to suppress political speech is a far cry from trying to restrict oil production. Not all firms covered by fair-access laws enjoy the same levels of legal protections and powers banks enjoy. A firm’s management acting with the support of its owners is different from management acting without such support. The balance of equities may vary from case to case.
Is the Market Willing and Able to Solve the Problem?
Even if there are cases where a pure market solution could address the harm there are unfortunately reasons for skepticism that the market would consistently provide an adequate solution. These reasons stem from the structure of the financial market, the power dynamics market participants are subject to, and the nature of the harm that customers could be subject to.
The Market may be Less Capacious than Thought
First, the market for financial services is not uniform. For example, one can say that there are thousands of banks in the United States and be correct, but any given customer cannot get services from all those banks. The twenty-five largest banks in the US have roughly 60% of assets and deposits, and make over half of the loans, including commercial loans, by value.
Most of the remaining banks are too small and locally focused to serve any given customer outside of their area, so even if they were otherwise willing, it is often an impossibility. Plus, some customers may need specialized services only some banks provide or need access to so much capital that only large banks or a collection of large banks can suffice. As such, the sheer number of banks may not tell us whether any given customer could find an adequate substitute.
For example, GEO Group, a company that builds and manages private prisons used by countries including the United States saw all of its banking partners cut ties with it in the face of pressure from activists, media, and investors to defund the private prison industry as a tool to reduce or eliminate private prisons as a tool of public policy. GEO Group’s major competitor, Core Civic saw a similar curtailment of existing bank partnerships.
This curtailment of banking relationships had a significant effect on those firms’ ability to access capital and contributed to a credit rating downgrade for one of the firms, raising their cost of capital in the securities markets.
Because of the intensity of these firms’ need for capital only banks of a certain size and capacity are well suited to assist. Both firms continue to express concern that they will not be able to access adequate capital in significant part due to political pressure placed on banks and other financial firms to not do business with them.
Market Participants may be Subject to Common Sources of Pressure
The risk that the market may not be able to respond is exacerbated to the extent that banks are not making independent decisions because they are under pressure from common sources. This could be as simple as enough relevant bank managers share a common world view, consume information from the same sources, and wish to appear respectable by similar standards. It is unlikely that the management of thousands of banks would feel that way, but if the relevant number of banks for a given customer is much smaller (because of bank size, specialization, or geography) this could have a material effect on the market.
Regulators are another group that can pressure financial firms as a whole to move away from certain clients, even if such pressure isn’t legally justified. Such an event happened when the FDIC pressured banks to cut ties with refund anticipation loan (RAL) providers, despite the products being legal and profitable. All the banks who served that industry ceased under regulatory pressure, and no new banks entered to fill the void, because while the RAL industry was a profitable customer, dealing with them was not worth the cost of regulatory coercion.
Regulations also undercut market discipline in other ways. For example, the regulatory barriers to entry for banks are extensive. (p. 75-82) This may prevent new banks who wish to target otherwise disfavored clients from entering the market. Further, to the extent that a market might punish a bank for cutting ties with a legal but disfavored group that effect may be blunted, intentionally or unintentionally, given the many barriers to exit that regulators have used to stop bank failures in the name of “bank stability.” (p. 94-110)
It isn’t only regulators who can wield such power over large sections of the banking industry. As mentioned previously, handful of large asset managers like BlackRock, as well as large public pensions hold large stakes in public companies, including banks. This concentrates a significant amount of power over corporations, including banks, in a small group of people who may have similar political preferences. To the extent this small group of organizations owns significant stakes in public banks (or their holding companies) they could apply pressure broadly throughout the industry.
As mentioned in the previous post, asset managers and pension funds control a significant amount of corporate equity on behalf of millions of individuals. These asset managers pose a unique threat because they also are rife with potential agent-principal problems, especially regarding retirement funds. The money at risk is invested by individuals or represents part of an individual's compensation but the individual likely lacks any say on who manages the funds unless the employee is willing to leave their job, and perhaps forgo vesting in their pension.
As such, while the individual provides the money, and bears the risk, the corporate control that comes with the investment is kept by the asset manager, who has limited incentive to respect the preferences of those individuals.
Concern about the role of asset managers over banks has been raised by Jonathan McKernan, a member of the FDIC’s board, and has resulted in a proposal by the FDIC to improve its monitoring of asset managers to ensure they do not use their ownership stake to exercise any control over the banks. While such a proposal could mitigate some of the risk posed by asset managers, enforcement, especially to prevent asset managers using back-door conversations with management, could pose a challenge.
Other groups may also have significant, albeit softer power. The media, politicians, activists, and large customers (among others) can all place significant pressure on not just individual firms but broad swathes of an industry to cut ties with disfavored but legal groups.
The mechanism by which this works is akin to a secondary boycott. When one group (A) tries to harm another group (B) by telling the financial firm (C) that it must cut off B or else lose A’s business what A is trying to do is change the economic calculus for C. Now C must determine whether B is an economically viable customer not only on its one merits, but also figuring in the loss caused by losing A’s business. This means that it is possible B might be an economically viable customer on their own merits, but not when the efforts of A are factored in.
Put a different way, part of what A wants to buy from C is harming B. Such a market does not square with common assumptions of how capitalism is supposed to work.
One significant example of an attempt to do just this, which contributed in a change to American law, is the Arab boycott of Israel in the 1970s (p. 28-31). As part of the boycott Arab governments tried to condition working with American banks on those banks restricting or refusing to do business with Israel. It was also alleged the boycott effort also extended to Jewish owned businesses and individuals.
In this case the Arab governments tried to use the promise of more profitable business and/or the threat of losing business to push banks away from Israeli and Jewish customers. The goal was not just to ensure that the banks the Arab states already did business with would not serve the boycott’s target. Rather, the intent was to use the Arab states significant wealth to induce as many banks as possible to cut ties through manipulation of economic considerations.
Such efforts were strongly decried by regulators and activists and it appears that banks did not acquiesce to the more overtly discriminatory demands. However some banks, including Citibank, appear to have complied with more limited provisions, such as including anti-Israeli requirements demanded by Arab states in the letters of credit the bank issued for exports to Arab countries. While Citibank stated that it understood the purpose of the requirements of the boycott to be “based on economic and not religious or racial grounds” and decried the “use of restrictions on domestic and international trade to achieve what are essentially political ends[,]” it also said that “diplomatic persuasion by appropriate government agencies” was necessary to deal with the boycott.
The desire to protect Israeli and Jewish customers, as well as prevent the American financial system from being coopted as a weapon against a friendly country were cited as one reason why national origin and religion should become protected classes under the Equal Credit Opportunity Act. (ECOA) Not only did the law protect customers, but it also protected financial firms from being dragged into political struggles by allowing them to tell customers, investors, and other groups that they cannot comply with requests to target lawful clients based on a protected characteristic, and neither could any other firm.
This change to anti-discrimination law is in effect a fair-access law and has been generally well accepted. It is unclear whether, absent strong legal requirements, more banks would have ultimately been influenced by the economic incentives imposed on them by Arab governments.
It is also worth noting that the original efforts to amend ECOA included making political affiliation a protected class. This provision was dropped because while almost everyone, including the American Bankers Association agreed such discrimination would be inappropriate and contrary to the purpose of a bank, it was also believed that such discrimination was unheard of.
Finding a New Partner may not Solve the Problem
Finally, it is important to remember that a customer can be harmed even if they are ultimately able to find alternative providers. Losing access to an established relationship is disruptive and finding new partners imposes search costs on the targeted customer. Further, with fewer potential providers competing for the customer’s business they may face some combination of higher costs and inferior service. After all, Econ 101 tells us that less competition is likely to raise prices, and if the new provider was better than the old, why didn’t the customer use them initially or change on its own?
In cases where the customer has limited financial resources, limited bandwidth to search, or operates a business that has small profit margins, the marginal degradation of service from their financial provider could cause material harm to the customer or force them to acquiesce to the demands of those pressuring financial firms to cut ties. As such, even a market “solution” may not be an actual solution.
The market is supposed to weed out the bad ideas and weak firms and support the strong. But in this case the market is being asked to answer a political question, rather than an economic one, and the risk is that the market will not tell us who is right, but only who is rich.
Of course, whether the market can provide an adequate solution to economic harm is ultimately an empirical question that may vary depending on the customer. In some, perhaps all cases the market may be able to effectively protect customers from coercion. Still, given there a plausible reasons for skepticism, policy makers having to make an ex ante decision on whether to support a fair-access law may not feel such an assumption is justified.
Conclusion
The state intervening in the market and making people do business with those they would prefer not to is no small thing. It is inherently coercive and risks further normalizing government control of the economy. It is, at best, unfortunate.
And yet, at times it may be a lesser and necessary evil. A world where the wealthy, powerful, and connected can threaten to impose economic harm on others unless their political demands are met is not one most want to live in. Nor is it consistent with the ideas that underpin our system of government and its legitimacy.
Whether fair-access laws are wise or necessary is a question that must be worked out with fear and trembling. However, we also live in a world where there are efforts to de facto regulate through controlling access to the financial system by powerful private and public interests, and the threat that poses to Americans should not be glibly dismissed. Until that threat abates this will, and should, be a live debate.