Four Arguments that Might Justify “Fair-Access” Laws (Pt. 2)
Fair-access laws are criticized as infringing on the rights of financial firms. But is that always the case?
This is the second in a three-part series discussing arguments that could justify the use of fair-access laws, or at least address concerns raised against them. This post will discuss the argument that such laws may be a legitimate tool to prevent the misuse of government granted power and protection and that the claims the laws violate firm’s “rights” may be harder to sustain than expected given the risk of agent-principal problems in many modern corporations.
The first post discussed the argument that, given how essential access to financial services are to operating in modern society and the political process, fair-access laws can be a legitimate tool to protect citizens’ ability to meaningfully exercise their rights.
The final post will discuss a response to the claim that fair-access laws are unnecessary because the market can address any harm. It will be published tomorrow. As mentioned in the previous post, these arguments are not the only arguments that might support a “fair-access” law, nor are they equally applicable in all cases or necessarily dispositive.
In the previous post we discussed fair-access laws, which are laws aimed at preventing banks and other financial firms from denying service to controversial but legal customers, such as gun companies, oil companies, private prisons, and political causes, unless such denial was based on traditional banking considerations like profitability and regulatory compliance.
These laws are an emerging response to efforts by advocates, politicians, and others to use conditioning or cutting off access to the financial system as a way to de facto regulate in areas where direct regulation has proven difficult for political or constitutional reasons.
The laws are unsurprisingly controversial, including among libertarians and some conservatives, who generally oppose government action interfering with freedom of action and association.
In the previous post we discussed one argument that could justify fair-access laws even if we take freedom of association seriously – that the other rights that are being protected should take precedence. If people are trying to use financial services to deprive Americans of the meaningful ability to exercise core rights, state intervention to prevent this could be justified.
Of course, to the extent that argument has force, it must be because there are core rights at stake. However, efforts to use financial firms as de facto regulators, and the responding fair-access laws, go beyond what are generally considered to be core rights. One may have a right to speak, or to own a firearm, but the right to coal fired powerplants is generally not recognized.
One response is that there is also a right to have regulation done through the proper process, subject to checks and balances and constitutional limitation. If the current efforts to cut off firms from financial services is an effort to end-run around that process intervention might be warranted.
It is unclear how strong this argument is on its own. However, to the extent that financial firms can serve as a “choke point” because they were granted unique power and protection by law for specific purposes which are inconsistent with using that power as a tool to try and control others, the argument in favor of fair-access laws gets much more powerful.
It is this argument we will turn to next. We will then discuss a response to the critique that fair-access laws interfere with firms’ right of free association, namely that modern capital markets and corporate governance raise significant questions as to who gets to say how the right of free association should be used, and that fair-access laws could help prevent significant agent-principal problems.
We also will preview the final argument, which will be discussed in detail in the next post, which is that there are reasons to be skeptical that the market will provide an acceptable alternative solution to the problem fair-access laws are seeking to address.
Argument 2 – Preventing Misuse of Government Granted Power and Protection
When looking at the argument that the state can step in to protect the meaningful exercise of certain rights, one can accept that that idea has some weight and also admit that rights cut both ways. What about the rights of financial firms to use their property as they see fit, or to choose who they do business with? Aren’t these rights also important? There is a clear tension at play.
However, in some cases there is another relevant factor. Fair-access laws may help ensure that firms who receive significant and unique power and protection from public policy do not misuse that privileged status to the detriment of citizens.
While no market is truly free, banking is uniquely distorted. (p. 73-119) Banks are given a massive amount of power and protection by public policy. Such protections include barriers to competition, preferential legal treatment, preferential or exclusive access to government provided services (often at below market cost), and of course, protection from failure through both routine and extraordinary government interventions, such as bailouts or other actions in the name of “bank stability.” These protections dramatically exceed generally provided public goods like roads and courts. They are interwoven into the very nature of modern banking.
Why? Why are banks so protected and insulated, to the benefit of bank managers, employees, and shareholders? The American people privilege banks (and to a lesser degree some other types of financial firms) to facilitate and protect the lawful economy. The lawful economy in turn is driven by the political process to determine what is legal and by market preferences to determine what is economically viable.
The services banks provide in terms of capital accumulation, allocation, and distribution are essential to the functioning of a modern economy, and bank failures can have significant collateral damage. For these reasons banks are insulated from ruthless competition and weak banks are often protected from true market discipline.
To the extent financial firms use the position that public power gives them to de facto regulate, for example by trying to restrict access to financial services to force change on the market, such conduct is at best inconsistent with the justification for that power and at worst an outright abuse.
Even if one has a right to use one’s own property as they see fit, there is no right to use power and protection granted for a particular purpose for an unrelated or contradictory purpose. Fair-access laws can therefore be distinguished from “quid-pro-quo” style regulation where the provision on one benefit (e.g. roads) is used to justify an unrelated demand.
Provided fair-access laws allow banks to use traditional concerns like profit maximization, true safety and soundness, and compliance with the law (as opposed to regulator preferences masquerading as such), to make business decisions while preventing banks from using their privileged position to try to control others, they would be consistent with ensuring that citizens get the benefit of the bargain they have struck with banks in granting them so much power and protection.
The danger of “Safety-and-Soundness”
One thing does need to be said about “safety and soundness” however: As currently used by regulators it is such a nebulous and expansive concept that it can facilitate significant abuse.
“Safety and soundness” has been invoked repeatedly as a justification for regulators to impose their personal preferences on banks and other financial firms, without any need to show that a bank’s safety was actually in jeopardy. Safety and Soundness could also be cited by management or some other constituency as a justification for what they wish to do anyway, since it’s lack of objectivity makes it hard to second-guess.
Further, the logic of “safety and soundness” as currently employed can be abused even if the regulator is truly neutral because it could grant government force to what is in effect a secondary boycott. Assume a group with leverage over a firm, such as a large customer, shareholder, or group of employees (A) wishes to strike at another group (B) by cutting off their access to financial services. If A forces a bank (or other financial firm under similar regulation) (C) to choose between A and B, and if A is more financially lucrative, or can convince the regulator that they are, the logic of safety and soundness would incentivize even a neutral regulator to at a minimum caution C about the risk of doing business with B. (p, 27-32) Given the regulatory reality faced by banks and other financial firms such “cautions” are often intended, or at least interpreted, as orders. (p. 2-27)
As such, mere assertions of “safety and soundness” should not be seen as a per se legitimate reason to oppose fair-access laws or as a justification to refuse service. Rather, such invocations should be evaluated critically to ensure they are not merely convenient excuses.
Argument 3 – The Agent-Principal Problem
While preventing firms from misusing the power and protection that have been granted could potentially justify fair-access laws, the argument is inherently limited. Not all firms receive comparable powers and protections. Further, even if we take that argument seriously there is the countervailing concern about the rights of the firm to free association.
However, when we talk about the rights of the firm, we need to ask whose rights we are trying to protect. Is it the rights of the firm’s management to direct the firm’s conduct? Is it the right of the firm’s owners to have their property used consistent with their wishes? When we talk about owners, do we mean the owners of the firm’s stock or the people who put money at risk?
Increasingly, they are not one and the same. More and more the equity of banks and financial institutions is owned by large asset managers like BlackRock, or large public pension funds like CalPERs, on behalf of individual investors who pay for the stock or for whom the stock is part of their employment compensation. While the individuals bear the economic risk of the stock, the institutions as owners get to vote the shares and leverage the power that provides.
These asset managers, or a firm’s management, or their employees, or some other constituency, who use their position of influence to get the firm to deny or restrict services to lawful customers who could otherwise be profitably served enjoy a concentrated benefit. However, this benefit is potentially at the expense of the firm, and the firm’s other constituencies.
This is the classic “principal-agent” problem. The owners of the corporation entrust managers to manage their property to further the owners’ interest. However, if the manager acts in a way inconsistent with the owners’ interest it can be hard for the owners to detect and stop this misuse.
In a closely held corporation where the owners and managers are very tightly connected, if not the same people, the risk may be limited. In a public corporation however, especially one where institutional investors hold large positions on behalf of millions of dispersed individuals, preventing agent malfeasance can be very difficult. For example, to the extent an individual’s employer sponsored retirement fund or pension is managed by an asset manager who the individual disagrees with, the individual would need to change jobs or forgo the retirement benefit to have their money controlled by someone different. This dynamic undercuts the tools of “corporate democracy” that the Supreme Court has traditionally cited as the best means by which shareholders can protect themselves.
Importantly, in the present case the firm’s management might not be motivated solely, or even partially, by a desire to deny controversial customers access. However, if as discussed above, there is a powerful constituency hostile to the controversial customer, that places pressure on the manager, the manager may “buy the peace” by using the firm’s resources in a way that may not be in the economic interest of the firm or consistent with the normative preferences of those who have placed their money at risk for the firm.
The denied customer is obviously harmed, but to the extent the firm is passing up on profitable business, narrowing its customer base, or potentially alienating other powerful constituencies, it risks the financial well-being of the firm. Importantly, the firm does not need to fail for other constituencies, especially shareholders, to be harmed. It merely needs to forgo some value creation it would otherwise have enjoyed.
While agent-principal problems are nothing new in corporate governance, here they implicate whether a fair-access law restricts someone’s rights, or if it is merely restricting agents’ ability to use their principals’ assets for their own purposes. To the extent fair-access laws prevent agents from exploiting their influence over the principal’s property they can be seen less as a tool in the culture-war and more as corporate governance laws, where state involvement is inherent.
There is of course the possibility that a firm’s equitable owners will support management’s decision to cut ties with a customer, and perhaps fair-access laws should be amended to allow this; assuming other arguments for mandating fair-access do not apply with sufficient weight. Still, there are likely to be many cases where a firm’s owners’ preferences run counter to management’s decision or are at least unknowable. In these cases, it becomes harder to sustain the critique against fair access laws that they infringe on the rights of a firm, since it is not at all clear this is what the firm’s owners actually want to do with their property.
Conclusion
The two arguments above can be used to undercut concerns that fair-access laws will harm the legitimate rights of financial firms, at least as articulated by their management. First, one may have a right to free association but no right to misuse power given for a different purpose. Second, it is frequently unclear that a firm cutting ties with a customer is a true expression of the desires of the firm’s owners as opposed to a misuse of the owners’ property for some other purpose.
Still, there are costs to state intervention, so it is worth asking if it is necessary. This question is especially poignant if there are acceptable alternatives to government action that would protect the beneficiaries of fair-access laws without the downsides. If the market can adapt to meet the economically rational needs of those targeted for debanking why risk the law?
This is an excellent question, but as will be discussed in the next post, there are reasons to be skeptical that the market can provide an adequate solution.