Blockchains, bazaars and price fixing cartels
While in Istanbul for a blockchain conference, we came across Matt Levine’s latest Money Stuff column, in which he observes the following about the Libor manipulation and anti-trust case:
The Libor system itself emerged in the late 1970s from the chaos of the burgeoning market for eurodollar deposits. Indeed, before it was known as Libor, it was known as the London interbank eurodollar rate.
The need for a consensus on the rate came about largely because banks needed a holistic view of the demand and supply of true dollar settlement funds to help manage their risk and to avoid self-destruction. That is to say, it was in the interests of competing bank institutions who had hitherto specialised in undercutting each other on eurodollar credit creation — a.k.a dollars originated outside of the US but backed by obligations to convert those dollars at any given moment — to draw a line in the sand on how low those rates could go to protect their margins. This line, as a result, represented the cost of raising dollar liquidity from each other if and when needed — a number influenced indirectly by the cost of operating foreign subsidiaries in the US.
Libor ended up being based on a quoted offered rate — rather than a bid or done transaction rate — because banks only really needed to know the hypothetical cost of dollar funds on any given day to be able to set compelling margins and to protect against the risk of doing loss-making credit deals (where rates offered to customers were lower than the rates banks could fund those liabilities).
Was this cartel formation? Of course it was.
Was it a sinister form of collusion? Only if you think market players in strategic network dependent industries should never be able to defend break-even rates or use collaborative solutions — based on information sharing — to reduce the risk of offering funds at rates which can’t be matched in interbank funding markets.
Which brings us to a more general point about how cartels often end up as natural byproducts of overly competitive markets, popping up whenever the cost of production is zero, wherever the barriers to entry are teeny tiny (the mafia’s protection racket comes to mind) or whenever inefficient or purposefully skewed markets (say, due to regulatory prohibition or natural inelasticities) incentivise over-investment to such a degree that oversupply threatens to shut down the industry altogether. In a bid to protect margins and rents — and with it their investments — dominant players are understandably minded to establish common rules, protocols and agreements on minimum prices, rates and qualities; to regulate industry quotas or members; or even to share information in mutually beneficial or protective way.
Back in the 1970s, the eurodollar market was precisely this sort of frenzied and unconstrained free market. Consequently had it not subscribed to a network agreement on a minimum rate it may not have survived. Instead, we got a daily implicit agreement on the rate below which banks would not undercut each other — a rate which was tantamount to the break-even rate for the industry.
To wit, here’s Diana Hancock, of the Fed, arguing convincingly in the 1990s that bank profitability depends upon the strength of the banking system’s monopoly position, and why banks feel it’s justified on risk grounds:
Perhaps that’s because industry has always lobbied hard to make self-regulation sound like a prudent and justified alternative to government regulation, rather than an oligopolistic tactic? Or perhaps it’s because people don’t mind a bit of collusion when it comes in the name of self-preservation, break-even cost protection, risk management or stability of service supply?
Or perhaps even it’s because collusion only gets under our skin when it’s motivated by a desire to profiteer from being part of an elite member’s club or for setting prices well above break-even rates routinely?
In any case, Libor’s collaborative function only really became problematic for society when it became entirely detached from the wholesale cost of funding, and routinely misused for allocating windfalls to the entire banking system as well as for obscuring the true amount of risk present in the system.
In that regard, we were struck by Istanbul’s Grand Bazaar on our travels, not least because of its brutally competitive nature but also because of the self-preservation tactics it has deployed over the ages, from guild formation and price fixing policies, to welfare protection and security provision for member merchants — including protection from thievery or damages — to government supervision and support.
Those chaps on the right, by the way, appeared to us to be setting some sort of fix for their wares, possibly for gold inventory due to their proximity to the gold stalls.
In short, none of this is new. And none of this should be surprising. Ruthlessly competitive markets have always encouraged cartel formation for risk reduction and self-preservation reasons. And while antitrust has a role to play, a much bigger role is arguably to be played by government. After all, if applying antitrust measures to markets makes them so competitive they become unviable for private interests to operate, this also threatens their existence. If the underlying services provided a worthwhile public good, it stands to reason some incentives or protections should be maintained to keep the systems operational.
In other words, if we must handover rents or social security benefits to banking oligopolies to maintain a banking system, may these rents at least be overseen by a democratically mandated government and continuously reviewed vis-a-vis the underlying wholesale costs of providing the business.
Related links:
Inequality and the monopolies of unfettered techno markets – FT
It is fairly well established that a bunch of big banks manipulated the London Interbank Offered Rate, and that the dollar numbers attached to Libor manipulation are quite large, so a bunch of investors and plaintiffs’ lawyers got together a while back to sue the banks and get some of those dollars. One of their main theories was that the banks’ collusion to manipulate Libor was an antitrust conspiracy. But the district court threw out this theory, reasoning that it can’t be an antitrust conspiracy for the banks to get together and agree on Libor, because banks getting together to agree on Libor is just Libor. It can’t be illegal to do anticompetitive stuff with Libor, because Libor isn’t a competitive market; it’s “a cooperative endeavor,” so the fact that the banks cooperated in setting a false Libor, while it might be bad, can’t be an antitrust violation. I am not an antitrust expert but I found this interpretation clever, and fairly convincing.As it happens, we’ve always contended that Libor is not a clear cut case of abuse precisely because of the ambiguities in hand. Furthermore, we’ve also contended that some industries, among them banking, can’t help but encourage cartels or antitrust abuse because their raison d’etre is all about being a network information sharing platform or a club which purposefully excludes people for risk reasons. As a result, cooperative oligopolies pop up in banking almost everywhere, from payment revenue-sharing clubs and blockchain consortiums to mutually owned trading platforms and messaging networks. One might even say banking without cartels wouldn’t be banking — hence why competition can often bring more trouble than it’s worth.
But yesterday an appeals court said, no, it can still be an antitrust conspiracy: When a bunch of competitors get together to fix prices, even if that is kind of what Libor was anyway, that just looks so much like an antitrust violation that it has to be one. “Horizontal price-fixing constitutes a per se antitrust violation,” said the court. Again, I am not an antitrust expert but I find this kind of convincing too. I mean, they (allegedly) conspired to fix prices. Amidst all the dumb Libor e-mails and chats, one trader called it a “cartel.” It sure sounds like an antitrust problem.
Anyway it’s a big problem, because the Libor that the banks manipulated affected not only the payments on their own derivatives but also lots of other derivatives that they had nothing to do with:
Requiring the Banks to pay treble damages to every plaintiff who ended up on the wrong side of an independent LIBOR‐denominated derivative swap would, if appellants’ allegations were proved at trial, not only bankrupt 16 of the world’s most important financial institutions, but also vastly extend the potential scope of antitrust liability in myriad markets where derivative instruments have proliferated.
The appeals court sent the case back to the district court to think about that one for a while.
The Libor system itself emerged in the late 1970s from the chaos of the burgeoning market for eurodollar deposits. Indeed, before it was known as Libor, it was known as the London interbank eurodollar rate.
The need for a consensus on the rate came about largely because banks needed a holistic view of the demand and supply of true dollar settlement funds to help manage their risk and to avoid self-destruction. That is to say, it was in the interests of competing bank institutions who had hitherto specialised in undercutting each other on eurodollar credit creation — a.k.a dollars originated outside of the US but backed by obligations to convert those dollars at any given moment — to draw a line in the sand on how low those rates could go to protect their margins. This line, as a result, represented the cost of raising dollar liquidity from each other if and when needed — a number influenced indirectly by the cost of operating foreign subsidiaries in the US.
Libor ended up being based on a quoted offered rate — rather than a bid or done transaction rate — because banks only really needed to know the hypothetical cost of dollar funds on any given day to be able to set compelling margins and to protect against the risk of doing loss-making credit deals (where rates offered to customers were lower than the rates banks could fund those liabilities).
Was this cartel formation? Of course it was.
Was it a sinister form of collusion? Only if you think market players in strategic network dependent industries should never be able to defend break-even rates or use collaborative solutions — based on information sharing — to reduce the risk of offering funds at rates which can’t be matched in interbank funding markets.
Which brings us to a more general point about how cartels often end up as natural byproducts of overly competitive markets, popping up whenever the cost of production is zero, wherever the barriers to entry are teeny tiny (the mafia’s protection racket comes to mind) or whenever inefficient or purposefully skewed markets (say, due to regulatory prohibition or natural inelasticities) incentivise over-investment to such a degree that oversupply threatens to shut down the industry altogether. In a bid to protect margins and rents — and with it their investments — dominant players are understandably minded to establish common rules, protocols and agreements on minimum prices, rates and qualities; to regulate industry quotas or members; or even to share information in mutually beneficial or protective way.
Back in the 1970s, the eurodollar market was precisely this sort of frenzied and unconstrained free market. Consequently had it not subscribed to a network agreement on a minimum rate it may not have survived. Instead, we got a daily implicit agreement on the rate below which banks would not undercut each other — a rate which was tantamount to the break-even rate for the industry.
To wit, here’s Diana Hancock, of the Fed, arguing convincingly in the 1990s that bank profitability depends upon the strength of the banking system’s monopoly position, and why banks feel it’s justified on risk grounds:
The traditional reason given for deposit rate ceilings is that bank competition for deposits allegedly leads to a high rate of bank failures. According to this view, bank competition for deposits led individual banks in the 1920′s and early 1930′s to offer higher interest rates in order to maintain or increase individual share of the market. The banks were forced to rely on higher yielding riskier assets to offset incurred deposit costs. This placed the banks in a vulnerable position. Any adverse economic developments, either national or local, would be sufficient to make these risky assets uncollectible by the bank. Deposit rate ceilings affect consumers, since they receive less for deposits than would otherwise be the case, but the accompanying increased monopoly power of financial institutions makes them allegedly more sound.And that’s precisely what makes the antitrust case so interesting: the time really to have brought a case against the banks was the 1970s. And yet… nobody did.
Perhaps that’s because industry has always lobbied hard to make self-regulation sound like a prudent and justified alternative to government regulation, rather than an oligopolistic tactic? Or perhaps it’s because people don’t mind a bit of collusion when it comes in the name of self-preservation, break-even cost protection, risk management or stability of service supply?
Or perhaps even it’s because collusion only gets under our skin when it’s motivated by a desire to profiteer from being part of an elite member’s club or for setting prices well above break-even rates routinely?
In any case, Libor’s collaborative function only really became problematic for society when it became entirely detached from the wholesale cost of funding, and routinely misused for allocating windfalls to the entire banking system as well as for obscuring the true amount of risk present in the system.
In that regard, we were struck by Istanbul’s Grand Bazaar on our travels, not least because of its brutally competitive nature but also because of the self-preservation tactics it has deployed over the ages, from guild formation and price fixing policies, to welfare protection and security provision for member merchants — including protection from thievery or damages — to government supervision and support.
Those chaps on the right, by the way, appeared to us to be setting some sort of fix for their wares, possibly for gold inventory due to their proximity to the gold stalls.
In short, none of this is new. And none of this should be surprising. Ruthlessly competitive markets have always encouraged cartel formation for risk reduction and self-preservation reasons. And while antitrust has a role to play, a much bigger role is arguably to be played by government. After all, if applying antitrust measures to markets makes them so competitive they become unviable for private interests to operate, this also threatens their existence. If the underlying services provided a worthwhile public good, it stands to reason some incentives or protections should be maintained to keep the systems operational.
In other words, if we must handover rents or social security benefits to banking oligopolies to maintain a banking system, may these rents at least be overseen by a democratically mandated government and continuously reviewed vis-a-vis the underlying wholesale costs of providing the business.
Related links:
Inequality and the monopolies of unfettered techno markets – FT
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