Identifying the Consequences of Financial Mergers

June 6, 2013
By Doug Gavel, Harvard Kennedy School Communications

There may be some benefits to consumers when big banks become bigger, but the Great Recession has demonstrated how potentially harmful the risks may be. That is one conclusion in a new Harvard Kennedy School Faculty Working Paper authored by F.M. Scherer, professor of public policy and Corporate Management in the Aetna Chair, Emeritus.

"Financial Mergers and Their Consequences" examines the history and implications of the concentration of market share and assets in the hands of a small number of banking companies and financial institutions -- and the ways in which recent trends are related to changes in the financial industry structure.

"...The six largest survivors of 2008, with end-of-2010 assets totalling $9.3 trillion, or 66 percent of U.S. gross domestic product, stemmed in their recent history from 193 merged entities," Scherer writes. "The rising trend in the concentration of banking institution assets is provokingly similar to another rising trend: in the share of total U.S. corporate profits attributable to financial institutions (including insurance companies), presumably driven mainly by the performance of banking corporations."

Scherer argues that with a smaller number of firms holding a larger percentage of assets, an oligopolistic marketplace could emerge, whereby any one leading bank firm is considered "too big to fail," in effect tying the hands of regulators and governments and setting up a moral hazard, which could encourage more reckless behavior in the future.

One possible solution, Scherer concludes, would be to enforce a new set of separate standards based on those articulated in the Glass-Steagall Act or under appropriate revisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

"Doing the job right requires at minimum (1) obtaining detailed organization charts for each leading bank; (2) classifying the reported activities into meaningful markets; and (3) securing asset data for each line in each relevant market," Scherer writes.

"Short of retroactive merger reversal, the least one can reasonably ask is that a broader approach be taken to merger review in the future," Scherer concludes, "so that undue concentrations are prevented in specialized investment banking product lines as well as in localized commercial banking markets."

F. M. Scherer is Aetna Professor Emeritus in the John F. Kennedy School of Government, Harvard University. He received an A.B. degree with honors and distinction from the University of Michigan in 1954; an M.B.A. with high distinction from Harvard University in 1958; and a Ph.D. in business economics from Harvard University in 1963. His research specialties are industrial economics and the economics of technological change.

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F.M. Scherer, professor of public policy

F.M. Scherer, professor of public policy

"Short of retroactive merger reversal, the least one can reasonably ask is that a broader approach be taken to merger review in the future," Scherer concludes.