SHOULD CRISIS CARTELS EXIST AMIDST CRISES?

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SHOULD CRISIS CARTELS EXIST AMIDST CRISES? Dr Ioannis Kokkoris* INTRODUCTION Cartels generally involve price fixing, market division, control of output, mitigation of technological improvement, limiting of production. Most antitrust laws against cartels incorporate three elements, the element of prohibition, the element of exemption as well as the element of penalty. A review of antitrust legislation in relation to cartels across jurisdictions reveals that there are two principles which govern the approach that countries take towards prohibiting the anticompetitive conduct of cartels. Under the per se prohibition, cartelistic behaviour is per se illegal. On the contrary under the “control of abuse” approach, cartelistic behaviour may be permitted to some extent, but sufficient regulation is exercised to prevent any harm induced by such activities. The reason for this multitude of approaches across jurisdictions is the overriding social objectives behind some antitrust laws. For example, the adoption of the per se approach in the US emanates from the nineteenth-century Populist movement that resented the anticompetitive activities of various business trusts and, therefore, sought free competition at any cost. In the EU and Germany, however, the need for economic and technical development and efficiency is reflected in viewing its antitrust role as a supervisory one through the use of the control of abuse concept.1 A number of antitrust legislations incorporate exemptions as a means to avoid condemnation of certain cartelistic conducts. Such legislations include provisions which specifically exempt certain enterprises and conducts from the scope of the antitrust legislation because of the overriding social objectives behind antitrust legislations. Fines operate as a penalising instrument against the conduct of a cartel as well as a disincentive against the creation of cartelistic behaviour. The US, UK, Ireland and Germany, for example, have criminal and civil penalties for corporate and/or individual violations of their antitrust laws, while the EC has a civil penalty only against the corporation. The key significance of the criminal regime from an enforcement perspective lies in its deterrence value and, in particular, its separation of the interests of individuals from those of the businesses that employ them. A report prepared for the Office of Fair Trading (“OFT”) by Deloitte,2 in which competition lawyers and

* Reader, University of Reading, Visiting Professor, Bocconi University, International Consultant on Competition Policy, International Organisation for Security and Cooperation. For an extensive review of crisis cartels see further: IOANNIS KOKKORIS, RODRIGO OLIVARES-CAMINAL, ANTITRUST POLICY IN THE WAKE OF FINANCIAL CRISES, (2010). 1 Timothy J. Grendell, The Antitrust Legislation of the United States, the European Economic Community, Germany and Japan 29 THE INTERNATIONAL AND COMPARATIVE LAW QUARTERLY 1, 64-86, (1980). 2 The deterrent effect of competition enforcement by the OFT, November 2007 (OFT962).

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companies were asked about the relative importance of various factors in deterring competition law infringements. Both the lawyers and companies surveyed regarded criminal penalties as being the most important3. Where cartel prohibitions are enforced with criminal sanctions on individuals, (including imprisonment), the standard of proof has to be particularly high ("beyond any reasonable doubt") and it is more difficult to discharge the burden of proof without the active help of cartel members, i.e. without admissions and without the agreement of the companies. These personal risks also have the effect of further destabilising cartels, making it more likely that, once entered into, they will not be sustained. When operating alongside an effective leniency policy that aligns the interests of individuals with those of their employers, together with other sources of intelligence, it also means that cartels are more likely to be detected and punished, thus reinforcing deterrence. According to Tierno,4 criminal sanctions would lead to under-enforcement if they are to be applied in a place where cartelists are not socially perceived as criminals. The majority of countries' antitrust laws provide for enforcement by administrative agencies, with review by the courts. Cartel justifications that have been proposed include that a cartel will prevent cutthroat competition. In industries where fierce competition would yield below-cost pricing, the cartel guarantees a “reasonable” price. In addition it has been argued that a cartel sustains needed capacity and prevents excess capacity. Furthermore, a cartel reduces uncertainty as regards the average price of a product. It also assists in financing desirable activities e.g., R&D, and in providing countervailing power since if there is a single buyer (monopsonist/oligopsonist) or supplier (monopolist/oligopolist), there is unequal bargaining power that a cartel can address.

Without the industry wide agreement on capacity reduction that can be achieved through a crisis cartel, smaller firms may exit the market leaving thus a limited number of choices for customers as well as inducing unemployment. In such conditions, may operate at inefficient output levels and may even be incurring losses. The Treaty of Rome did not contain any clauses regarding crisis conditions. When the Treaty was signed, economic expansion seemed to be the likely to continue. Due to the lack of express clauses in the Treaty of Rome the Commission could not justify applying the Article 101(3) criteria. Thus, the Commission initially reduced fines in cartels existing in situations of crises.

In the European Union the problem of structural overcapacity after the second oil shock was exacerbated by the increased competition at an international level that induced further reductions in capacity utilisation in some industries. Such capacity reductions may not represent reductions of the least efficient capacity. Thus, agreements among competitors to reduce capacity are likely to lead to better long term prospects for the economy. The Commission has defined structural overcapacity as existing “where over a prolonged period all the undertakings concerned have been experiencing a significant reduction in their rates of capacity utilisation, a drop in output

3 Id. paragraphs 5.55 to 5.59. 4 Tierno M. Centella An optimal enforcement system against cartels in !HE CHALLENGE OF AN OPTIMAL ENFORCEMENT SYSTEM, (Ioannis Kokkoris, Ioannis Lianos, eds 2009).

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accompanied by substantial operating losses and where the information available does not indicate that any lasting improvement can be expected in this situation in the medium term.”5 The German legislation, the Treaty of Rome and the Treaty of Paris had adopted different attitudes to the existence of crises in the economy. The German statute was more lenient towards crisis cartels by allowing structural crisis agreements.6 The Treaty of Paris, although not exempting crisis cartels, allows for the intervention by Community institutions to ensure minimum prices.7 In contrast the Treaty of Rome adopts a stricter approach and does not contain any exemptions for crisis cartels. This paper will address crisis cartels in detail and will provide arguments why crisis cartels should be permitted, under certain circumstances, in order to sustain the viability of firms as well as of markets. Crisis Cartels Pursuant to the Treaty establishing the European Economic Community (Treaty of Rome) Looking at the academic literature of the earlier decades, it is noteworthy to examine the approach that was believed to be taken by the EU towards anticompetitive agreements and in general in the competition enforcement. Grendell8 argued that the EU appears to different objectives compared to the US. Under the US legislation free competition is paramount, although the primary underlying goal of EEC antitrust legislation according to Grendell is “rationalisation”. By the latter term Grendell implies the promotion of economic development and efficiency through the more rational allocation of community resources. Early European Commission (“Commission”) Reports on Competition Policy strongly suggested that European competition policy was aimed at the promotion of consumer welfare. The European Commission, 1st Competition Policy Report in 1971, stated that:

“competition policy endeavours to maintain or create effective conditions of competition by means of rules applying to enterprises in both private and public sectors. Such a policy encourages the best possible use of productive resources for the greatest possible benefit of the economy as a whole and for the benefit, in particular of the consumer.”9

The Commission and the Court of Justice10 in their fundamental decisions reached in the 1970s, interpreted the objective of protecting competition as referring to the protection of the economic freedom of market actors. These important decisions were not based on economics or consumer welfare. In these early cases the Commission and Community courts were not focused on 5 12th European Commission Competition Policy Report points 38-39. 6 See further: IOANNIS KOKKORIS, RODRIGO OLIVARES-CAMINAL, ANTITRUST POLICY IN THE WAKE OF FINANCIAL CRISES”, (2010). 7 Rene Joliet, Cartelisation, Dirigism and Crisis in the European Community 3 The World Economy 403, 405 (1981). 8 Grendell, supra note 1. 9 At p. 12 10 Pursuant to the Lisbon Treaty (Treaty for the Functioning of the European Union, “TFEU”), the European Court of Justice (“ECJ”) is renamed as Court of Justice.

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consumer welfare, but on the protection of the economic freedom of the market players as well as on preventing firms from using their economic power to undermine competitive structures.11 In Continental Can, the Court ruled:

… abuse may therefore occur if an undertaking in a dominant position strengthens such position in such a way that the degree of dominance reached substantially fetters competition, i.e. that only undertakings remain in the market whose behaviour depends on the dominant one … it can … be regarded as an abuse if an undertaking holds a position so dominant that the objectives of the Treaty are circumvented by an alteration to the supply structure which seriously endangers the consumer’s freedom of action in the market such a case necessarily exists if practically all competition is eliminated.12

As Grendell argues that the rule of reason adopted in the EU included a look beyond the economic impact of the arrangement to see if it was justified. Unlike the rule of reason approach that was taken in the US, which balances the benefits and burdens on competition, Grendell argues that an agreement between petroleum companies to drill jointly for oil and sell such oil at a fixed price would be likely to be allowed on the basis of efficient resource allocation by the EU but under the US per se approach it would be likely be prohibited.13 As regard enforcement, the Commission can request for the anticompetitive agreement to cease the arrangement, and impose fines. If the undertaking involved is located within a Member State, the Commission’s remedies are applicable within Member States under the civil enforcement procedures of the States. The thorny issue of crisis cartels in Europe was so eminent in the 60s and 70s. Two approaches had been suggested to legalise crisis cartels. One referred to a regulation enabling crisis cartels to be authorised. In the late 70s the synthetic fibres sector was under strong pressure from the decreasing demand and the excess capacity. The Commissioner for Industrial Affairs, Davignon, suggested to the producers to cooperate in order to sustain the crisis. The US companies would not be able to participate due to the sanctions of Section 1 of Sherman Act. The agreement could not exempted pursuant to Article 101(3). Commissioner Davignon and Commissioner for Competition Vouel produced a proposal on a draft regulation pursuant to Article 103 specifically covering crisis cartels. According to Article 103 TFEU

11 Lisa Gormsen, Article 102 EC: Where are we coming from and where are we going to?, 2 THE COMPETITION LAW REVIEW 2, 19 (2006). 12 Case 6/72 Europemballage Corp and Continental Can Co. Inc v. Commission (Continental Can), [1973] ECR I-215, § 26. 13 Grendell, supra note 1 at 75.

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1. The appropriate regulations or directives to give effect to the principles set out in Articles 101 and 102 shall be laid down by the Council, acting by a qualified majority on a proposal from the Commission and after consulting the European Parliament.

2. The regulations or directives referred to in paragraph 1 shall be designed in particular:

a. to ensure compliance with the prohibitions laid down in Article 101(1) and in Article 102 by making provision for fines and periodic penalty payments;

b. to lay down detailed rules for the application of Article 101(3), taking into account the need to ensure effective supervision on the one hand, and to simplify administration to the greatest possible extent on the other;

c. to define, if need be, in the various branches of the economy, the scope of the provisions of Articles 101 and 102;

d. to define the respective functions of the Commission and of the Court of Justice in applying the provisions laid down in this paragraph

e. to determine the relationship between national laws and the provisions contained in this Section or adopted pursuant to this Article.

Under this proposed Regulation, Article 101(1) would be declared inapplicable to agreements between firms aiming at balancing excess capacity with a lasting decline in demand. This reduction should be achieved with means that are indespensible to the achievement of the coordinated reduction. The Council of Ministers would decide, upon proposal by the Commission, whether a coordinated reduction in the capacity of a sector was necessary. The proposed Regulation was met with significant opposition from some members if the Commission. Opponents were arguing that such a Regulation would open the floodgates of cartelisation. In addition, there were concerns regarding the success of these crisis cartels as well as the implications of such crisis cartels for downstream industries.14 The essential question was whether practices that were deemed illegal based on Article 101 would be considered legal under Article 103. Articles 101(3) and 103 did not provide an adequate statutory basis for such a general regulation.15 According to Joliet, the Council of Ministers cannot, based on Article 103(c), rule out the applicability of Article 101 except within the limits imposed by the features of the sector.16 The sectors included in the proposed Regulation were not determined in advance and thus the Regulation would apply to all possible sectors. Furthermore, the proposed Regulation would aim at modifying the exemption criteria of Article 101(3) rather than rendering Article 101(1) inapplicable to a particular sector. However, the Council of Ministers cannot provide more flexible exemption conditions compared to the ones contained in Article 101(3). Finally, the proposed Regulation could not be adopted pursuant to Article 231 as that Article enables the Council of Ministers to add new rules to the Treaty (e.g. for mergers) rather than reduce the applicability of existing rules (e.g. Article 101).

14 Joliet, supra note 7. 15 After the Lisbon Treaty, Article 85 is renumbered as Article 101 and Article 87 is renumbered as Article 107. 16 Joliet, supra note 7, at 419.

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For such an amendment to the applicability of the competition rules, there needs to be an amendment to the Treaty. It should also be noted that granting to the Commission power to suspend the enforcement of competition legislation is frought with political ramifications. In 1978 the Commission announced that it would not propose to the Council of Ministers a draft regulation which would allow it to suspend application of Article 101(1)17 to crisis cartels for a period of one to five years.18 The second approach relied on crisis cartels being exempted pursuant to Article 101(3). Arguably a crisis cartel cannot satisfy the Article 101(3) criteria as such cartels may involve restriction in output, price maintenance as well as market division. A crisis cartel may not satisfy the criterion of consumer benefit envisaged in Article 101(3). A crisis cartel will require the coordinated reduction of capacity allowing undertakings to possibly eliminate competition. As regards crisis cartels the Commission has in the 7th European Commission Competition Policy Report announced that measures to open competition were necessary in circumstances of adverse social and regional circumstances. According to Sharpe19 these measures were general in application and were aimed at suspending the application of Article 85 under certain circumstances. In the 8th European Commission Competition Policy Report the Commission argued that it is inclined to accept that under certain conditions agreements between firms aimed at reducing excess capacity may be authorised under Article 85(3) but only where the firms have not simultaneously whether by agreement or concerted practice fixed either prices or production or delivery quotas.20 The Commission has later indicated that agreements to reduce structural overcapacity which involve all or a majority of the undertakings in an entire sector, can be accepted if they are aimed solely at a coordinated reduction of overcapacity and do not restrict the commercial freedom of the parties involved. Agreements involving a smaller number of firms can also be accepted if they aim at allowing reciprocal specialisation in order to achieve closure of excess capacity. However, the Commission argues that such agreements must not incorporate any price fixing, quota fixing or market allocation.21 17 Articles 101 and 102 TFEU (ex 81 and 82 of the EC Treaty. They were 85 and 86 prior to the Treaty of Amsterdam which came into force on the 1st of May 1999. Article 12 of the Treaty of Amsterdam provided for the renumbering of the EC Treaty Articles). 18 Commission statement July 26 1978. See further: Barry Hawk, UNITED STATES, COMMON MARKET AND INTERNATIONAL ANTITRUST: A COMPARATIVE GUIDE, 143-150 (1985). 19 Thomas Sharpe, The Commission's Proposals on Crisis Cartels 17 C.M.L.REV. 75 (1980). 20 8th European Commission Competition Policy Report, paragraph 13. http://ec.europa.eu/competition/publications/annual_report/index.html 21 13th European Commission Competition Policy Report, paragraph 56. http://ec.europa.eu/competition/publications/annual_report/index.html

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The Commission has stated that structural overcapacity occurs when over a long period, undertakings are experiencing a reduction in their capacity utilisation, a drop in output as well as operating loses, and there is no sign of possible recovery in the medium-term.22 In the 23rd European Commission Competition Policy Report, the Commission argued that23 it may condone such agreements which will aim at reducing the overcapacity as long as the agreement applies to a sector as a whole. Such agreements will not involve price fixing or quota agreement and will not impair the free decision making of firms. In a case involving a restructuring plan to tackle the excess capacity in bricks in the Netherlands, an agreement notified to the Commission for exemption was initially not approved as it contained several restrictions of competition including quota agreement. The agreement was exempted after the parties excluded any fixing of prices or output and since the agreement was in line with the criteria outlined in the 23rd European Commission Competition Policy Report.24 In the Polypropylene case,25 the Commission discovered evidence in 19103 that the major polypropylene producers supplying the EEC market had been involved, since 1977, in a cartel where the firms were fixing prices, setting sales targets and were allocating markets. After a meeting between producers of polypropelene and the Commission a report on the problems facing the industry concluded that a “crisis cartel” was not warranted and that unilateral or bilateral agreements to reduce excessive capacity would mitigate the adverse conditions of the industry. The Commission has outlined its view on crisis cartels and had argued that price and quota fixing is usually unacceptable.26 The Commission will authorize a restructuring plan involving sectoral agreements if it is believes that the Article 101(3) criteria are met. These criteria will be met if the reduction in the capacity of the sector will in the long term lead to more efficent capacity utilisation enhancing the competitiveness of the sector and thus benefiting consumers. Thus, a detailed plan of plant

22 12th European Commission Competition Policy Report, paragraph 38. http://ec.europa.eu/competition/publications/annual_report/index.html 23 Point 84. 24 23rd European Commission Competition Policy Report, point 89, http://ec.europa.eu/competition/publications/annual_report/index.html. IV/34.456 - Stichting Baksteen OJ L 131/15. 25 Re Polypropylene O.J. 1986 L230. 26 See further the following Annual European Commission Competition Policy Reports (http://ec.europa.eu/competition/publications/annual_report/index.html): 2nd, points 29-31; 8th, point 42; 11th, points 45-48; 12th, points 38-41; 13th, points 56-61; 14th, points 80-85. See also the following cases: Re BPCL/ICI O.J. 1984 L212/1, [1985] 2 C.M.L.R. 330, noted (1986) 11 E.L.Rev. 67; Re Synthetic Fibres O.J. 1984 L207/17, [1985] 1 C.M.L.R. 787, noted (1986) 11 E.L.Rev. 64; Re ENI/Montedison O.J. 1987 L5/13 Re Neickem/ICI O.J.; Re Akzo/Shell (Rovin) Bull. EC 5-1984, 14th European Commission Competition Policy Report, point 85, noted (1985) 10 E.L.Rev. 229; Re Montedison/Hercules (Himont), 1988 L50/18. See also the preliminary Notices in Re Zinc Shutdown Agreement O.J. 1983 C164/3, [1983] 2 C.M.L.R. 473 Bull. EC-1987 point 2.1.71., Re PRB/Shell O.J. 1984 C189/2. See further: Case Comment on Re Polypropylene E.L. REV. 1988, 13(3), 205-209.

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closures as well as avoidance of creation of new capactiy are also necessary factors in the agreement being accepted by the Commission. Furthermore, the reduction in capacity can in the long-run increase profitability, restore competitiveness as well as mitigate the adverse impact on competitiveness.27 The agreement must contain a detailed and binding programme of closures for each production centre in order to ensure reduction of existing capacity and to prevent the creation of new capacity. The incorporated restrictions of competition must be indispensable in order to achieve the restructuring of the sector. The agrement must be of certain duration that will allow for the technical implmentation of the capacity reduction.28 Consumers must enjoy a share of the benefits resulting from the agreement, since in the longer run they will benefit from a competitive environment while in the short-run they will have not been deprived of choices of products. Thus, in a nutchell, the conditions that need to be fulfilled before an exemption is granted (i.e. the Article 101(3) criteria are satisfied) include improvement of production and distribution, indispensability of the restrictions, not complete elimination of competition, a fair share of the benefits to consumers, and finally the benefits must outweigh the disadvantages. The agreement aiming at the coordinated reduction in capacity will not be likely to restrict competition since the parties to the agreement will independently decide their strategies on elements other than the coordinated reduction in capacity. There may be other firms in the market not parties to the agreement, which may be able to provide competitive constraints. In addition, the agreement must constitute indespensible means of achieving the necessary capacity reduction. The limited duration of the agreement, the existence of firms in the industry which are not party to the agreement as well as the fact that the coordinated reduction in capacity is only element in the business strategy of firms constitute reassurances that competition will not be eliminated. The Commission has faced difficulties in exempting crisis cartels pursuant to the Article 101(3) criteria. Thus, the Commission has sometimes relied on the maintenance of employment in order to exempt such agreements. The Court of Justice in the Metro case29 argued that a medium term supply agreement was deemed to satisfy the first condition of Article 101(3) since it was considered likely to help maintain employment in situations of economic crisis. Similarly the Court of Justice in Walt Wilhelm held that:30 27 The Commission seems to place importance on non-competition factors such as employment. The Commission clearly states that reorganization operations should be such as to secure the employment situation within the sector concerned. 12th European Commission Competition Policy Report, paragraph 39. http://ec.europa.eu/competition/publications/annual_report/index.html 28 As the Commission states in the 12th European Commission Competition Policy Report, (paragraph 39) exchange of information is acceptable provided it does not induce coordination either on sale conditions or on the remaining capacity. http://ec.europa.eu/competition/publications/annual_report/index.html 29 Case 27/76, [1977] E.C.R. 1875. 30 Case 14/68 Walt Wilhelm v. Bundeskartellamt [1969] E.C.R. 1 Motif, 11. As Hornsby argues, this passage is increasingly used to provide a legal base for the Commission's use of the

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while the Treaty's primary object is to eliminate by this means (proceedings under Article 85(1)) the obstacles to the free movement of goods within the Common Market and to confirm and safeguard the unity of that market, it also commits the Community authorities to carry out certain positive, though indirect, action with a view to promoting a harmonious development of economic activities within the whole community in accordance with Article 2 of the Treaty.31

As the Commission interestingly argues a factor that will be taken into account is the impact of the capacity coordination on the mitigation of the adverse impact of the crisis on employment.32 The Commission explicitly states that reorganisation operations should also be used to stabilize and secure the employment situation in the sector concerned.33 The Commission uses the positive impact of a coordination of business conduct of competitors on employment as a factor favouring exemption of the agreement. However, Hornsby34 argues that the Metro judgment may not justify an exemption pursuant to Article 101(3) for industry-wide crisis cartels. The maintenance of employment is mentioned neither in the competition rules applying to undertakings nor in Article 2 of the Treaty of Rome. There have been a number of cases under the Treaty of Rome involving crisis cartels. As the following analysis will illustrate, in the majority of the cases the undertakings requested an exemption pursuant to Article 101(3).

Crisis Cartel Caselaw pursuant to the Treaty of Rome There can be multiple types of agreement that companies may use to overcome capacity problems. Crisis cartels through bilateral or multilateral agreements can satisfy the conditions of Article 101(3). Bilateral agreements are the most likely form of rationalisation agreement that competition rules to achieve other policy objectives. See further: Sean Hornsby Competition policy in the 80's: more policy less competition? 12 E.L. REV. 2, 79-101, (1987). 31 Hornsby (Id.) adds that decisions explicitly justifying crisis cartels by reference to distortions caused by state aids could be legally justified in appropriate cases by reference to the preliminary provisions of the Treaty as indicated by the European Court in Walt Wilhelm. Not only has the Commission and the European Court used such a legal technique before (see Case 6/72 Europemballage and Continental Can v. Commission [1973] E.C.R. 215. Cases 6 and 7/73 Commercial Solvents v. Commission [1974] E.C.R. 223 motif 25), but also emphasis on the more economic criteria set out in the preliminary Articles would be more consistent with Article 85(3) than references to employment considerations which are not referred to at all in the rules applying to undertakings. See further: Hornsby supra note 30, at 93. 32 23rd European Commission Competition Policy Report, point 85. http://ec.europa.eu/competition/publications/annual_report/index.html 33 23rd European Commission Competition Policy Report, point 88. http://ec.europa.eu/competition/publications/annual_report/index.html 34 Hornsby supra note 30, at 93.

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has satisfied the conditions of Article 101(3), provided they can lead to a reduction in the excess capacity, rationalise production and not lead to elmination of competition. The reason of the higher rate of success of bilateral agreements is that achieving the coordinated reduction in capacity among two firms is easier than among a larger number of firms. However, as Ritter and Braun, argue35 the number of independent competitors gets reduced. In addition, restrictions on imports imposed by intergovernmental voluntary restraint agreements may also lead to a reduction in the excess capacity of a sector.36 Cementregeling voor Nederland The Commission has adopted a stricter approach under the Treaty of Rome compared to the approach under the Treaty of Paris. The Cementregeling voor Nederland37 case concerned an agreement sharing the Netherlands market. A varying quantity of the product was reserved by the members of the agreement for sale, in free competition. In the course of the proceedings those concerned had sealed off until 30 September 1967 access to the Netherlands market for outside producers or dealers, by establishing collective exclusive dealing relations with the organized Netherlands cement dealers.38 The Commission had forbidden these restraints as part of other proceedings39 and in 1971 the Commission had forbidden the dealers' price control arrangements. Although they had discontinued common price fixing and standardized selling terms, the producers involved had applied for exemption for a limited-duration modified quota system, which they wished to maintain for a transitional period, the "CRN-1971". The Commission did not agree that the Netherlands market should remain closed to free imports of cement from other Member States. The Commission argued that the exemption of Article 101(3) could not be granted to an arrangement as restrictive as a quota agreement, as the quota agreement was not indispensable for the achievement of the objectives pursued by the undertakings concerned. Quota agreements are unlikely to solve the capacity surplus problem. The Commission also refused exemption from the ban of Article 101(1) for the Belgian cement industry agreement: "La Cimenterie belge--CIMBEL SA".40 Polyester Fibres In another case, the Commission argued that the notified agreement on cut polyester fibres was not satisfying the criteria for exemption under Article 101(3). The parties argued that the agreement was designed to ensure coordination of investment and rationalization of production 35 Lennart Ritter, David Braun, EUROPEAN COMPETITION LAW 184 (2004). 36 For further info on such agreements see: Ritter, Braun supra note 35. 37 Commission Decision of 18 December 1972, OJ L 303, 31.12.1972, p. 7. 38 2nd European Commission Competition Policy Report. http://ec.europa.eu/competition/publications/annual_report/index.html 39 1st European Commission Competition Policy Report sec. 9. http://ec.europa.eu/competition/publications/annual_report/index.html 40 Commission Decision of 22 December 1972, OJ L 303, 31 December 1972, p. 24.

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with a view to eliminating or to preventing excess capacity in this industry. Although the cut polyester fibre industry exhibited heavy surplus capacity the Commission argued that41 even in periods of crisis as well as of adverse structural factors the question as to whether these difficulties, which could well derive not only from factors competition legislation must be adhered to. In this case the Commission argued that the agreement notified failed to meet the criteria included in Article 101(3), since it covered a wider area and extended to the participants' production and marketing policies.42 Man-Made Fibres The leading producers of man-made fibres notified, in 1978,43 an agreement for examption to the Commission. The agreement provided for a reducton in the capacity according to a structured plan. The Commission argued that structural crisis cartels involving an agreement to cut capacity will be exempted pursuant to Article 101(3), provided that the agreement does not involve agreements on production, sales or prices.44 The agreement was not exempted and after the parties’ amendments concering the elimination of all clauses related to the commercial conduct of the undetakings, the agreement was exempted. Zinc Producers The “shutdown” agreement45 notified for exemption by six major producers exempted the agreement due to the heavy financial losses that the European zinc industry was facing. The agreement was of fixed duration which played a singificant role in it being exempted and the companies would voluntarily and unilaterally close capacity and notify a trustee of their closure plans. The Commission argued that if the viability of the sector improved, the agreement could not be exempted. The agreement involved voluntary closure of plants in order to reduce capacity.46 Synthetic Fibres

41 2nd European Commission Competition Policy Report. http://ec.europa.eu/competition/publications/annual_report/index.html 42 2nd European Commission Competition Policy Report. The agreement was cancelled and the notification withdrawn. http://ec.europa.eu/competition/publications/annual_report/index.html 43 8th European Commission Competition Policy Report, paragraph 42. http://ec.europa.eu/competition/publications/annual_report/index.html 44 10th European Commission Competition Policy Report, paragraph 46. http://ec.europa.eu/competition/publications/annual_report/index.html 45 OJ C164, 23.1983. 46 13th European Commission Competition Policy Report, paragraph 58. http://ec.europa.eu/competition/publications/annual_report/index.html

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As mentioned above, following the suggestion of the Commissioner for Industrial Affairs Davignon, in 1977 eleven major manufacturers of synthetic fibres agreed to reduce capacity and guarantee increased sales by Italian members. The Commission was initially favourable to granting an exemption. However, it concluded that the agreement is anticompetitive as it involved market sharing, production quotas as well as price provisions. It is difficult to envisage how the coordinated reduction in capacity, which is the aim of a crisis cartel, can be achieved without any agreement on price or quota, since price competition between the parties to the agreement but also from external sources can affect the coordinated reduction in capacity. In 1984 the Commission accepted that joint measures aiming at the reduction of structural overcapacity or other restructuring measures in an industry which is in a state of crisis, may be accepted provided that effective competition is not eliminated, consumers have alternative choices of suppliers and does not involve conducts such as fixing prices or quotas.47 In 1984 the Commission exempted an agreement of reduction in the production of synthetic textile.48 The ten largest European manufacturers reduced their production capacity by 18%. In order to exempt the agreement, the parties undertook to supply a trustee with information on the planned capacity to be reduced as well as of the plants. In addition, compensation would be paid to the other participants to the agreement in case some parties did not fulfill the capacity reduction. The parties should consult each other in the case of important changes in the market and should not fail to implement the planned reductions in capacity. The Commission requested the deletion of some clauses of the original agreement. These clauses were related to a ban on investment leading to capacity increases without consent of all parties as well as to a requirement not to operate a plant at more than 95% capacity. The Commission did not accept the latter clause as it would have allowed the parties to monitor output and deliveries. The Commission argued that the agreement fulfilled the Article 101(3) criteria as it contributes to the improvement of production and importantly, allowed the restructuring process to proceed in a socially accepte way by making suitable arrangements for the retaining and redeployment of workers made redundant.49 Thus, the Commission in exempting the agreement took into account employment and social factors into account in exempting the agreement. Futhermore, the Commission argued that consumers would receive a fair share of the benefits as the restructuring will result in an industry able to offer better products at, according to the Commission, competitive terms. In order the Commission to satisfy itself that competition will continue to exist in spite of this agreement reducing capacity, it took into account that the agreement is of limited duration, there are substitute products from other competitors outside the agreement or the involved countries. 47 14th European Commission Competition Policy Report. See also: 12th European Commission Competition Policy Report points 38-41, 13th European Commission Competition Policy Report, points 56-61. http://ec.europa.eu/competition/publications/annual_report/index.html 48 OJ L207/17, 2.8.1984. 49 14th European Commission Competition Policy Report. http://ec.europa.eu/competition/publications/annual_report/index.html

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British Petroleum Chemicals/Imerial Chemical Industries Bilateral agreements have also been used to mitigate problems of structural overcapacity. Such agreements have been a particular feature of the petro-chemical sector in recent years. The effect of these arrangements is to enable petrochemical companies to specialise in products where they have a comparative advantage. Such agreements will have adverse effects on competition. Such a bilateral agreement was the agreement to reduce capacity was exempted is BPCL/ICI50 where two British manufacturers in the petrochemical sector. BPCL was involved in low density polyethelene (LDPE) and ICI in polyvinylchloride. The restructuring involved specialisation of production in the UK leading to reductions in output. The agreement concerned the reciprocal sale of ICI’s production plant and goodwill as well as the licencing of technology to BPCL giving the latter sole control. Both parties proceeded to the closure of certain plants (ICI of LDPE plants and BPCL of PVC plants in the UK), closures not provided for in the agreement but constituting a consequence of the agreement. The parties closed down two remaining plants in the markets where they considered that they suffered a comparative disadvantage. Even though the agreement concerned acquisition of sole control through a reciprocal sale, Article 101 was applied, as the agreement would restrict competition.51 The Commission argued that52

(34) In view of the industry-wide structural over-capacity for the products in question and the fact that the agreements and associated plant closures reduced this surplus capacity and improved plant loading without eliminating effective competition, the advantages resulting from these agreements and associated plant closures outweigh harmful effects they may entail. (35)… Given that the over-capacity in the industry is of a structural nature, market forces would have been too slow at bringing about the necessary radical changes. These agreements by their immediate closure of plants, accelerate the tendency to re-establish the equilibrium in supply and demand.

The agreement was exempted pursuant to Article 101(3). The sector was characterised by excess capacity and as a result of the agreement the two firms would be able to reduce the costs of production. Thus, the agreement was expected to contribute to the efficiency of production. Similar to the previous cases where the Commission has granted an exemption, the Commission added that even after the elimination of one producer consumers would still have choices of supplies.

50 OJ L212, 8.8.1984. 51 14th European Commission Competition Policy Report. http://ec.europa.eu/competition/publications/annual_report/index.html 52 OJ L212, 8.8.1984, at 34 and 35.

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ENI/Montedison53 Similar to the BPCL/ICI case the Commission in ENI/Montedison assessing a rationalisation agreement argued that pursuant to Article 101(3), the provisions of Article 101(1) were declared inapplicable to the agreements between Ente Nazionale Idrocarburi and Montedison SpA involving a reciprocal transfer of certain lines of business in the petrochemical sector (base chemicals, thermoplastics and certain rubbers) and the contracts and behaviour associated with and dependent on these aforesaid agreements implying both plant closure and a de facto specialization by each party. The agreements allowed the selection of the businesses in which ENI and Montedison would each concentrate. The selection was based on a study of their relative strengths, in terms of technology, marketing expertise, production facilities, and objectives, in the main thermoplastics products. The exemption was justified because the agreements were an essential first step in the rationalisation of ENI's and Montedison's petrochemical business which formed part of an industry suffering serious structural overcapacity in the whole Community. As a result of the agreements, the parties were able to restructure their businesses more quickly and fundamentally than would have been possible individually. The agreements thus reduced the excess capacity in an industry suffering from structural overcapacity. According to the Commission this benefit would outweigh any restrictions of competition. Similarly in Enichem/ICI 54 the Commission argued that the agreements between Enichem and ICI continued the strategies adopted by the two companies to rationalize their respective VCM/PVC businesses. This process started in 19102 and allowed Enichem and ICI to concentrate their efforts on the sectors where their position as manufacturers was strongest. The aim of Enichem and ICI in setting up EVC is to complete the restructuring of their VCM/PVC business in order to regain competitiveness and progressively reduce losses. Thus, pursuant to Article 101(3), the Commission exempted for the period 26 March 1986 to 25 March 1991 the agreement dealing with the setting up of a jointly-owned company, European Vinyls Corporation (EVC), to operate their VCM and PVC sectors, and the agreement concerning the distribution of PVC primary and secondary plasticizers. Shell/AKZO55 This jont venture aiming at improving the utilisation of capacity and thus aiding the restructuring the petrochemical sector was exempted by the Commission as it would sustain a choice of supply for consumers. Pursuant to the joint venture agreement, the two parties would put the PVC and VCM plants at the disposal of the joint venture.56 53 IV/31.055 - ENI/Montedison [1987] OJ L005/13. 54 IV/31.846 - Enichem/ICI [1988] OJ L 050 /18. 55 OJ C295, 2.11.1983. 56 14th European Commission Competition Policy Report. http://ec.europa.eu/competition/publications/annual_report/index.html

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Stichting Baksteen57 In Stichting Baksteen the Commission assessed a crisis cartel in the brick industry in the Netherlands. The industry was in recession due to a combination of larger plants and a fall in demand. The undertakings were not able to balance supply and demand due to the inelasticity of price. Such balance could only be achieved by an industry-wide reduction in capacity. The Commission did not accept the original plan due to the inclusion of quota agreements. After amendments to the original agreement, the latter was exempted. The application of Article 101(3) could vary depending on the economic conditions surrounding agreements that incorporate restructuring measures. The Commission argued that58

(29) Article 85 (3) provides that an agreement must allow consumers a fair share of the resulting benefit. Consumers in the present case should benefit from the improvement in production because in the long term they will be dealing with a healthy industry offering competitive supplies and, in the short term, they will go on enjoying the advantages of continuing competition between the parties. Thanks to the agreement they can also be sure that structural adjustment keeps competitive firms or capacities on the market whilst eliminating outmoded or obsolescent capacity which might otherwise have affected healthy capacity through loss compensation within a group. (30) There are a sufficient number of producers remaining, whether or not parties to the agreement, to give consumers a choice of supplier and security of supply, while ruling out the risk of over-concentrated supply.

The Commissioner for Competition, Mr van Miert, in announcing the Commission's decision in Stichting Baksteen, argued that cartels do not improve structures or production capacities. On the other hand, the Commission argues that the wider “economic and legal context”, within which firms’ conduct must be assessed is the one where markets are expanding as liberalisation occurs.59 Italian cast glass 60 In Italian cast glass 61 the Commission argued that the agreements concluded between Fabbrica Pisana SpA, Società Italiana Vetro SpA (SIV), Fabbrica Lastre di Vetro Sciarra SpA and Fides-Unione Fiduciara SpA infringed Article 101(1) as regards their clauses concerning the quantitative sharing of the various kinds of cast glass, the exchange of commercial information on quantities sold and prices of each type of product, as well as the measures for implementing

57 1995, 4 CMLR 646. 58 1995, 4 CMLR 646, at 29 and 30. 59 1993 European Commission Competition Policy Report, point 79. http://ec.europa.eu/competition/publications/annual_report/index.html 60 IV/29.869 - Italian cast glass [1980] OJ L 3103/19. 61 IV/29.869 - Italian cast glass [1980] OJ L 3103/19.

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the obligations concerning the forwarding of the abovementioned information and the supervision of compliance with the quantitative sharing between the undertakings. Referring to the sectoral crisis situation which the parties put forward as a justification of the conclusion of their agreements cannot be considered as being such for the purposes of Article 101(3) since the provision makes no reference to a crisis situation and, the agreements contained no decisions to reduce the productive capacities of the undertakings. The Commission adds that such reduction might have been appropriate to a structural crisis situation. It added that the parties decided unilaterally to set quantitative shares for sales of cast glass on the Italian market, to the benefit exclusively of the manufacturers, without any advantage for consumers. Thus, the Commission could not allow, in the guise of a crisis cartel, restrictions of competition which are not indispensable. Welded Steel Mesh,62 Cockerill-Sambre v. Commission63 and Trefilunion64 The product under analyses is welded steel mesh which is a prefabricated reinforcement product made basically from smooth or ribbed cold-drawn reinforcing steel wires joined together by right-angle spot welding to form a network. It is pretty much used in almost all areas of reinforced concrete construction. According to the Commission of the European Communities as from 1980 several companies, including Cockerill Sambre, formerly Steelinter SA, a company incorporated under Belgian law, established in Brussels, have breached the Article 85 (1) of the EEC Treaty by articulating a series of deals and/or concerted practices concerning establishing quotas, prices and sharing market of welded steel mesh. In addition, the Commission also stated that although the major targets were French, German or Benelux, the plot also affect others state members’ undertakings, once they also took part in the scheme at issue. The Commission alleged that a cartel existed in the welded steel mesh sector involving price and quota agreements were being operated during the early 1980s in France, Italy, the Benelux and Germany. It must be said, nevertheless, that on 31 May 1983 the Bundeskartellamt (Federal Cartel Office) granted authorisation for the establishment of a structural crisis cartel of German producers of welded steel mesh which, after being renewed once, expired in 1988. The cartel agreement included almost all German producers. The authorisation terminated in 1988, and permitted organised capacity cuts, quotas and price fixing. This authorization as to price was granted only for the first two years. For the German crisis cartel to be effective it had to include other EC producers which were able to import into Germany. The formally authorised agreement included, however, only German 62 Welded Steel Mesh [1989] OJ L260/1. 63 General Court, March 11th, 1999, Cockerill-Sambre v. Commission, Case T-138/94, [1999] ECR II-333. 64 Judgment of the Court of First Instance (First Chamber) of 6 April 1995. Tréfilunion SA v Commission of the European Communities. Competition - Infringement of Article 85 of the EEC Treaty. Case T-148/89.

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producers. The Commission in the decision argued that:65

The cartel arrangement, and in particular subsections 5 (2) and 7 (1) thereof, not only restricted competition between the cartel members in the Federal Republic of Germany, but also distorted competition in respect of intra-Community trade because it led to artificial changes in the conditions for deliveries of German producers to other European markets and for deliveries of foreign producers to the German market (127 to 130). This being so, the cartel arrangement was liable to affect trade between Member States. These provisions had, moreover, as their object, or at least as their effect, the use of the structural crisis cartel as an instrument for reaching bilateral arrangements between German producers on the one hand and producers from other Member States on the other. The representatives of the German producers, in particular BStG, could now appear as representatives of the ´German cartel association' in contacts and negotiations and could thereby rely on the discipline of most members of the German structural crisis cartel (see, for example, 130). In this way the creation of general agreements limiting interpenetration was facilitated, as was likewise stressed by leading representatives of the German producers (see 92 and 130). These bilateral arrangements had the object of shutting off the German market or at least of preventing unregulated imports, so that the object of the cartel (reduction of capacity, setting of delivery quotas and price rises) should not be endangered. This was admitted by the cartel representative himself (see 131).

The Commission added that the use of the cartel to protect the German market against competition from other Member States by measures which are illegal under Community law cannot be validated by the existence of a cartel authorisation by the Federal Cartel Office. Certain French producers argued that they were in fact only operating a crisis cartel, in an attempt to mitigate the adverse impact of the alleged restructuring of the French welded steel mesh industry. This argument was rejected by the Commission because the cartel agreements contained no clauses on restructuring, capacity reduction, etc., which did exist in the formally approved German agreement. The Commission took into account that at the time when the cartel was operating the industry was going through a period of crisis linked to the general crisis in the European steel industry. The industry was suffering from a structural decline in demand as well as excess capacity. The Commission issued a notice concerning the competitive situation, which ended on fines to a number of French companies, including a fee of ECU 315 000 to Cockerill Sambre, for taking action and engaging in practices whose object or effect was to restrict or distort competition during the period of 1982 to 1984. 65 At 174 - 175.

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The applicant appealed to General Court66 claiming the following: annul the Decision and order the Commission to pay the costs; in the alternative: annul Article 3 of the Decision, in so far as it imposes on the applicant a fine of ECU 315 000 or, at least, reduce the fine to a token amount and, in any event, order the Commission to pay the costs; on the other hand, the Commission argued that the court should dismiss the application as unfounded; and order the applicant to pay the costs. In short, the court found, base on the facts and proves analysed, that the applicant took part in several meetings and got into agreements about price and quotas on French market, as well as the Commission presented proves about the fixing prices as to Benelux and Germany’s market, but no strong proves about the division of quotas on the same markets. Therefore, the applicant indeed conducted his business breaching the rules established by the article 101 (1). Concerning the imposed fee, the court decided that once the infringement did not cover the Germany and Benelux market, as stated by the commission, the court reduced the fee by one-fifth to ECU 252 000. Cockerill Sambre along with the other companies clearly agreed on the portion of market (French, Germany and Benelux markets) each of them would stick with and a common price for the French market of welded steel mesh. As a result, they without a doubt infringed Article 101 (1). In the appeal of the Trefilunion67 the applicant alleged that the Commission failed to take into account the economic context of the building and wire sector. Although the price increases were as a result of the market crisis and thus the need to ensure positive margins the Commission did take into account the condition of the market but found that this did not justify the meetings which were contrary to Article 101. The General Court differentiating the facts of this case from other cases involving crisis cartel agreements,68 interestingly argued that69

The Court also considers that the applicant cannot rely on the three Commission decisions ° in the Synthetic Fibre, Zinc and Flat Glass cases ° since they relate to circumstances fundamentally different from those of the present case. The Synthetic Fibre Decision concerns an agreement for the coordinated reduction of capacity, which had been notified and was granted an exemption under Article 85(3) of the Treaty. In the Zinc and Flat Glass Decisions, the Commission prohibited quota and price

66 The Court of First Instance (“CFI”) is renamed as General Court after the Lisbon Treaty. 67 Judgment of the Court of First Instance (First Chamber) of 6 April 1995. Tréfilunion SA v Commission of the European Communities. Competition - Infringement of Article 85 of the EEC Treaty. Case T-148/89. 68 IV/30.350 Zinc Producer Group, [1984] OJ L 220/27, IV/30.988 Agreements in and concerted practices in the flat-glass sector in the Benelux countries, [1984] OJ L 212/13. 69 Judgment of the Court of First Instance (First Chamber) of 6 April 1995. Tréfilunion SA v Commission of the European Communities. Competition - Infringement of Article 85 of the EEC Treaty. Case T-148/89, paragraph 117.

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agreements, although, as in the present case, the prevailing crisis was taken into account as a mitigating circumstance. The Court also considers that the applicant' s alleged restructuring plan cannot be regarded as an agreement for the coordinated reduction of overcapacity and that, in any event, it was open to the producers to notify their agreements to the Commission under Article 85(3) of the Treaty, which would have enabled the Commission, if appropriate, to rule as to whether they met the criteria laid down by that provision. Since the applicant did not avail itself of that opportunity, it cannot rely on the crisis to justify setting up secret agreements contrary to Article 85(1) of the Treaty.

The court found that some of the arguments put forth with regard to subject future export quotas was found on thin evidence and reversed this thus reducing the fine. Nevertheless the company was found in breach of other claims such as price fixing and still had to pay a fine. Brasserie Nationale SA v Commission of the European Communities The Court had to decide whether the creation of clienteles could be justified by the need to mitigate other factors affecting the market in issue. In 1985, five Luxembourg brewers, effected an agreement prohibiting distributors from selling any beer to the on-trade outlet which was guaranteed to one of their signatory brewers. The Commission had imposed fines on the brewers for the infringement of Art.101(1) on the basis that such agreement aimed at creating a clientele market in Luxembourg and preventing foreign brewers from participating in the market. Such arrangements in the view of the Commission would restrict competition in the Single Market. The brewers applied for an annulment of the Commission’s decision on the grounds that their arrangement had no appreciable effect on the trade within the member states and neither had they formed a clientele as described by the Commission. Their aim was to resolve the problem of annulment of exclusive agreements by the courts and the perfidy by operators in the outlets of Luxembourg. The General Court argued that70

As regards the three reasons which supposedly underpin the Agreement, referred to in paragraphs 47 to 51 above, it must be stated that, even if established, they are not such as to justify a restrictive arrangement with an anti-competitive object. It is unacceptable for undertakings to attempt to mitigate the effects of legal rules which they consider excessively unfavourable by entering into restrictive arrangements intended to offset those disadvantages on the pretext that they have created an imbalance detrimental to them (see, to that effect, Case T-29/92 SPO and Others v Commission [1995] ECR II-289, paragraph 256, in the context of the application of Article 81(3) EC, and Joined Cases C-238/99 P, C-244/99 P, C-245/99 P, C-247/99 P, C-250/99 P to C-252/99 P and C-254/99 P Limburgse Vinyl Maatschappij and Others v Commission [2002] ECR I-10375, paragraph 487, with regard to a crisis in the market). It must be

70 At 81.

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added that not only the applicants but all economic operators had to contend with the difficulties that the Agreement was allegedly intended to mitigate.

The Court held that the intention of an agreement was not sufficient to justify its exclusion from the ambit of Article 101 where the analysis of the agreement revealed that it had an object that would affect competition in the common market. The allegation that the agreement did not prevent foreign brewers from concluding contracts was irrelevant. The act of forming clienteles is not permitted pursuant Article 101 even where such acts are based on protective reasons which would help the clientele as a group. Restriction of competition, whether as an object or effect, within the market was the key issue for liability. Limburgse Vinyl Maatschappij NV (LVM) (C-238/99 P), et al. v Commission of the European Communities71 The undertakings to which this decision is addressed are all major petrochemical producers. 17 undertakings participated in the infringement during the period covered by this decision. PVC was one of the first bulk thermoplastic products to be developed. It is produced from vinyl chloride monomer (VCM), itself obtained from ethylene and chlorine feedstock. PVC has many important uses in heavy industry and construction as well as varied consumer applications. It can be converted into hard material or - compounded with plasticizers - made into flexible articles, including film. From about the end of 1980 the producers of PVC supplying the Community were parties to a complex collusive scheme, arrangements and measures which were worked out in the framework of a system of regular meetings. The arrangements involved:

- the setting of target prices, - the modalities of concerted price initiatives intended to raise price levels up to the agreed targets, - the division of the Western European markets according to annual volume targets, - the exchange of detailed information on their market activities in order to facilitate the coordination of their commercial behaviour.

71 Limburgse Vinyl Maatschappij NV (LVM) (C-238/99 P), DSM NV and DSM Kunststoffen BV (C-244/99 P), Montedison SpA (C-245/99 P), Elf Atochem SA (C-247/99 P), Degussa AG (C-250/99 P), Enichem SpA (C-251/99 P), Wacker-Chemie GmbH and Hoechst AG (C-252/99 P) and Imperial Chemical Industries plc (ICI) (C-254/99 P) v Commission of the European Communities.

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The basic purpose behind the institution of the system of regular meetings and the continuing collusion of the producers was to create a permanent mechanism for controlling the tonnage sold and achieving concerted price increases. The situation did not render an exemption necessary. The Commission took into consideration the crisis but also found that the competitive forces of the market should have been maintained. The Commission’s decision was appealed to the General Court which annulled Article 1 of Commission decision in so far as it holds that Société Artésienne de Vinyle participated in the infringement in question after the first half of 1981. The General Court also reduced the fines. The applicants appealed the General Court judgment that they had breached Article 101 by engaging in concerted practice. This case included several claims by the claimants but of note was the alleged claim that there was a crisis in the oil markets which had caused some companies to withdraw from the industry. The Court of Justice partially annulled the General Court judgment to the extent that it dismissed the new plea raised by Montedson SpA alleging infringement of its right of access to the Commission's file and failed to respond to the plea raised by Montedison SpA alleging a definitive transfer to the Community judicature of the power to impose penalties following the Commission's decision. Montedipe SpA v Commission72 This case involved 15 producers of polypropelene. The Commission found that the purpose of the meetings was to decide on price initiatives, to agree on sales volume targets, to compare market shares and to adopt accompanying measures such as the "account leadership" system. The purpose was thus to agree on the harmonization of the sales strategies of the participants in the meetings. In this case it must be noted that there was a constraint on the market faced by all producers i.e. price of raw materials. However, this did not involve all other factors of production such as taxes, wages and other expenses. The firm did not deny having attended the meetings but asserts it never considered itself bound by the results or proposals arrived at in the meetings and that it determined its own conduct on the market in complete independence. In order for there to be an agreement within the meaning of Article 101(1) it is sufficient that the undertakings in question should have expressed their joint intention to conduct themselves on the market in a specific way. Such is the case where there are common intentions between undertakings to achieve price and sales volume targets. 72 Judgment of the Court of First Instance (First Chamber) of 10 March 1992. Montedipe SpA v Commission, Case T- 14/89.

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The General Court argued that73

133 As regards the second argument put forward by the applicant, the Court considers that the economic context of the price initiatives cannot explain the manner in which the price instructions issued by the different producers correspond to each other and to the price targets set at the producers' meetings. The identical nature of the constraints faced by the various producers and the situation of market crisis cannot explain the fact that their price instructions, expressed in different national currencies, were identical, since the identical nature of those constraints was restricted to certain factors of production, such as the price of raw materials, and did not relate to general expenses, wage costs or tax rates, which meant that the profitability threshold for the various producers was significantly different.

In dismissing the appeal the court argued that participants in a cartel which seeks to raise prices from a level below cost to a level at or above cost cannot argue, in justification of their conduct, that the cartel sought to eliminate unfair competition. Raiffeisen Zentralbank Österreich In December 2006, the General Court in its judgment on the Commission's decision74 concerning the Austrian banking cartel,75 considered that the Commission had made a mistake in assessing the market share for the fine on the Österreichische Postsparkasse and reduced its fines by half to EUR3,795 million. This case concerned longstanding practices in Austria involving widespread meetings and information exchanges, which were continued after Austria's accession to the EEA and the European Union. The Commission criticised a number of banks for establishing a system of regular meetings (‘the committee meetings’ or ‘the committees’), to which it refers as the ‘Lombard network’, in which they covered every conceivable subject and regularly coordinated their conduct with respect to the essential factors of competition in the Austrian market in banking products and services. As regards specifically the crisis in the banking sector, the General Court argued that76

As regards, finally, the structural crisis in the banking sector in Austria referred to by Erste, it must be borne in mind that the Commission is not required to treat the poor financial health of the sector in question as a mitigating circumstance (Case T-16/99 Lögstör Rör v Commission [2002] ECR II-1633, paragraphs 319 and 320). The fact that in previous cases the Commission took account of the economic situation in the sector as a mitigating circumstance does not mean that it must necessarily continue to follow that

73 At para 133. 74 Case COMP/36.571/D-1: Austrian banks – ‘Lombard Club’, OJ 2004 L 56/1. 75 Raiffeisen Zentralbank Österreich v Commission (T-259/02, T-260/02, T-261/02, T-262/02, T-263/02, T-264/02 & T-271/02), unreported, December 14, 2006. 76 At 510.

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practice (ICI v Commission, cited in paragraph 196 above, paragraph 372). As a general rule, cartels come into being when a sector is experiencing difficulties.

Thus, the General Court confirms that the crisis in the banking sector was not mitigating factor that should be taken into account. As the above analysis of the caselaw illustrates, the Commission has on several occasions encountered crisis cartels. Over the development of crisis cartels, the Commission has developed the assessment criteria that it will apply to crisis cartels. In a nutchell, the conditions that need to be fulfilled before an exemption is granted (i.e. the Article 101(3) criteria are satisfied) include improvement of production and distribution, indispensability of the restrictions, not complete elimination of competition, a fair share of the benefits to consumers, and finally the benefits must outweigh the disadvantages. CONCLUDING REMARKS As the caselaw illustrates crisis cartels are likely to appear in industries where production facilities are durable and specialized and consumer demand falls due to adverse market conditions. Apart from the Commission the European courts, the US and German authorities and courts have been lenient to crisis cartels. Germany recently abolished the sections on rationalization cartels as well as structural crisis cartels. US authorities and courts have always been stricter than Germany and EU on such cartels assessing them pursuant to an approach of per se illegality.77 The EU and US authorities have also accepted the financial constraints argument in their assessment of cartels and have thus been lenient on the imposed fines. The existence of such an argument may incentivize parties in industries experiencing difficulties to conclude cartel agreements and then once caught, they can invoke this argument and achieve a reduced fine. Thus, the likely payoff of such a cartel agreement is higher than would be the case without invoking the financial constraints argument, and is likely to induce parties to engage in cartel agreements. In spite of the strict assessment of crisis cartels the US, as well as the EU, as the above analysis indicated, have been more lenient in reducing the fines on cartelists operating in industries experiencing crises.78 As the above analysis indicates, the Commission and the European Court will authorize a restructuring plan involving sectoral agreements if it is believes that the Article 101(3) criteria are met. These criteria will be met if the reduction in the capacity of the sector will in the long term lead to more efficent capacity utilisation enhancing the competitiveness of the sector and thus benefiting consumers. In addition, as the Commission interestingly argues a factor that will

77 See further: KOKKORIS, OLIVARES-CAMINAL, supra note 6. 78 For a complete analysis of the financial constraints defence see: KOKKORIS, OLIVARES-CAMINAL, supra note 6.

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be taken into account is the impact of the capacity coordination on the mitigation of the adverse impact of the crisis on employment.79 The Commission explicitly states that reorganisation operations should also be used to stabilize and secure the employment situation in the sector concerned.80 Again the Commission uses the positive impact of a coordination of business conduct of competitors on employment as a factor favouring exemption of the agreement. Thus, a detailed plan of plant closures as well as avoidance of creation of new capactiy are also necessary factors in the agreement being accepted by the Commission. In addition, the agreement must constitute indespensible means of achieving the necessary capacity reduction. The limited duration of the agreement, the existence of firms in the industry which are not party to the agreement as well as the fact that the coordinated reduction in capacity is only element in the business strategy of firms constitute reassurances that competition will not be eliminated. Competition authorities should be pragmatic in enforcing competition legislation in periods of crises. In adopting such a pragmatic approach, competition authorities should aim at minimizing adverse precedential issues as well as adverse effects on competition, effects that can sustain after the crisis is over. Such an approach should be used cautiously and by no means universally. Competition policy must be able to address sudden exogenous shocks and the wide ranging implications of such shocks to whole markets. " fine balance needs to be struck between competition policies and other policies ensuring economic and market stability. Such a balance is an imperative in order to ensure long term consumer welfare.

79 23rd Report on Competition Policy, point 85. http://ec.europa.eu/competition/publications/annual_report/inddex.html 80 23rd Report on Competition Policy, point 88. http://ec.europa.eu/competition/publications/annual_report/index.html

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ABSTRACT:

LESSONS FOR COMPETITION LAW FROM THE ECONOMIC CRISIS: THE PROSPECT FOR ANTITRUST RESPONSES TO THE “TOO-BIG-TO-FAIL” PHENOMENON

Jesse W. Markham, Jr. Marshall P. Madison Professor of Law University of San Francisco School of Law This article examines whether, and the extent to which, antitrust law could contribute to a broader regulatory effort to control the too-big-to-fail problem. The article begins by exploring the nature of the problem. Against this backdrop, it considers antitrust policy and rules to evaluate whether antitrust might play a meaningful role. The article concludes that antitrust law, if vigorously enforced with an emphasis on avoiding too-big-to-fail problems, can be a useful public policy tool to address the problem. However, it can come nowhere near solving it or preventing recurrences of recent systemic failures.

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TABLE OF CONTENTS

1. INTRODUCTION

A) THE PARADOX OF TOO-BIG-TO-FAIL AND ANTITRUST B) THE PUBLIC POLICY DILEMMA – DAMNED EITHER WAY

2. DEFINING THE PROBLEM – SOME ELEMENTS OF THE TOO BIG TO FAIL PROBLEM A) BIGNESS

B) INTERRELATEDNESS WITH THE ECONOMIC ECOSYSTEM: UNUSUAL DEPENDENCIES

C) SURROUNDING ECONOMIC CONTEXT 3. POST-CHICAGO ANTITRUST LAW AND THE “TOO-BIG-TO-FAIL” PROBLEM

A) THE NARROW MODERN FOCUS OF U.S. ANTITRUST POLICY B) INHERENT LIMITATIONS OF POST-CHICAGO ANTITRUST AS A PUBLIC

POLICY TOOL TO ADDRESS TOO-BIG-TO-FAIL PROBLEMS C) SPECIFIC PROBLEMS WITH THE APPLICATION OF EXISTING ANTITRUST

RULES TO THE TOO-BIG-TO-FAIL FIRM I) THE BIGNESS PROBLEM II) THE SELF-INFLICTED WOUND PROBLEM III) THE INCIPIENCY PROBLEMS IV) THE CURRENT REACH OF SECTION 5 OF THE FTC ACT

V) CONSOLIDATION, EFFICIENCY AND THE CURRENT REACH OF SECTION 7 OF THE CLAYTON ACT

4. COULD ANTITRUST LAW HELP? A) HARNESSING THE DYNAMISM OF ANTITRUST B) WAS THE PARADOX REALLY SO BAD? C) THE PROBLEM OF DISECONOMIES OF SCALE 5. CONCLUSIONS

A) EXISTING MERGER LAW COULD HELP PREVENT SOME OUT-SIZED COMBINATIONS

I) DISECONOMIES OF SCALE IN MERGER ANALYSIS II) TOO-BIG-TO-FAIL AS A FACTOR IN MERGER ANALYSIS B) TOWARD A PARTIAL RESTORATION OF ANTITRUST POLICY C) LEGISLATIVE POSSIBILITY

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Jesse W. Markham, Jr. Marshall P. Madison Professor of Law University of San Francisco School of Law1

© 2010

“[If] the free-market sector of the economy is allowed to develop under antitrust rules that are blind to all but economic concerns, the likely result will be an economy so dominated by a few corporate giants that it will be impossible for the state not to play a more intrusive role in economic affairs . . . .” Robert Pitofsky, 19792

____________

1. Introduction

This article examines whether, and the extent to which, antitrust law could contribute to a broader regulatory effort to control the too-big-to-fail problem. The article begins by exploring the nature of the problem. Against this backdrop, it considers antitrust policy and rules to evaluate whether antitrust might play a meaningful role. The article concludes that antitrust law, if vigorously enforced with an emphasis on avoiding too-big-to-fail problems, can be a useful public policy tool to address the problem. However, it can come nowhere near solving it or preventing recurrences of recent systemic failures. The narrowed focus antitrust developed under the influence of the Chicago School greatly limits its potential utility in this context and it is worth serious reconsideration. Nevertheless, the dynamism of antitrust policy in adjusting to intellectual movements and economic conditions could be harnessed to re-establish the broad reach of antitrust and thus forge a reasonably useful public policy weapon to direct at the too-big-to-fail problem. Antitrust law could make a greater contribution in resolving this public policy problem if Congress enacted or the judiciary forged more robust rules preventing and dismantling unwieldy corporate size in excess of any plausible scale efficiency

1 A version of this article was presented by the author at the Murphy Conference on Corporate Law at Fordham University Law School, March 12, 2010. The author wishes to express his gratitude to many who contributed to the research and writing of this article in a variety of capacities. Professor Steven Schatz graciously reviewed an early stage of the article. Robin Bennett provided invaluable background research. The University of San Francisco School of Law provided generous support for this project and the law faculty, in numbers too great to thank here individually, offered insightful suggestions at a presentation based on a formative draft. 2 Robert Pitofsky, The Political Content of Antitrust, 127 U. PA. L. REV. 1051, 1051 (1979).

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justification. Such rules would be consistent with the historic purposes of antitrust law to protect consumers against the output, innovation and price effects of catastrophic failures.

It is worth noting at the outset that the thesis here is not that antitrust law, even if more vigorously interpreted and enforced, could have made much difference in averting any part of the recent global financial crisis. There is no real consensus about the causes of that crisis, but recent changes in the business of global banking and finance beyond the mere size of financial enterprises contributed to a systemic weakness, rather than isolated weakness in one or a few participants. When Bear Stearns was rescued, the intent presumably was to prevent that domino from toppling into others and knocking down too many others. Since holding that domino upright did not prevent systemic failure, it seems probable that the causes do not merely reside in one or a few too-big-to-fail enterprises, but, rather, underlie the system.

Nevertheless, there remains an important public policy issue regarding whether to permit firms to combine where the resulting enterprise exceeds efficient scale and at the same time escapes failure by being too-big-to-fail. If the out-sized firm is not allowed to fail, then allowing it to exist creates a risk to the economy and the treasury. If no offsetting benefit exists, the question then becomes whether there exists an administratively practical way for antitrust law to help contain the size of such enterprises.

This article presupposes the existence of some enterprises in key sectors of our economy whose scale exceeds optimal efficient levels, but that are too big to allow them to fail. These are arguable assumptions that I leave to others to argue about. This article does not seek to resolve those empirical questions, but, rather, to explore whether antitrust should play a role in controlling the too-big-to-fail problem if these assumptions are accurate.

a. The Paradox of Too-Big-to-Fail and Antitrust

It seems paradoxical that antitrust law appears to have had nothing to say about the problem of firms becoming too big to fail. The antitrust laws are uniquely addressed to the problem of maintaining healthy markets against distortion from excessive aggregations of economic power. Yet, antitrust law has not intervened to prevent or redress the recent outbreak of systemic threats caused directly by companies that are too big and too integral to the functioning of markets to allow those firms to function normally without massive governmental infusions of capital. In some instances, these companies have accumulated assets exceeding $1 trillion,3 and they cut across a broad swath of economic activity, including investment banking,4 depositary banking,5

3 As of September 30, 2008, American International Group, Inc. (“AIG”) reported assets exceeding

$1 trillion. See, Report Pursuant to Section 129 of the Emergency Economic Stabilization Act of

2008: Restructuring of th eGovernment’s Financial Support for the American International Group,

Inc. (Nov. 10, 2008) (“AIG Report”).

4 See, Report Pursuant to Section 129 of theEmergency Economic Stabilization Act of 2008: Bridge

Loan to Bear Stearns Companies Through JP Morgan Chase (Oct. 31, 2008)(“Bear Stearns Report”).

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insurance,6 securities,7 mortgage lending,8 and automobile manufacturing.9 All of these industries are subject to antitrust law. Furthermore, nearly all of the firms that have been considered too big to fail grew in large part by acquisition activity that is within the reach of antitrust laws and subject to pre-transaction government clearance.10 Yet, antitrust laws did nothing to intervene to prevent these firms from reaching potentially catastrophic dimensions. The Sherman Act surely was not enacted so that firms could become so big, and so economically and politically powerful, that the mere possibility of their failure would impose unacceptable policy choices on the nation. Why, then, are so many firms too big to fail, and why has antitrust not done its part to prevent the possibility of these catastrophic failures?

This paradox begins to unravel when one considers the ever-narrowing reach of modern antitrust law. As currently interpreted by the courts, U.S. antitrust law is a shadow of its original self. Whatever animated their enactment, antitrust laws no longer concern themselves with preventing bigness, and indeed tend instead to encourage large-scale enterprise for efficiency’s sake. Beginning with Continental T.V., Inc. v. GTE Sylvania, Inc.,11 the antitrust laws in the United States began a steady process of judicial erosion to eliminate multiple and possibly conflicting policy objectives, distilling in their place the exclusive purpose of promoting consumer welfare through allocative and dynamic efficiency. With marginal and mostly theoretical exceptions, the efficient allocation of society’s scarce resources through the use of existing technologies and the production of goods and services more efficiently using innovative new ones, comprise the sum total of

5 On September 25, 2008, JPMorgan Chase acquired the banking operations of Washington

Mutual Bank in a transaction facilitated by the Federal Deposit Insurance Corporation. See.

“JPMorgan Chase Acquires Banking Operations of Washington Mutual

FDIC Facilitates Transaction that Protects All Depositors and Comes at No Cost to the Deposit

Insurance Fund,” FDIC Press Release available at

http://www.fdic.gov/news/news/press/2008/pr08085.html. 6 AIG Report, supra.

7 See, Bear Stearns Report, supra.

8 “On Saturday, September 6, 2008, FHFA placed Fannie Mae and Freddie Mac into

conservatorships.” See, Statement of James B. Lockhart, III, Director, Federal Housing Finance

Agency Before the Senate Committee on Banking, Housing, and Urban Affairs On “Turmoil in the

U.S. Credit Markets: Examining Recent Regulatory Responses” (October 23, 2008) available at

http://www.fhfa.gov/webfiles/120/revisedtestimonySBC102308.pdf.

9 10 The Hart-Scott-Rodino Antitrust Improvements Act of 1976 requires pre-transaction notification to the federal antitrust authorities of most mergers and acquisitions where the parties and transaction meet certain inflation-adjusted size thresholds. 15 U.S.C. § 18a (1976). 11 433 U.S. 36 (1977).

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the residual policy underpinnings of modern antitrust law.12 In light of these modern movements in antitrust law, it is perhaps not entirely surprising that antitrust law has not prevented the too-big-to-fail problem, since consumer welfare may be enhanced, rather than harmed, by permitting firms to become big and even indispensible.

However, the paradox is not altogether attributable to the narrowing focus of modern antitrust law. Although at one time antitrust law considered the emergence of very large corporations to present unacceptable risks to the public, the risks that were of concern did not include the too-big-to-fail problem. Instead, antitrust law in an earlier era was concerned about the threat of harm out-sized enterprise posed to others by its sheer power, rather than its vulnerability to collapse. Thus, there remains a perplexing aspect to this paradox: even the more robust antitrust regime that was overrun by the modern law and economics movement seems to have been unconcerned with preventing systemic failure by constraining firms from becoming too big to fail.

12 It has been argued that "[t]o this day, the Supreme Court has not come close to saying that economic efficiency is the exclusive concern of the antitrust laws . . ." HERBERT HOVENKAMP, FEDERAL ANTITRUST POLICY: THE LAW OF COMPETITION AND ITS PRACTICE 69 (3d ed. 2005). However, no Sherman Act case since Klor’s, Inc. v. Broadway-Hale Stores, Inc., 359 U.S. 207 (1959), has even arguably turned on the policies of personal freedom to pursue economic opportunity, or the statutory policy of policing fairness in the marketplace, although those policies were frequently echoed in early antitrust cases. Aside from cases decided under the Robinson-Patman Act, 15 U.S.C. §§ 13a-13b, 21a (2000), no recent antitrust case turned on the policy of favoring small enterprise for its own sake, also frequently given voice on in an early generation of Sherman Act decisions. More to the point, however, there has been an outright abandonment of what once was central antitrust policy favoring fragmented markets populated by small businesses, even at some expense in the form of efficiency. Recent decisions make no mention of any general antipathy for big business nor preference for smaller enterprise, such as Judge Hand invoked in United States v. Aluminum Co. of America: “[A]mong the purposes of Congress in 1890 was a desire to put an end to great aggregations of capital because of the helplessness of the individual before them. . . . Throughout the history of [the Sherman Act, the Surplus Property Act and the Small Business Mobilization Act] it has been constantly assumed that one of their purposes was to perpetuate and preserve, for its own sake and in spite of possible cost, an organization of industry in small unites which can effectively compete with each other.” 148 F.2d 416, 428-29 (2d Cir. 1945). Since Brown Shoe v. United States, there has been no serious mention by the high court of any preference for small enterprise for its own sake. 370 U.S. 294, 344 (1962) (“But we cannot fail to recognize Congress’ desire to promote competition through the protection of viable, small, locally owned, businesses. Congress appreciated that occasional higher costs and prices might result from the maintenance of fragmented industries and markets. It resolved these competing considerations in favor of decentralization.”). The most recent reference by the Supreme Court to the preference for “keeping a large number of small competitors in business” was the much excoriated United States v. Von’s Grocery Co., 384 U.S. 270, 275 (1966).

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Curiously, though, the older antitrust regime was very much concerned with bigness for reasons that apply to the too-big-to-fail firm. Before the courts rewrote them, United States antitrust laws were understood as providing the public with protection against behemoth economic enterprises not only because of their tendency toward market dominance, but also because of their power to paralyze or control democratic institutions through their vast wealth. Nearly 100 years ago, Justice Harlan described the Sherman Act as arising from a universal conviction that “the country was in real danger from another kind of slavery . . . that would result from the aggregations of capital in the hands of a few.”13 As recently as 1979, near the onset of the Chicago School antitrust revolution, Robert Pitofsky wrote:

It is bad history, bad policy and bad law to exclude certain political values in interpreting the antitrust laws. By ‘political values,’ I mean, first, a fear that excessive concentration of economic power will breed antidemocratic political pressures, and, second, a desire to enhance individual and business freedom by reducing the range within which private discretion by a few in the economic sphere controls the welfare of all. A third and overriding political concern is that if the free-market sector of the economy is allowed to develop under antitrust rules that are blind to all but economic concerns, the likely result will be an economy so dominated by a few corporate giants that it will be impossible for the state not to play a more intrusive role in economic affairs.14

Of course, this final prediction could not have been more accurate. The ungainly size and perceived indispensability of “too-big-to-fail” enterprises has recently forced the government to become the largest investor in the U.S. automobile industry,15 a controlling owner of some of the largest lenders in the country including Freddie Mac and Fannie Mae,16 and to inject hundreds of billions of dollars into the financial services sector through equity investments, loans and loan guarantees17. The government also has infused federal funds into the home mortgage refinance marketplace to forestall foreclosures.18 At least some of this government intervention was at least arguably a consequence of these sectors of economy being “dominated by a few corporate giants.” Moreover, government intrusion into the private sector in response to the too-big-to-fail issue appears to be nowhere near an end. Additional government intervention of a more

13 Standard Oil Co. of N.J. v. United States, 221 U.S. 1, 83 (1911) (Harlan, J., concurring in part and dissenting in part). 14 Pitofsky, supra note 2, at 1051. 15 U.S. GOV’T ACCOUNTABILITY OFFICE, GAO 09-553, SUMMARY OF GOVERNMENT EFFORTS

AND AUTOMAKERS’ RESTRUCTURING TO DATE 1 (2009).

16 MARK JICKLING, Cong. Research Serv., RL34412, CONTAINING FINANCIAL CRISIS 16-20 (2008). 17 EDWARD V. MURPHY, Cong. Research Serv., RS22963, FINANCIAL MARKET INTERVENTION FAQ 2-4 (2008). 18 See, e.g., Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, 122 Stat. 2654 (codified as amended in scattered sections of 12 U.S.C.).

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durable sort seems inevitable as Congress considers enacting new laws to try to forestall in the future what existing regulatory law did not. Federal and state regulation has been enacted or is under consideration addressing dozens of areas of economic activity including real estate mortgage lending practices, trading in derivatives and other securities, solvency of financial institutions, management compensation, corporate governance, and even the permissible maximum size and investment activity of banks.

From its origins, antitrust law has been concerned with preventing the accumulation and exercise of economic power in big enterprises, rather than the vulnerability of the public to potential widespread economic disruption from the inherent vulnerability of big enterprises.19 It has never concerned itself with firms being too big to fail. Indeed, the events that began in the second half of 2007 have led to a good deal of reflection about the extent to which antitrust law has weakened in recent decades and whether its focus has become too narrow. However, as various alternative regulatory strategies are considered to address the problem, antitrust law has emerged as having at least some potential to promote a healthier economy that relies less on the economic stability of a small number of very large firms. There is renewed interest in reinvigorating antitrust law to address the too-big-to-fail problem by invoking its original underlying policy concerns.

Federal Trade Commissioner J. Thomas Rosch has advanced the view that a merger with the potential for catastrophic effects on a market as a whole can be challenged under the Clayton Act or the Federal Trade Commission Act for its tendency to destroy competition and harm consumers. He has also opined that amendments to antitrust laws are not needed to bring these Acts to bear in preventing undesirable growth of enterprises.20 That view, though admittedly controversial, is an important one because it suggests the possibility of expanding existing analytical approaches, rather than necessarily amending the antitrust laws or turning exclusively to regulatory law instead. Assistant Attorney General for antitrust Christine Varney has also suggested that the relaxation of antitrust enforcement played a role in creating conditions that led to the economic collapse in 2008, which similarly suggests that enforcement of existing law could contribute to broader efforts to prevent catastrophic business collapses.21

19 See, e.g., Standard Oil Co. ,, supra, 221 U.S. 1, 83 (1911) (Harlan, J., concurring in part and dissenting in part). 20 See J. Thomas Rosch, Comm'r, Fed. Trade Comm'n, Remarks at the New York Bar Association Annual Dinner: Implications of the Financial Meltdown for the FTC (Jan. 29, 2009) [hereinafter, Rosch] (“The Clayton Act is inherently prospective and the current standard prevents anticompetitive harm in its incipiency. Hence, if a merger creates a firm whose failure is likely to have a catastrophic effect on the market as a whole, because it is so integral to the market, the end result may be a substantial lessening of competition.”). 21 See Christine A. Varney, Assistant Att'y Gen., U.S. Dep’t of Justice, Remarks as Prepared for the United States Chamber of Commerce: Vigorous Antitrust Enforcement in This Challenging Era (May 12, 2009), available at

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While these official views may be correct, antitrust law might surely play an even more important role if it were reinvigorated. Although there is no precedent for applying antitrust sanctions to block corporate expansion for the reason that a company might catastrophically fail to the detriment of the nation’s economy as a whole, there is no reason in principle why antitrust law could not respond to the emergence of such growth in the future. Of course, it may be that some too-big-to-fail companies got there without any possibility of antitrust intervention, at least not as antitrust is currently understood. Indeed, if one considers the recent failures of companies like AIG and Citigroup, which grew via conglomerate rather than horizontal accretion, even a clairvoyant prediction of the catastrophe that these companies precipitated would not have drawn antitrust intervention under the existing approach. However, other accumulations of corporate size, such as the mergers of financial institutions that were already too-big-to-fail, might be an appropriate target for antitrust law. Thus, the potential that antitrust law could prevent some ultimately catastrophic combinations or even force break-ups of companies that become too big merits at least some consideration.

This article argues that modern antitrust law can contribute more than it has to reigning in the causes of long-run systemic instability represented by the too-big-to-fail problem. Post-Chicago antitrust law narrowly focuses on allocative efficiency, which is rarely directly threatened by the sorts of risky conduct that give rise to systemic failures. However, antitrust law and policy have shown impressive adaptability and dynamism over the 120 years since the enactment of the Sherman Antitrust Act in 1890.22 Indeed, despite the evolution of antitrust law in recent decades, the broad array of policies that represented the foundations of antitrust for roughly a century have begun to rekindle interest among scholars and policymakers – and antitrust law reinvigorated by a revival of the original broader policy underpinnings that predated the law and economics movement might have at least a less modest role to play.

This article explores the potential application of such a revived antitrust law to the problem of the too-big-to-fail enterprise. It argues that a combination of reinvigorated existing law in conjunction with new antitrust legislation, could contribute significantly to the public policy arsenal of weapons for confronting this problem without offending the fundamental objectives of antitrust law. Part 2 of this article defines the problem of “too-big-to fail” and identifies some of its essential characteristics. Part 3 examines the limited reach of modern U.S. antitrust law, particularly how it largely fails to address the essential characteristics of too-big-to-fail firms. Part 4 then explores whether new or revived antitrust rules might provide some traction in addressing the policy problem presented by threats of catastrophic market failures. Part 5 concludes by advocating a modest proposal for reform.

http://www.usdoj.gov/atr/public/speeches/245777.htm (“This country's prior experience raises the question of whether current economic challenges reflect a ‘failure of antitrust.’ In other words, could United States antitrust authorities have done more? As many observers agree, in past years, with the exception of cartel enforcement, the pendulum swung too far from Thurman Arnold's legacy of vigorous enforcement.”). 22 See, e.g., 15 U.S.C. §§ 1-2 (2004).

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2. Defining the Problem – Some Elements of the “Too-Big-to-Fail” Problem

a. The Public Policy Dilemma – Damned Either Way

Applying antitrust concepts to the too-big-to-fail problem would seek to prevent or soften a public policy dilemma that has recently forced difficult choices on the nation. The prospect of protecting a company against failure presents a deeply troublesome public policy dilemma. If a firm’s failure will cause a wave of failures in a large enough segment of the economy as a whole, one policy option is to provide public infusions of capital to stave off unacceptable outcomes that would follow the failure, such as widespread economic disruption. The bail-out policy choice, however, carries with it another unacceptable outcome in addition to the taxpayer burden: moral hazard. Public rescue distorts future rational economic calculations of decision makers throughout the economy. Economic actors can be expected to take greater risks if they believe that they will be protected against adverse consequences. Furthermore, the bail-out prospect for only the largest firms creates a potentially undesirable incentive for firms to grow in order to attain that protection. If a firm can become “too big to fail,” it can more freely run risks with the expectation that the attendant risks will shift to the treasury rather than shareholders and managers. The risk-assessment incentive structure created by the likelihood of bailouts thus encourages firms to position themselves precariously and to take risks that would otherwise be irrational.23 Therefore, a bailout may solve one failure by inviting others later on.

Another public policy dilemma created by a threatened systemic failure is presented when a government with finite resources must choose which among competing failures to cure via bailout funding. In the recent crisis, the federal government elected to preserve one investment bank, but not another. In March, 2008, Bear Stearns advised federal regulatory agencies that its liquidity position was so depleted that it would need to file for bankruptcy the next day absent an infusion of capital.24 Within days, the Federal Reserve and the Treasury Department moved to fund approximately $30 billion to JPMorgan Chase to allow the commercial bank to acquire the failing investment bank.25 Six months later, the Federal Reserve Bank of New York was confronted with the failure of another investment bank, Lehman Brothers.26 Although the Fed again considered a bridge

23 See GARY H. STERN & RON J. FELDMAN, TOO BIG TO FAIL: THE HAZARDS OF BANK BAILOUTS 11 (2004). 24 Robin Sidel, Greg Ip, Michael M. Phillips and Kate Kelly, The Week That Shook Wall Street: Inside the

Demise of Bear Stearns, WALL ST. J., March 18, 2008, at A1.]

25 Robin Sidel, Greg Ip, Michael M. Phillips and Kate Kelly, The Week That Shook Wall Street: Inside the

Demise of Bear Stearns, WALL ST. J., March 18, 2008, at A1.

26 Damian Paletta, Susanne Craig, Deborah Solomon, Carrick Mollenkamp and Matthew

Karnitschnig, Lehman Fate Spurs Emergency Session --- Wall Street Titans Seek Ways to Stem Widening Crisis,

WALL ST. J., September 13, 2008, at A1.

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solution via Bank of America and Barclays, and those banks declined, ultimately the Federal Reserve participated in a decision about how far it would go to preserve both investment banks.27 Lehman Brothers is gone, Bear Stearns was saved. Regulators themselves concede that they should not be making this sort of choice:

Normally the market sorts out which companies survive and which fail, and that is as it should be . . . To prevent a disorderly failure of Bear Stearns and the unpredictable but likely severe consequences for the market functioning and broader economy, the Federal Reserve, in close consultation with the Treasury Department, agreed to provide funding to Bear Stearns through JPMorgan Chase.28

The different contexts in which the two decisions were made may very well explain and even justify the Fed’s different approaches to Bear Stearns and Lehman Brothers. A decision in November 2008 to salvage Lehman Brothers would have been made by a Fed that was already buried in political fallout from its earlier rescue of Bear Stearns and in an economic environment that was going to require considerably more Fed assistance than was politically realistic. Something had to give way, and it turned out to be an investment bank. The demise of Lehman Brothers seems to have been forced by the many too-big-to-fail crises looming over the Fed as it made its decision.

Therefore, the too-big-too-fail dilemma is twofold. First, the prospect of such a failure forces the government to choose between unacceptable immediate economic risks and long-term moral hazard. Second, it can involve the government in making decisions that are generally left to marketplace dynamics and outside the normal provinces of regulatory intervention, which runs contrary to the fundamental structure of a capitalist economic system.

b. Bigness Before turning to the antitrust law issues, it is worth pausing to examine the phenomenon of systemic failure and the characteristics of firms that create the threat. “Too-big-to-fail” is shorthand and widely agreed to be a misnomer because “bigness” alone is not the problem. Very big firms in a number of industries have failed without provoking serious discussion of public bailout to avoid broader economic systemic failures.

27 Jon Hilsenrath, Deborah Solomon and Damian Paletta, Crisis Mode: Paulson, Bernanke Strained for

Consensus in Bailout, WALL ST. J., November 10, 2008, at A1. 28 Developments in the Financial Markets: Hearing Before the S. Comm. on Banking, Housing, and Urban Affairs, 110th Cong. (2008) (statement of Ben S. Bernanke, Chairman, Federal Reserve System), available at http://www.federalreserve.gov/newsevents/testimony/bernanke20080403a.htm.

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For example, Enron failed in late 2001, at a time when it employed approximately 22,000 people and claimed to have revenues exceeding $100 billion.29 Based on reported revenues, Enron ranked 7th on the Fortune 500 list in 2001.30 Its failure was not attended with any serious consideration of bailing it out, despite the enormous hardships that its demise visited upon tens of thousands of citizens. Enron was big, but not “too big to fail,” and indeed the Chairman of the Federal Energy Regulatory Commission reported to Congress a few months later that “Enron's collapse has not caused significant damage to the nation's energy trading or energy supplies.”31 Similarly, WorldCom was ranked the 42d largest company in America when it failed in 2001 with $39.2 billion in reported revenues and 85,000 employees.32 WorldCom was not simply big, it was far flung, having acquired MCI in 1998 to become the second largest U.S. long-distance carrier, and also having acquired UNet, CompuServe, and America Online’s data network to become a leading internet infrastructure operator33. Its market capitalization dropped precipitously by nearly $150 billion by early July 2002 as a consequence of revelations about accounting irregularities and also due to the vast oversupply in the market for telecommunications capacity34. On July 21, 2002, WorldCom filed what was at the time the largest bankruptcy in the nation’s history35. No public policy debate emerged over whether to bail WorldCom out of its difficulties despite the extensive hardships and economic disruption its failure prompted.

c. Interrelatedness with the Economic Ecosystem: Unusual Dependencies

The firm that is too-big-to-fail is really both big and integral to one or more industries of critical importance to the overall economy (or as one observer nicely put it, the “business ecosystem”).36 American Insurance Group, Inc. (“AIG”) provides an instructive example

29 GILLIAN TETT, FOOL’S GOLD: HOW THE BOLD DREAM OF A SMALL TRIBE AT J.P. MORGAN

WAS CORRUPTED BY WALL STREET GREED 83 (2010).

30 MARK JICKLING, Cong. Research Serv., RS21135, THE ENRON COLLAPSE: AN OVERVIEW OF

FINANCIAL ISSUES 1 (2002). 31

The Effect of the Bankruptcy of Enron on the Functioning of Energy Markets: Testimony Before the Subcomm. on Energy and Air Quality of the H. Comm. on Energy and Commerce, 107th Cong. 32 (2002) (statement of Hon. Patrick H. Woods III, Chairman, Federal Energy Regulatory Commission). 32 BOB LYKE & MARK JICKLING, Cong. Research Serv., RS21253, WORLDCOM: THE ACCOUNTING

SCANDAL 2, 4 (2002).

33 Id. at 2.

34 Id.

35 Id. at 1. 36 See Too Big To Fail? The Role of Antitrust Law in Government-Funded Consolidation in the Banking Industry: Hearing Before Subcomm. on Courts and Competition Policy of the H. Comm. on

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of a company that was determined to “be too big to fail” based not only on its size, but on other factors as well. It certainly was very big. AIG operated in four major business lines: (i) general property and casualty insurance, (ii) life insurance and retirement services, (iii) financial services, and (iv) asset management. As of September 30, 2008, AIG reported consolidated total assets in excess of $1 trillion and stockholders’ equity of approximately $71 billion. In 2007, AIG’s life and health insurance businesses ranked first in the United States measured by net premiums written ($51.3 billion) and third in terms of total assets at year-end ($364 billion). For the same period, AIG’s property and casualty insurance businesses ranked second in the United States measured by net premiums written ($35.2 billion) and third based upon total assets at year-end ($124.5 billion).37 It has been argued that the solution to the to-big-to-fail problem, at least in the financial services sector, should include limiting the size of firms like AIG so that any single firm’s failure would present less systemic risk.38

However, AIG’s size alone does not explain the perceived need for its rescue, which, instead, stemmed from its vast commitments throughout the global financial markets. It was feared that a default on AIG’s commitments would have created a shock-wave effect across a broad swath of economic activity. Those who were at risk from a failure of AIG included large investors, small investors in money market mutual funds (including retirement accounts), insurance policyholders and claimants, state and local governments that had extended credit to AIG, global commercial banks, investment banks, and other financial institutions, as well as subsidiaries of AIG itself. AIG was a major participant in the derivatives markets, as well as a significant counterparty to a large number of major national and international financial institutions. Out of credit swaps that had been sold by an AIG division having a notional value of $372 billion, approximately $250 billion represented transactions designed to provide financial institutions with regulatory capital relief39. AIG’s failure would have impaired or even gutted the capital bases of the Judiciary, 110th Congress 9 (2009) (statement of Albert A. Foer, President, American Antitrust Institute). 37 Report Pursuant to Section 129 of the Emergency Economic Stabilization Act of 2008: Restructuring of the Government’s Financial Support to the American International Group, Inc. (Nov. 10, 2008), available at http://www.federalreserve.gov/monetarypolicy/files/129aigrestructure.pdf. 38 See, e.g., Systemic Risk: Are Some Institutions Too Big To Fail And If So, What Should We Do About It?: Hearing Before H. Comm. on Fin. Servs., 111th Cong. 60 (2009) (statement of Simon Johnson, Ronald Kurtz Professor of Entrepreneurship, MIT Sloan School of Management; Senior Fellow, Peterson Institute for International Economics) (“[S]ome will complain about ‘efficiency costs’ from breaking up banks, and they may have a point. But you need to weigh any such costs against the benefits of no longer having banks that are too big to fail. Anything that is ‘too big to fail’ is now ‘too big to exist.’”) (emphasis added). 39 Bd. of Governors of the Fed. Reserve Sys., Report Pursuant to Section 129 of the Emergency

Economic Stabilization Act of 2008: Restructuring of the Government’s Financial Support to the

American International Group, Inc., at 2,3 (2008), available at:

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many of the world’s largest financial institutions. Federal Reserve Board Chairman Benjamin Bernanke concluded, along with the Treasury Department, that:

At best, the consequences of AIG's failure would have been a significant intensification of an already severe financial crisis and a further worsening of global economic conditions. Conceivably, its failure could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income, and jobs.40

On September 16, 2008, the Federal Reserve and Treasury agreed to extend $85 billion in secured loans to AIG, an amount that subsequently increased to more than double that amount.41 The objective was not merely to protect AIG from the normal processes of bankruptcy, but to prevent a downward spiraling of the entire financial services sector in the United States and globally. AIG’s elaborate, unregulated and risky commitments cast a dark shadow across a network of counterparties whose contractual interrelationships had created mutual dependencies on a vast scale.

Interrelatedness is thus a characteristic of the too-big-to-fail firm, whose mutual interdependencies are substantial in scope and incapable of satisfactory resolution through bankruptcy. The extent of these interdependencies seems important in distinguishing between firms that are too big to fail and firms whose failures result in harsh but acceptable consequences. Many large companies maintain interdependent relationships with many others, but only some of these reach levels that can draw entire economic systems into potential collapse. Enron, for example, was intricately interconnected and certainly was not in its own solitary orbit when it failed. It was deeply interrelated in energy markets, and its failure caused serious problems in entirely unrelated markets, as well as in the natural gas market, where the prospect of Enron’s contracts going unhonored sent shock waves through that particular market. More immediately, its demise cost over 28,000 employees at Arthur Andersen’s U.S. operations their jobs and 1,750 Andersen partners lost most of their entire life savings.42 However, the extent of economic harm from Enron’s demise was contained without http://www.federalreserve.gov/monetarypolicy/files/129aigrestructure.pdf; Bd. of Governors of the

Fed. Reserve Sys., Periodic Report Pursuant to Section 129(b) of the Emergency Economic

Stabilization Act of 2008: Update on Outstanding Lending Facilities Authorized by the Board Under

Section 13(3) of the Federal Reserve Act, at 7,8 (2009), available at:

http://www.federalreserve.gov/monetarypolicy/files/129periodicupdate02252009.pdf

40 Chairman Ben S. Bernanke, American International Group, Before the Committee on Financial

Services, U.S. House of Representatives, Washington, D.C. (March 24, 2009) available at

http://www.federalreserve.gov/newsevents/testimony/bernanke20090324a.htm.

41 [Amy Wright] 42 See Cassell Bryan-Low, Andersen Layoff to Hit Support Staff Hardest, WALL ST. J., Apr. 8, 2002, at C1.

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government bailouts, and no threat across the economy as a whole was perceived. Thus, a firm that is too-big-to-fail is one whose interdependencies extend so far that failure of the firm spells broader failures that could harm the economy as a whole. Enron’s failure might have brought about failures of a large number of natural gas traders, for example, but the emanations for those failures would not have been anything comparable to the global bank failures that would apparently have resulted from a failure to rescue AIG.

c. Surrounding Economic Context

Defining a firm as too big to fail also requires consideration of context, particularly the economic conditions surrounding the potential failure. By the time AIG stood at the edge of failure, the financial system, especially the credit markets, were already deeply troubled. AIG’s counterparties included a significant part of the world’s credit markets, and they in turn were very much at risk of collapse if AIG’s commitments to them turned out to be worthless. Furthermore, AIG was not alone in its perilous condition, and many of its largest counterparties were weak or had already failed. When the United States loaned AIG $85 billion on September 16, 2008, credit markets were already in turmoil from the government’s takeover of Fannie Mae and Freddie Mac ten days earlier, and from the Lehman Brothers’ bankruptcy filing on September 15, 2008.43 Other major financial institutions were under stress, including, among others, Bear Stearns and Merrill Lynch.44 The risks of allowing AIG to file for bankruptcy in this context were perceived as too great. As Chairman Bernanke testified before Congress, the decision to invest in AIG was driven not just by AIG’s role in the broader economic ecosystem, but by the economic context in which the failure of AIG would have occurred absent government intervention:

It was an extraordinary time. Global financial markets were experiencing unprecedented strains and a worldwide loss of confidence. Fannie Mae and Freddie Mac had been placed into conservatorship only two weeks earlier, and Lehman Brothers had filed for bankruptcy the day before. We were very concerned about a number of other major firms that were under intense stress.45

It follows from this testimony that the public policy makers who decided that the government needed to invest in AIG probably would not have taken that step in some other economic climates. Had credit markets not already been strained, had Fannie Mae, Freddie Mac, Lehman Brothers, Bear Sterns, Merrill Lynch, Citigroup, Wachovia and

43 Oversight of the Federal Government’s Intervention at American International Group: Before the H. Comm. On

Fin. Servs., 111th Congress 10 (2009) (statement of Ben C. Bernanke, Chairman, Federal Reserve

System).

44 EDWARD V. MURPHY, Cong. Research Serv., RS22963, FINANCIAL MARKET INTERVENTION

FAQ 3-4 (2008). 45 Oversight of the Federal Government’s Intervention at American International Group: Before the H. Comm. on Fin. Servs., 111th Congress 71 (2009) (statement of Ben C. Bernanke, Chairman, Federal Reserve System).

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many other financial behemoths not been imperiled at the same moment, there exists reason to doubt whether AIG failing all by itself would have threatened the economy as a whole as it did. Thus, a company is not simply too-big-to-fail in the abstract, but poses broader risks in some contexts than others – some of these presenting unacceptable risks.

3. Post-Chicago Antitrust Law and the “Too-Big-to-Fail” Problem

The foregoing is not intended as an empirical study of the problem, which would certainly be a worthy, but different, undertaking.46 Rather, identifying certain characteristics of firms whose failures presented unacceptable consequences focuses the consideration on the problems that antitrust would need to address to help mitigate or avoid the public policy dilemmas posed by these impending business failures. It is with this in mind that the partial list above was fashioned. Again, these characteristics include: (1) size; (2) interrelatedness in the economic ecosystem; and (3) surrounding economic context or events. Having identified some common elements of the too-big-to-fail problem, it begins to emerge why United States antitrust law as it is currently understood and enforced might have, at most, very limited application to help avert or solve future too-big-to-fail problems. a. The Narrow Modern Focus of U.S. Antitrust Policy The current state of antitrust law is often referred to as embracing “Post-Chicago School” economic theory. Post-Chicago School antitrust is the stepchild of Chicago School antitrust, which represented a radical departure from historic antitrust policy. As discussed later in this article, antitrust policy (and thus antitrust law itself) has had a dynamic history, changing rather dramatically in response to intellectual developments in the field of economics and to changes in the economy itself. Early antitrust decisions embraced a sweeping array of economic, political and social policies.47 A turn toward a less value-laden antitrust law began to take shape in the 1970s, promoted by intellectual 46 Nor is this analysis exhaustive. For example, another characteristic of a firm that presents a too-big-to-fail problem might be the absence of certain types of culpability. Public bailouts are unlikely to be considered in response to a failure brought about by criminal misconduct on the part of corporate management. “Too-big-to-fail” problems often result from risky conduct, and indeed the problem is essentially one of loss-shifting to the treasury and away from the corporate actors who took the risks. When the risks that precipitate corporate collapse are substantially aggravated by illegal or fraudulent conduct, however, relief sought from the government meets with an additional layer of political resistance. Enron and WorldCom failed as a direct consequence of conduct that was highly risky and which was unlawfully and deliberately concealed in violation of civil and criminal securities laws, among others. Fraud concealing their financial downturn allowed the risky conduct to persist until its cumulative effects brought about irreversible failures. No serious consideration was given to public bailouts. If criminality brings on a business collapse with devastating collateral damage to the economy or investors, however, the resulting problem is more directly addressed by means other than antitrust law. 47 See infra Part 3.b.

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descendants of Oliver Wendell Holmes.48 Lawyers for corporate interests and industrial organization economists of the Chicago School mounted an organized effort that succeeded in persuading the federal courts to adopt a far narrower view of antitrust that has as its single objective the avoidance of economically inefficient transactions, referred to by economists as “allocative efficiency.”49 In the last two decades of the Twentieth Century, antitrust law embraced this narrow, Chicago School, doctrinal approach to antitrust law and accepted the optimization of allocative efficiency of firms and markets as the dominant antitrust policy.50 This objective was advocated in some influential

48 For an interesting historical treatment of the legacy of Oliver Wendell Holmes, see ALBERT W. ALSCHULER, LAW WITHOUT VALUES: THE LIFE, WORK, AND LEGACY OF JUSTICE HOLMES (2000). 49 See, Pitofsky, supra note 2, at 1051; Peter M. Gerhart, The Supreme Court and Antitrust Analysis: The (Near) Triumph of the Chicago School, 1982 SUP. CT. REV. 319, 349 (1982); Richard A. Posner, The Rule of Reason and the Economic Approach: Reflections on the Sylvania Decision, 45 U. CHI. L. REV. 1, 13 (1977). 50 Allocative or economic efficiency of markets refers to the situation in which it is impossible to generate a larger total societal welfare from the available resources without technological advancement. Allocative efficiency differs from distributive values or fairness. Chicago School proponents argue that economics should concern itself only with aggregate welfare rather than distributive welfare – i.e., how much society produces at what cost, but not who gets it. The founder of the Chicago School articulated its value-barren approach:

Why do economists object to monopoly? The purely ‘economic’ argument against monopoly is very different from what noneconomists might expect. Successful monopolists charge prices above what they would be with competition so that customers pay more and the monopolists (and perhaps their employees) gain. It may seem strange, but economists see no reason to criticize monopolies simply because they transfer wealth from customers to monopoly producers. That is because economists have no way of knowing who is the more worthy of the two parties—the producer or the customer. Of course, people (including economists) may object to the wealth transfer on other grounds, including moral ones. But the transfer itself does not present an ‘economic’ problem. Rather, the purely ‘economic’ case against monopoly is that it reduces aggregate economic welfare (as opposed to simply making some people worse off and others better off by an equal amount). When the monopolist raises prices above the competitive level in order to reap his monopoly profits, customers buy less of the product, less is produced, and society as a whole is worse off. In short, monopoly reduces society’s income.

George J. Stigler, The Economists and the Problem of Monopoly, 72 AM. ECON. REV. 1 (1982). By defining economics as “value neutral,” and then pressing for purely economics-driven antitrust law interpretations, the Chicago School sought to strip

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quarters as the exclusive policy of the Sherman Act. For example, a leading proponent of the Chicago School argued that the “whole task of antitrust can be summed up as the effort to improve allocative efficiency without impairing productive efficiency so greatly as to produce either no gain or a net loss in consumer welfare.”51 In the earliest phase of this revision and reconstruction of antitrust law, Chicago School adherents persuaded courts not only to restrict antitrust to the enforcement of efficient markets, but, more radically, also persuaded them that markets whose allocative efficiency is distorted by monopolistic or conspiratorial misconduct tend to self-correct without great cost to society and, thus, take greater benefit from judicial restraint than from costly and error-prone judicial intervention.52 The Chicago School came to dominate judicial and federal agency interpretations of the law, and played a central role in a string of Supreme Court decisions overturning more liberal, time-worn, precedents.53 The elevation of allocative efficiency as the central goal of antitrust became widely accepted, so much so that courts and commentators often seem to believe that this had always been antitrust’s exclusive concern.54 Allocative

antitrust of any role as referee over the fairness of markets or the distributive fairness of the economy as a whole. 51 ROBERT BORK, THE ANTITRUST PARADOX: A POLICY AT WAR WITH ITSELF 91 (1993). 52 See Bell Atl. Corp., v. Twombly, 550 U.S. 544, 567-68 (2007); Credit Suisse Sec., LLC v. Billings, 551 U.S. 264, 285 (2007); Verizon Commc'ns, Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 411 (2003). 53 Pac. Bell Tel. Co. v. Linkline Commc'ns, Inc., 129 S. Ct. 1109, 1120-21 (2009) (overturning the price squeeze prohibition in United States v. Aluminum Co. of Am., 148 F.2d 416 (2d Cir. 1945), based on “developments in economic theory and antitrust jurisprudence since Alcoa”); Leegin Creative Leather Prods. v. PSKS, Inc., 551 U.S. 877, 882 (2007) (overruling Dr. Miles Med. Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911)); State Oil Co. v. Khan, 522 U.S. 3, 7 (1997) (overruling Albrecht v. Herald Co., 390 U.S. 145 (1968)); Brooke Grp. Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 221 (1993) (overruling Utah Pie Co. v. Cont'l Baking Co., 386 U.S. 685 (1967)); Cont'l T.V., Inc. v. GTE Sylvania, Inc., 433 U.S. 36, 47 n.12 (1977) (overruling United States v. Arnold, Schwinn & Co., 388 U.S. 365 (1967)). 54 As a senior economist at the United States Department of Justice Antitrust Division put it succinctly: “efficiency is the goal, competition is the process.” Kenneth Heyer, Address before the Merger Task Force of the European Commission's Directorate General for Competition (Apr. 9, 2002); see also Lawrence Summers, Competition Policy in the New Economy, 69 ANTITRUST L.J. 353, 358 (2001), ("[I]t needs to be remembered that the goal is efficiency, not competition. The ultimate goal is that there be efficiency."). The efficiency-oriented policy of competition law has also gained favor in international circles largely at the insistence of United States policy makers and scholars. For example, a 1996 report of the Organization for Economic Cooperation and Development affirmed that “the basic objective of competition policy is to protect competition as the most appropriate means of ensuring the efficient allocation of resources -- and thus efficient market outcomes -- in free market economies.” OECD,

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efficiency is equated with consumer welfare in the sense that consumers are best off in a market that achieves optimum allocative efficiency – prices in such markets send accurate signals to producers and innovators to yield optimum outcomes for consumers. While the most extreme position, that no other policies aside from consumer welfare have any relevance, was not adopted by the courts, economic efficiency came to predominate to a large extent and effectively displaced other policy objectives that at one time or another were considered important considerations in the application of antitrust law. During this Chicago School phase, antitrust enforcement at the federal level was largely confined to unambiguous cartel activity and blatantly problematic mergers, leaving more subtle misconduct to marketplace self-corrections that the Chicago School doctrine anticipated would always or nearly always solve problems better than antitrust courts.55

Critics of the Chicago School found a number of flaws in the theory, and also cautioned against elevating theory over facts in deciding antitrust issues. Markets do not tend to follow theory neatly, and market imperfections can confound the application of theory to the complex factual settings that typically are encountered in antitrust matters.56 A new, more moderate “Post-Chicago School” approach thus emerged in the early 1990s,57 and eventually succeeded in establishing a somewhat more tempered approach. Post-Chicago antitrust theory continues to adhere to the limited objective of economic efficiency, but relies with less assurance on market forces to correct interferences with market competition.58 Although somewhat tempered as measured against the early Chicago School, “Post-Chicago” antitrust theory departs from the Chicago School views mostly around the margins. Post-Chicago antitrust theory does not regard market concentration as an ill, let alone an evil, in the absence of entry barriers;59 it scrupulously distinguishes abuse of monopoly power from vigorous successful competition by dominant firms;60 it broadly tolerates vertical price and non-price restraints;61 it regards predatory pricing as

Competition Policy and Efficiency Claims in Horizontal Agreements, at 5, OECD/GD Doc. (96)65 (1996). 55 See Richard Posner, The Chicago School of Antitrust Analysis, 127 U. PA. L. REV. 925, 928 (1979). 56 See, e.g., Eastman Kodak Co. v. Image Tech. Serv., Inc., 504 U.S. 451, 473 (1992). 57 See Thomas G. Krattenmaker & Steven C. Salop, Anticompetitive Exclusion: Raising Rivals' Costs To Achieve Power Over Price, 96 YALE L.J. 209, 230-49 (1986). 58 J. Thomas Rosch, Commissioner, Fed. Trade Comm'n, Address at the International Bar Association Antitrust Section Conference: I Say Monopoly, You Say Dominance: The Continuing Divide on the Treatment of Dominant Firms, Is It the Economics? (Sept. 8, 2007), available at http://www.ftc.gov/speeches/rosch/070908isaymonopolyiba.pdf. 59 See e.g., JOHN S. MCGEE, IN DEFENSE OF INDUSTRIAL CONCENTRATION (1971). 60 See Verizon Commc'ns, Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 414 (2004) (“Under the best of circumstances, applying the requirements of § 2 ‘can be difficult’ because ‘the means of illicit exclusion, like the means of legitimate competition, are myriad.’”) (citing United States v. Microsoft Corp., 253 F.3d 34, 58 (D.C. Cir. 2001) (en banc)). 61 See e.g., Leegin Creative Leather Prods. v. PSKS, Inc., 551 U.S. 877, 890 (2007) (“The justifications for vertical price restraints are similar to those for other vertical

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an unlikely source of consumer harm.62 Under this theory, antitrust has retained as its primary targets the more virulent forms of cartel activity and certain obviously problematic merger activity. Although “Post-Chicago” confidence in the self-correcting tendencies of markets has dampened, it remains a persistent theme. Recently, Joseph Schumpeter’s 1942 treatise Capitalism, Socialism and Democracy, which predicted the self-destruction of capitalism, has enjoyed a surprising and influential revival, at least as to its metaphorical description of the “gales of creative destruction.”63 According to Schumpeter and his modern adherents, market participants are understood to be, in many cases, competing for the market, rather than within it, and competition on the basis of price is a poor heuristic to explain how markets actually function.64 Citing Schumpeter for a position that is broadly tolerant of monopoly power as a lure toward innovation, the (now former) Assistant Attorney General for antitrust remarked in 2006 that “[t]he existence of firms with large market shares does not necessarily or even typically reflect competitive harm—to the contrary, firms typically obtain large market shares by offering products that consumers prefer over other firms’ offerings.”65 Thus, Post-Chicago antitrust theory remained skeptical of antitrust intervention, but marginally less so than its more radical precedent in the Chicago school. However, current antitrust law has been blunted by concerns about so-called “type I error” or over-enforcement of antitrust rules.

restraints. Minimum resale price maintenance can stimulate interbrand competition -- the competition among manufacturers selling different brands of the same type of product -- by reducing intrabrand competition -- the competition among retailers selling the same brand. The promotion of interbrand competition is important because ‘the primary purpose of the antitrust laws is to protect [this type of] competition.’” (citations omitted). 62 Brooke Grp. Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 226 (1993). “As we have said in the Sherman Act context, ‘predatory pricing schemes are rarely tried, and even more rarely successful,’ and the costs of an erroneous finding of liability are high. ‘[T]he mechanism by which a firm engages in predatory pricing -- lowering prices -- is the same mechanism by which a firm stimulates competition; because ‘cutting prices in order to increase business often is the very essence of competition . . . [;] mistaken inferences . . . are especially costly, because they chill the very conduct the antitrust laws are designed to protect.’” (citations omitted). 63 See e.g., Thomas O. Barnett, Assistant Attorney General, U.S. Dep’t of Justice, Opening Remarks before the Antitrust Division and Federal Trade Commission: The Gales of Creative Destruction: The Need for Clear and Objective Standards for Enforcing Section 2 of the Sherman Act (June 20, 2006), available at http://www.usdoj.gov/atr/public/speeches/216738.htm. 64 Joseph A. Schumpeter, Capitalism, Socialism and Democracy (New York: Harper, 1975) [orig. pub.

1942], pp. 82-85. 65 Id. at 6.

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b. Inherent Limitations of Post-Chicago Antitrust as a Public Policy Tool to Address Too-Big-to-Fail Problems

A preliminary consideration is thus whether current Post-Chicago economics and antitrust policy could conceivably be applied to prevent or unwind the existence of a too-big-to-fail firm, or to prevent its actual or impending failure. On its face, this seems a doubtful proposition. The central purpose of modern antitrust law is the protection of consumer welfare, specifically price, output and innovation.66 It has been suggested that the actual or even potential collapse of a too-big-to-fail firm implicates consumer welfare, 67 and does so in a manner that existing antitrust law principles might address by application of Section 7 of the Clayton Act68 to the mergers and other business combinations that create these behemoths, or perhaps by application of Sections 1 or 2 of the Sherman Act.69 For example, Commissioner J. Thomas Rosch of the Federal Trade Commission (“FTC”) has speculated that “mergers should arguably be examined with an eye toward whether they are creating a merged entity that is ‘too big to fail.’ If so, the transaction may violate Section 7 (or Section 1).”70 Commissioner Rosch’s point was not the trivial one that some mergers that create very big combinations may violate the standards set forth in existing law or policy statements by exceeding tolerable concentration levels.71 Instead, Commissioner Rosch articulated the view that it is at least possible, without amending the law, to interpret existing antirust law to protect against some instances of the sorts of business collapse that result in traditional forms of consumer harm, such as reduced output, when an entire industry is hobbled. Furthermore, since antitrust laws addressing mergers are prophylactic, the argument extends not only to cleaning up a too-big-to-fail problem, which comes too late to protect consumers, but, more ambitiously, to prevent the problem before it bubbles up. Since the failure of a too-big-to-fail firm would unavoidably reduce economic activity, and thus output, for a protracted period of time and might also eliminate or restrict investments in R&D (so goes the argument),72 antitrust policy should address itself to this general area of public concern. That is, if the failure of a too-big-to-fail firm could bring about the

66 See Brooke Grp., 509 U.S. at 221 (noting the antitrust laws' “traditional concern for consumer welfare and price competition”); Nat’l Collegiate Athletic Ass'n v. Bd. of Regents, 468 U.S. 85, 107 (1984) (“Congress designed the Sherman Act as a ‘consumer welfare prescription.’” (quoting Reiter v. Sonotone Corp., 442 U.S. 330, 343 (1979))). 67

See Rosch, supra, n.9. 68 15 U.S.C. § 18. 69

15 U.S.C. §§ 1-2. 70 See, Rosch, supra note 9. 71

See, e.g., U.S. DEP’T OF JUSTICE, HORIZONTAL MERGER GUIDELINES (1997), available at http://www.justice.gov/atr/public/guidelines/horiz_book/hmg1.html [hereinafter MERGER GUIDELINES]. 72 Rosch, supra.

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sorts of consumer harm that the antitrust laws protect against, then antitrust law might be implicated by the emergence of such firms in the first place, before they fail. The argument is appealing, but has apparent limitations. First, not all consumer harm in the form of higher prices, reduced output or diminished innovation implicates antitrust policy because these harms sometimes are brought about by mechanisms that antitrust is not concerned with. Consumers have certainly suffered a variety of hardships from the financial meltdown, including evictions from their homes,73 loss of jobs,74 disappearing retirement savings,75 higher prices for certain types of credit,76 and generally diminished output throughout the economy.77 These harms were, to a large degree, precipitated by the mismanagement of too-big-to-fail banks and other financial institutions. However, are these antitrust harms? Not obviously, anyway, and antitrust law deliberately has been limited to avoid extending antitrust remedies to every sort of conduct that may harm consumers – they must be harmed in particular ways that are quite narrow. For example, consumers also suffered economic harms when the attacks on September 11, 2001 led to (among other more horrible consequences) the immediate grounding of all air traffic within the United States, thus reducing output in the air transportation markets – but no one could argue that Khalid Sheikh Mohammed violated the antitrust laws by restraining trade in those markets. The mechanism by which output was affected by terrorist attacks was different from the sort of activity that antitrust is intended to prevent.78 Antitrust law seeks to prevent antitrust injury, and courts have narrowly construed the “antitrust injury” element of an antitrust case to mean injury flowing from conduct that violates antitrust rules of conduct, which prohibit, for example, price fixing.79 On this basis, courts have limited antitrust remedies to redress only certain types of reasonably

73 John Leland, As Owners Feel Mortgage Pain, So Do Renters, N.Y. TIMES, November 18, 2007, at p. 1.

74 JANE G. GRAVELLE ET AL., Cong. Research Serv., R41578, UNEMPLOYMENT: ISSUES IN THE

112TH CONGRESS 1 (2011).

75 Kelly Evans, U.S. News: Ranks of Older Workers Swell as Losses Shorten Retirement, WALL ST. J., May 9,

2009, at A2.

76 Congressional Oversight Panel, May Oversight Report: The Small Business Credit Crunch and the

Impact of the TARP 15-17 (2009). Available at:

http://cop.senate.gov/documents/cop-051310-report.pdf

77 JANE G. GRAVELLE ET AL., Cong. Research Serv., R41578, UNEMPLOYMENT: ISSUES IN THE

112TH CONGRESS 3 (2011). 78 See generally, Brunswick Corp. v. Pueblo Bowl-O-Mat, Inc., 429 U.S. 477, 489 (1977) (“Plaintiffs must prove antitrust injury, which is to say injury of the type the antitrust laws were intended to prevent and that flows from that which makes defendants’ acts unlawful. The injury should reflect the anticompetitive effect either of the violation or of anticompetitive acts made possible by the violation.”) 79 See FTC v. Sup. Ct. Trial Lawyers Ass’n, 493 U.S. 411 (1990).

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well-understood categories of marketplace misconduct, so that flying an airplane into the World Trade Center does not count regardless of its intended and actual consequences for the economy. Thus, one challenge with addressing antitrust law to the too-big-to-fail problem is to connect the requisite sorts of consumer harm with the sorts of anticompetitive mechanisms that antitrust law cares about. Being big or about to fail are not obviously among these anticompetitive mechanisms since antitrust is not a status offense. Beyond that, even being very big and taking what turn out to be poorly considered risks are not obviously antitrust offenses either because that is not the sort of conduct antitrust seeks to prevent – at least not under post-Chicago antitrust. Thus, as a starting point, antitrust intervention to prevent too-big-to-fail problems could not prevent the collapse of a firm that would not cause any sort of antitrust injury to consumers or that caused such harm via the wrong mechanisms. An additional limitation of Post-Chicago antitrust is its preoccupation with so-called Type One errors, or over-deterrence. For example, in Brooke Grp. Ltd. v. Brown & Williamson Tobacco Corp., the Supreme Court was centrally motivated by its desire to avoid punishing price cutting behavior that might be predatory, coupled with any perceivable risk of simultaneously discouraging price cutting that is competitive, when it redefined, and all but eliminated, the offense of predatory pricing. It found that “[a]s a general rule, the exclusionary effect of prices above a relevant measure of cost either reflects the lower cost structure of the alleged predator, and so represents competition on the merits, or is beyond the practical ability of a judicial tribunal to control without courting intolerable risks of chilling legitimate price cutting.”80 Such preoccupation with Type One errors also reaches other antitrust cases beyond the predatory pricing context. The case that extended the Brooke rule to predatory bidding evoked an amicus brief from the Antitrust Division that, along with several of its other amicus briefs, evidenced the same preoccupation with the “false positive” problem and over-deterrence.81 In that case, the Supreme Court agreed with the Justice Department, again reciting “intolerable risks of chilling legitimate procompetitive conduct.”82 Most recently, the Court introduced a new rule to bar most “price squeeze” claims, again citing this same “intolerable risk” of false positives, and again supported by the Antitrust Division’s refrain that “the risk of imposing liability in cases involving procompetitive price-cutting, and ‘the costs of [such] an erroneous finding of liability are high,’… because such errors (or ‘false positives’) would ‘chill the very conduct the antitrust laws are designed to protect.’”83 In another decision that recites this same policy basis, the

80 Brooke Grp. Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209, 223 (1993). 81 "[A] broader rule could lead to ‘false positives’ and thereby ‘chill the very conduct the

antitrust laws are designed to protect.’” Brief for the United States as Amicus Curiae, Weyerhaueser Co. v. Ross-Simmons Hardwood Lumber Co., 549 U.S. 312 (2007) (No. 85-381). 82 Weyerhaeuser Co. v. Ross-Simmons Hardwood Lumber Co., 549 U.S. 312, 325 (2007). 83 Brief for the United States as Amicus Curiae Supporting Petitioners at 26, Pac. Bell Tel. Co. v. Linkline Commc’ns, Inc., 129 S. Ct. 1109 (2009) (No. 07-512).

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Court all but eviscerated the essential facilities doctrine along with the Second Circuit’s “monopoly leveraging” rule. It reasoned that “[m]istaken inferences and the resulting false condemnations ‘are especially costly, because they chill the very conduct the antitrust laws are designed to protect.’”84 Here too, the Antitrust Division, along with the Federal Trade Commission, encouraged the result, urging that the doctrine “encourages litigants to seek antitrust remedies for ordinary commercial and regulatory disputes” – in other words, the doctrine chills competitive conduct.85 From this policy perspective, a number of antitrust rules have been relaxed or even eliminated. When one considers the conduct that Post-Chicago antitrust prohibits against the backdrop of the characteristics of a too-big-to-fail firm, it becomes apparent that current antitrust principles have very limited application to the problem. This is not to say there is no room for productive antitrust intervention, but, realistically, there is very little.

c. Specific Problems with the Application of Existing Antitrust Rules to the Too-Big-to-Fail Firm

Among the attributes of a too-big-to-fail company identified above, the “bigness” attribute seems the most obvious subject for antitrust policy. There are three main impediments in the way of applying modern antitrust law to prevent bigness of the too-big-to-fail sort. First, allocative efficiency tends to favor or, at most, be neutral to bigness. Since the vast scale of the too-big-to-fail enterprise is an essential ingredient of the problem, antitrust’s modern ambivalence or outright resistance to controlling bigness poses one problem. A second problem is that of the self-inflicted wound: antitrust opposes monopolistic misconduct, mergers or collusion, but it does not oppose the self-destruction of a dominant firm, even where the same sort of consumer harm or allocative inefficiency results. Third, prophylactic antitrust rules are timid about speculating, and the too-big-to-fail problem is layered in just the sort of contingencies that antitrust precedents resist to predict. If antitrust is to have a meaningful role in containing the problem of catastrophic business failures, it will need to overcome these three problems. (i) The Bigness Problem The approach that antitrust law currently takes toward bigness creates the first of these limitations. Antitrust as currently understood has no particular antipathy toward large-scale enterprise. In fact, on balance, antitrust tends to encourage large-scale enterprise. It recognizes that the potential economies of scale attainable by large enterprises may create

84 Verizon Commc’ns, Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398, 414 (2004). 85

Brief for the United States and the FTC as Amici Curiae Supporting Petitioner, Verizon Commc’ns, Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 U.S. 398 (2004) (No. 02-682).

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increased efficiencies, which can benefit consumers.86 Thus, where economies of scale may be involved, modern antitrust law exercises caution before condemning large enterprises..87 For example, economies of scale may (like other efficiencies) constitute a defense to a merger challenge.88 In evaluating a hospital merger under the Clayton Act,89 an appellate court noted that the “evidence shows that a hospital that is larger and more efficient . . . will provide better medical care than either of [the merging] hospitals could separately. The merged entity will be able to attract more highly qualified physicians and specialists and to offer integrated delivery and some tertiary care . . . The evidence shows that the merged entity may well enhance competition.”90 Of course, it was of no consequence in that case that the merged firm’s ability to attract the best doctors might adversely affect other hospitals, or that its size might make the firm indispensible to the community so that its failure could never be tolerated. In the context of a single firm with monopoly power, antitrust law does not inhibit its taking advantage of economies of scale even where smaller rivals are disadvantaged as a result.91 Mergers are not the only setting in which antitrust champions scale efficiencies. At the retail level, economies of scale constitute a legitimate reason for a manufacturer to limit intrabrand competition by imposing vertical restraints.92 Antitrust law also generally

86 See, e.g., Northwest Wholesale Stationers, Inc. v. Pacific Stationery & Printing Co., 472 U.S. 284, 287 (U.S.

1985)(“The cooperative arrangement thus permits the participating retailers to achieve economies of

scale in purchasing and warehousing that would otherwise be unavailable to them.”)

87 Id (collusion and joint ventures).; see also, MERGER GUIDELINES, supra note 43; I., 186 F.3d 1045,

1054 (8th Cir. 1999)(Scale economies recognized as a cognizable efficiency in antitrust merger

analysis); 88

See MERGER GUIDELINES, supra note 43; United States v. Long Island Jewish Med. Ctr., 983 F. Supp. 121 (E.D.N.Y. 1997). 89 Section 7 of the Clayton Act prohibits certain mergers and acquisitions whose effects may be to substantially lessen competition in any line of commerce. 15 U.S.C.A. § 18 (2010). 90 FTC v. Tenet Health Care Corp., 186 F.3d 1045, 1055 (8th Cir. 1999). 91 Spirit Airlines, Inc. v. Northwest Airlines, Inc., 431 F.3d 917 (6th Cir. 2005); see also, Conwood Co. v. U.S. Tobacco Co., 290 F.3d 768, 783 (6th Cir. 2002) (“In determining whether conduct may be characterized as exclusionary, it is relevant to consider its impact on consumers and whether it has impaired competition in an unnecessarily restrictive way. If a firm has been attempting to exclude rivals on some basis other than efficiency, it is fair to characterize its behavior as predatory [or exclusionary.] However, merely because an entity has monopoly power, does not bar it from taking advantage of its scale of economies because of its size. Such advantages are a consequence of size and not the exercise of monopoly power.”) (citations omitted). 92 “A purpose to facilitate point-of-sale services or to protect minimum economies of scale could induce a manufacturer to limit intrabrand competition. Notwithstanding price

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tolerates combinations of competitors into joint ventures to achieve economies of scale, with the presence of such efficiencies removing a challenge from the application of per se condemnation and establishing a facially plausible justification for the concerted activity.93 Removing conduct from per se illegality comes close to legalizing it, given the rarity of plaintiff successes in challenging the conduct under the rule of reason.94 Thus, modern antitrust law tends to encourage, rather than discourage, bigness. In fact, its focus on allocative efficiency renders this consequence unsurprising. A firm achieving scale economies produces greater output at lower cost. That other competitors might be devastated in the process is not a modern antitrust concern. Nor is it of any concern that scale efficiency may result in indispensability to the marketplace. Only in the most indirect way does modern antitrust law discourage bigness by imposing somewhat more stringent standards on firms that have market power (which sometimes equates to bigness, although not always) or that operate in oligopoly markets (in which the small number of rivals sometimes means that they are large, but not always). The existence of monopoly power is not unlawful by itself, but Section 2 of the Sherman Act imposes different, more stringent, standards of conduct on firms that have (or threaten to achieve) market power.95 Moreover, antitrust law imposes a different set of rules on the conduct of large monopolies. Section 1 of the Sherman Act sometimes imposes more stringent standards on firms in highly concentrated markets, or at least exposes them to antitrust risks that probably inhibit a certain amount of marketplace conduct than would otherwise occur.96 Firms operating in a market with an oligopolistic structure are subject to certain limitations on their behavior, and may more easily be found to have engaged in unlawful price fixing or tacit collusion than firms in more diffuse markets. For instance, “a showing of parallel business behavior is admissible circumstantial evidence from which the fact finder may infer agreement” in a Sherman Act conspiracy case.97 While

effects, such limitations are lawful when reasonable and not subject to automatic condemnation." Business Electronics Corp. v. Sharp Elecs. Corp., 485 U.S. 717, 746 (1988) (quoting 7 P. Areeda, Antitrust Law § 1457, 174-75 (1986)). 93 See Northwest Wholesale Stationers, Inc. v. Pac. Stationery & Printing Co., 472 U.S. 284, 296 (1985). 94 One rare successful challenge under the rule of reason is found in Polygram Holding, Inc. v. FTC, 416 F.3d 29 (D.C. Cir. 2005), a case that is indicative of the difficulties plaintiffs face under Post-Chicago School antitrust rules. In that case the FTC challenged an agreement between competing record companies to suspend advertising and discounting of two record albums temporarily during the launch period for a jointly-produced recording. The court affirmed the FTC’s application of the rule of reason to the challenged agreement, even though it involved competitors agreeing not to put specific products on sale for a period of time – a collusive restriction on price and advertising that in an earlier era probably would have met with per se condemnation. 95 15 U.S.C. § 2 (1952). 96 15 U.S.C. § 1 (1952). 97 Bell Atl. Corp. v. Twombly, 550 U.S. 544, 554 (2007).

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such parallel conduct alone is not enough to support a conspiracy complaint,98 the potential exposure to antitrust remedies can discourage firms in an oligopolistic market from acting as freely as they might in a more competitive one. This holds particularly true if firms interact through trade associations or in other contexts that would add to the inference of agreement.99 Thus, antitrust law imposes certain burdens on monopolists and oligopolists, and, to this limited extent, can be seen as disfavoring these market structures. However, it is one thing to demand higher standards of conduct in monopolistic and concentrated markets, and quite another to discourage the existence of big firms. First, size and market power are not the same thing, such that many big firms do not have market power that would even implicate the constraints of heightened antitrust scrutiny. These constraints apply to some big firms, but not all, and also can apply to small firms. Indeed, monopolies can be large, but they also can be small by any measure, such as a monopoly held by virtue of a patent over a small but essential input, or in a market that can sustain only a single small seller, such as the local baker in a village without any others.100 More importantly, the possibility of encountering more stringent antitrust conduct rules would not plausibly lead firms to control their own size. The economic inducements for growth and market power are compelling, and, in some cases, vast size can be obtained without even implicating antitrust rules, such as by conglomerate or out-of-market acquisition activity. It seems unlikely that a firm would decide, for example, to forego an opportunity to increase its size and market share on the thin ground that doing so would require it to exercise more caution when attending trade association meetings. Market extension combinations that do not even implicate antitrust rules have fueled growth in key sectors of the economy. The banking industry, one that is central to the too-big-to-fail crisis, provides an excellent example. The banking industry transformed itself from relatively small and local enterprises to global giants through merger activity and relaxed regulation. Between 1980 and 1999, the number of commercial banks declined from approximately 15,000 to just 9,000. The trend toward concentration continued into the new century. At the end of 2000, there were 397 banks with assets of $1 billion or more; by mid-2009 there were 136 more of these large banks, and at the same time, the total number of commercial banks dropped by approximately 1,320 banks.101 The concentration of the banking industry provoked almost no antitrust intervention. Bank mergers implicate antitrust laws only when they combine competing

98 See id. 99 See e.g., Petruzzi's IGA Supermarkets, Inc. v. Darling-Delaware Co., Inc., 998 F.2d 1224 (3rd Cir. 1993)

(noting that a range of circumstantial evidence can show collusion; “[f]or example, have they

attended meetings or conducted discussions at which they had the opportunity to conspire…?”) 100 See Mitchel v. Reynolds, 24 Eng. Rep. 347 (K.B. 1711). 101 FDIC “Statistics on Banking,” available at http://www2.fdic.gov/SDI/SOB/.

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banks with overlapping geographic reach.102 The biggest bank mergers often involved little in the way of competitive overlap and were waived through by antitrust and banking regulators without conditions or with minimal divestitures imposed as conditions for these approvals.103 Thus, antitrust does not deter the existence of big firms by treating those with market power somewhat differently than those without it. What is missing from antitrust is any real discipline against the vast attenuated size and shape of the too-big-to-fail company. Antitrust law contains no prohibition against size, and, instead, modern antitrust law probably coddles, more than it impedes, corporate expansion. (ii) The Self-Inflicted Wound Problem The second difficulty with resorting to antitrust law to prevent colossal failures is that antitrust conduct standards do not restrict risk taking activity, even if the risks are obviously ill-advised. A violation of antitrust law inflicts a wound on consumers and perhaps on rivals, but not on the actor. All aspects of antitrust law prohibitions concur in this respect. For example, monopoly law prohibits certain forms of predatory and exclusionary conduct by dominant firms that harm consumers and market competition by weakening or destroying the monopolist’s rivals or preventing their emergence into the marketplace.104 Merger prohibitions seek to prevent the acquisition of monopoly power

102 For example, the proposed merger of PNC Financial Services Group, Inc. with

National City Corporation was approved by the Antitrust Division of the United States Department of Justice on the condition that the parties divest a total of 61 branches in western Pennsylvania with approximately $4.1 billion in deposits, as well as certain middle-market lending operations of National City Bank in the region. Thus, in the area of their most significant competitive overlap, the merger implicated antitrust rules pertaining to mergers and triggered the imposition of the divestiture remedy. Even with this structural remedy, however, the merger created the nation’s fifth largest bank with $289 billion in assets and about $180 billion in total deposits. The $4.1 billion divestiture represented only a little more than 2% of the merging parties aggregate deposits. See Press Release, United States Department of Justice, Justice Department Requires Divestitures in Acquisition of National City Corporation by PNC Financial Services Group (Dec. 11, 2008), available at http://www.justice.gov/atr/public/press_releases/2008/240315.pdf. 103 See generally, Yomarie Silva, Developments in Banking and Financial Law: 2008-2009: The Credit

Crisis of 2008: XII The “Too Big to Fail” Doctrine and the Credit Crisis, 28 REV. BANKING &

FIN. L. 115 (2009).

104 “The conduct that § 2 brands as anticompetitive must… cause or threaten harm to consumers

from lower market output, higher prices, reduced innovation, or some other indicator of diminished

competitiveness.” P. E. Areeda and H. Hovenkamp, Fundamentals of Antitrust ¶ 6.04 (2003).

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for the same ultimate purpose.105 Similarly, conspiracy antitrust prohibitions target the combined exercise of market power to harm competition.106 No antitrust prohibition directs itself against harm a firm inflicts on itself.107 Rather, antitrust economics proceeds on the assumption that all firms seek to maximize profits. In order to maximize profits, firms must decide how much to produce and sell, and how to produce and sell it – that is, they must decide how to compete. If a firm decides to take a risk in that endeavor, antitrust courts will not second-guess it to block the taking of that risk ex ante or to punish it ex post. Antitrust fosters competition only by keeping it open, not by preventing it or directing companies in how to succeed or at least avoid failure. The too-big-to-fail firm threatens the economy by virtue of wounds it inflicted upon itself, rather than by virtue of wounds it inflicted on others for its own advancement. Thus, the essential feature of a firm that has become too big to fail is that it has somehow threatened its own economic survival, generally by taking ill-advised risks or pursuing a disastrous business strategy. If such a firm fails, it is, by definition, inefficient in the sense that the resources dedicated to the firm produced poor results. However, supporting an inefficient participant’s existence in a market and averting its failure serves no antitrust objectives, even when the failure of such a firm would harm consumers by eliminating that firm’s rivalry. If, instead, such a firm exits its market, thereby leaving its last standing rival with a monopoly, it is not the case (nor should it be) that the exiting firm violated the antitrust laws by closing up shop. True, its conduct created a monopoly, but it created a monopoly in another firm rather than for itself. Yet, absent a collusive deal in which the firm receives payment to exit the market, the mere act of departure is not illegal. To hold otherwise would impose a sort of Iron Curtain around markets, forbidding departures on pain of civil or even criminal prosecution. Thus, antitrust law is directed at conduct that harms other firms, and not self-inflicted wounds that characterize the too-big-to-fail firm. This creates a moral hazard problem, spurring the firm that is too big to fail to take risks that fall on someone other than the 105 See, Horizontal Merger Guidelines of the U.S. Dept. of Justice and Federal Trade Comm’n (2010)

§1 (“[M]ergers should not be permitted to create, enhance, or entrench market power or to facilitate

its exercise... A merger enhances market power if it is likely to encourage one or more firms to raise

price, reduce output, diminish innovation, or otherwise harm customers as a result of diminished

competitive constraints or incentives.”)

106 See, e.g. U.S. v. Socony-Vacuum Oil Co., 310 U.S. 150, 223 (1940)(Holding that the Sherman Act is

directed, among other things, against combinations of power to control prices even in a “substantial

part of the commerce in [a] commodity.”) 107 Some antitrust violations involve agreements that restrict the freedom of firms to expand their market share by competing, and in some sense thus involve what might be regarded as self-inflicted harm. A market allocation or similar such restraint, however, is intended on balance to be profitable for the conspirators, and so impose no net harm on them. The too-big-to-fail firm is one that is approaching collapse, and antitrust rules do not prohibit companies from collapsing.

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firm, and also leading to excessive and inefficient risk taking. However, antitrust law is simply not directed at preventing even mindless leaps toward profits, even if the results of such conduct may very well inflict catastrophic consumer harm. (iii) The Incipiency Problems A final problem with the application of existing antitrust rules to the too-big-to-fail problem is the incipiency issue. Mostly, antitrust law applies post hoc to condemn past conduct that has already interfered impermissibly with competitive markets. Furthermore, standing and antitrust injury remedial standards for private litigation require proof that both the marketplace and the plaintiff suffered harm.108 Thus, most antitrust prohibitions do not reach incipient problems at all, and those few that do only apply to likely or probable violations. For example, the standard for assessing most claims under Section 1 of the Sherman Act, the Rule of Reason, evaluates whether concerted action has had a net anticompetitive effect taking into account the history and nature of the restraint.109 This standard scrutinizes alleged offenses under Section 1 for past actual effects rather than projected future effects. There are, of course, antitrust statutes applicable to prevent incipient harm. Section 7 of the Clayton Act prohibits any transaction “where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.”110 It seeks to forestall anticompetitive mergers “in their incipiency,” before their effects occur, and thus requires a prediction about the merger’s impact on future competition.111 Proving a Section 7 violation does not require showing that a merger has caused higher prices in the affected market, but, rather, “that the merger create an appreciable danger of such consequences in the future. A predictive judgment, necessarily probabilistic and judgmental rather than demonstrable is called for.”112 Section 5 of the Federal Trade Commission Act also has prospective as well as post hoc reach.113 It has long been established that the FTC can challenge as an unfair method of competition prohibited by Section 5 any conduct that would be unlawful under the antitrust laws, as well as conduct that threatens to become a violation. Thus, in FTC v. Motion Picture Advertising Servs. Co.,114 the Supreme Court concluded that the Commission can proceed under Section 5 to prohibit in their incipiency practices that threatened to become a Sherman Act violation

108 Atlantic Richfield Co. v. USA Petroleum Co., 495 U.S. 328 (1990). 109 Leegin Creative Leather Prods. v. PSKS, Inc., 551 U.S. 877, 880 (2007). 110 15 U.S.C.A. § 18 (2010). 111 See United States v. Phila. Nat’l Bank, 374 U.S. 321, 362 (1963). 112 Hosp. Corp. of Am. v. FTC, 807 F.2d 1381, 1389 (7th Cir. 1986). 113 15 U.S.C.A. § 45 (2010) (“(1) Unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce, are hereby declared unlawful.”) Subsection (2) empowers the Commission to “prevent persons… from using unfair methods of competition….” but excludes, among other industries, banking from the reach of this power. 114 344 U.S. 392, 394 (1953).

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when fully grown. Subsequently the Supreme Court has repeatedly upheld Commission challenges under Section 5 without requiring proof of market power or anticompetitive effects, affirming the FTC’s “power under § 5 to arrest trade restraints in their incipiency.”115 Finally, the prohibition against attempted monopolization in Section 2 of the Sherman Act reaches incipient problems, condemning conduct that presents a dangerous likelihood of successful monopolization.116 As Justice Holmes observed in Swift & Co. v. United States:

Where acts are not sufficient in themselves to produce a result which the law seeks to prevent — for instance, the monopoly — but require further acts in addition to the mere forces of nature to bring that result to pass, an intent to bring it to pass is necessary in order to produce a dangerous probability that it will happen . . . But when that intent and the consequent dangerous probability exist, this statute, like many others and like the common law in some cases, directs itself against that dangerous probability as well as against the completed result.117

A too-big-to-fail problem is one of layered contingencies. As explored above, one element of a too-big-to-fail problem is the broader economic context in which a company’s imminent threatened failure occurs. At the time when firms like AIG and Bear Sterns were rescued, many other economic problems of national scope had already accumulated before the bail-out decisions had to be made.118 It is uncertain, if not doubtful, whether the bailout of any single firm would have been considered a pressing need had the surrounding circumstances been less threatening. In any event, a firm is only in the requisite sense too-big-to-fail if it is very big and deeply integral to broader economic activity that depends upon it, and also if there are economic conditions surrounding the corporate crisis rendering the imminent failure unacceptably catastrophic. If AIG was too big to allow its demise in the fall of 2008 when these problems coalesced, was it also “too big” during the housing boom that was in full bloom just months earlier? Had it failed in 2006, would the United States have had any reason to intervene to prevent collapse? At what point along the pathway toward a full-blown catastrophe does the incipient problem become palpable enough to raise the specter of bail-outs or some alternative governmental intervention? By the same token, at what point could antitrust intervention, if it is available, be expected to kick in? The point of intervention would not be to punish or exact damages, but to prevent catastrophe. However, any intervention, whether from antitrust or other sources, would face significant difficulties anticipating the contingencies involved, including the potential for an adverse turn of events in the broader economic context and the likely effects of a particular company’s interrelations with others in the event that it failed. Moreover,

115 Spectrum Sports, Inc. v. McQuillen, 506 U.S. 447, 455 (1993). 116 Swift & Co. v. United States, 196 U.S. 375 (1905). 117 Id. at 396. 118 EDWARD V. MURPHY, Cong. Research Serv., RS22963, FINANCIAL MARKET INTERVENTION

FAQ 2-4 (2008).

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antitrust law, in particular, is limited by various doctrines that preclude intervention based on speculation.119 Even the antitrust statutes with some preventive reach are of limited use in forestalling a catastrophic business collapse because the narrow range of possibilities against which Post-Chicago substantive antitrust guards barely overlaps with the possibilities that a catastrophic potential failure portend. For antitrust incipiency statutes to intervene to avert a too-big-to-fail scenario would require an imminent threat of the right sort. Under existing antitrust laws that are based on Post-Chicago assumptions, it is theoretically possible that intervention could happen, but it will be the unusual case to be sure. Section 2’s prohibition against attempted monopolization seems of no possible application outside the coincidental circumstance in which a very big company is both headed for a train wreck and happens, at the same time, to be conducting its business with an unlawful intent and likely effect of maintaining or creating a monopoly. This case will be the exceptional circumstance almost by definition: a company is unlikely to become a monopoly at the same time as it is likely to fail. The more plausible candidates for intercepting a too-big-to-fail failure are Section 5 of the FTC Act and Section 7 of the Clayton Act. (iv) The Current Reach of Section 5 of the FTC Act Is it, or could it be, a violation of Section 5 for a company to engage in some form of risky conduct that poses a threat to its own survival and a strong possibility of governmental protection or bail out? If so, at what point in time along the continuum of events would that conduct rise to the level of an “unfair method of competition”? Is it “unfair” in the requisite sense for a firm to take unreasonable risks that its smaller rivals cannot afford to take given an imbalance in the likelihood of governmental rescue for the “too big” company? Section 5 is an adaptable statute by its nature. It proscribes “unfair methods of competition,” which the Supreme Court has found to be a concept that is “flexible ... with

119 For example, causation and standing in antitrust jurisprudence are restrictive concepts, limiting

damage claims to plaintiffs whoe injury is direct. In Assoc. General Contractors of California, Inc. v.

California State Council of Carpenters, 459 U.S. 519 (1983), the Court held that a union lacked standing to

challenge a boycott against unionized firms on the ground that the injury was too indirect and

speculative, notwithstanding that there was not real doubt that the boycott had injured union firms.

See. Sullivan and Grimes, supra at p.925. Similarly, the indirect purchaser damages exclusion

established in Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977) denies a damages remedy to indirect

purchasers from a price-fixing cartel again without serious doubt that downstream customers are

often harmed, but out of concern for burdening federal courts with imponderable antitrust damages

apportionment problems. Id. At 478-79.

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evolving content.”120 The Court has repeatedly held that the meaning of “unfair methods of competition” can be ascertained only on a case-by-case basis by the “gradual process of judicial inclusion and exclusion.”121 The results of judicial articulation of the concept have been inconclusive and spotty, but a few points have emerged. First, Section 5 prohibits whatever is also prohibited by the antitrust laws (subject to certain jurisdictional limitations of the FTC Act).122 However, Section 5 is not confined to conduct that violates antitrust law:

In the area of anticompetitive practices, the FTC Act functions as a kind of penumbra around the federal antitrust statutes. An anticompetitive practice need not violate the Sherman Act or the Clayton Act in order to violate the FTC Act . . . However, the scope of the FTC is nonetheless linked to the antitrust laws. The power of the Federal Trade Commission to declare anticompetitive trade practices “unfair” extends primarily to “trade practices which conflict with the basic policies of the Sherman and Clayton Acts even though such practices may not actually violate those laws.123

Thus, conduct that may fall outside the reach of antitrust laws for technical reasons may violate Section 5, such as an invitation to fix prices where no agreement to do so is actually formed.124 Moreover, since as long ago as 1972, the Supreme Court has held that conduct that does not implicate antitrust law or policy may fall within the potential reach of Section 5:

Thus, legislative and judicial authorities alike convince us that the Federal Trade Commission does not arrogate excessive power to itself if, in measuring a practice against the elusive, but congressionally mandated standard of fairness, it, like a court of equity, considers public values beyond simply those enshrined in the letter or encompassed in the spirit of the antitrust laws.125

120 FTC v. Bunte Bros., 312 U.S. 349 (1941). 121 FTC v. Raladam Co., 284 U.S. 643, 648 (1931). 122 FTC v. Ind. Fed'n of Dentists, 476 U.S. 447, 454 (1986); United States v. Am. Bldg. Maint. Indus., 422 U.S. 271, 279 n.7 (1975); FTC v. Brown Shoe Co., 384 U.S. 316, 321-22 (1966); Times-Picayune Publ’g Co. v. United States, 345 U.S. 594, 609 (1953); FTC v. Motion Picture Adver. Serv. Co., 344 U.S. 392, 395 (1953), reh'g denied, 345 U.S. 914 (1953); FTC v. Cement Inst., 333 U.S. 683, 690, 693 (1948), reh'g denied, 334 U.S. 839 (1948). 123 Chuck's Feed & Seed Co. v. Ralston Purina Co., 810 F.2d 1289, 1292-93 (4th Cir. 1987) (dictum) (quoting Brown Shoe Co., 384 U.S. at 321). 124 See In re Quality Trailer Prods., 5 Trade Reg. Rep. (CCH) 23,247 (Aug. 11, 1992); see also In re YKK (U.S.A.), Inc., 58 Fed. Reg. 19,454 (Apr. 14, 1993), 58 Fed Reg. 41,790 (Aug. 5, 1993) (consent decree); In re AE Clevite, Inc., 58 Fed. Reg. 17,405 (Apr. 2, 1993), 58 Fed. Reg. 35,459 (July 1, 1993) (consent decree). 125 FTC v. Sperry & Hutchinson Co., 405 U.S. 233, 244 (1972).

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The sweep of Section 5’s “unfair methods of competition” has been regarded as a broad grant of authority that affords the agency power to intervene to protect the public against practices that may defy categorization. For example, a company using deceptive advertising, intentionally or not, that other companies complying with the Act do not use, creates an unfair advantage over its competitors.126 Conduct that is legally proper, such as bringing lawsuits in courts of proper venue, has been held to be an unfair method of competition where the defendants in those lawsuits were consumers who were disadvantaged by having to travel long distances to defend themselves against the plaintiff corporation’s charges.127 However, courts have imposed limitations on the scope of Section 5 in the interest of predictability, especially where the conduct is outside the reach of antitrust laws. Where “unfairness” is applied to conduct that is not measurable by unfairness standards under other statutes, “standards for determining whether it is ‘unfair’ within the meaning of § 5 must be formulated to discriminate between normally acceptable business behavior and conduct that is unreasonable or unacceptable.”128 The conduct that creates a too-big-to-fail problem can fall into an infinite variety of categories, some of which Section 5 intervention might theoretically reach. First, of course, growth is often accomplished by mergers and acquisitions. The antitrust standard for such a transaction is only implicated where market power is increased, but Section 5 could reach further. For example, the FTC might block a conglomerate merger on the ground that the scale efficiencies or other putative benefits from the combination are outweighed by looming indispensability problems, particularly if the moral hazard created by the merger gave the merging firms an unfair advantage over smaller rivals who could not rely on bailouts. The market extension mergers in the banking industry, again, provide an excellent example. Suppose that Bank A is the dominant commercial bank in Region A, and it acquires Banks B, C and D, which each dominate in their respective Regions B, C and D. By hypothesis, none of these banks competes with the others, such that the merger is not horizontal and likely does not provoke any resistance under Section 7.129 While the failure of pre-merger Bank A standing alone might pose a significant but manageable clean-up problem for the Federal Reserve System, at some point, that will no longer be the case if Bank A merges with enough dominant banks in enough geographic markets. Eventually, market extension mergers can and do create banks that cannot be allowed to fail. If it is additionally supposed that it would be economically rational for post-merger Bank A to take advantage of its too-big-to-fail status, such as by engaging in high-risk-high-return lending on a global scale with the expectation of federal rescue if risks materialize, is that an “unfair method of competition”? If so, are the mergers that

126 Montgomery Ward & Co. v. FTC, 379 F.2d 666, 672 (7th Cir. 1967). 127 Spiegel, Inc. v. FTC, 540 F.2d 287, 294 (1976). 128 E. I. Du Pont de Nemours & Co. v. FTC, 729 F.2d 128, 139 (2d Cir. 1984). 129 For purposes of antitrust analysis, geographic market extension mergers are essentially no different from product market extension mergers. In 1998, for example, Citi Group acquired Travelers, extending its banking business into the business of insurance.

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position Bank A to engage in that unfair method of competition also unfair, or is it too speculative even for the incipiency standards of Section 5? There is no case authority to resolve this, but at least one current Commissioner controversially believes that Section 5 plausibly applies.130

(v) Consolidation, Efficiency and the Current Reach of Section 7 of the Clayton Act

Section 7 of the Clayton Act,131 containing the principal federal statutory provision governing mergers, provides that:

No person engaged in commerce or in any activity affecting commerce shall acquire, directly or indirectly, the whole or any part of the stock or other share capital and no person subject to the jurisdiction of the Federal Trade Commission shall acquire the whole or any part of the assets of another person engaged also in commerce or in any activity affecting commerce, where in any line of commerce or in any activity affecting commerce in any section of the country, the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly.

As currently understood, Section 7 of the Clayton Act represents no particular objection to size, and instead concerns itself with combinations that create market power or facilitate its exercise. Policy makers have sometimes toyed with the idea of limiting mergers of large and leading companies, but those proposals have not been implemented or enacted into law.132 Indeed, the failed attempts to outlaw mergers exceeding specified size thresholds make clear that existing law does not prohibit such transactions.133 Section 7 instead limits aggregations of market power, rather than size – and the two do

130 See Rosch, supra note 9, at 8. 131 15 U.S.C. § 18 (2010). 132 See, e.g., Phil C. Neal, REPORT OF THE WHITE HOUSE TASK FORCE ON ANTITRUST POLICY, 115 CONG. REC. 13,890 (1969) (recommending limiting certain acquisitions by firms having $250 million in sales or $500 million in assets of leading firms in concentrated markets; in 1979 a bill was introduced in the Senate that would have prohibited mergers between a companies with sales or assets exceeding $2 billion as well as smaller mergers in concentrated markets); Donald I. Baker & Karen L. Grimm, S. 600 – An Unnecessary and Dangerous Foray into Classic Populism, 40 OHIO ST. L. J. 847 (1979). 133 In response to the current crisis, legislation has been proposed to enable regulators to dismantle or impose discipline on any firm that poses a too-big-to fail risk. A proposal by Congressman Kanjorski of Pennsylvania would empower a newly-created financial industry regulatory Council to make determinations about the size, scope of operations, business relationships and interconnectedness, and mix of activities of the largest financial services businesses and to impose, among other things, divestiture to unaffiliated companies upon a finding of systemic risk. This provision would not amend Section 7 but might cast a different light on it. H. Amdt. 527, 111th Cong. (2009) (unenacted).

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not correlate. Conglomerate mergers can be very large without affecting concentration in any relevant economic market, and thus very large mergers are permitted in very large markets. The most influential interpretation of this broadly-worded statute is embodied in federal agency guidelines rather than judicial opinions, largely because the Supreme Court has only rarely taken cases that would allow it to expand on the statute’s meaning.134 As the Merger Guidelines make clear at the outset: “The unifying theme of the Guidelines is that mergers should not be permitted to create or enhance market power or to facilitate its exercise. . . . [T]he result of the exercise of market power is a transfer of wealth from buyers to sellers or a misallocation of resources.”135 The evaluation of the legality of a merger under the 1992 Guidelines, which is also generally followed by the courts, proceeds by defining the relevant markets in which the transaction may increase concentration and then by measuring its concentration effects, taking certain defenses and justifications into account as to transactions that otherwise exceed stated permissible concentration thresholds. Nothing in the case law or the 1992 Guidelines addresses the problem of unwieldy size or the possibility that the resulting firm might wield intolerable political power or present unacceptable risks of its own failure. Size does not constitute a valid basis for disapproving a merger under the Guidelines analysis, and so it is no surprise to find that mergers of enormous size are routinely approved by antitrust enforcers and federal courts applying Section 7. One increasingly important defense is the presence of merger-specific efficiencies, since scale efficiencies are often articulated as a motivation for many mergers. At one time, efficiencies justifications for mergers were largely ignored on the ground that even the most anticompetitive transactions will create some efficiencies. In 1967, the Supreme Court held that “[p]ossible economies cannot be used as a defense to illegality. Congress was aware that some mergers which lessen competition may also result in economies but it struck the balance in favor of protecting competition.”136 Intervening years and the emergence of the Chicago School brought an increased tolerance of potential anticompetitive effects that are now regarded as potentially offset by merger specific efficiencies. In 1997, the FTC and U.S. Department of Justice expanded the efficiencies provisions of the Merger Guidelines in an effort to delineate how the agencies will evaluate claimed efficiencies and balance them against potential adverse competitive effects from mergers.137 An FTC study published in 2009 reviewed the agency’s experience with efficiencies justifications that had been proffered for mergers over a ten-

134 See MERGER GUIDELINES, supra note 43. The Supreme Court’s most recent antitrust

merger case was in 1990, and concerned remedies of private parties under Section 16 of the Clayton Act rather than substantive standards. California v. Am. Stores Co., 495 U.S. 271 (1990). 135 MERGER GUIDELINES, supra note 43, § 0.1. 136 FTC v. Proctor & Gamble Co., 386 U.S. 568, 580 (1967). 137 See MERGER GUIDELINES, supra note 43, § 4.

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year period.138 Of 118 mergers that were the subject of Bureau of Economics staff memoranda, 50 transactions presented at least one efficiency-related justification.139 Efficiencies arguments fared reasonably well at the agency, with the Bureau of Economics accepting roughly 27% of all efficiencies justifications advocated for merger transactions during the study period.140 While efficiencies of scale are considered in approving transactions, inefficiencies of scale are not, such that mergers resulting in inefficiently large scale are not disapproved on that particular ground. It is likely that at least some mega-mergers have had adverse effects on overall efficiency by creating out-sized firms. However, antitrust hardly puts in place an “inefficiency filter” to block big mergers that do not create or enhance the exercise of market power even if the merged firm is simply unwieldy. For example, certain high-profile mega-mergers have proved to have been ill-conceived and inefficient, such as AOL’s $182 billion merger with Time Warner in 2001. The combination was touted as creating a digital media powerhouse with the potential to reach every American with a computer or a television set. The FTC approved the merger under a consent decree that sought to prevent Time Warner from exploiting market power in broadband by discriminating or denying access in connection with its cable system,141 which serviced roughly 20% of U.S. households.142 The concept of the merger proved to be so ill-advised that within five years Time Warner could not find a buyer for AOL and was forced to spin off the failed internet access and online advertising business.143 The combined assets did not work efficiently together. One can of course debate whether the FTC’s ex ante review (or the parties themselves) should have anticipated the inefficiencies inherent in that transaction, but, even if it had, current antitrust law would have offered it no ground on which to oppose the transaction. At least some scholarly support exists for the proposition that many mega-mergers in the United States and globally in recent years have created outsized firms far surpassing efficient scale, resulting in unwieldy and inefficient, rather than more competitive,

138 MALCOLM B. COATE & ANDREW J. HEIMERT, FED. TRADE COMM’N, MERGER EFFICIENCIES AT THE FEDERAL TRADE COMMISSION: 1997– 2007 (2009), available at http://www.ftc.gov/os/2009/02/0902mergerefficiencies.pdf. 139 Id. at 34, tbl.1. 140 Id. at 35. Data were also reported for the Bureau of Competition, which reached substantially similar results, although there was some disparity between the two wings of the agency. Acceptance or rejection of efficiency defenses by either bureau was not necessarily reflected in the ultimate determination by the agency itself. 141 In re America Online, Inc. and Time-Warner, Inc., Agreement Containing Consent Orders, (Dec.

14, 2000)at http://www.ftc.gov/os/2000/12/aolconsent.pdf.

142 See, In re America Online, Inc. and Time-Warner, Inc , Analysis of Proposed Consent Order To

Aid Public Comment (Dec. 14, 2000), at http://www.ftc.gov/os/2000/12/aolanalysis.pdf

143 Shira Ovide & Emily Steel, It’s Now Official: AOL, Time Warner to Split, WALL ST. J., May 29, 2009,

at B1.

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enterprises. In many industries, including financial services, the minimum efficient scale has increased over time along with technological advances, deregulation and other developments. However, it seems likely that merger size has grown at a much larger rate, casting some doubt on the notion that bank mega-mergers are generally necessary to achieve scale efficiencies. As long ago as 1993, a scholarly assessment of merger activity in the banking industry concluded that x-efficiency, or managerial ability to control costs, played a substantially greater role than scale efficiencies in the overall performance of banks, and that bank mergers often did not yield any scale efficiencies at all.144 Subsequent scholarly assessments of consolidation and efficiency in financial services markets echo similar observations.145 One study concluded: “Ex post results of M&As seem to contradict the motivations given by practitioners for consolidation, which are largely related to issues of economies of scale and scope and to improvements in management quality.”146 Mega-mergers are more or less routine, and have rarely been blocked by antitrust agencies, at least not since the much-disparaged cases like Von’s Grocery three decades back.147 In 2008, for example, Anheueser-Busch’s $52 billion acquisition by InBev topped the list of mergers exceeding $2 billion. 148 Notwithstanding credible arguments that some mega-mergers deliver scale inefficiencies, Section 7 does not put the courts or agencies in a position to second-guess the desirability of a merger that is otherwise lawful. Horizontal mergers of enormous size are not objectionable under current standards, which are quite relaxed by comparison with historic standards or even standards imposed in certain other jurisdictions. Furthermore, by definition, conglomerate mergers do not aggregate horizontal market power and are essentially beyond the reach of Post-Chicago antitrust law. Conglomerate mergers, therefore, can create behemoth enterprises of ungainly and inefficient proportions with impunity. An efficiencies defense might be of interest for certain horizontal mergers, but no defense based on efficiency or otherwise is required, or even relevant, to a merger that does not increase concentration or pose a vertical foreclosure problem. Conglomerate and market extension mergers do neither. Thus, the existing antitrust law approach to mergers and acquisitions could do almost nothing to prevent the accumulation of

144 See Dean Amel et al., Consolidation and Efficiency in the Financial Sector: A Review of the International Evidence, Aug. 2002), available at www.federalreserve.gov/pubs/feds/2002/200247/200247pap.pdf. 145 See id. 100 See id. at 42. 147 United States v. Von’s Grocery Co., 384 U.S. 270 (1966). 148 See, Dept. of Justice Press Release approving merger with modifications, available at www.justice.gov/opa/pr/2008/November/08-at-1008.html. For a summary of data on mergers and acquisitions ranked by size see Institute on Mergers, Acquisitions and Alliances Statistics, available at http://www.imaa-institute.org/statistics-mergers-acquisitions.html. See also JOHN WILLIAMSON, Cong. Research Serv., R40447, LARGEST MERGERS AND ACQUISITIONS BY CORPORATIONS IN 2008 2 (2009).

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resources into a poorly positioned firm whose own failure would also risk broader systemic failure. Therefore, Post-Chicago antitrust is not a public policy weapon of much use in preventing too-big-to-fail problems. As a general matter, Post-Chicago theory concerns itself more with over-deterrence than under-deterrence, embodies laissez faire tendencies relying on markets to self-correct, and, most importantly, applies antitrust law to enhance allocative efficiency to the virtual exclusion of other societal values. The too-big-to-fail problem barely intersects with the problem of optimizing allocative efficiency and, for the same reason, barely invites antitrust intervention of any sort. The only limitation on this conclusion is the possibility that Section 5 of the FTC Act might sometimes be invoked to prevent or dismantle an out-sized merger that created a substantial likelihood of “unfairness,” based on a rational economic expectation that the merged firm would operate under presumed bail-out protection. 4. Could Antitrust Law Help? Since Post-Chicago antitrust has very little to contribute in combating the too-big-to-fail problem, the natural question becomes: could antitrust do a better job without doing violence to fundamental doctrine? Responding to this question presents particular difficulty because what “fundamental antitrust doctrine” comprises has never been altogether clear. Indeed, antitrust doctrine has shifted around over time. However, at one time, antitrust had a broader reach than it currently does, and the very dynamism of antitrust law could theoretically free up courts to restore some or all of that earlier reach, or perhaps even give antitrust another new face, as was done by the Chicago School revolution. Also, whatever “fundamental antitrust doctrine” means, it ought to at least include the important and uncontroversial advances that the law made in response to advances in the field of economics. For example, “restoring” antitrust should not entail reversing course to re-declare all vertical territorial exclusivity agreements per se illegal because the potential efficiencies from such arrangements are uncontroverted. Contrastingly, “restoring” the law’s original distrust of highly concentrated market structures would not ignore any important or uncontroversial advances in economics. If, as is probably the case, many too-big-to-fail companies are in markets that are highly concentrated (the measurement of which, in turn, might be open to redesign), then perhaps prophylactic antitrust rules could be fashioned to forestall at least some systemic failures. Given the very high costs of the recent systemic failures, it might be worth imposing such newly-fashioned antitrust rules even at some more modest expense in terms of efficiency. Moreover, efficiency claims made by some too-big-to-fail firms lack much empirical support or even prima facie plausibility, and so the social costs of dismantling a few potentially catastrophic firms may be less than advertised in some quarters. Finally, there is no reason in principle why antitrust must remain rigidly devoted to economics-based policy as its sole source of direction. There is also a substantial difference between preventing and curing too-big-to-fail problems. Even current antitrust law ought to help make corrections when markets have

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failed. It is not surprising that the Assistant Attorney General for Antitrust, Christine Varney, concluded in the midst of the recent crisis that: “First, there is no adequate substitute for a competitive market, particularly during times of economic distress. Second, vigorous antitrust enforcement must play a significant role in the Government's response to economic crises to ensure that markets remain competitive.”149 As Professor Maurice Stucke observes (echoing many others), “antitrust enforcement is not a luxury reserved for more prosperous times.”150 Thus, antitrust might play an important curative role after a too-big-to-fail crisis. Moreover, if restoring competition in the wake of collapse is an important public policy tool for redressing the problem, it also seems well worth considering whether the enforcement of competition law in advance of a collapse might play a preventative role. a. Harnessing the Dynamism of Antitrust Antitrust law cannot help avert the need for too-big-to-fail bailouts unless it adapts to address some of the sources of the problem. However, antitrust is a legal system whose rules are formed and applied with very specific reference to the policies underlying the law. Those policies have proved to be subject to dramatic changes over time in response to evolutions in the economy, developments in the related field of economics, and trends in society and politics. As policies have changed, so have antitrust rules. Therefore, there is no reason to believe that antitrust law has settled once and for all upon Post-Chicago policy and theory. Indeed, the history of antitrust policy is instructive as to this unlikelihood. The public policies embodied in the nation’s antitrust laws have never been precisely clear, but, clearly, antitrust policy has been anything but stagnant. While some adherents of the Chicago School have advocated an exclusive focus on consumer welfare, defined as allocative efficiency, the courts, including the Supreme Court, have never gone that far.151 Moreover, antitrust policy has undergone broad historic shifts. It evolves, sometimes through legislative reform, sometimes by judicial reinterpretation, and at other times by policy statements of federal and state enforcement agencies. Indeed, United States antitrust law has had a rich and varied history in Congress, the courts and enforcement agencies. A detailed tracing of shifts in policy underpinnings through time is complex and beyond the scope of this article,152 but it is important here to understand how modern antitrust law came to sharpen and narrow its focus on the objective of allocative efficiency, or consumer welfare, and how momentous a policy shift was required to bring us to the narrow Post-Chicago approach.

149 “Vigorous Antitrust Enforcement ina Challenging Era,” Remarks of Christine A. Varney as Prepared for the Center for American Progress ,May 11, 2009, available at http://www.justice.gov/atr/public/speeches/245711.pdf. 150 Maurice E. Stucke, New Antitrust Realism 20 (Univ. of Tenn. Legal Studies Research, Paper No. 1323815, 2009), available at http://ssrn.com/abstract=1323815. 151 HERBERT HOVENKAMP, FEDERAL ANTITRUST POLICY: THE LAW OF COMPETITION AND ITS PRACTICE 56 – 77 (4th ed. 2005). 152 For an interesting summary of the evolution of antitrust policy, see id.

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Antitrust as a legislative response to large enterprise has a particularly significant and uneven history. While the current policy devotion to allocative efficiency regards bigness in a neutral or positively favorable manner, antitrust policies of an earlier era viewed the presence of large corporations as posing a variety of dangers to our economy. The early sweeping construction of the Sherman Act mirrored the prevailing public fear and mistrust of large corporations.153 In fact, the name “antitrust” derives from the peculiar form of business organization, the “trust,” that was used to aggregate large business enterprises under unitary control, in circumvention of the constraints of 19th Century state corporations codes154. Early in the 20th century, the Supreme Court overruled Trans-Missouri Freight and introduced the “rule of reason” in its controversial Standard Oil decision, which was perceived at the time as limiting the reach of the law – although notably the decision broke apart the Standard Oil trust.155 A few years later, in 1914, Congress passed what many regarded as remedial legislation in the Clayton Act.156 In the 1921 decision of United States v. American Can Co., the District Court reaffirmed the prevailing view that antitrust law was designed to address “a public danger” from big business, and a preference, therefore, for smaller business:

If it be true that size and power, apart from the way in which they were acquired, or the purpose with which they are used, do not offend against the law, it is equally true that one of the designs of the framers of the Anti-Trust Act was to prevent the concentration in a few hands of control over great industries. They preferred a social and industrial state in which there should be many independent producers. Size and power are themselves facts some of whose consequences do not depend upon the way in which they were created or in which they are used. It is easy to conceive that they might be acquired honestly and used as fairly as men who are in business for the legitimate purpose of making money for themselves and their associates could be expected to use them, human nature being what it

153 See United States v. Trans-Missouri Freight Ass'n, 166 U.S. 290 (1897). 154 LAWRENCE A. SULLIVAN & WARREN S. GRIMES, THE LAW OF ANTITRUST: AN INTEGRATED

HANDBOOK, 6 (2000); 155 Standard Oil Co. of N.J. v. United States, 221 U.S. 1 (1911). The Court in Standard Oil sustained a decree that required the dismantling of the Standard Oil trust, but the rule of reason announced in the case was regarded by Progressives and others as weakening the law. Justice Harlan’s dissent exclaimed that “the action of the court in this case might well alarm thoughtful men who revered the Constitution.” Id. at 104. 156 In the presidential election of 1912, antitrust was an important issue that brought sometimes fierce debate among Woodrow Wilson, William Howard Taft and Theodore Roosevelt. Once elected, President Wilson pressed for the enactment of the Clayton Act (15 U.S.C. § 12 et seq.). See J.P. MILLER, Woodrow Wilson’s Contributions to Antitrust Policy, in THE PHILOSOPHY AND POLICIES OF WOODROW WILSON, 132 et seq. (Earl Latham ed., 1958).

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is, and for all that constitute a public danger, or at all events give rise to difficult social, industrial and political problems.157

In the decades following, enforcement priorities were mixed, with relatively lax regulation of industrial concentration,158 but more aggressive enforcement against certain forms of unfair or exclusive conduct, such as resale price maintenance,159 exclusive dealing,160 and anticompetitive trade association activity.161 In the 1930s and 1940s, following a brief relaxation of antitrust rules under the Codes of Fair Competition,162 federal antitrust enforcement expanded to attack monopolies,163 vertical integration,164 and various forms of tacit collusion.165 At its extreme, the preference for small enterprise was embodied in the enactment of the Robinson-Patman Act.166 Beginning around 1950, with the enactment of the Celler-Kefauver amendments to the Clayton Act,167 federal antitrust policy became explicit in regarding large enterprise with some degree of suspicion. In Brown Shoe Co. v. United States, the Supreme Court explained the Celler-Kefauver amendments as stemming from “a fear of what was considered to be a rising tide of economic concentration in the American economy,” and recited an array of public policies behind that enactment, including economic efficiency, inherent dangers of unchecked corporate expansion, desirability of local control over industry, protection of

157 United States v. American Can Co., 230 F. 859, 902 (D. Md. 1916), appeal dismissed 256 U.S. 706 (1921). Despite the court’s recognition of these policy concerns about “size and power” it went on to withhold the government’s requested decree to break up the company because however large and powerful it was, the defendant had not misbehaved. “[Congress] has not yet been willing to go far in the way of regulating and controlling corporations merely because they are large and powerful, perhaps because many people have always felt that government control is in itself an evil, and to be avoided whenever it is not absolutely required for the prevention of greater wrong.” Id. 158 See, e.g., United States v. U.S. Steel Corp., 251 U.S. 417 (1920). 159 See, e.g., Dr. Miles Medical Co. v. John D. Park & Sons Co., 220 U.S. 373 (1911); United States v. Colgate & Co., 250 U.S. 300 (1919); United States v. A. Schrader’s Son, Inc., 252 U.S. 85 (1920); FTC v. Beech-Nut Packing Co., 257 U.S. 441 (1922). 160 See, e.g., FTC v. Sinclair Refining Co., 261 U.S. 463 (1923). 161 See, e.g., Bd. of Trade of Chicago v. United States, 246 U.S. 231 (1918); Am. Column & Lumber Co. v. United States, 257 U.S. 377 (1921); Maple Flooring Manufacturers’ Ass’n v. United States, 268 U.S. 563 (1925). 162 The Codes of Fair Competition under the National Recovery Administration (“NRA”) provided an avenue for antitrust exemptions for corporations that complied with the standards set out. See ELLIS W. HAWLEY, THE NEW DEAL AND THE PROBLEM OF MONOPOLY (1966). The NRA and the Codes of Fair Competition barely took effect before losing public support and eventual condemnation by the Supreme Court in A.L.A. Schechter Poultry Corp. v. United States, 295 U.S. 495 (1935). 163 See, e.g., United States v. Aluminum Co. of Am., 148 F.2d 416 (2d Cir. 1945). 164 See, e.g., United States v. Paramount Pictures., 334 U.S. 131 (1947). 165 See, e.g., Interstate Circuit v. United States, 306 U.S. 208 (1939). 166 15 U.S.C. § 13(a) 167 15 U.S.C. § 12-27, amended by 29 U.S.C. §§ 52-53 (1950).

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small business, and “the threat to other values” aside from economic ones.168 Influential economists in the 1950s and 1960s fueled the most aggressive period of antitrust enforcement against industry concentration, believing that market structure drove marketplace performance, ultimately culminating in the 1968 Justice Department Merger Guidelines.169 In addressing the too-big-to-fail issue, it is thus important to recognize that as recently as the 1970s, the antitrust laws were still understood by at least the courts and some leading scholars to promote a rich mix of social, political and economic objectives.170 These included, among others: advancing economic efficiency, innovation and consumer welfare; the protection of individual traders and their business freedom against certain kinds of private interference; the prevention of antidemocratic political pressures that might flow from concentrations of economic power and wealth; limiting wealth transfers from consumers to monopolies and cartels; and (at various times and in varying degrees) limiting the growth of big business as an end in itself.171 Walter Adams and James W. Brock wrote in 1991:

The primary purpose of antitrust is to perpetuate and preserve a system of governance for a competitive, free enterprise economy. Efficiency and consumer welfare constitute ancillary benefits that are expected to flow from a system of economic freedom. Like the U.S. Constitution, antitrust is concerned primarily with process and only secondarily with outcomes. Antitrust calls for a dispersion of power, buttressed by built-in checks and balances, to guard against the abuse of power and to preserve not only individual freedom, but also more importantly a free system. Antitrust is founded on a theory of hostility toward private concentration of power so great that even a democratic government can be entrusted with it only in exceptional circumstances.172

168 Brown Shoe Co. v. United States 370 U.S. 294, 315-16 (1962). 169 See, e.g., U.S. DEP’T OF JUSTICE, HORIZONTAL MERGER GUIDELINES (1968), available at http://www.justice.gov/atr/hmerger/11247.pdf. See generally, CARL KAYSEN & DONALD F. TURNER, ANTITRUST POLICY: AN ECONOMIC AND LEGAL ANALYSIS (1959); JOE S. BAIN, BARRIERS TO NEW COMPETITION: THEIR CHARACTER AND CONSEQUENCES IN MANUFACTURING INDUSTRIES (1956); THEODORE P. KOVALEFF, BUSINESS AND GOVERNMENT DURING THE EISENHOWER ADMINISTRATION: A STUDY OF THE ANTITRUST POLICY OF THE ANTITRUST DIVISION OF THE JUSTICE DEPARTMENT (1980). 170 See generally, LAWRENCE A. SULLIVAN & WARREN S. GRIMES, THE LAW OF ANTITRUST: AN

INTEGRATED HANDBOOK, 11-15 (2000); Pitofsky, supra n.2. 171 Id.. 172 See Walter Adams & James W. Brock, Antitrust & Enforceability: An Empirical Perspective, in REVITALIZING ANTITRUST IN ITS SECOND CENTURY: ESSAYS ON LEGAL, ECONOMIC AND POLITICAL POLICY 152-60 (Harry First et al., eds. 1991).

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Some of these policies do not seem so far removed from the too-big-to-fail problem. The preference for small over large enterprise as an end in itself bears directly on the matter. Similarly, the preference for local control over industry, the aim to protect small business men and women from oppression from gigantic corporations, and the desire to shield democratic institutions from the corrupting influence of concentrations of wealth might all speak to the problem. Indeed, it may be that the emergence of a too-big-to-fail enterprise violates every single policy, other than allocative efficiency, that has ever been mentioned in connection with the Sherman Act. Moreover, it can also be argued that even the more strictly economics-driven underpinnings of antitrust have unnecessarily disregarded the problem of corporate size by ignoring diseconomies of scale, allowing conglomerate and market extension merger activity even where consumer welfare may be harmed by shifting resources into ungainly enterprises and squandering the output, price and innovation advantages of smaller enterprise. Given the dynamism of antitrust law and policy, there is good reason to consider a new dynamic shift. b. Was the Paradox Really so Bad?

Of course, it is one thing to note that antitrust policy is dynamic enough to adapt to the too-big-to-fail problem, but quite another to conclude that it ought to adapt. Many good reasons explain why the older order of antitrust broke down and gave way to the Chicago School. However, some of those reasons now seem to have been overstated, and the antitrust “paradox” that launched the Chicago School antitrust movement has its own problems. Robert Bork successfully advocated that pre-Chicago School antitrust policy was paradoxical and “at war” with itself.173 More specifically, he argued that there had never been any policy underpinning to antitrust other than allocative efficiency and that, by embracing other policies, courts had created an internally inconsistent law that sought to promote efficiency but also rewarded inefficient firms with viable antitrust claims. However, was it really so bad for a statute with the breadth and importance of the Sherman Act to embrace multiple policies that sometimes were in tension with one another? Even if the answer is yes, which is not clear, was abandoning all antitrust policies aside from allocative efficiency really always in the best interests of consumers, or were Bork’s laissez faire achievements instead in the interests of the corporations to which consumers turn for goods and services? Finally, have laissez faire policies themselves led to the paradoxical result that government ultimately has been forced to take a greater role in the private sector?

It was an overstatement to say that antitrust never was concerned with anything except allocative efficiency or that antitrust policy never objected to large enterprise for other reasons. In fact, that assertion behind the Chicago School argument is bizarrely at odds with history. Nearly 100 years ago, Justice Harlan described the Sherman Act as arising from a universal conviction that “the country was in real danger from another kind of slavery . . . that would result from the aggregations of capital in the hands of a few.”174 That was not a statement about allocative efficiency. As discussed above, the first 100 173 See BORK, supra note 25. 174 Standard Oil Co. of N.J. v. United States, 221 U.S. 1, 83 (1911) (Harlan, J., concurring in part and dissenting in part).

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years of antitrust jurisprudence seem to contain an unwavering commitment to a number of competing policies sometimes acknowledged to be in tension with one another.

Furthermore, it is arguable that laissez faire policies indeed yielded a paradox of their own by bringing about the recent need for massive government intrusion into the private sector. In what has turned out to be a prescient warning about the perils of the then-emergent Chicago School, in 1979, Robert Pitofsky wrote:

It is bad history, bad policy and bad law to exclude certain political values in interpreting the antitrust laws. By ‘political values,’ I mean, first, a fear that excessive concentration of economic power will breed antidemocratic political pressures, and, second, a desire to enhance individual and business freedom by reducing the range within which private discretion by a few in the economic sphere controls the welfare of all. A third and overriding political concern is that if the free-market sector of the economy is allowed to develop under antitrust rules that are blind to all but economic concerns, the likely result will be an economy so dominated by a few corporate giants that it will be impossible for the state not to play a more intrusive role in economic affairs.175

This final prediction could not have been more accurate. The emergence of a few corporate giants that were left to take under-regulated risks and to grow without significant government intervention eventually forced the United States government to become the largest investor in the U.S. automobile industry, a controlling owner of some of the largest banks and other financial institutions in the country, as well as to infuse hundreds of billions of dollars into the private financial sector in the form of equity investments, loans and loan guarantees.176 The government has also injected federal funds into the home mortgage refinance marketplace to forestall foreclosures.177 All of this bail-out activity came with unavoidable pressures for governmental control over a range of private enterprise decision making, even including management compensation. Additional government intervention of a more durable sort also seems inevitable as Congress and regulatory agencies respond to a stinging public backlash against a government that is perceived (rightly or not) to have let the country’s booming economy disintegrate. Federal and state regulation addressing dozens of areas of economic activity including real estate mortgage lending practices, trading in derivatives and other securities, solvency of financial institutions, management compensation and corporate governance has been enacted or is under consideration.178 All of this can, in some

175 See Pitofsky, supra note 2, at 1051 (emphasis added). 176 See generally, Wright, Robert E. ed. Bailouts: Public Money, Private Profit (New York: Columbia

University Press, 2009). 177 Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, 122 Stat. 2654 (codified as amended in scattered sections of 12 U.S.C.). 178 See, e.g., Economic Stimulus Act of 2008, Pub. L. No. 110-185, 122 Stat. 613; Emergency Economic Stabilization Act of 2008, Pub. L. No. 110-343, 122 Stat. 3765; Troubled Asset Relief Program, Pub. L. No. 110-343, 122 Stat. 3765 (2008); American Recovery and Reinvestment Act of 2009, Pub. L. No. 111-5, 123 Stat. 115.

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measure, be attributed to inadequate government oversight of sectors of the economy that are “dominated by a few corporate giants.” Thus the new paradox: laissez faire policies that have led to unprecedented government intervention in the private sector.

Which paradox is worse? One problem with myopic attention to allocative efficiency is that consumers could be worse off if firms must be too big to fail to achieve optimum scale. The too-big-to-fail problem never figured into economic arguments for “letting the marketplace decide,” and it changes the equation. Suppose, for the sake of argument, that banks in the United States really need to be as big as the nation just permitted them to become to compete for one-stop-shopping corporate customers in the global financial services markets. That is, suppose that their current gigantic size has not yet crested optimum efficient scale. That does not necessarily mean that their gigantic size could not pose a threat of greater consumer harm than would follow from the marginal loss of scale efficiency that would result (by hypothesis, at least) if the banks were required to be a bit smaller. Certainly, some consumer harm has resulted from the too-big-to-fail problem even if one assumes that these same firms were generating economies of scale as they claim. Commissioner Rosch correctly noted that the failure of a too-big-to-fail enterprise causes consumer harm in the form of reduced output, resulting in higher prices and possibly diminished innovation, and no one has ever measured those harms against whatever consumer benefits supposedly flow from allowing firms to become too-big-to-fail.179 Thus, even if it would be a paradox of one sort to impose antitrust-based limits on some corporate size, it may equally be a paradox of another sort not to – even viewing antitrust myopically as concerned with nothing except output, price and innovation.

c. The Problem of Diseconomies of Scale

Post-Chicago antitrust contains yet another paradox, or at least an inconsistency worthy of further study: optimum scale efficiency is considered measurable and a presentable basis for allowing a merger transaction, but excessive-scale inefficiency is not considered a proper basis on its own for disallowing a merger. That is, no court or agency has ever blocked a merger on the exclusive ground of scale diseconomies, let alone that the merged entity would be too big to fail – there has to be another basis for antitrust to intervene. The reverse no longer holds true since the revision to the Horizontal Merger Guidelines in 1997.180 The Guidelines now provide for a quantitative assessment of merger specific efficiencies, and indicate that the agencies will consider such efficiencies as capable of offsetting some potential adverse competitive effects of a merger. Although the Guidelines acknowledge that efficiencies “are difficult to verify,” they invite merger proponents to “substantiate efficiency claims so that the Agency can verify by reasonable means the likelihood and magnitude of each asserted efficiency.” Nowhere do the Guidelines attempt to quantify or address the consumer harm that can result when an otherwise benign merger creates an out-sized merged enterprise of inefficient scale.

Diseconomies of scale can harm consumer welfare just as much as the prevention of economies of scale. Diseconomies of scale result when a firm’s marginal cost begins to 179 Rosch, supra (note 16). 180 See MERGER GUIDELINES, supra note 43, § 4.

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exceed long-run average costs.181 This can occur when a firm’s size becomes so unwieldy that each additional unit of production costs more than the one before. Among the many causes that have been studied include the tendency for large organizations to isolate decision makers from the results of their decisions182 – a familiar theme in recent discussions about corporate compensation excesses divorced from performance measures. Other causes of diseconomies of scale in large enterprises include increased communications costs, duplication of effort, inertia, and internal culture clashes.I183d. By definition, when a firm exceeds optimum scale, each additional unit produced costs more, and consumers pay the price for that. Why is it that optimal scale efficiency is measurable and constitutes a proper consideration to permit a transaction and overcome some anticompetitive potential, yet diseconomies of scale are not considered worthy of any sort of antitrust inquiry at all (other than perhaps to rebut claims of scale economies)?

This may add one more justification for antitrust to address itself to some too-big-to-fail problems. Although current antitrust rules do nothing to preserve smaller enterprise for its own sake, even the narrowest economic doctrinal underpinnings may support doing so in some limited circumstances.

5. Conclusions Antitrust is quintessentially addressed to the optimum organization of the nation’s economy, even if it does not purport to address all aspects of it. The central concern of antitrust law is economic power and its potential to be misused. Vast aggregations of economic power in convergence with other phenomena cause too-big-to-fail crises. It therefore stands to reason that antitrust ought to be concerned with some aspects of the too-big-to-fail problem, at least insofar as the problem stems from aggregated economic size and power. Since the too-big-to-fail problem is complex, it is unsurprising that antitrust alone is not the cure, but it could make a difference by controlling certain forms of conduct that lead to firms becoming excessively large. The foregoing considerations lead to a few conclusions and proposals for bringing antitrust into the public policy discussion about preventing or limiting the need for public rescues of private firms that are too big, too interconnected and perhaps too powerful to be allowed to fail.

a. Existing Antitrust Merger Law Could Help Prevent Some Out-sized Combinations

181 See, Sullivan & Grimes, supra, at 532. A seminal explanation of so-called “X-inefficiency” is

found at Leibenstein, Harvey (1966), "Allocative Efficiency vs. X-Efficiency", American Economic

Review 56 (3): 392–415

182 Id.

183 Id.

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Antitrust law reaches a range of business practices, and many of them (such as price discrimination) are unlikely ever to have any role in the creation of a too-big-to-fail crisis. The most relevant prohibitions relate to mergers. Although some firms become too-big-to-fail by internal growth, the public has at times been forced to rescue some firms that grew by merger activity. It is perfectly appropriate for antitrust law to consider whether a merger transaction threatens consumer harm. The 1992 Horizontal Merger Guidelines are currently under review, and some attention might be paid in the final product to the problems related to combinations that create merged entities that are too-big-to-fail. Although too-big-to-fail is not central to most merger analysis, enormous consumer harm has resulted from allowing corporate growth to create so many indispensible firms. Put differently, since size contributes to the problem, controlling size might contribute to a solution. A few ways exist in which antitrust law might more assertively intervene to control the population growth in the too-big-to-fail category of businesses.

(i) Diseconomies of Scale in Merger Analysis

Mergers could be reviewed under a modified standard that takes into account the possibility that the merged entity will simply be too big measured by its own economics. Since consumer harm in the form of higher prices and reduced output can result from allowing a firm to achieve a scale that exceeds the optimum, here is one place where antitrust might play a role without much adaptation from its current approach. However, this is a controversial proposal, to be sure, because the Clayton Act only prohibits combinations whose effects “may be substantially to lessen competition or tend to create a monopoly,” and theoretically a firm could exceed optimum scale without doing either of those things.184 There will also be disagreement about what constitutes efficient scale, as is already a matter of public debate about the size of the nation’s four largest banks. Still, sometimes a firm’s becoming very large and inefficient will dampen competition and place upward pressure on prices, and that should be of concern to antitrust agencies and courts.

Another objection would be that the government ought not to intervene in the entrepreneurial process by dictating optimum scale instead of allowing the marketplace to decide. If a firm decides to grow to a certain size in the hope of obtaining competitive advantage, it may be argued that the government should not determine that such a marketplace gamble is inefficient. Notably, other types of likely inefficient results of mergers are already taken into account in orthodox merger review. For example, it is understood that a profit maximizing monopoly may be willing to spend resources inefficiently to retain its monopoly position, such as through various forms of costly predation, so long as the costs do not exceed the monopoly profits. Also, those who will argue that the government has no business deciding the optimum scale of private enterprise need to explain why the efficiencies provisions added to the 1992 Guidelines do not run afoul of the same principle. If economists can take measurements to assure the public that a business combination will achieve scale efficiencies sufficient to offset 184 Section 5 of the Federal Trade Commission Act, 15 U.S.C. § 45 (2006), is not limited by the language of the Clayton Act.

47

presumptive monopoly power, they ought equally to be able to warn the public that another merger would move the combined firm beyond the optimal scale. The standard analysis of merger-specific efficiencies is a complex one, but its basic arithmetic is simple enough: the presumptive monopoly deadweight welfare loss is calculated to be a number that is less than the combined firm’s reduction in cost-per-unit times the number of units produced.185 The converse should be no more difficult or speculative. Of course, just as scale efficiencies are difficult for merger proponents to quantify, those opposing a combination on inefficiency grounds should bear a similar burden. Oftentimes, the burden may turn out to be too great, in which case a diseconomies of scale filter would do no good. However, a diseconomies of scale filter would not appear to do any harm and it might prevent some out-sized combinations that create inefficient firms.

(ii) Too-Big-to-Fail as a Factor in Merger Analysis

A second proposal that would entail little or no adjustment of current antitrust economics dogma is to incorporate the too-big-to-fail problem itself into merger review standards. This was Commissioner Rosch’s idea,186 which he acknowledged to be a provocative one. However, the controversy is not one about the basic economics of Post-Chicago antitrust. Assuming a merger presents a palpable prospect of creating a firm that cannot be allowed to fail under conditions where failure can be foreseen, the threat of antitrust-type consumer harm from the transaction may meet the standard of incipiency under Section 7 of the Clayton Act or Section 5 of the FTC Act. For example, the recent banking industry mergers that were permitted as a sort of private bail-out of the acquired banks could be analyzed along these lines. In appropriate cases, it would seem to do no violence to current Post-Chicago antitrust law and policy to block such mergers on this ground, since consumer harm via reduced output, higher prices and impaired innovation are uncontroversial objects of antitrust sanctions. Again, quantifying the threat to consumer harm may be daunting and the burden of establishing such a likelihood should not be a light one since the likelihood that any particular firm will at some point meet all of the criteria of a too-big-to-fail enterprise is not a routine conclusion. A firm might present only a very remote too-big-to-fail threat at the time it proposes a merger, and that threat might not materialize until it is too late for antitrust intervention under existing antitrust theory. One can anticipate any number of problems, but the concept remains a sound one: allowing firms to merge into a size that could not be allowed to fail through normal bankruptcy proceedings presents a threat to consumer welfare that is indistinguishable from the harms that flow from mergers we already block for other reasons. If one of the nation’s four largest banks proposed to combine with another large financial services firm, would it be too much to ask whether a non-publically funded

185 Under the 1992 Merger Guidelines, the efficiencies “defense” only comes into play where the transaction is presumptively anticompetitive based on the structural and behavioral analysis set forth in the Guidelines. This means that efficiencies as a defense is only calculated where there is at least a presumption of post-merger market power sufficient to reduce output, raise prices and thus create a monopoly “deadweight welfare loss.” MERGER GUIDELINES, supra note 43, § 4. 186 See, Rosch, supra note 16.

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resolution would be feasible if their liabilities were to become unmanageable? It is the rare merger that ought to present such a question, and, in those few contexts, the question seems an appropriate one to consider.

b. Toward a Partial Restoration of Antitrust Policy

It is time to set aside the myth that antitrust law has always had as its sole objective the optimum allocation of productive resources and to restore to antitrust the policies that were jettisoned by the Chicago School by including reference to these broader policies in formulating and applying antitrust rules. It is modern mythology to suggest that antitrust was never intended to limit the economic and political power of the trusts. That myth was merely one of the arguments, and not the most forceful, for moving antitrust into a laissez faire posture that trusted markets to make better decisions than the courts or agencies. The primary Chicago School objection to older antitrust policy, the real “antitrust paradox,” was that it rewarded inefficient market participants with antitrust remedies exacted from their more efficient rivals. This paradox does not need to be revived in antitrust law. Rather, what ought to be restored in antitrust rules are those policies that were directed at protecting consumers, traders, democratic institutions and the economy against the perils of excessive concentrations of corporate economic power. While courts and agencies never explicitly repudiated these non-economic antitrust policy objectives, they have ignored and, at times, disparaged them. Competitor collaborations, conduct of monopolies and potentially catastrophic mergers should be subject to antitrust review that takes these other policies into account.

The too-big-to-fail public policy problem directly intersects with these other antitrust values, while almost not at all overlapping with allocative efficiency concerns. Perhaps the core value of antitrust is its preference for marketplace activity to serve the needs of consumers. However, when firms are rescued by public bailouts, the government almost inevitably must intrude into the machinery of the marketplace – just the result antitrust seeks to avoid. That alone would form a reasonable basis for objecting on antitrust grounds to the formation of a too-big-to-fail firm. Thus, a central tenet of antitrust should favor some control to prevent the combination of firms into too-big-to-fail companies whose indispensability poses a risk of displacing normal marketplace activity with ad hoc crisis-driven government intervention. Antitrust ought to block a proposed merger that would create a firm exceeding maximum optimal scale and whose failure, if it occurred, would foreseeably require government bail-out intervention.

Furthermore, antitrust’s political policy recognizes a threat to democratic institutions that has considerable resonance today. When firms become so large that they cannot be allowed to fail, they also tend to have disproportionate power over the political process. For example, a perception exists that the mega-banks formed via a combination of bail-outs and mergers significantly influenced Congressional reform of financial services regulation. A Pulitzer Prize-winning columnist for the New York Times observed: “Three years into the crisis, we are no closer to reining in too-powerful-to-fail companies or eliminating the risks that they pose to taxpayers.”187 Had the original intent of the

187 Gretchen Morgenson, Future Bailouts of America, N.Y. TIMES, Feb. 14, 2010, at 1.

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Sherman Act been considered in connection with the recent perplexing decision to solve the too-big-to-fail problem by creating even bigger banks, perhaps a different and more tempered outcome might have emerged from the process.

Antitrust also seeks to protect the freedom of traders to do business without anticompetitive interference or exclusion from the marketplace. Klor’s188 makes a most interesting case in point. That case involved allegations that a rival retailer formed a conspiracy with manufacturers to boycott and ruin the plaintiff.189 The boycott was held to fall within the per se prohibitions of Section 1 of the Sherman Act.190 Yet, Klor’s was a single retailer in a competitive market served by sufficiently many others such that no allocative efficiency justification exists for the result in that case191 Indeed, the complaint under review in that case might not withstand a motion to dismiss under the newer standards for Federal Rule of Civil Procedure 12192 in force today, since it was implausible that the manufacturers would have any incentive to collude with one another to exclude a customer from the market. In any event, under the Post-Chicago view, Klor’s was wrongly decided because consumers were not harmed by having one less retailer in a densely populated retailer marketplace. Still, what is objectionable about a rule that prohibits rivals from joining together to force another enterprise out of business, even if consumers do not pay higher prices as a result of the exclusion? Assuming the truth of the allegations, Klor’s was deprived of the freedom to conduct business. Until the Chicago School, a public policy against the very deprivation of such freedom formed a part of anti-monopoly law since at least the Case of Monopolies in 1603.193 It is no objection to such a rule to say that inefficient rivals whose failure is their own fault will try to blame others and sue them on trumped up antitrust claims. Courts can and should decide whether defendants colluded or not. If they have colluded to drive someone out of the market, it seems a reasonable and time-honored public policy to give the victim a remedy at law, regardless of whether consumers paid higher prices as a consequence.

The policy of protecting the freedom of traders also plays a part in the too-big-to-fail discussion, because the moral hazard problem places the mega-enterprise at a distinctly unfair advantage that could prevent smaller rivals from thriving. How, for example, could a small bank offer competitive terms on credit transactions if its largest rivals in the same market have the ability to take risks whose downside potential is backed by the United States Treasury? This policy, if considered, would bring yet another consideration into play in evaluating a small number of mergers that present a plausible too-big-to-fail risk.

188 Klor’s, Inc. v. Broadway-Hale Stores, Inc. 359 U.S. 207 (1959).

189 Id., at 209.

190 Id., at 212-14.

191 Id.

192 Federal Rules of Civil Procedure Ruloe 12. See, Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007). 193 See Darcy v. Allin, 77 E.R. 1260 (1601).

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c. Legislative Possibility

Further amending antitrust law to block the formation of a too-big-to-fail firm would be consistent with the original intent of the Sherman Act, and certainly with intervening enactments, such as the Celler-Kefauver amendments to the Clayton Act. Additionally, amending the Clayton Act to permit the break-up of a firm that has grown to such proportions might move antitrust in a novel direction. These sorts of legislative enactments are under consideration, and it is beyond the scope of this article to draw a conclusion as to whether public policy would be well or ill served by their enactment. However, if a too-big-to-fail statute were to be enacted, the foregoing discussion suggests that doing so would only do violence to very recent antitrust orthodoxy, but would not offend historic and original policies behind American antitrust law. The presence of these oversized enterprises, whose numbers are growing, threatens the political system because their indispensability makes them nearly impossible to govern. It also menaces important markets with the uneven playing field created by the moral hazard problem. Moreover, the presence of oversized enterprises poses the risk of unusually catastrophic harm to vast numbers of consumers and the public treasury. These are concerns that certainly are not new to antitrust.

!!AAI Working Paper No. 11-01

Date: April 14, 2011

Title: The Role of Competition Policy and Competition Enforcers in the EU Response to the Financial Crisis: Applying the State Aid Rules of the TFEU to Bank Bailouts in Order to Limit Distortions of Competition in the Financial Sector

Author: Jonathan M. DeVito*

Abstract: Governments throughout the world responded to the financial crisis of 2008-2009 by granting massive bailouts to their largest and most interconnected banks. In most jurisdictions, financial stability took precedence over all other policy concerns, which meant that competition policy was relegated to the position of a distant spectator in the proceedings. This was not the case in the EU, however, where competition policy and competition enforcers played a lead role in shaping the European response to the crisis. This paper evaluates the EU’s exercise of its State aid authority to prevent bailouts from distorting competition in the financial sector. In doing so, this paper explores (a) the importance of competition policy during a financial crisis, and (b) the ability of competition enforcers to coordinate with banking authorities in order to form an effective response. As lawmakers assess the outcomes of the crisis, and consider what might be done differently to prevent or respond to a future crisis, they should draw upon the most effective aspects of the EU model, and incorporate competition policy and competition officials in future crisis proceedings. Author Contact: [email protected] View the entire paper at www.antitrustinstitute.org. AAI Working Papers are works in progress that will eventually be revised and published elsewhere. They do not necessarily represent the position of the American Antitrust Institute

2

I. Introduction

The systemic nature of the recent global financial crisis posed a significant challenge for the

European Commission Directorate-General of Competition (“Commission”), the body responsible

for enforcing the European Union’s (“EU”) competition laws.1 Under Article 107 of the Treaty on

the Functioning of the European Union (“TFEU”),2 Member States of the EU (“Member States”)

are generally prohibited from granting government-funded subsidies (“State aid”) to their businesses,

because of the potential for such aid to distort competition in the EU Single Market (“Single

Market”).3 However, beginning in autumn 2008, as the crisis spread throughout Europe and

threatened the total collapse of its financial system, Member States pressured the Commission to

suspend the competition rules prohibiting them from unilaterally rescuing their distressed banks.4

Although the Commission recognized that State intervention was necessary in order to restore

financial stability, it refused to abandon the competition principles underlying its control of State aid.

Rather, the Commission vigorously upheld competition policy as an essential element of the solution

to the crisis.

The central role of competition policy and competition enforcers, inherent in the EU

response, is what distinguishes it from virtually all other responses of jurisdictions affected by the

crisis. Outside of the EU, “few governments allowed their intervention to be disciplined in any way

* 2010 Summer Research Fellow, American Antitrust Institute; J.D. Candidate May 2011, Rutgers School of Law—Camden; Managing Notes Editor, Rutgers Journal of Law & Public Policy.

1 Simon Polito, EU and UK Competition Laws and the Financial Crisis: The Price of Avoiding Systemic Failure, 2009 FORDHAM COMP. L. INST. 120 (B. Hawk ed. 2010).

2 Consolidated Version of the Treaty on the Functioning of the European Union art. 107, Dec. 13, 2007, 2010 O.J. (C 83) 45, 91 [hereinafter TFEU].

3 TFEU, supra note 2, art. 107(1).

4 Neelie Kroes, Eur. Comm'r for Competition Pol'y, Competition policy and the crisis – the Commission’s approach to banking and beyond. COMPETITION POLICY NEWSLETTER 2010-1, available at http://ec.europa.eu/competition/publications/cpn/2010_1_1.pdf

3

by competition policy considerations.”5 Thus, to the extent it has been argued that government

interventions have contributed to the emergence of a more concentrated financial industry--

comprised of even bigger banks, with the ability to wield greater political power, and to operate

under more favorable conditions than their smaller, less-aided competitors6-- it is crucial to identify

the appropriate lessons to be learned from the various government responses, particularly as

lawmakers consider how to prevent and/or respond to a future crisis.

The purpose of this paper is to evaluate the EU’s exercise of its State aid authority in order

to curtail the anticompetitive effects of bank bailouts during the financial crisis. In doing so, this

paper explores: (a) the importance of competition policy during a financial crisis, and (b) the ability

of competition enforcers to coordinate with banking authorities, in order to form a response that

both addresses competition policy concerns and restores financial stability. Section II provides a

brief overview of the EU State aid regime and the State aid reform movement, which greatly

influenced the Commission’s response to the crisis. Section III describes how the competition

policies underlying the State aid rules remained applicable as the crisis took hold in Europe, and

demonstrates how Commissioner Kroes successfully promoted competition policy as a vital part of

the solution to the crisis. Section IV provides a detailed explanation of the four Communications

released by the Commission, between October 2008 and June 2009, which governed its application

of the State aid rules to bank bailouts during the crisis. Section V identifies two primary competition

policy objectives pursued by the Commission during the crisis, and discusses the specific conditions

5 Philip Marsden & Ioannis Kokkoris, The Role of Competition and State Aid Policy in Financial and Monetary Law, 13 J. INT'L ECON. L. 875, 875 (2010).

6 See SIMON JOHNSON & JAMES KWAK, 13 BANKERS: THE WALL STREET TAKEOVER AND THE NEXT FINANCIAL MELTDOWN 180-181 (2010); see also European Parliament Resolution of 20 January 2011 on Competition Policy and the Financial Crisis, EUR. PARL. DOC. P7_TA (2011) 0023, available at http://www.europarl.europa.eu/sides/getDoc.do?pubRef=-//EP//TEXT+TA+P7-TA-2011-0023+0+DOC+XML+V0//EN (last visited March 1, 2011).

4

imposed on bailout beneficiaries, which were tailored to achieving those objectives. Section VI

evaluates the Commission’s response, and Section VII concludes.

II. EU State Aid Regime

a. General Rules & Principles

The scope of the EU State aid regime is defined by the terms of Articles 107 and 108 TFEU.

Under Article 108 TFEU, the Commission is vested with the authority to control the

implementation of State aid measures by Member States.7 Member States are required to inform the

Commission of any plan to grant or alter State aid measures, and may not implement any such plan

without first receiving approval from the Commission.8 Aid implemented without the

Commission’s approval is automatically “unlawful,” and the Commission may order its recovery.9

As a general rule, Member States are prohibited by Article 107(1) TFEU from granting any

government-funded subsidy10 or “state aid” that distorts, or threatens to distort, competition and

trade between Member States.11 The EU’s prohibition of State aid emanates from its fundamental

goal of “maintain[ing] a level playing field for all firms in the EU single market, no matter in which

7 TFEU, supra note 2, art. 107 - 108, 2008 O.J. (C 115); see Polito, supra note 1, at 122.

8 TFEU, supra note 2, art. 108(3); see Polito, supra note 1.


10 “State aid has been interpreted broadly to include inter alia government loans, tax rebates, deposit guarantees, purchases of shares, and capital injections.” SIR CHRISTOPHER BELLAMY & GRAHAM CHILD, EUROPEAN COMMUNITY LAW OF COMPETITION, 1505 (P.M. Roth & V. Rose eds., 6th ed. 2008). The concept of ‘aid’ is wide, going beyond mere subsidy, and comprises any form of intervention or assistance which has the same or similar effects to a subsidy.” Id. at 1503. In order to determine whether a grant of public funds constitutes State aid, the Commission employs the market economy investor principle – which identifies State aid as existing where “the terms on which the funds are provided go beyond those that a private investor, operating under normal market economy conditions and having regard to the information available and foreseeable developments at that time, would find acceptable when providing funds to a comparable private undertaking.” Id. at 1507.


5

member state they are established.”12 In particular, the bar on State aid targets “measures which

provide unwarranted and selective advantages to some firms, thereby decreasing overall European

competitiveness.”13 Such measures can “lead to a build-up of market power in the hands of some

firms,” and as a result, “customers may be faced with higher prices, lower quality goods, and less

innovation.”14

Although State aid is generally “incompatible” with the Single Market, it is not forbidden per

se. The Commission may approve particular forms of aid that it determines to be “compatible” with

the Single Market. The key compatibility provisions are found in Articles 107(3)(b) and 107(3)(c)

TFEU. Under Article 107(3)(b), aid is compatible with the Single Market if it is granted to “remedy

a serious disturbance in the economy of a member state.”15 Since the applicability of 107(3)(b) is

limited to a serious economic disturbance, it was rarely used prior to October 2008.16 Instead, the

Commission consistently based its approval of aid to failing firms upon Article 107(3)(c), which

“permits aid to facilitate the development of certain economic activities . . . where such aid does not

adversely affect trading conditions to an extent contrary” to the goals of the Single Market.17

The Commission assesses the compatibility of aid to “firms in difficulty,”18 under Article

107(3)(c) TFEU, pursuant to the framework set forth in the Rescue & Restructuring Guidelines of

12 Commission of the European Communities, State Aid Action Plan: Less and Better Targeted State Aid: A Roadmap for State Aid Reform 2005-2009, COM (2005) 107 Final 5 (June 2005) [hereinafter Action Plan].

13 Id.

14 Id.

15 TFEU, supra note 2, art. 107(3)(b).

16 Prior to Oct. 2008, the Commission had only used art. 87(3)b EC Treaty (as in effect 2007)(now 107(3)(b) TFEU) three times in the last 50 years. Polito, supra note 1, at 122.

17 TFEU, supra note 2, art. 107(3)(c).

18 Under the R&R Guidelines, a firm is regarded as “being in ‘in difficulty’ where it is unable, whether through its own resources or with the funds it is able to obtain from its owner/ shareholder or creditors, to stem losses which, without State intervention, will almost certainly condemn it to going out of business in the short or medium term.” BELLAMY &

6

2004 (“R&R Guidelines). The R&R Guidelines require government rescue measures to be: (a)

necessary & proportionate, i.e. well-targeted to achieve their objective, in terms of the form, scope, and

duration of the aid;19 (b) subject to conditions (e.g. compensatory measures and behavioral

safeguards) designed to prevent undue distortions of competition; and, (c) in certain cases, subject to the

implementation of a restructuring plan, capable of restoring the long-term viability of the aid

recipient.20 The R&R Guidelines draw an important distinction between “rescue aid” and

“restructuring aid,” and outline specific compatibility requirements for each. Rescue aid consists of

temporary and reversible liquidity assistance available to keep an ailing firm afloat pending

restructuring or liquidation.21 Rescue aid must be limited to the amount necessary to keep the firm

afloat during the relevant period; restricted to loans or guarantees of certain debts for a maximum

six-month term, carrying a market-based interest rate; and confined to a one-time offering.22

Restructuring aid is defined as aid which is permanent and irreversible, e.g. capital injections and any

loan or guarantee lasting more than six months.23 Grants of restructuring aid must be accompanied

by the implementation of a restructuring plan, which is capable of restoring the firm’s long-term

viability within a reasonable time and on the basis of realistic assumptions.24

CHILD, supra note 10, at 1552, citing Commission Communication, Community Guidelines on State Aid for Rescuing and Restructuring Firms in Difficulty, Oct. 1, 2004, 2004 O.J. (C 244) 2, at para. 9 [hereinafter R&R Guidelines].

19 See R&R Guidelines, supra note 18.

20 See Polito, supra note 1, at 126, citing R&R Guidelines supra note 18, at paras. 10-11, 25(c), 39-40.

21 See BELLAMY & CHILD, supra note 10, at 1552-1553.

22 See id.

23 See id.

24 See id.

7

During normal times, the rules of State aid procedure require the Commission to complete a

“preliminary examination” of an aid proposal within two months of its notification.25 The R&R

Guidelines reduce the preliminary examination period to one month, but only under limited

circumstances.26 Once the Commission completes its preliminary examination, it may either

authorize the aid or subject it to further review in a “formal investigation.”27 Final decisions in State

aid matters must be adopted by the College of Commissioners (“College).28 State aid cases brought

under the standard procedural framework often span several months.29

b. State Aid Reform

In 2005, as part of a broad initiative, known as the “Lisbon Strategy,” to enhance the

competitiveness of the EU economy,30 the Commission adopted the “State Aid Action Plan”

(“Action Plan”),31 which is meant to revamp the substance and procedure of State aid regulation.32

The Action Plan calls for “less and better-targeted aid,” and seeks to “simplify the State aid rules by

reference to a coherent set of fundamental principles which can be consistently applied in different

settings.” These principles focus on identifying the positive impact of the aid and the level of

distortion it will create. In general, the positive impact of the aid depends on: (i) how accurately the

25 See Commission Regulation 659/99, art. 4, 1999 O.J. (L83)1, available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:1999:083:0001:0009:EN:PDF.

26 Only in cases involving rescue aid in an amount less than ! 10 million. See R&R Guidelines supra note 18, at § 30.

27 See Commission Regulation 659/99, art. 4, supra note 25.

28 See Decision 2005/960, of the European Commission of 15 November 2005 Amending its Rules of Procedure, arts. 1, 4, 2005 O.J. (L347) 83, available at http://eur-lex.europa.eu/LexUriServ/site/en/oj/2005/l_347/l_34720051230en00830090.pdf.

29 See Damien Gerard, EC Competition Law Enforcement at Grips with the Financial Crisis: Flexibility on the Means, Consistency in the Principles, in Concurrences, at 46, 57 (INST. OF COMPETITION L., ISSUE NO. 1, 2009), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1338000.

30 See BELLAMY & CHILD supra note 10, at 1499.

31 See Action Plan, supra note 12.

32 See Paris Anestis & Sarah Jordan, The Handling of State Aid During the Financial Crisis: an Efficient Response or Trouble for the Future? EUR. ANTITRUST REV. (2010).

8

accepted objective of common interest has been identified; (ii) whether an appropriate alternative to

State aid is available; and (iii) whether the aid creates the needed incentives and is proportionate.33

The level of distortion created by the aid depends on: (i) the procedure for selecting beneficiaries

and the conditions attached to the aid; (ii) characteristics of the market and of the beneficiary; and

(iii) the amount and type of the aid.34 By streamlining its State aid policies, and focusing on the most

distortive types of aid, the Action Plan is directed at “mak[ing] State aid control more predictable

and user friendly, thereby minimizing legal uncertainty and the administrative burden both for the

Commission and for Member States.”35

III. EU Competition Policy & the Financial Crisis

The crisis in Europe began in September 2007 with the collapse of Northern Rock36 in the

United Kingdom (“UK”) and several of Germany’s Landesbanken37 -- each sophisticated credit

institutions that relied heavily on mortgage securitization and related derivatives to fuel the rapid

growth of their balance sheets, without maintaining adequate capital reserves to protect their

depositors.38 These cases introduced the Commission to “the risky behaviors and stubborn defiance

of the financial sector,” and greatly influenced its adaptation of the State aid framework a year later.39

33 See BELLAMY & CHILD supra note 10 at 1499.

34 Id.

35 Id.

36 See Commission Press Release, State Aid: Commission Approves Rescue Aid Package for Northern Rock, IP/07/1859 (Dec. 5, 2007); see also Northern Rock: Lessons of the Fall – How a Financial Darling Fell From Grace and Why Regulators Didn’t Catch It, ECONOMIST (Oct. 18, 2007), available at http://www.economist.com/node/9988865.

37 See Commission Press Release, State Aid: Commission Approves Restructuring of Sachsen LB, IP/08/849 (June 4, 2008); see also SachsenLB Has EU3 Billion in Subprime, Person Says (Update 4), BLOOMBERG (Aug. 21, 2007), http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aosVPIhxcCCg&refer=home (last visited Feb. 7, 2011).

38 See id.

39 Kroes, supra note 4.

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At this stage, however, the Commission did not perceive the Northern Rock and Landesbanken

cases to be symptomatic of a serious economic disturbance – the prerequisite for applying the broad

and rarely used exemption of Article 107(3)(b) TFEU. Rather, the Commission perceived them to

be “individual problems, [requiring] tailor-made remedies, which could be addressed under the

existing rules for firms in difficulty.”40 Thus, throughout 2007, the Commission approved bailouts

of distressed banks under the R&R Guidelines and Article 107(3)(c) TFEU, while it expressly

rejected all attempts to invoke the ostensibly broader exemption provided by Article 107(3)(b)

TFEU .41 The Commission’s refusal to relax the State aid rules during the initial phase of the crisis

incited sharp criticism from the finance ministers of several Member States, who felt that they were

best situated to deal with the problems facing their nation’s banks.42

Despite vocal opposition, the Commission, led by former Competition Commissioner

Neelie Kroes, vigorously upheld competition policy as a vital element of the solution to the crisis.

Kroes observed that “[i]n the midst of massive government intervention, we need to make sure that

we do not – along the way – also lose the level playing field and the future dynamism that comes

from competition.”43 The European economy relies on competition to provide the fundamental

incentives for businesses to innovate and increase their efficiency, in order to deliver lower prices

and higher quality to consumers.44 Kroes warned that “[g]iving up on competition was the surest

way to waste state aid funds and hurt consumers as they began to hurt from job losses, home

40 Michael Reynolds et al., EU Competition Policy in the Financial Crisis: Extraordinary Measures, 33 FORDHAM INT'L L.J. 1670 (2010).

41 Polito, supra note 1, at 123.

42 See Stephen Castle, European Regulators Again Revise Bank Subsidy Rules, N.Y. TIMES, Dec. 2, 2008, available at http://www.nytimes.com/2008/12/03/business/worldbusiness/03euro.html (quoting several European finance ministers’ expressions of discontent regarding State aid control during the financial crisis).

43 Kroes, supra note 4.

44 Id.

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foreclosures, and the general economic malaise” resulting from the crisis.45 Moreover, Kroes

emphasized that the advantages gained by beneficiaries of state aid could enable them to obtain

market power, which would allow them to raise prices and restrict output.46 Thus, unrestricted

bailout measures would only cause additional harm to consumers, and further deepen the

recession.47 48

IV. The Commission’s Response

News of Lehman Brothers’ Chapter 11 Bankruptcy filing on September 15, 2008, triggered a

rapid erosion of confidence in the stability of banks throughout Europe.49 Lehman’s collapse caused

lending between banks to dry up almost instantaneously. The threat of insolvency, previously

limited to individual, “unsound” banks -- whose troubles were a direct result of endogenous risk --

45 Id.

46 Id.

47 Id.

48 Relaxed competition enforcement during times of deep recession can have serious, long-term negative effects. The suspension of the competition rules in the US under the National Industrial Recovery Act of 1933 is argued to have added years to the duration of the Great Depression, See Harold Cole & Lee Ohanian, New Deal Policies and The Persistence Of The Great Depression: A General Equilibrium Analysis, 112 J. POL. ECON. 779 (2004). Similarly, government intervention to restrict competition in “structurally depressed industries” prolonged the Japanese recession in the 1990s. See Fumio Hayashi & Edward Prescott, The 1990s in Japan: A Lost Decade, 5 REVIEW OF ECONOMIC DYNAMICS 206 (2002). In a presentation before the Commission in June 2009, DG COMP Chief Economist, Damien Neven, highlighted lessons from the US and Japanese experiences that are relevant to the recent crisis. According to Neven, the US experience demonstrates that “[r]elaxing competition rules by transferring rents to firms depresses consumers’ purchasing power,” which in turn “delay[s] recovery and resumption of trend growth.” Furthermore, Neven asserted that the Japanese experience is evidence that “artificially maintaining firms can have disastrous consequences.” Specifically, he observed that Japan’s “protracted ‘L shaped’ recession can be directly traced back to the existence of ‘zombie’ banks undertaking ‘zombie’ lending.” Instead of shedding workers and losing market share, as would have occurred under normal competitive conditions, the “zombies’ congested the market, reduced the profits for healthy firms, [and] discouraged their entry and investment.” Damien Neven, The Current Financial Crisis and EU Competition Policies, Presentation to European Commission, Brussels, 24 (June 16, 2009).

49See Damien Gerard, Financial Crisis Remedies in the European Union: Balancing Competition and Regulation in the Conditionality of Bailout Plans, ECRI/CEPS No. 12, pg. 36 (2010), available at, http://aei.pitt.edu/14441/1/ECRI_RR_No_12_with_covers_final.pdf (last visited March 1, 2011)[hereinafter Balancing Competition & Regulation].

11

now extended to healthy banks, unable to access liquidity because of exogenous market instability.50

With Europe’s financial sector on the brink of collapse, the Commission recognized that the existing

State aid framework was not equipped to handle the unique challenges of the systemic crisis, and the

wave of urgent and complex bailout requests that was sure to follow.51 On October 6, 2008,

speaking before the EU’s Economic and Financial Affairs Council (“ECOFIN”), Commissioner

Kroes announced that the Commission would turn to Article 107(3)(b), regarding aid granted in

response to a serious economic disturbance, as the new legal basis for approving bank bailouts in

response to the crisis.52 53

a. The Communications

In order to assist Member States in developing emergency measures to restore financial

stability, and to provide legal certainty in the process, the Commission issued four

“Communications,” between October 2008 and July 2009, which established the legal and

procedural framework for evaluating financial sector bailouts under Article 107(3)(b) TFEU.54 The

50 See Gerard, At Grips with the Financial Crisis, supra note 29, at 46, 48.

51 European Commission, State Aid Scoreboard: Spring 2010 Update, COM (2010) 255, available at http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2010:0255:FIN:EN:PDF.

52 European Commission, State Aid Scoreboard: Autumn 2010 Update, COM (2010) 701, available at http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2010:0701:FIN:EN:PDF.

53 The Commission’s transition to Article 107(3)(b) occurred within the context of a rapid series of crisis-related activities among several EU institutions. On October 7, 2008, the EU’s Economic and Financial Affairs Council (“ECOFIN”) concluded that all necessary measures, including government guarantees and recapitalizations, should be taken “to enhance the soundness and stability of the banking system in order to restore confidence and the proper functioning of the financial sector.” See Banking Communication, infra note 55. Furthermore, the ECOFIN Council emphasized that rescue measures must be decided within a coordinated framework and on the basis of the EU’s competition principles. See id. Consistent with the ECOFIN Council’s resolutions, the Eurogroup, on October 12, 2008, committed to: (1) “coordinate in providing [support measures], as significant differences in national implementation could have a counter-productive effect, creating distortions in banking markets, and to (2) ensure that support measures would be “designed in order to avoid any distortion in the level playing field and possible abuse at the expense of the non-beneficiaries of these arrangements.” See CEPS Task Force Report, infra note 64. On October 15 and 16, 2008, the European Council endorsed the ECOFIN resolutions and the Eurogroup’s decisions, and applied them to the EU as a whole. See Gerard, At Grips with the Financial Crisis, supra note 29, at n. 4.

54 See CEPS Task Force Report, infra note 64, at 8.

12

Banking Communication55 set forth criteria for the compatibility of government guarantees,

recapitalizations, and other forms of liquidity support, and adopted new, expedited procedures for

the handling of emergency cases. The Recapitalization Communication56 provided additional

guidance on the remuneration requirements for capital injections. The Impaired Assets

Communication57 addressed the removal of “toxic assets” from banks’ balance sheets, and the

Restructuring Communication58 outlined updated requirements for plans to restructure and restore

long-term viability.

1. Legal Framework

Based on existing State aid principles,59 the Communications required government bailouts

of financial institutions, whether in the form of national plans60 or ad hoc measures,61 to be: (i)

necessary & proportionate, i.e. well-targeted to remedy the alleged economic disturbance; (ii) subject to

conditions designed to limit distortions of competition in the financial sector; and (iii) in certain cases,

55 Communication from the Commission--The Application of State Aid Rules to Measures Taken in Relation to Financial Institutions in the Context of the Current Global Financial Crisis (EC) 25 Oct. 2008, 2008 O.J. (C 270) 8 [hereinafter Banking Communication], available at http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2008:270:0008:0014:EN:PDF

56 Communication from the Commission--The Recapitalisation of Financial Institutions in the Current Financial Crisis: Limitation of Aid to the Minimum Necessary and Safeguards Against Undue Distortion of Competition (EC) 15 Jan. 2009, 2009 O.J. (C 10) 2 [hereinafter Recapitalization Communication], available at http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:C:2009:010:0002:0010:EN:PDF

57 Communication from the Commission--The Treatment of Impaired Assets in the Community Banking Sector (EC) 26 Mar. 2009, 2009 O.J. (C 72) 1 [hereinafter Impaired Assets Communication], available at http://ec.europa.eu/competition/state_aid/legislation/impaired_assets.pdf

58 Commission Communication--The Return to Viability and the Assessment of Restructuring Measures in the Financial Sector in the Current Crisis Under the State Aid Rules (EC) 19 Aug. 2009, 2009 O.J. (C 195) 9 [hereinafter Restructuring Communication], available at http://ec.europa.eu/competition/state_aid/legislation/restructuring_paper_en.pdf

59 See R&R Guidelines, supra note 18.

60 National plans or “schemes” were programs established by the Member State, available to support all financial institutions operating within its borders, no matter their country of origin.

61 Ad hoc measures were granted by Member States to rescue and support individual financial institutions, and were sometimes supplemental to national schemes.

13

subject to restructuring in order to restore long-term viability to the recipient bank.62 Together, the

Communications outlined criteria for the compatibility of bailouts in the form of guarantees, capital

injections, and impaired asset relief measures.

Government guarantees of bank liabilities were the most widespread response during the

“liquidity crisis,” when it was necessary to encourage lending between banks.63 A “guarantee” is a

promise by the government to pay out on a bank’s liability if the bank itself is unable to pay.64 In

order to satisfy the proportionality requirement, guarantee schemes were limited in terms of the

types of debt instruments eligible for the guarantee, and the duration for which the guarantee could

be offered.65 Eligibility was limited to retail deposits, certain types of wholesale deposits, and certain

short and medium-term debt instruments.66 Guarantees could not last longer than two years, subject

to review by the Commission every six months following their implementation.67 In addition,

guarantees carried strict remuneration requirements and behavioral restrictions, which were designed

to limit the unfair competitive advantages that guarantees create; namely, depositors pulling their

money out of competing banks in order to seek a higher level of government protection.68 69

62 See Banking Communication, supra note 55, 2008 O.J. (C 270), at 10.

63 See State Aid Score Board Fall 2010, supra note 52.

64 Centre for European Policy Studies, Bank State Aid in the Financial Crisis: Fragmentation or Level Playing Field, (Feb. 5, 2010)[hereinafter CEPS Task Force Report], http://www.ceps.eu/ceps/download/3859.

65 See Gerard, At Grips With the Financial Crisis, supra note 29.

66 See Banking Communication, supra note 55, at para. 21.

67 See id. at para. 24.

68 See id. at paras. 19, 27.

69 See Centre for European Policy Studies, Tying and Other Potentially Unfair Commercial Practices in the Retail Financial Service Sector, [Final Report submitted to EC DG Internal Market] ETD/2008/IM/H3/78, 98 n. 199 (Nov. 24, 2010), [hereinafter CEPS Unfair Practices] available at, http://ec.europa.eu/internal_market/consultations/docs/2010/tying/report_en.pdf (identifying potential changes in competition for customers in the retail banking market as a result of the crisis).

14

Recapitalization was an important method used by Member States to stabilize the market in

the contexts of the liquidity crisis and the “credit squeeze,” when it was necessary to facilitate the

flow of credit to the real economy.70 In a recapitalization or “capital injection,” the government

strengthens a bank’s capital base by injecting funds into it in exchange for direct equity, preferred

shares, or subordinated debt.71 The Commission emphasized that, because capital injections directly

and irreversibly alter the financial structure of their recipients, they are potentially more distortive of

competition than other forms of aid, and therefore must be subject to additional considerations.72

The need for capital injections to receive special treatment under the new framework was

underscored by the diversity of possible objectives for which they were pursued. Capital injections

were used to: (1) rescue individual distressed banks; (2) strengthen banks’ capital ratios in order to

facilitate lending between banks and to the real economy: or (3) to pursue a combination of those

objectives. For each use, capital injections raise different competition and systemic concerns.73 The

Commission resolved this dilemma by drawing a crucial distinction between the recapitalization of

“sound” versus “unsound” banks,74 and delineating the types and levels of conditions appropriate

for each. Generally, the dichotomy drawn between sound and unsound banks meant the greater the

risk profile of the recapitalized bank, the heavier the conditions imposed.75 All capital injections

70 See State Aid Scoreboard: Fall 2010, supra note 52.

71 CEPS Task Force Report, supra note 64, at 8.

72 See Gerard, At Grips With the Financial Crisis, supra note 29, at para. 24.

73 See id. (observing that capital injections may generate unfair competitive advantages and/or frustrate the return of normal market conditions).

74 See Banking Communication, supra note 55, at para. 14 (defining an “unsound bank” as one whose illiquidity problems have been caused by endogenous factors, such as inefficiency, poor asset-liability management or excessive risk-taking, and a “sound bank” as one whose “viability problems are inherently exogenous,” i.e. caused by the instability of the financial market).

75 See Polito, supra note 1, at 136.

15

were subject to specific remuneration requirements76 and strict behavioral restraints. In addition,

unsound recapitalized banks were required to undergo restructuring (discussed in greater detail

below).

Despite the success of State guarantees and recapitalizations in averting financial contagion,

the remaining presence of “toxic assets” on banks’ balance sheets undermined further economic

recovery.77 In response, the Commission released its Impaired Assets Communication, which

provided guidance on the government purchase of toxic assets through the establishment of a “bad

bank,” as well as insurance solutions, additional guarantees, and the nationalization of banks.78 The

Commission required that each measure to remove toxic assets be “appropriately targeted and

accompanied by behavioral safeguards that align the incentives of banks with the objectives of

public policy,” i.e. to eliminate moral hazard.79 Eligibility for toxic asset relief was conditioned on

the recipient’s full ex ante transparency; disclosure of impairments on assets to be covered; and a full

review of its activities and balance sheet.80 Banks that received toxic asset relief were subject to

behavioral restraints, in addition to any other conditions that may have applied, e.g. mandatory

restructuring.

The Commission required fundamentally unsound banks that received government support

to undergo restructuring. In order to gain approval from the Commission, restructuring plans

needed to: (i) provide for the bank’s own contribution to the cost of its rescue; (ii) include

procompetitive measures to limit distortions of competition, and (iii) demonstrate strategies to

76 See Gerard, Balancing Competition & Regulation, supra note 49, citing Recommendations of the ECB Governing Council on the pricing of recapitalizations, available at, http://www.ecb.int/pub/pdf/other/recommendations_on_pricing_for_recapitalisationsen.pdf.

77 See State Aid Scoreboard: Spring 2010, supra note 52, at 4.

78 See Impaired Assets Communication, supra note 57; see also Reynolds et al., supra note 40, at 1685.

79 See Impaired Assets Communication, supra note 57, at para. 9; for discussion of moral hazard see infra Sec. V(b).

80 See Impaired Assets Communication, supra note 57, at §5.1.

16

restore the bank’s long-term viability.81 First, banks were required to appropriately contribute to the

cost of their rescue and restructuring.82 This ensured that banks would take responsibility for their

failure, and lessen the burden placed on taxpayers. Second, banks had to undertake procompetitive

measures designed to mitigate the unfair competitive advantages generated by government support.83

Compensatory measures included the reduction or divestment of certain assets.84 Lastly, the

Commission required banks to demonstrate how they would restore long-term viability, and survive

adverse market conditions, without relying on a bailout in the future.85 In order to develop well-

targeted structural remedies, banks underwent “stress tests” to identify their specific strengths and

weaknesses.86 The stress tests also helped to ensure that restructuring plans were based on realistic

assumptions, and could be carried out within a reasonable time frame.87

2. Procedural Framework

As the crisis intensified, it became critical for the Commission to provide market operators

with legal certainty, in order to restore confidence in the financial system.88 Legal certainty

depended largely upon the Commission’s ability to act quickly, on an emergency basis.89 During the

initial stages of the crisis, many critics of the Commission argued that its protracted review of

emergency bailout proposals undermined the effectiveness of rescue operations.90 Thus, on October

81 See Restructuring Communication, supra note 58.

82 See Restructuring Communication, supra note 58 at 7.

83 See Restructuring Communication¸ supra note 58, at 10.

84 See id.

85 See Restructuring Communication, supra note 58.

86 Reynolds et al., supra note 40, at 1687, citing Restructuring Communication, supra note 3, at 10.

87 See Restructuring Communication¸ supra note 58, at 3, para. 7.

88 See Gerard, At Grips with the Financial Crisis, supra note 29, at para. 32.


90 See supra note 42 and accompanying text.

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1, 2008, the College authorized Commissioner Kroes to -- in agreement with Commission President

Barroso, Finance Commissioner Almunia, and Internal Market Commissioner McCreevey --

approve emergency bailouts in the financial sector during the crisis.91 By lifting the requirement that

State aid decisions pass through the College, this expedited procedure enabled the Commission to

make decisions, if necessary, within hours, overnight, or over the weekend.92

V. Conditions Imposed on Bailout Recipients

The Communications demonstrate that the Commission was primarily driven by two policy

objectives in applying the State aid rules to bailouts during the crisis: (1) to prevent distortions of

competition between banks, and (2) to eliminate moral hazard in the financial sector. The

Commission sought to achieve both of these objectives by imposing on beneficiary banks a

combination of eligibility conditions, remuneration requirements, behavioral restraints, and

structural conditions – each designed to maintain a level playing field and promote long-term

stability in the EU financial sector.

a. Preventing Distortions of Competition

The Commission strived to prevent or limit the distortive effects of aid that amounted to: (i)

protectionist schemes, benefiting national heroes; (ii) disproportionate support, allowing banks to

artificially retain or increase market share; or (iii) any competitive advantage for a beneficiary over a

less-aided competitor.93 The Commission addressed the problems of protectionism and excessive

aid by requiring that bailouts adhere to the well-established State aid principles of nondiscrimination

91 See Gerard, At Grips with the Financial Crisis, supra note 29, at para. 35, citing Minutes of the 1845th meeting of the Commission, October 1, 2008, PV(2008) 1845 final, §10.4.

92 See Gerard, At Grips with the Financial Crisis, supra note 29, at para. 36.

93 Gerard, Balancing Competition & Regulation, supra note 49.

18

and proportionality.94 In addition, the Commission implemented a series behavioral restraints and

structural requirements, specifically designed to counteract the unique anticompetitive effects

created by bailouts during the crisis.

1. Behavioral Restraints

The Commission “systematically conditioned its approval of bailout plans on a series of

behavioral restraints that it has applied in a relatively homogeneous manner across the EU.”95 The

behavioral restraints barred aid recipients from using government funds, or the status of having

received them, to either retain business, or draw customers away from less-aided competitors. They

prohibited bailout beneficiaries from pursuing a range of aggressive commercial strategies, ranging

from bailout-based advertising, to price leadership and market expansion.96

The most pervasive behavioral condition imposed on bailout beneficiaries was a prohibition

of advertisements claiming the advantages of government support.97 Stemming from the

Commission’s concern over “bank runs” during the early stages of the crisis, the ad-ban prevented

banks from encouraging depositors to pull their money out of their existing banks, only to seek

higher levels of government protection.98 The prohibition of bailout-based advertising was

enhanced by a corresponding ban on commercial practices aimed at attracting business from less-

aided competitors.

94 See id.

95 See id.

96 It is important to note the extraordinary nature of the restrictions imposed on bailout recipients by the Commission during the crisis. Under normal market conditions, these types of restraints would be anticompetitive, i.e. obstacles to price competition and consumer choice. Thus, it is ironic to see a competition agency enforce such restraints, although they are justified by the exceptional circumstances created by the crisis.

97 The ad ban was pervasive because it attached to aid in the form of a guarantee, the most widely used bailout instrument, and it applied to both sound and unsound aid recipients.

98 See Gerard, Balancing Competition & Regulation, supra note 49, citing Banking Communication, supra note 55, at para. 26; see also, supra note 73 and accompanying text.

19

The Commission imposed price leadership bans on a number of recapitalized banks for

certain retail and small & medium-sized enterprise (“SME”) banking products and services.99 For

example, Fortis Bank agreed not to offer interest rates for internet accounts higher than other main

retail banks in Belgium, unless its market share were to drop below 25%.100 Similarly, Dexia

committed not to offer interest rates for retail deposits exceeding the three best rates offered by the

ten largest retail banks in Luxemburg, France, and Belgium.101 In addition, the Commission

prevented Commerzbank from taking deposits under more favorable price conditions than its top

three competitors in markets where it has a market share above 5%.102 Notably, in an appeal

pending before the European Court of Justice, ING has challenged several of the conditions

attached to its recapitalization, including a ban on price leadership, which it claims to be excessive.103

Many national schemes approved by the Commission in the weeks following its adoption of

the crisis framework prohibited banks from exceeding a certain balance sheet growth rate.104 The

Commission later abandoned that practice, “acknowledging that it could form an obstacle for

fundamentally sound banks to sustain lending to the real economy and, generally, to compete for

customers and increase output levels.”105 However, the Commission continued to place restrictions

on growth, particularly in cases where capital injections accompanied fire-sales or mergers. For

example, upon its acquisition of Dresdner Bank, Commerzbank was restricted from acquiring any

99 See, e.g. CEPS Task Force Repost, supra note 64, at 16-17; see also discussion, supra note 96.

100 See Commission Decision on Fortis NN 42/2008, 2009 O.J. (C 80) 7.

101 Gerard, Balancing Competition & Regulation, supra note 49, at 42, citing Commission Decision on Dexia NN 50/2008, 2010 O.J. (L274) 54.

102 Commission Press Release, State Aid: Commission Approves Recapitalization of Commerzbank, IP/09/711(May 7, 2009).

103 Appeal Against Specific Elements of EC Decision, ING, http://www.ing.com/group/showdoc.jsp?docid=432710_EN (last visited Feb. 28, 2011).

104 Ana Petrovish & Ralf Tutsch, National Rescue Measures in Response to the Current Financial Crisis, (EUR. CENT. BANK, LEGAL WORKING PAPER SERIES, No. 8, 2009).

105 Gerard, Balancing Competition & Regulation, supra note 49, citing Recapitalization Communication, supra note 56 at n.18

20

other competing bank for a period of three years.106 Likewise, in its acquisition of Fortis Bank, BNP

Paribas agreed not to acquire the assets of Fortis Belgium (purchased by the Netherlands) for a

period of four years.107

2. Structural Requirements

In order to prevent inefficient banks from crowding the market, to the detriment of healthy

competitors, the Commission required unsound banks to undergo restructuring as a condition of

receiving government support.108 The Commission determined the type of restructuring appropriate

for each bank on a case-by-case basis, considering facts specific to the bank in question as well as

the markets in which it operates.109 Restructuring typically involved the reduction or divestment of a

portion of the bank’s activities or assets.110 According to the Restructuring Communication,

reductions and divestments were necessary in order to level the playing field between the rescued

bank and its competitors, and, in some cases, to enable the entry or expansion of healthy

competitors.111

The case of Lloyds Banking Group (“LBG”) in the UK is perhaps the best example of the

detailed restructuring requirements imposed on an aid beneficiary by the Commission.112 In January

2009, Lloyd’s TSB received a £17 billion capital injection from the UK to facilitate its

takeover/rescue of HBOS, which was on the verge of collapse.113 The acquisition of HBOS enabled

106 Commission Press Release, supra note 102.


108 See Restructuring Communication, supra note 58, at para. 28.


110 See id. at n.6.


112See Marsden & Kokkoris, supra note 5, at 889.

113 Id.

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Lloyds to significantly increase its market share, and to eliminate a competitor in the already

concentrated UK banking sector.114 In order to mitigate the distortive effects of the aid, and to

ensure that LBG emerged as a stable, profitable bank, the Commission required LBG to divest or

wind down “non-core businesses and activities in the corporate, wholesale, personal and small

business segments.”115 In addition to undertaking a program to achieve a £181 billion reduction in a

specified pool of assets by the end of 2014, LBG plans to dispose of a retail banking business,

including its branches, staff, customers, customer accounts, and support infrastructure.116 The

divested entity will “provide an appropriate means of increasing competition in the concentrated

UK retail banking market,” because it will “constitute a sufficiently attractive target for some

competitors wishing to enter [that] market.”117

b. Eliminating Moral Hazard

As current Competition Commissioner Almunia proudly declared in June 2010, the EU is

“the only jurisdiction in the world that has explicitly tackled the moral hazard issue.”118 Moral

hazard exists wherever one party “makes the decision about how much risk to take, while someone

else bears the cost if things go badly.”119 Bailouts create moral hazard by insulating banks from their

losses, which are instead transferred to the taxpayer.120 The Commission viewed moral hazard not

114 Id.

115 Id. at 890.

116 Id.

117 Id.

118 Joaquín Almunia, State Aid Rules Can Help Europe Exit Crisis, Speech at European State Aid Law Institute, Brussels, (June 10, 2010), available at http://europa.eu/rapid/pressReleasesAction.do?reference=SPEECH/10/301&format=HTML&aged=0&language=EN&guiLanguage=en (last visited Feb. 28, 2011).

119 PAUL KRUGMAN, THE RETURN OF DEPRESSION ECONOMICS AND THE CRISIS OF 2008 63 (2009); see also Organization for Economic Co-Operation and Development (“OECD”), Competition and the Financial Crisis, 5 (Feb. 17, 2009)(discussion paper), http://www.oecd.org/dataoecd/52/24/42538399.pdf (last visited Feb. 16, 2011).

120 Georges Siotis, Economist, DG COMP, EU Competition Policy in Times of Financial Crisis, 5 ECRI/CEPS (2010).

22

only as a distortive effect of bailouts, but as a problem that could “trigger the next crisis down the

line.”121 The Commission addressed moral hazard by subjecting aid beneficiaries to strict eligibility

criteria, behavioral restraints, and structural requirements—targeting the incentives of both the

shareholders and managers of unsound banks.122

1. Eligibility & Remuneration Requirements

The Commission sought to ensure that unhealthy banks share the burden of the

consequences of the crisis, and that they properly contribute to the cost of their rehabilitation. It

accomplished these objectives by attaching strict eligibility and remuneration requirements to

guarantees and capital injections.

The Commission limited the type of debt instruments eligible for guarantees to retail and

wholesale deposits, and short and medium-term debts.123 Hybrid and subordinated debts,

considered as Tier 2 capital, were excluded from eligibility, because shareholders and investors were

not permitted to unduly benefit from the guarantee.124 The Commission also required that

guarantees be subject to proper remuneration.125 Remuneration consisted of service fees based on

the recipient bank’s risk-profile, and fixed premiums calculated according to a methodology devised

by the European Central Bank (“ECB”).126

The Commission was particularly concerned with setting appropriate remuneration

requirements for capital injections. In order to ensure that the remuneration rates were appropriate,

giving due consideration to important financial policy goals, the Commission drew a crucial 121 See id.


123 See Banking Communication, supra note 55, at para. 21.

124 Gerard, At Grips With the Financial Crisis, supra note 29, at 52, para. 21.

125 Gerard, Balancing Competition & Regulation, supra note 49, at 39.

126 See Recommendations of the Governing Council of the European Central Bank on Government Guarantees for Bank Debt (Oct. 20, 2008), available at http://www.ecb.int/pub/pdf/other/recommendations_on_guaranteesen.pdf.

23

distinction between capital provided to sound banks versus unsound banks. It adopted a formula

established by ECB, which required unsound banks to pay higher rates than sound banks.127 In

general, banks that received capital injections were required to reimburse the state at an interest rate

of 8-12%.128

2. Behavioral Restraints

In order to ensure that banks are guided by the right incentives, and favor stability over

excessive risk-taking, the Commission called for a number of behavioral restraints to be placed on

the management and shareholders of failing banks. Within the new framework, the Commission

endorsed the UK’s nationalization of the Royal Bank of Scotland,129 Germany’s review of risk

management and corporate governance practices in the case of Commerzbank,130 and France’s

limitation of management compensation and severance packages.131 In addition, the Commission

restricted recapitalized banks’ distribution of dividends, repurchasing of shares, and autonomy in

making key decisions.132

3. Structural Requirements

The Commission required that unsound banks undergo restructuring in order to internalize

their risk and reorient their business models toward achieving long-term viability. Restructuring

entailed inter alia reduced activities and divestments, which (in addition to the Lloyd’s divestments

mentioned above) included: SachsenLB’s and WestLB’s termination of proprietary trading

127 See Recommendations of the Governing Council of the European Central Bank on the Pricing of Recapitalisations (Nov. 20, 2008), see also Recapitalization Communication, supra note 56, at para. 16.

128 Gerard, Balancing Competition & Regulation, supra note 49, at 39.

129 Reynolds, et al., supra note 40, at 1681.

130 See Commission Decision on Commerzbank N 625/2008.

131 See Commission Decision N 618/2008.

132 See Commission Decision N 512/2008; see also Commission Decision N 51/2008.

24

activities;133 Commerzbank’s reduction of investment banking activities and divestment of certain

entities by 2014;134 and ING’s divestment of several insurance brands, plus a complete separation of

insurance and banking by the end of 2013.135

VI. Post-Crisis Observations

Governments throughout the world responded to the financial crisis by granting massive

bailouts to their largest and most interconnected banks. In most government responses, financial

stability took precedence over all other policy concerns, meaning that competition policy was

“relegated to a distant spectator in the proceedings.”136 In this respect, the EU response contrasted

sharply with that of other jurisdictions. In the EU, competition policy and competition enforcers

not only participated in the proceedings, but played a lead role in shaping the response and laying

the groundwork for sustainable recovery.

From the onset of the crisis, the Commission, led by former Commissioner Kroes, stood at

the frontlines of the EU response. Drawing upon evidence from past crises, Kroes highlighted the

importance of competition policy and competition enforcement in preventing bailouts from causing

worse outcomes and prolonged economic malaise. Kroes effectively promoted competition policy

as a vital element of the solution to the crisis, and the Commission as an essential partner with

Member States – assisting their development of aid measures compatible with the competition-based

goals of the Single Market. The steps taken by the Commission throughout 2008 and 2009

demonstrate that the formation of partnerships between competition authorities and other

133 See Commission Decision on Sachsen LB C 9/2008; see also Commission Decision on West LB NN 25/2008.

134 See Commission Decision on Commerzbank N 625/2008.

135 See CEPS Task Force Report, supra note 64, at 16.

136 Marsden & Kokkoris, supra note 5, at 875.

25

regulatory bodies, across borders and across disciplines, is both achievable and prudent. By

developing relationships with central banks, and coordinating with other EU institutions, the

Commission was able to establish a new State aid framework, capable of responding to the urgent

and complex demands of Member States and financial markets, while adhering to the competition

principles underlying the State aid provisions of the TFEU.

Moving forward, Commissioner Almunia has concentrated the Commission’s efforts on

restoring long-term viability to the European financial sector. Under Almunia’s leadership, the

Commission has continued its efforts to curb moral hazard, and has begun implementing strategies

for the orderly withdrawal of government support. Almunia has emphasized the Commission’s

treatment of moral hazard as being one of the most crucial steps toward preserving long-term

stability in the EU financial system. With over 40 European bank restructurings pending,137 it

remains critical for the Commission to ensure that unhealthy banks reorient their business strategies,

in order to provide effective customer service without relying on the possibility of a bailout in the

future. Lastly, under Almunia’s leadership, the Commission has actively encouraged sound banks to

withdraw from State support programs, further promoting the return of the financial system to

normal market conditions.

Although it is clear that competition policy was integral to the EU response, no data yet

exists to demonstrate precisely how effective the Commission was at preserving competition

between banks in the Single Market.138 In the absence of such evidence, the Commission has been

subject to a variety of criticisms; some arguing that its decisions regarding individual banks were too

strict, and others arguing that its decisions in general were too lenient.

137 See Almunia, supra note 118, at 3.

138 See European Parliament Resolution of 20 January 2011 on Competition Policy and the Financial Crisis, EUR. PARL. DOC. P7_TA (2011) 0023.

26

In its October 2010 report on banking aid during the crisis, the Centre for European Policy

Studies (“CEPS”) argues that the Commission measured competition at a national level, rather than

at the European level, which, CEPS contends, led to disparate results, particularly between banks

that received aid as part of a national scheme versus those that were supported through individual,

ad hoc measures.139 CEPS reaches this conclusion by comparing the French national scheme to a

number of the Commission’s decisions regarding Germany’s troubled Landesbanken. According to

CEPS, the Commission approved the French national scheme quickly, without placing any

additional demands on individual banks.140 CEPS argues that the Commission’s treatment of the

French scheme is inconsistent with its “13 individual bank cases in Germany, some of which are still

under in-depth investigation, and much deeper restructuring demands.”141 In addition, CEPS argues

that the Commission’s allegedly “fragmented” approach to measuring competition has led to claims

that its decisions have been “arbitrary” and “inflexible.”142 In support of this claim, CEPS points to

ING’s appeal to the European Court of Justice (“ECJ”), objecting to the price leadership restrictions

and the proportionality of the restructuring measures imposed by the Commission. 143

In contrast, Drs. Phillip Marsden and Ioannis Kokkoris contend that the EU “rubber-

stamped” almost all Member State interventions in support of their domestic banks.144 According to

Marsden and Kokkoris, a review of the Commission’s decisions during the crisis reveals that it

largely approved Member States’ bailout proposals “unconditionally.”145 “As the new rules are very

139 CEPS Task Force Report, supra note 64, at 19-20.

140 Id.

141 Id.

142 Id.

143 Id; see also ING press release regarding ECJ appeal, supra note 103.

144 See Mardsen & Kokkoris, supra note 5, at 875.

145 Id at 876.

27

lenient,” Marsden and Kokkoris state, the “few cases where the Commission has raised concerns

relate to measures that were so complex” that the EU had to subject them to formal

investigations.146 Although they ultimately support the opposite view, Marsden and Kokkoris note

that the extent to which the Commission “bent with the wind” may discourage other jurisdictions

from looking favorably upon the EU model.147

These are soft criticisms when viewed in light of the exceptional demands placed on the

Commission by the crisis; namely, the difficult balancing of competition and financial policy

objectives in approving emergency bailout measures. Nevertheless, the disparate results of national

schemes versus ad hoc measures may be justified under the crisis framework. The Communications

provided ex ante guidance to Member States, enabling them to prepackage their bailout proposals

with the conditions necessary to limit distortions of competition. Member States had every

incentive to comply, because doing so meant that their proposals would gain speedier approval.

Moreover, as the CEPS report later acknowledges, national measures “raised much less of a

competition policy problem, as they provided support for the whole banking sector” of a Member

State. National measures were adopted in large part to address the systemic difficulties faced by

both sound and unsound banks. In contrast, individual measures were used to remedy the more

pervasive deficiencies of unsound banks. Therefore, such ad hoc decisions required greater scrutiny

by the Commission, and often resulted in heavier restraints and restructuring requirements. Lastly,

in addition to conditions discussed in Section V of this paper, the ING appeal itself runs counter to

the proposition that the Commission simply “bent with the wind” during the crisis.148

146 Id.

147 Id.

148 Id.

28

Although some have made recommendations as to how the EU crisis response model might

be improved in the future, the Commission is widely regarded as having successfully risen to the

extraordinary challenges presented by the crisis. Indeed, as Frederic Jenny, Chairman of the OECD

Competition Committee, observes, “[EU] competition law enforcement has, on the whole, been

adapted intelligently and pragmatically to the challenges raised by a rapid and dramatic economic

downturn without compromising the goals of competition law . . . and without lowering the

standards of competition law enforcement, unlike what happened after the 1929 economic crisis.”149

VII. Conclusion

Through the exercise of its State aid authority under the TFEU, the Commission played a

lead role in shaping the EU response to the financial crisis. Under the leadership of Commissioners

Kroes and Almunia, the Commission worked in tandem with other EU institutions (e.g. ECOFIN

and the ECB) and Member State finance ministries, to facilitate the orderly and transparent release

of aid, with the least anticompetitive outcomes. The Commission placed meaningful limits on

bailout measures in order to prevent healthy, less-aided banks from becoming unduly disadvantaged.

In addition, the Commission explicitly dealt with the issue of moral hazard, ensuring that bailouts do

not create conditions that may trigger yet another crisis. However, unlike the EU, where

competition enforcers “sat at the head of the table” during the crisis, competition enforcers in other

jurisdictions were absent from the table when crisis policy decisions were made. Therefore, as

lawmakers assess the outcomes of the crisis and consider what might be done differently in the

future, they should draw upon the most effective aspects of the EU model, and, ultimately,

incorporate competition policy and competition enforcers in future crisis proceedings. 149 Frederic Jenny, Preface to Ioannis Kokkoris & Rodrigo Olivares-Caminal, Antitrust Law Amidst Financial Crises, at xiii (2010).

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SHOULD CRISIS CARTELS EXIST AMIDST CRISES?