Chillin'Competition

Relaxing whilst doing Competition Law is not an Oxymoron

The Economist Corner (1) – When State aid rules get seriously wrong…

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Unlike many lawyers who keep on bashing the use of economics in competition proceedings, Alfonso and I love antitrust economics. The reptilian reflex of dismissing economics as a source of legal uncertainty is misguided (although on this point Alfonso has more nuanced views that he will develop here). As explained by J. Sims, the introduction of economics in competition law, and the ensuing flexibility of competition analysis does not necessarily mean that legal certainty is degraded. Antitrust economics help channeling discussion in competition proceedings. It has helped define more accurate theories of harm (the boundaries of infringements) and the requirements necessary for them to fly (the conditions of infringements). And those concerned that opening the gates to antitrust economics means accepting the Trojan horse of small, Chicago-like, antitrust policy should think of a minute to how economists have helped enlarging the scope of competition law in the past decades. Examples of such expansions abound, with doctrines such as collective dominance, below-dominance unilateral effects, raising rivals’ costs, etc.

With this background, and to help our lawyer-friends feel more at ease with economics, we have decided to create a new, bi-monthly column on this blog, called “The Economist Corner”. Our first invited blogger for this column is Benoît Durand from RBB Economics. It would take too long to go through Benoît’s full biography, but as most of the guys we like here, Benoît has a wealth of experiences, having worked as an official in COMP and at the UK Competition Commission, and being the author of a Phd. in Economics from Boston College. More importantly, Benoît is a fun person to have a beer with – we did a natural experiment of this 2 weeks ago – and a huge rugby fan.

For his first column, Benoît has decided to focus on State aid in the Banking sector. As with our posts, this post reflects Benoît’s own, personal opinions,  which cannot be attributed to the firm he works for. We hope you’ll enjoy the reading.

When the financial crisis hit the banking sector in 2008, some European governments had to step in to rescue banks in order to avoid a financial meltdown.  For example, Gordon Brown, the UK prime minister, announced in October 2008 that the government would inject capital in some of the major banks, Lloyds TSB, Royal Bank of Scotland and HBOS.  Little did he know that these capital injections violated state aid rules, which meant that in return for being saved from bankruptcy, the banks had to severe a limb to satisfy Brussels.

The European Commission enforcement of State aid rules is based on the view that government rescue distorts competition.  That is, the public capital injection gave the recipient banks an unfair competitive advantage, and in return for this advantage, the bailed out banks had to be penalised so as to restore the level playing field.

This simple logic cannot be applied in the banking sector.  Government interventions in the UK and elsewhere most surely averted a severe bank crisis, possibly a financial meltdown, which would have taken down other banks in the UK and in Europe.  By rescuing a few large banks, the UK government helped other banks survive.  This is because banks own each other’s debt.  And if one large bank goes down, it would jeopardise the financial health of other banks.

One cannot help but thinking that the enforcement of State aid rules can go seriously astray.  Surely the Treaty was not meant to be enforced this way. Penalising firms that are already in financial difficulties neither helps these firms recover and become viable competitors again, nor, in the case of banks, does it help support the stability of the banking sector.  What the “founding fathers” who drafted the Treaty had in mind with State aid rules was to prevent a government from supporting a national champion.  When a government supports a nation firm against foreign companies, this may act as a barrier to trade, and the aid may help the recipient sustains artificially low prices.  This type of practice may jeopardise the formation of a single internal market, triggering in reaction government subsidies in other sectors.

By averting a financial meltdown the bail out of the banking sector surely did not distort competition nor did it restrict trade between member states.  Absent these capital injections, the banking sector would have been in far dire conditions, raising the cost of borrowing and harming the European economy as a whole.

The capital injections, however, raise a serious moral hazard issue.  The management of a bank that is “too big to fail” may take risky initiatives, knowing that when things go wrong, the government would have to step in to rescue the bank.  How the divestments for making the capital injections lawful help alleviate this moral hazard problem is totally unclear.  This is the issue the Commission should be focusing on so as to avoid the next crisis.

Benoît Durand, 26 February 2012

Written by Nicolas Petit

29 February 2012 at 8:44 pm

One Response

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  1. It’s true that the “compensatory measures” required under the temporary rules have an impact on banks long term viability, however it sends a strong signal to banks: asking for money to MS is not free, addressing the problem of moral hazard that you mention. Besides, this requirement is in line with the Rescue and Restructuring Guidelines principles (whose legal basis is 107(3)(c) and not 107(3)(B)), that is the framework for bailing out ailing firms in a stable competitive market, showing the willingness of the Commission to apply extraordinary rules to banks without giving up on the backbone of the state aid control principles. Another point is that without these commitments to divest or withdraw from different markets and sectors, state aid recipient banks could use their recapitalisations to keep growing, worsening the moral hazard problem of the TBTF financial institutions. It is true, however, that the supervisor (EC) is becoming the regulator, and this is something that should worry us.

    Curian

    3 March 2012 at 1:19 pm


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