Recently I have had many complaints about my bank. You see, they do what all banks do, clearing debits before credits, and clearing the credits largest to smallest to maximize overdraft fees. They also had a bit of a brouhaha over the fact that they cashed a post-dated check several days early. And there have been a few other headaches as well. Anyway, while complaining about banks I have had the thought that in a free market this would probably not occur.

"Wait!" I hear some of you saying "We DO have a free market in banks." And that is where you are wrong.

You see, people think banks are "free market" and that the banking practices they find annoying, and the lack of responsiveness from banks, is a symptom of what the free market would be like if implemented everywhere, but they are wrong.

Yes, banks are privately owned, but they are far from "free market". Private ownership is not enough, banks are a cartel. There are severe limits to entry, which allows banks to compete with a restricted pool of competitors. Thus, banks do not need to be as responsive as, for example, car washes. Anyone can open a car wash (except in cities with zoning restrictions, or placed with draconian business licensing, where car washes can be as unresponsive as banks). But banks ar enot as open. So, banks do compete, but they don't compete as strongly as companies do in areas where entry is free.

How so?

Well, let us take the practice of resolving accounts debit first, and largest debit to smallest, which maximizes overdraft charges and guarantees an overdraft if a withdraw and deposit come in on the same day. Why do we accept that? Because "All banks do it". In a non-cartel situation, that wouldn't work. Someone, who knew they could still turn a profit without the cushion of overdraft fees, would open a bank with a more depositor-friendly processing sequence. They probably wouldn't even have to advertise the fact, word of mouth would draw huge numbers of deposits to them. And with the pool of loans that wealth of deposits could support, they may actually end up better off than their competitors who maximized the fees they could collect.

But no one does this?

Why not? Because the market is closed. So long as your handful of competitors does not do this, the incentive is not as strong for you to do this either. In a cartel, even one which does not actively collude, the pressures are conservative, to continue doing what works, as any change may bring a challenge form the competitors in another area where you earn cartel profits. So "rocking the boat" could effectively destroy everyone's cartel profits. better to go along with everyone and jointly reap out-sized profits.

On the other hand, in a market where entry is open, you can't rely on the forbearance of your competitors, as anyone can enter at any time, so the pressure is on existing firms to innovate just as much as new firms. When you do not know who your potential competitors are, or even how many there may be, you can't rely on practices which benefit you remaining in place forever, as someone else may see an advantage in challenging them and do so. It is not the comfortable insulated market of the cartel.

Then again, it is hard to give a true example of a "free market" competition in today's world, as every market, or nearly every market, in the US is impeded by some sort of regulation. I can think of no type of business which does not have some barrier or regulation which protects the existing firms form competition. Be it licensing, zoning restrictions, regulatory overhead, certification requirements, unions, trade barriers, quotas, government purchase contracts, stock regulations, or what have you, so many of our markets are effectively, to one degree or another, cartels, that is hard to find a real world market with full open competition. The existing firms in every field, knowing there is an advantage to closing their market, almost always work to get politicians to deny free entry to competitors. Of course, they don't describe it that way, it is always "licensing to protect consumers" or "unions for the workers", but the firms involved know they are also benefiting by keeping out newcomers. (This is why so often libertarians are puzzled by industries which welcome regulation and licensing. The answer is simple, they know the costs will be more than made up by the ability to charge more by cartel pricing.)

But that actually makes my point for me. You see, whenever I talk about the free market and the fact that it is superior to any regulatory scheme, people always bring up an example of this business or that. The problem is, their examples are never really form free markets. In fact, the most alarming almost inevitably come from the areas where government involvement is the greatest. And that is what we need to recall. Private ownership is not enough to have a free market. Just because we think businesses are owned privately and there is no evident regulatory scheme controlling the industry, that does not mean there is anything approaching a free market. There are countless ways the government can close out competition. And, until you are sure entry is absolutely free, and there are no government practices (such as government purchase agreements) which favor existing firms, then you can't really say that what you are seeing is a free market.

POSTSCRIPT

I don't mean to imply that the free market would always produce the ideal result.The free market will not. Abuses will exist int he free market and companies will continue to pursue practices which make customers unhappy. What the free market will do is allow others, seeing those abuses, to evaluate whether the removal of those abuses will create enough benefit to make it worthwhile to compete in that market. And, in many cases, that will exert a pressure to make the company more responsive to consumer concerns. It won't automatically generate utopia, nor will it always result in the best outcome. But it will definitely produce outcomes superior to any cartel situation.

I just want to be clear, I am not over-selling the free market as so many do. The free market does not guarantee perfection, it simply drives us in the right direction more often than any other system.

POSTSCRIPT II

And I also don't want any comments form angry bankers. I worked in financial jobs and I know we often did all we could to please customers. However,t he fact remains, overall company policy is still established in a cartel environment, so there is much less pressure to adjust to consumers than in other fields. Yes, some is the result of senseless government regulations (eg. not paying interest on demand deposits), but even in areas where there are no regulations, or where regulations have been removed, there is an inherent conservatism which stops useful change. And it is not, as many argue, the conservatism of bankers, it is the conservatism of cartels. If you doubt me, explain why it took so long for banks to break the 9 AM to 2 PM hours (or thereabout) they followed for so long?

Actually, a better example of how cartels effect banks is in the area of loose change. At one time., banks would count and redeem your change for free. Faced with declining profits during the 90's, most banks first started demanding coins be rolled before redeeming them, and then just stopped entirely. They would redeem coins for customers, but only reluctantly, and did not advertise the service.

This is interesting in two aspects. First, in how a cartel changes practices. In other fields of endeavor, where competition is more open, businesses respond to losses by offering more service to bring in customers (unless they are on the verge of bankruptcy, when they may have to cut back or fold, but that is usually just a delaying tactic, and a company cutting service sis usually not long for this world), where cartel businesses, knowing they have a captive customer base, respond by cutting services. It is the easiest way to identify a closed market, the tendency to reduce what is provided, or to begin charging for things that were once free. It is characteristic of cable companies, phone companies, utilities, home owners' associations and banks, all businesses with a guaranteed captive audience.

The second thing that is quite telling is that the cartel made a mistake here. Since redeeming coins had always been a function of banks, they thought of it as a banking service. But nothing in the law said private individuals could not redeem coins. So, when banks stopped providing the service, in steeped several private firms that began to make a tidy profit providing for a small fee the service once performed by banks. In other words, by trying to save costs, the cartel ended up surrendering a potential source of profit to private firms outside their cartel. Which is yet another example of how the anti-competitive pressures of cartels tend to reduce potential innovation. (Though in this case the service could be provided from outside the cartel, and thus innovation occurred anyway.)

Actually, the most amusing aspect of this is that banks have started installing CoinStar machines (and other equivalent firms' devices) in their banks, and offering to redeem them for account holders without the normal fee, in short, subsidizing the service for account holders. Which probably ends up making them some profit, as I am sure they get a cut of the profits, but, had they simply continued to offer their original service at a nominal fee, they would now be realizing 100% of the profits. Even the devices which now make this easier, when they were developed, would have probably been marketed to the banks, rather than sold to private firms. They could now be reaping the profits that go to CoinStar and others. However, thanks to the excessively conservative atmosphere generated by cartels,t hey assumed their functions were under their total control, that there could never be a competitor and they allowed a huge source of revenue escape.

Actually, what is the CoinStar machine but a stand-alone version of the coin counting machines banks have used since at least the 1960's, if not earlier? (Granted, I don't recall the electronic counter existing until the late 70's, but otherwise the technology is hardly new.) Which means that banks did not even need the device. They could simply have accepted sacks of coins, run them through the sorting and counting machines, and then calculated their cut. They would have had even less overhead, in terms of machines, maintenance, space rental and sharing profits with the businesses redeeming coins, than CoinStar, and presumably greater profits. Instead they are now receiving only a percentage of profits on a service they once provided.

POSTSCRIPT III

When I described the practice of cutting services to deal with losses, or charging for things once free, it reminded me of one other business, universities. And, thanks to government aid for educational expenses, as well as research grants and other practices, universities are effectively a cartel, though there are no formal barriers to free entry. But explaining how the government created this pseudo-cartel, which traditional economics may not agree is one, is a long topic, and something I will save for another post.

Some of my thinking on the matter can be found in my earlier post "The State Versus Universities".

As the cartelization resulting from financial aid schemes is an interesting topic (at least I think it is), an as my earlier esssay did not delve into this outcome, it may merit a new essay combining the two thoughts and going into them in a bit mroe detail.

So stay tuned for more on this.