Big Business. Big Labor. Big Government. Now, Big Regulation.

In December, The Wall Street Journal noted that the presidents of J.P. Morgan and Goldman Sachs have both come out against repeal of Dodd-Frank.  In 2015, Lloyd Blankenship, head of Goldman Sachs, explained that, far from being a problem for Goldman, the huge regulatory costs of Dodd-Frank were actually a plus.  Dodd-Frank set up barriers to entry, making it harder for banks that are not already huge, to compete with the likes of Goldman.   

While it may be counterintuitive, the Journal noted that the Independent Community Bankers of America, which represents small banks all over the country, has also come out against repeal of Dodd-Frank.  Though small banks complain about the burden of regulation, the Journal suggests that small banks see Dodd-Frank regulation as a weapon they can use against finance companies and tech start-ups, to keep them out of their business.

The Journal sees all of this support of Dodd-Frank regulation as an example of “regulatory capture,” which George Stigler, Nobel laureate in economics, described more than 45 years ago: “[A]s a rule, regulation is acquired by the industry and is designed and operated primarily for its benefit.”

Buy I’m not sure that is quite it.  It seems too soon for the banks, whether big or small, to have captured the regulators, at least in the way the railroads took over the old Interstate Commerce Commission.  Rather, this seems to be more of an example of one of Warren Buffet’s famous rules for investing: the need for “moats.”

Here is how Mr. Buffet described the idea of “moats” to Berkshire-Hathaway’s 2000 annual meeting:

“So we think in terms of that moat and the ability to keep its width and its impossibility of being crossed as the primary criterion of a great business.  And we tell our managers we want the moat widened every year.  That doesn't necessarily mean the profit will be more this year than it was last year because it won't be sometimes.  However, if the moat is widened every year, the business will do very well.  When we see a moat that's tenuous in any way – it's just too risky.  We don't know how to evaluate that.  And, therefore, we leave it alone.  We think that all of our businesses – or virtually all of our businesses – have pretty darned good moats.”

Morningstar lists some of things that can give a company the kind of moat that Warren Buffett is talking about: being the low-cost producer; high switching costs; network effect; and intangible assets (i.e., things like patents or brand names).

Regardless of whether the big banks, like J.P. Morgan and Goldman Sachs. have captured the regulator yet, what they are seeing in Dodd-Frank is a form of moat.  Dodd-Frank is so complex, and the rules and regulations enforcing it are so dense, that only the biggest institutions can afford the staff to interpret them and insure that the banks comply with them across the board.  The compliance part is critical because the penalties for violating the rules, especially for the big banks, are so great.  Dodd-Frank is so complex that it is the ultimate barrier to entry, stopping other banks from competing with the big boys.  The big banks still compete against each other (to some extent), but they don’t have to worry about new competitors coming along.

While the small banks understand the moat between them and the big boys, they are willing to accept that moat, as long as Dodd-Frank establishes a moat protecting them on the other side, between them and the finance companies and on-line start-ups that might be trying to encroach on their territory.

Warrant Buffett likes moats to protect his investments and to give them a chance to make extra profits.  Banks, both big and small, see the regulation of Dodd-Frank as a moat they can use against their competitors, to keep their prices, charges, and profits up.

At one point in our history, the worry was about Big Business, looking out for themselves.  Then came Big Labor, unions focusing more on themselves than the country as a whole.  In the last half century, the concern has been Big Government, too; as government expanded its size and power over more and more things.

But now we have another problem.  It’s not government growing bigger and doing more things itself; it’s government trying to control more and more things by regulation and bureaucratic rules and interpretations.  In effect, “Big Regulation.”

Instead of businesses trying to build their moats by cutting costs, developing better products, or doing other things that help consumers, businesses now get their moats from Big Regulation, either by controlling it to their own benefit or by taking advantage of the unintended consequences of somebody’s good intentions.  It’s hard to see how that helps.