As we noted in our analysis of Treasury’s fintech report, it says a lot that’s interesting, but nothing of real substance on the biggest questions fintech raises about finance as we may now quaintly think we know it: what would happen if giant platform companies such as Facebook use their already-formidable powers as natural monopolies to cherry-pick the financial transaction and intermediation value chain?  Coverage earlier this week in the Wall Street Journal reinforces my fear that Facebook is thinking about weaponizing finance much like advertising.  According to both the Journal and American Banker, the banks approached by Facebook declined to be its spear-carriers.  However, a lot of Romans didn’t want to join their army either.  Would finance run by Facebook be any better than political advertising or public discourse?  I wish Treasury had provided policy guidance before we find out the hard way.

What’s a natural monopoly?  According to U.S. legal tradition dating back to Louis Brandeis, a natural monopoly “exists in an industry where a single firm can produce output such as to supply the market at a lower per-unit cost than can two or more firms.”  As a recent New York Times op-ed by one scholar noted, examples include utilities that consolidate all of the different electricity lines in a market after buying them out or Ma Bell, which did the same for the many phone companies once servicing even a single office building that undermined telephone connectivity because there was no central switchboard.

As these natural monopolies showed their fearsome power at the turn of the 20th century, public policy split up some of them – e.g., Standard Oil.  And, where network effects were overwhelming and thus favored the consumer, a new concept arose: the utility.  Initially, these public utilities were only barely regulated and thus posed additional market hazard, but New Deal reforms put an end to that.  Since then, public-utility pricing power has reasserted itself, but utilities remain structurally different than natural monopolies.

Or at least they were until now.  In 2018, we have a totally asymmetric framework.  Natural monopolies in old-school activities are split up (telecom) or controlled by utility regulation (e.g., energy transmission).  The very biggest banks are assumed to pose natural-monopoly risk but also to have network-effect benefits.  As a result, they aren’t broken up, but regulated within narrow boundaries – the one between banking and commerce of most interest in this concept. 

What of platform companies such as Facebook, Alphabet, and Amazon?  They already control huge positions in their initial target markets (e.g., advertising, retailing).  What now for finance if they combine assumed network effects, vertical depth in core product areas, pricing power, exemptions from virtually all prudential regulation, and enormous smarts?

Global regulators are deeply suspicious of platform-company power, with the Financial Stability Board worried not only by the prospect of natural monopolies, but also natural oligopolies.  However, its fear is not so much that companies empowered by enormous artificial-intelligence (AI) and machine-learning (ML) capabilities will disintermediate finance to the detriment of financial stability and economic equality, but rather that banks relying on platform companies for cloud or similar services are putting all their operational eggs in one big, unregulated, potentially fragile basket. 

The European Banking Authority shares these concerns, but adds to them with fears that reliance on Apple and Google for mobile-banking services similarly houses larger and larger amounts of financial infrastructure in fewer and fewer companies.  All of these regulators urge someone somewhere to think about operational resilience and redundancy. However, none has.  

Indeed, Treasury’s report touches on only a few of these issues – e.g., credit-underwriting opacity – and then largely only in passing.  Reflecting its deregulatory bent, it instead suggests that existing financial companies rely on cloud services, AI, and ML, with regulators told to look for ways to speed this up. 

If Treasury really wants to let platform companies rip, it should have said so.  If it really sees them as handy-dandy service providers to existing financial companies, then it should have gone on to deal with structural implications already evident not only in every business the platform companies take seriously, but also in their increasingly potent inroads into those financial intermediation products that make it even easier for one company to do what two – or even a few thousand – once did.  The network-effect benefits of platform companies in finance may well not only be inevitable, but also desirable.  If so, though, should they be utilities?  Maybe Alexa knows.