“US Regulators Have Essentially Become Do-Nothing Institutions”

In an interview with ProMarket, Jonathan Tepper talks about the rise of America’s oligopoly problem, why he believes antimonopoly is not a left-right issue, and how a passionate fan of free markets came to write a book titled “The Myth of Capitalism.”

Something has gone terribly, terribly wrong with American capitalism. This argument, put forth by Jonathan Tepper and Denise Hearn, lies at the heart of their explosive new book The Myth of Capitalism: Monopolies and the Death of Competition. Instead of delivering on its stated promise to provide more opportunity, prosperity and choice, they argue, Americans today are subjected to a system that encourages and rewards predatory behavior, in which corporate monopolists and oligopolists are allowed to bleed consumers dry (and sometimes literally make them bleed) with impunity because the government has been “captured to rig the rules of the game for the strong at the expense of the weak.” 

The two, it should be noted, are no Marxists—quite the opposite. A staunch and passionate advocate for free markets, Tepper is the founder of Variant Perception, an investment research firm that caters to hedge funds, banks, asset mangers and family offices. A senior fellow at The American Conservative, he has previously worked at SAC Capital and Bank of America (where was he was Vice President in proprietary trading).

How does a self-professed fan of markets end up writing a book titled “The Myth of Capitalism”? For one, argues Tepper, what is often called capitalism today is not, in fact, capitalism: competition is the essence of capitalism, and there is almost no competition in the American economy today. “Capitalism,” write Tepper and Hearn, “has been the greatest system in history to lift people out of poverty and create wealth, but the ‘capitalism’ we see today in the United States is a far cry from competitive markets.” Instead, the US economy has been overtaken by a “fake version of capitalism,” with government officials allowing (even cultivating) the concentration of economic and political power in the hands of few powerful monopolists who “cozy up to regulators to get the kind of rules they want and donate to get the laws they desire.”

A clear and incisive indictment of the United States’ increasingly monopolized economy, where rising market power has led to less competition, lower productivity, lower wages and staggering inequality, The Myth of Capitalism is also an urgent call to action for both the left and the right to support the restoration of America’s antimonopoly ideals. [We published an excerpt from the book last week. Read it here.]

In a recent interview with ProMarket, Tepper talked about the rise of America’s oligopoly problem, explained why he believes antimonopoly is not a left-right issue, and called on those who believe in free markets to support meaningful reforms. “If the people who love capitalism and competition don’t reform markets,” he warns, “people who don’t like capitalism are going to do it, and I think that we’ll all be worse off.”

[Note: the following conversation has been edited and condensed for clarity and length.]

Q: You start the book with David Dao, the passenger that was a beaten and forcibly removed from a United flight last year for refusing to give up his seat. What is it that makes what happened to Dao “a metaphor for American capitalism in the twenty-first century,” as you call it?

First, I think the episode clearly resonated with the public because people feel that something’s changed in the airline industry, that airlines are nickel and diming them, and that part of it is also tied to increasing concentration and market power.

But the main reason [David Dao] came to my mind is that in the days after, I was reading the news and there were quite a few articles pointing out how airlines are now an oligopoly and that you have no choice, and most of the Wall Street research houses were putting out similar notes, so the stock went up. The idea was that it just doesn’t matter what you do in terms of public relations or how you treat customers—if you have a lock on the customers, they have no choice.

So you have the passenger who was bloodied, and that’s horrific. But what was almost more horrific was that once everyone started focusing on the fact that it was an oligopoly, the stock went up.

Q: Essentially, the market rewards oligopolistic behavior.

Absolutely. Very much so. If you look at Equifax for example, they had their breach, the stock went down, and then everyone started pointing out that you really have no choice and that the government is not really going to go after them, and the stock went up.

Many of these companies are not only too big to fail, but essentially too big to jail, and so the stocks recover. There really isn’t much punishment for bad behavior in markets today.

Q: You describe yourself as a capitalist and advocate for free markets.

Absolutely. Very much.

Q: And yet you argue that what we have in the United States today is a “grotesque, deformed version of capitalism.” What is the difference between capitalism, as you see it, and today’s US economy?

Jeremy Grantham once said that “profit margins are the most mean-reverting series in finance. If margins don’t revert, something has gone wrong with capitalism.” Given that we have record-high corporate profit margins and very little mean reversion, it is a sign that we aren’t seeing a lot of competition. It’s not just obvious that we don’t have a lot of competition from new entrants, but there’s relatively little competition in many industries—a lot of markets are divided up geographically, or there’s collusion.

Capitalism is not just having private property and not being communists, but rather it’s actually having competition. Competition is what creates clear price signals that help drive supply and demand. So the absence of competition, the absence of contestability, is troubling.

Q: In the book, you call this “fake capitalism.” Others have referred to it as predatory.

In his endorsement of the book, Martin Wolf refers to it as predatory capitalism, and I think it’s a very apt description. Not every company is predatory, obviously, and not every industry is highly concentrated. But there are significant industries where there’s no competition or very little competition, and then there are companies that are not creating any value but are essentially value extractors, and that’s a form of predatory capitalism.

Q: One of the book’s core themes is lack of choice. Freedom of choice is the basic promise of free market capitalism, and yet Americans have very little choice these days.

I do think that choice and competition are key. Some areas of the economy are not very concentrated, restaurants for example. But if you think about the decisions that affect people’s lives intimately—your local cable company, the local hospital system or insurance market, whether you live near a fortress hub in terms of what airline you can use, or even going to the bar and getting a beer—a lot of these daily choices are essentially preset for you, in the sense that one company decides and has a significant amount of pricing power over the consumer.

The idea that markets are contestable is just simply not true. If you look at the airline industry in the US, for example, Jet Blue is the last national entrant and that was over 20 years ago.

Q: There has been a lot of talk in the media about America’s monopoly problem in recent years, but you argue that the US doesn’t have a monopoly problem so much as an oligopoly problem. Why is oligopoly the more pressing problem?

Having four players is not vastly better than having one. Some people say that only monopolies are bad and therefore if you don’t have a monopoly, things are totally fine. The truth is there are sectors in the economy where you have duopolies or an oligopoly with three, four, even five players. What ends up happening is that you end up with tacit collusion, where companies play repeated games with each other and have no incentive to compete on price.

You’d think that if one of them hikes prices, the others might then want to capture some market share, but basically competitors tend to move in lockstep. You don’t even have to do that by speaking to each other—it’s pretty well understood that you can use company conference calls and establish essentially what you’re going to do in terms of trying to chase market share or not, or your levels of pricing and all that.

In the book, I quote one of the world’s top pricing experts who wrote a book where he pretty much advises companies to send signals to the market, whether it’s via press releases or quarterly conference calls, but recommends that the readers consult with their lawyers and attorneys first, clearly understanding that speaking directly is illegal but speaking indirectly is not. There’s been research done on airline conference calls and how airlines have used conference calls to indicate whether they’ll expand or not. The FTC was in fact looking into that—but the FTC is a do-nothing institution and I doubt anything will come of it. 

But you find this in many other areas. In the book, I compare this to how the mob commission used to divide up the US: One family might have one part of the city and another family might have the other part of the city, and people would stay off each other’s turf. If you look at the way that the insurance markets carved up the United States, where you’ll have one or two dominant insurers per state, or how retail stores divided up the US geographically and tend not to compete head on, it’s very similar.

Q: Oligopoly seems to be the key term here, since having three or four players in an industry provides the appearance of competition. You quote Tim Wu in the book: “We know how to fight monopolies, but regulators are confused when it comes to duopolies and oligopolies.”

Yes, absolutely. There’s evidence by John Kwoka showing that when you get below six players, you end up with price increases. As you get down to very few players, investors tend to call these “rational oligopolies.” That is essentially code for companies that don’t really compete intensely with each other.

The funny thing is that I think the FTC and the K Street law firms that push mergers through are probably the only people who think that competition is alive and well, when most equity investors are in fact looking for oligopolies where there’s little competition and are well aware that that’s what makes these attractive.

Q: So in the US today, we basically have many companies that don’t want to compete and many investors who only want to invest in monopolies.

Absolutely. There are some industries that have natural monopolies, but the truth is there are many other industries and companies that don’t have any natural characteristics that would make them a monopoly. And what happens instead is that they try to erect barriers around the industry, via regulation or via laws.

The search for what I call unnatural monopolies is one of the things that corrupts the political process.

Q: The US economy you describe in the book is markedly different than what American capitalism looked like 40-50 years ago. How did we end up here?

The counterrevolution which led us to where we are today really started essentially in the 1960s and 1970s, when Robert Bork and others did not like the fact that the antitrust was being vigorously enforced. They thought it was preventing efficiency and some economies of scale, and they did have a point—antitrust was very restrictive, and some minor deals that wouldn’t have caused any competitive issues were blocked.

But the problem is that when you fast forward 40 years later, what started out as possibly a worthwhile effort to allow slightly more mergers has ended up becoming basically a policy that’s become a do-nothing policy, in which K Street law firms, economists-for-hire that go in and out of government at the DOJ and the FTC, and Wall Street firms are all spectacularly well paid to push mergers through.

It’s very much like the NCAA’s Sweet 16, where you start out with 16 teams and then get down to eight, and then four and then two. We’ve had a merger wave in the 1980s that graduated in the 1990s, a merger wave leading up to the 2007 crisis and then a merger wave that peaked around 2015, and in many industries we’ve just basically been eliminating player after player.

That’s really sort of how we got here: a ratchet effect where each merger wave takes out more and more players. The process of getting mergers through is deeply corrupted, with economists-for-hire presenting models showing that prices will go down and studies showing that these models are almost always wrong and that you generally get higher prices. The whole system is essentially a charade.

Q: But also, the government was not a silent player in all this. Many political choices were made along the way.

I completely agree. I think that one of the key issues is that the government completely and radically changed antitrust through the bureaucracy, through the merger guidelines, and then basically by doing nothing and allowing mergers to proceed. Whereas the Sherman Act and Clayton Act were political acts passed by Congress, this is not something that we’ve collectively agreed is what we want. I think that most people are appalled at how things have changed.

In many cases, the people who are pro-merger have also taken over the courts and basically made the burden of proof so high that it’s very difficult to stop mergers. A lot of this is highly, highly ideological, in the sense that most of the pro-merger studies or models that are done before mergers turn out to be wrong, retrospectively. I have loads of footnotes in the book, and I hope people do go and read further studies.

What really happened is basically what I call an orgy of influence-peddling, with people moving in and out of the top of the FTC and the DOJ essentially green-lighting mergers and helping make them happen once they’re out of government.

Q: The Financial Times reported last week that US antitrust enforcement has fallen to its lowest level in five decades under Trump. But as you write in the book, there was little to no difference between the Trump and Obama administrations when it came to market concentration.

What’s important for the readers to know is that this is not a left or right issue—both in terms of reform, which I think everyone should get behind, but also in terms of the complete regulatory capture. This has happened under Republican and Democratic presidents. While Obama and Trump might radically disagree about society or culture, they essentially employ the same cast of characters going in and out of government and have no difference in terms of their antitrust policy, really.

The merger wave that happened in 2014 and peaked in 2015 really did quite a lot of damage in terms of massive healthcare and insurance mergers, massive pharma mergers, a huge beer merger that created a duopoly. It’s just completely insane that all this was allowed to happen.

And the record shows that the main reason why deals don’t go through is because companies get cold feet. It has nothing to do with the regulators. US regulators have essentially become do-nothing institutions.

Q: What was the role of the consumer welfare standard in antitrust in getting us to this point?

Before the consumer welfare standard, size itself—and by size I mean market share—was generally considered to be a problem. When companies had a high market share, mergers generally weren’t allowed [in order to] prevent concentrations of economic and political power and to prevent smaller businesses from being abused by bigger businesses. Once the consumer welfare standard came in, all of those considerations were essentially pushed aside.

The consumer welfare standard reminds me of what Gandhi said about Western civilization: I think it would be a good idea—if it actually did what it was intended to do, which is bring us lower prices and deliver more efficiency. But it doesn’t, and all the major studies of mergers show that when you get down to a very few competitors, you get price increases in almost all cases. In practice, you end up with higher profit margins for monopolists and higher prices for consumers.

Investors and hedge fund investors know it, investment banks know it. That’s why they push for mergers, because they want pricing power—they want power to squeeze the suppliers. I quote a few hedge fund managers in the book, and some of the most successful ones have tended to find companies that have tremendous power to raise prices and little competition, so they end up with relatively high returns on capital. They are able generally to buy back shares. Often, these companies do outperform. But as I point out in the book, there’s a very clear social cost to that.

Q: Did academic capture play a part in all of this? 

There’s a large apparatus of well-paid and well-funded economists, lawyers, even think tanks meant to promote mergers and pretend that we live in the best of all possible worlds and that mergers are creating more efficiency and a better life for us, when in fact we’d be much better off with more competition. Google, for example, has paid academics-for-hire to write papers.

If you take introductory economics classes, you’re told that people respond to incentives. That is the essential basis of economics. Bizarrely, antitrust economists and lawyers are the only people on the planet who are not subject to incentives. They’re paid by clients to get mergers through, but mysteriously they always manage to come up with the objective truth about whether mergers are good or bad right there. I find it laughable that they would say that the money being thrown at them by pro-merging parties does not influence their judgment and is not a powerful incentive.

It’s a very well-traveled path, and one that’s very well understood by starting lawyers: You can be fabulously well paid if you leave the FTC and go work in private practice, then end up back at the FTC. Some of these people have gone in and out of government two, three, and even four times over the last 20, 30 and 40 years.

Q: You mentioned Google, but many other companies are funding research as well.

Oh, absolutely. Now, maybe some of these academics already agree with Google or whichever company is paying them, but they certainly do perform on-demand. And the worst part about it is that the funding is often not fully disclosed. They also host conferences, bringing regulators in as if these are impartial settings. At a minimum, it’s unseemly.

Q: What is your proposed solution for reforming markets and restoring an open, competitive economy?

In the book, I have a series of principles and specific reforms based on those principles. They’re fairly broad and I don’t pretend to have all the answers. There are many other people that put forward good ideas. Some of the key principles I mention are trying to reduce barriers to entry, to enhance competition, enforcement of antitrust, which means preventing mergers that reduced competition as well as undoing previous mergers that have created less competitive markets. Another key principle is to limit the revolving door. In the case of the US, you want to make sure that companies are limited in terms of how they can influence elections.

Those are just very basic reforms, but they could go a long way if implemented. Markets will not reform themselves. Monopolists are not going to want to give up their power and the current status quo in antitrust, because it pays them very, very well.

I would add that I’m not in favor of more regulation on its own. High levels of regulation create higher barriers to entry, and the most regulated sectors tend to be the ones with the highest concentration. What I’m in favor of is principles-based regulation rather than rules-based regulation. Glass Steagall was 35 pages long and worked for about 70 years, while Dodd-Frank is 2,200 pages and we’ve basically seen almost no new banks. I am also wary of creating new regulators or making regulators more powerful without making them accountable, because then you get regulatory capture. But I do believe we need more vigorous antitrust and a sensible reform of regulations.

Q: Monopoly, you argue, is not a left and right issue. You yourself are conservative, from the right side of the political spectrum, a self-professed fan of free markets. Your background is in finance, you worked for and with hedge funds. How did you end up writing a book titled The Myth of Capitalism?

I don’t consider myself to be very political. I am generally bored or angered by politics and try to stay away from it. I enjoy markets. I enjoy thinking about economics and business cycles, and that’s really sort of what I do. I started a company called Variant Perception, and our clients are hedge funds and family offices.

One of the things that I do is trying to figure out whether inflation is going up or whether wages are going up, whether growth is going to turn down. One day, I noticed that our indicator for wages was telling us that wages should be going up, but wages have barely budged over the last ten years while our other leading indicators have been turning up. I thought that maybe something has changed in the economy, and realized that if I figured this out it would have important implications for investing. When speaking to friends, they were talking to me about Piketty and the broader debates about capitalism, and I realized that this is not just between me and my clients, but actually a much broader issue that’s important to figure out.

But I haven’t really come to this issue with an axe to grind. I don’t really have a political agenda at all. I’m disinterested politically, essentially, but I think this is a very important economic argument because it affects us all.

Q: The endorsements you received for the book include a remarkable array of thinkers and scholars, from Nobel laureates like Angus Deaton and Michael Spence to prominent conservatives like Niall Ferguson to progressive thinkers and staunch leftists like Yanis Varoufakis. Were you surprised by the bipartisan interest in this issue?

I was very pleasantly surprised. I am conservative, but I do think that it’s not a left or right issue. While the left might be motivated by a greater desire for equality, the right might be motivated by a desire for freer markets. Ultimately, what we want is the same thing, which is greater competition and to make sure that we don’t have high concentrations of power and a corruption of the political process.

Q: Do you envision a bipartisan movement to reform markets?

I think that will happen. I think that the desire is there. I think that on the left and the right people are waking up to the dangers of large companies, and I’ve just been overwhelmed by people from the left and the right emailing me to say that they fully agree.

I do think that the sentiment has changed. If you look at pop culture, John Oliver and others have been talking about this issue. Magazines are covering it. It’s quite clear that the voters are going to end up leading politicians to a solution, because this is what people want. And I suspect that when politicians realize that, they’re going to want to get ahead of the parade rather than follow the voters.

For more on how to reform antitrust enforcement, check out this three-part series on US antitrust law by the Capitalisn’t podcast:

Disclaimer: The ProMarket blog is dedicated to discussing how competition tends to be subverted by special interests. The posts represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty. For more information, please visit ProMarket Blog Policy.